**UNITED STATES********SECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

----

**FORM 10–Q**

----

**(Mark One)**

 
| **ý** | **QUARTERLY REPORT PURSUANT TO  SECTION 13 OR 15 (d) OF THE**                                                            | ** ** |
|------------|-------------------------------------------------------------------------------------------------------------------------------|------------|
|       | **SECURITIES EXCHANGE ACT OF 1934**                                                                                           |       |
|       |                                                                                                                          |       |
|       | **For the  quarterly period ended September 30, 2004**                                                                   |       |
|       |                                                                                                                          |       |
|       | **OR**                                                                                                                        |       |
|       |                                                                                                                          |       |
| **o**      | **TRANSITION REPORT PURSUANT TO  SECTION 13 OR 15 (d) OF THE**                                                           | ** ** |
|       | **SECURITIES EXCHANGE ACT OF 1934**                                                                                           |       |
|       |                                                                                                                          |       |
|       | **For the  transition period from                  to** |       |
|       |                                                                                                                          |       |
|       | **Commission  File No:  0 - 14535**                                                                                      |       |

 

**CITIZENSBANCSHARES CORPORATION**

(Exact name of registrant asspecified in its charter)

 

| **Georgia**                                                                                                           | **58-1631302**                     |
|-----------------------------------------------------------------------------------------------------------------------|------------------------------------|
| (State or other  jurisdiction of  incorporation or organization)                                                      | (IRS Employer  Identification No.) |
|                                                                                                                  |                               |
| **175 John  Wesley Dobbs Avenue, N.E., Atlanta, Georgia**                                                             | **30303**                          |
| (Address of principal  executive offices)                                                                             | (Zip Code)                         |
|                                                                                                                  |                               |
| Registrant’s telephone  number, including area code:       **(404) 659-5959** |

 

Indicate by check mark whether the registrant (1) hasfiled all reports required to be filed by Section 13 or 15 (d) of theSecurities Exchange Act of 1934 during the preceding 12 months (or for suchshorter period that the registrant was required to file such reports), and (2)has been subject to such filing requirements for the past 90 days.

ý  Yes    o  No.

 

Indicate by check mark whether the registrant is anaccelerated filer (as defined in Rule 12b-2 of the Exchange Act)                   o  Yes    ý  No.

 

APPLICABLE ONLY TO ISSUERSINVOLVED IN BANKRUPTCYPROCEEDINGS DURING THE PRECEDINGFIVE YEARS:

 

Indicate by check mark whether registrant has filedall documents and reports required to be filed by Sections 12, 13, or 15(d) ofthe Securities Exchange Act of 1934 subsequent to the distribution ofsecurities under a plan confirmed by a court.     o  Yes    o  No.

 
| SEC 1296 (08-03) | **Potential persons who are to  respond to the collection of information contained in this form are not  required to respond unless the form displays a currently valid OMB control  number.** |
|------------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

APPLICABLE ONLY TO CORPORATEISSUERS:

 

Indicate the number of shares outstanding for each ofthe issuer’s classes of common stock as of the latest practicable date:1,985,276 shares of Common Stock, $1.00 par value and 90,000 shares ofNon-Voting Common Stock, $1.00 par value outstanding on September 30,2004.

 

 

----

 

**PART 1.  FINANCIAL INFORMATION**

**ITEM 1.  Financial statements**

 

**CITIZENS BANCSHARES CORPORATION ANDSUBSIDIARIES**

 

**CONSOLIDATED BALANCE SHEETSSEPTEMBER 30, 2004 AND DECEMBER 31, 2003(In thousands, except share data)**

 
| ** **                                                                                                               | ** ** | **2004**        | ** ** | **2003**   | ** ** |
|--------------------------------------------------------------------------------------------------------------------------|------------|-----------------|------------|------------|------------|
| ** **                                                                                                               | ** ** | **(Unaudited)** | ** ** | ** ** | ** ** |
| **ASSETS**                                                                                                               |       |            |       |       |       |
| ** **                                                                                                               |       |            |       |       |       |
| Cash and due  from banks                                                                                                 |       | $               | 9,576      |       | $          | 11,694 |   |
| Interest-bearing  deposits with banks                                                                                    |       | 314             |       | 108        |       |
| Certificates  of deposit                                                                                                 |       | 800             |       | 2,983      |       |
| Investment  securities available for sale, at fair value                                                                 |       | 77,572          |       | 97,301     |       |
| Investment  securities held to maturity, at cost                                                                         |       | 10,081          |       | 10,553     |       |
| Other  investments                                                                                                       |       | 1,848           |       | 2,734      |       |
| Loans  receivable, net                                                                                                   |       | 200,042         |       | 208,814    |       |
| Premises and  equipment, net                                                                                             |       | 8,635           |       | 9,161      |       |
| Cash  surrender value of life insurance                                                                                  |       | 8,480           |       | 8,150      |       |
| Foreclosed  real estate, net                                                                                             |       | 1,418           |       | 2,053      |       |
| Other assets                                                                                                             |       | 6,851           |       | 6,892      |       |
|                                                                                                                     |       |            |       |       |       |
| Total assets                                                                                                             |       | $               | 325,617    |       | $          | 360,443 |   |
|                                                                                                                     |       |            |       |       |       |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY**                                                                           |       |            |       |       |       |
|                                                                                                                     |       |            |       |       |       |
| LIABILITIES:                                                                                                             |       |            |       |       |       |
| Noninterest-bearing  deposits                                                                                            |       | $               | 57,165     |       | $          | 55,832 |   |
| Interest-bearing  deposits                                                                                               |       | 210,204         |       | 220,947    |       |
|                                                                                                                     |       |            |       |       |       |
| Total  deposits                                                                                                          |       | 267,369         |       | 276,779    |       |
|                                                                                                                     |       |            |       |       |       |
| Accrued  expenses and other liabilities                                                                                  |       | 2,877           |       | 3,219      |       |
| Federal  funds purchased                                                                                                 |       | —          |       | 4,000      |       |
| Notes  payable                                                                                                           |       | 540             |       | 540        |       |
| Trust  preferred securities                                                                                              |       | 5,000           |       | 5,000      |       |
| Advances  from Federal Home Loan Bank                                                                                    |       | 24,500          |       | 46,961     |       |
|                                                                                                                     |       |            |       |       |       |
| Total liabilities                                                                                                        |       | 300,286         |       | 336,499    |       |
|                                                                                                                     |       |            |       |       |       |
| COMMITMENTS  AND CONTINGENCIES                                                                                           |       |            |       |       |       |
|                                                                                                                     |       |            |       |       |       |
| STOCKHOLDERS’  EQUITY:                                                                                              |       |            |       |       |       |
| Common stock  - $1 par value; 15,000,000 shares authorized; 2,230,065 shares issued                                      |       | 2,230           |       | 2,230      |       |
| Nonvoting  common stock - $1 par value; 5,000,000 shares authorized; 90,000 issued and  outstanding                      |       | 90              |       | 90         |       |
| Additional  paid-in capital                                                                                              |       | 7,443           |       | 7,445      |       |
| Retained  earnings                                                                                                       |       | 17,461          |       | 16,114     |       |
| Treasury  stock at cost, 244,789 and 249,518 shares at September 30, 2004 and December 31,  2003, respectively |       | (1,987          | )          | (2,025     | )          |
| Accumulated  other comprehensive income, net of income taxes                                                             |       | 94              |       | 90         |       |
|                                                                                                                     |       |            |       |       |       |
| Total  stockholders’ equity                                                                                         |       | 25,331          |       | 23,944     |       |
|                                                                                                                     |       |            |       |       |       |
|                                                                                                                     |       | $               | 325,617    |       | $          | 360,443 |   |

 

Seenotes to consolidated financial statements.

 

2

----

 

**CITIZENS BANCSHARES CORPORATION AND SUBSIDIARIES**

 

**CONSOLIDATED STATEMENTS OF INCOME**

**(Unaudited - In thousands, exceptper share data)**

 
| ** **                                           | ** ** | **Three Months  Ended September 30,** | ** ** | **Nine Months  Ended September 30,** | ** ** |
|------------------------------------------------------|------------|--------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                           | ** ** | **2004**                                   | ** ** | **2003**                                  | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                                           | ** ** | ** **                                 | ** ** | ** **                                | ** ** | ** ** | ** ** | ** ** | ** ** |
| Interest  income:                                    |       |                                       |       |                                      |       |   |   |   |   |
| Loans,  including fees                               |       | $                                          | 3,691      |                                      | $          | 3,681 |   | $ | 11,576 |   | $ | 11,104 |   |
| Investment  securities:                              |       |                                       |       |                                      |       |   |   |   |   |
| Taxable                                              |       | 668                                        |       | 592                                       |       | 2,115 |   | 2,020 |   |
| Tax-exempt                                           |       | 204                                        |       | 244                                       |       | 613 |   | 725 |   |
| Federal  funds sold                                  |       | —                                     |       | 1                                         |       | — |   | 10 |   |
| Interest-bearing  deposits                           |       | 3                                          |       | 36                                        |       | 22 |   | 114 |   |
| ** **                                           | ** ** | ** **                                 | ** ** | ** **                                | ** ** | ** ** | ** ** | ** ** | ** ** |
| Total  interest income                               |       | 4,566                                      |       | 4,554                                     |       | 14,326 |   | 13,973 |   |
| ** **                                           | ** ** | ** **                                 | ** ** | ** **                                | ** ** | ** ** | ** ** | ** ** | ** ** |
| Interest  expense:                                   |       |                                       |       |                                      |       |   |   |   |   |
| Deposits                                             |       | 692                                        |       | 747                                       |       | 2,051 |   | 2,491 |   |
| Other  borrowings                                    |       | 319                                        |       | 304                                       |       | 882 |   | 902 |   |
| Total  interest expense                              |       | 1,011                                      |       | 1,051                                     |       | 2,933 |   | 3,393 |   |
| ** **                                           | ** ** | ** **                                 | ** ** | ** **                                | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net interest  income                                 |       | 3,555                                      |       | 3,503                                     |       | 11,393 |   | 10,580 |   |
| ** **                                           | ** ** | ** **                                 | ** ** | ** **                                | ** ** | ** ** | ** ** | ** ** | ** ** |
| Provision  for loan losses                           |       | 225                                        |       | 100                                       |       | 775 |   | 380 |   |
| ** **                                           | ** ** | ** **                                 | ** ** | ** **                                | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net interest  income after provision for loan losses |       | 3,330                                      |       | 3,403                                     |       | 10,618 |   | 10,200 |   |
| ** **                                           | ** ** | ** **                                 | ** ** | ** **                                | ** ** | ** ** | ** ** | ** ** | ** ** |
| Noninterest  income:                                 |       |                                       |       |                                      |       |   |   |   |   |
| Service  charges on deposits                         |       | 1,017                                      |       | 965                                       |       | 2,794 |   | 2,702 |   |
| Gain on  sales of securities                         |       | —                                     |       | 489                                       |       | 58 |   | 707 |   |
| Gain on  sales of assets                             |       | 75                                         |       | 10                                        |       | 149 |   | 10 |   |
| Other  operating income                              |       | 352                                        |       | 253                                       |       | 1,329 |   | 839 |   |
| ** **                                           | ** ** | ** **                                 | ** ** | ** **                                | ** ** | ** ** | ** ** | ** ** | ** ** |
| Total  noninterest income                            |       | 1,444                                      |       | 1,717                                     |       | 4,330 |   | 4,258 |   |
| ** **                                           | ** ** | ** **                                 | ** ** | ** **                                | ** ** | ** ** | ** ** | ** ** | ** ** |
| Noninterest  expense:                                |       |                                       |       |                                      |       |   |   |   |   |
| Salaries and  employee benefits                      |       | 2,026                                      |       | 1,847                                     |       | 6,109 |   | 5,478 |   |
| Net occupancy  and equipment                         |       | 689                                        |       | 662                                       |       | 2,005 |   | 1,964 |   |
| Other  operating expenses                            |       | 1,612                                      |       | 1,907                                     |       | 4,728 |   | 4,612 |   |
| ** **                                           | ** ** | ** **                                 | ** ** | ** **                                | ** ** | ** ** | ** ** | ** ** | ** ** |
| Total  noninterest expense                           |       | 4,327                                      |       | 4,416                                     |       | 12,842 |   | 12,054 |   |
| ** **                                           | ** ** | ** **                                 | ** ** | ** **                                | ** ** | ** ** | ** ** | ** ** | ** ** |
| Income  before income taxes                          |       | 447                                        |       | 704                                       |       | 2,106 |   | 2,404 |   |
| ** **                                           | ** ** | ** **                                 | ** ** | ** **                                | ** ** | ** ** | ** ** | ** ** | ** ** |
| Income tax  expense                                  |       | 66                                         |       | 135                                       |       | 448 |   | 512 |   |
| ** **                                           | ** ** | ** **                                 | ** ** | ** **                                | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net income                                           |       | $                                          | 381        |                                      | $          | 569 |   | $ | 1,658 |   | $ | 1,892 |   |
| ** **                                           | ** ** | ** **                                 | ** ** | ** **                                | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net income  per share - basic                        |       | $                                          | 0.18       |                                      | $          | 0.27 |   | $ | 0.80 |   | $ | 0.91 |   |
| ** **                                           | ** ** | ** **                                 | ** ** | ** **                                | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net income  per share - diluted                      |       | $                                          | 0.18       |                                      | $          | 0.27 |   | $ | 0.80 |   | $ | 0.91 |   |
| ** **                                           | ** ** | ** **                                 | ** ** | ** **                                | ** ** | ** ** | ** ** | ** ** | ** ** |
| Weighted  average outstanding shares - basic         |       | 2,075                                      |       | 2,073                                     |       | 2,074 |   | 2,077 |   |
|                                                 |       |                                       |       |                                      |       |   |   |   |   |
| Weighted  average outstanding shares - diluted       |       | 2,080                                      |       | 2,073                                     |       | 2,080 |   | 2,077 |   |
| Dividends  per common share                          |       | $                                          | —     |                                      | $          | — |   | $ | 0.15 |   | $ | 0.15 |   |

 

See notes to consolidated financialstatements.

 

3

----

 

**CITIZENS BANCSHARES CORPORATION AND SUBSIDIARIES**

 

**CONSOLIDATEDSTATEMENTS OF CASH FLOWS**

**FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2004 AND2003**

**(In thousands)**

 
| ** **                                                                                   | ** ** | **September 30,** | ** ** |
|----------------------------------------------------------------------------------------------|------------|------------------------|------------|
| ** **                                                                                   | ** ** | **2004**               | ** ** | **2003** | ** ** |
| ** **                                                                                   | ** ** | **(Unaudited)**        | ** ** |
| **OPERATING  ACTIVITIES:**                                                                   |       |                   |       |   |   |
| Net income                                                                                   |       | $                      | 1,658      |   | $ | 1,892 |   |
| **Adjustments  to reconcile net income to net cash provided by operating activities:**       |       |                   |       |   |   |
| Provision  for loan losses                                                                   |       | 775                    |       | 380 |   |
| Depreciation                                                                                 |       | 807                    |       | 836 |   |
| Amortization  and accretion, net                                                             |       | 860                    |       | 1,126 |   |
| Provision  for deferred income taxes                                                         |       | 55                     |       | (166 | ) |
| Gain on sale  of assets and investments                                                      |       | (207                   | )          | (717 | ) |
| Change in  other assets                                                                      |       | (350                   | )          | 672 |   |
| Change in  accrued expenses and other liabilities                                            |       | (341                   | )          | (1,562 | ) |
|                                                                                         |       |                   |       |   |   |
| Net cash  provided by operating activities                                                   |       | 3,257                  |       | 2,461 |   |
|                                                                                         |       |                   |       |   |   |
| **INVESTING  ACTIVITIES:**                                                                   |       |                   |       |   |   |
| Proceeds  from calls and maturities of investment securities held to maturity                |       | 453                    |       | 530 |   |
| Proceeds from  sales and maturities of investment securities available for sale              |       | 28,679                 |       | 45,247 |   |
| Purchases of  investment securities held to maturity                                         |       | —                 |       | (7,229 | ) |
| Purchases of  investment securities available for sale                                       |       | (9,423                 | )          | (38,236 | ) |
| Net change  in other investments                                                             |       | 886                    |       | 92 |   |
| Net change  in loans receivable                                                              |       | 7,027                  |       | 5,195 |   |
| Increase in  cash surrender value of life insurance                                          |       | (98                    | )          | (1,006 | ) |
| Net cash and  cash equivalents acquired from CFS Bancshares                                  |       | —                 |       | 2,612 |   |
| Net proceeds  from the sale of foreclosed properties                                         |       | 1,543                  |       | — |   |
| Purchases of  premises and equipment, net                                                    |       | (272                   | )          | (457 | ) |
| Net change  in interest bearing deposits with banks                                          |       | (206                   | )          | 10,852 |   |
| Net change  in certificates of deposit                                                       |       | 2,183                  |       | 46 |   |
|                                                                                         |       |                   |       |   |   |
| Net cash  provided by investing activities                                                   |       | 30,772                 |       | 17,646 |   |
|                                                                                         |       |                   |       |   |   |
| **FINANCING  ACTIVITIES:**                                                                   |       |                   |       |   |   |
| Net change  in deposits                                                                      |       | (9,410                 | )          | (14,681 | ) |
| Sale of  treasury stock                                                                      |       | 38                     |       | 20 |   |
| Principal  payments on debt                                                                  |       | —                 |       | (200 | ) |
| Net change  in advances from Federal Home Loan Bank                                          |       | (22,461                | )          | (2,739 | ) |
| Decrease in  federal funds sold                                                              |       | (4,000                 | )          | — |   |
| Net change  in additional paid-in-capital                                                    |       | (2                     | )          | — |   |
| Dividends  paid                                                                              |       | (311                   | )          | (312 | ) |
|                                                                                         |       |                   |       |   |   |
| Net cash  used in financing activities                                                       |       | (36,146                | )          | (17,912 | ) |
|                                                                                         |       |                   |       |   |   |
| Net change  in cash and cash equivalents                                                     |       | (2,117                 | )          | 2,195 |   |
|                                                                                         |       |                   |       |   |   |
| Cash and and  cash equivalents, beginning of period                                          |       | 11,694                 |       | 11,117 |   |
|                                                                                         |       |                   |       |   |   |
| Cash and and  cash equivalents at end of period                                              |       | $                      | 9,577      |   | $ | 13,312 |   |
|                                                                                         |       |                   |       |   |   |
| **Supplemental  disclosures of cash paid during the period for:**                            |       |                   |       |   |   |
| Interest                                                                                     |       | $                      | 3,039      |   | $ | 3,384 |   |
|                                                                                         |       |                   |       |   |   |
| Income taxes                                                                                 |       | $                      | 638        |   | $ | 628 |   |
|                                                                                         |       |                   |       |   |   |
| **Supplemental  disclosures of noncash transactions:**                                       |       |                   |       |   |   |
| Change in  unrealized gain (loss) on investment securities available for sale, net of  taxes |       | $                      | 4          |   | $ | (571 | ) |

 

See notes to consolidatedfinancial statements.

 

4

----

 

**CITIZENSBANCSHARES CORPORATION AND SUBSIDIARIES**

**Notes tothe Consolidated Financial Statements**

(Unaudited)

 

**1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES**

 

**Basis of Presentation**

 

Citizens Bancshares Corporation (the “Company”) is aholding company that provides a full range of commercial banking and mortgagebrokerage services to individual and corporate customers in metropolitanAtlanta and Columbus, Georgia, and in Birmingham and Eutaw, Alabama, throughits wholly owned subsidiary, Citizens Trust Bank (the “Bank”).  The Bank operates under a state charter andserves its customers through eight full-service branches in metropolitanAtlanta, Georgia, one full-service branch in Columbus, Georgia, twofull-service branches in Birmingham, Alabama, and one full-service branch inEutaw, Alabama.

 

The accompanying unaudited consolidated financialstatements have been prepared pursuant to the rules and regulations forreporting on Form 10-Q.  Accordingly,certain disclosures required by generally accepted accounting principles arenot included herein. These interim statements should be read in conjunctionwith the financial statements and notes thereto included in the Company’slatest Annual Report on Form 10-K filed with the Securities and ExchangeCommission for the year ended December 31, 2003.  The results of operations for the interimperiods reported herein are not necessarily representative of the resultsexpected for the full 2004 fiscal year.

 

The consolidated financial statements of the Companyfor the three and nine month periods ended September 30, 2004 and 2003 areunaudited.  In the opinion of management,all adjustments necessary for a fair presentation of the financial position andresults of operations and cash flows for the nine month periods have beenincluded.  All adjustments are of anormal recurring nature.  All significantintercompany accounts and transactions have been eliminated in consolidation.

 

**Accounting Policies**

 

The Company’s consolidated financial statements havebeen prepared in accordance with accounting principles generally accepted inthe United States of America (“GAAP”), which often require the judgment ofmanagement in the selection and application of certain accounting principlesand methods.  Reference is made to theaccounting policies of the Company described in the notes to the consolidatedfinancial statements contained in the Company’s Annual Report on Form 10-K forthe year ended December 31, 2003. The Company has followed those policies in preparing this report.  Management believes that the quality andreasonableness of its most critical policies enable the fair presentation ofits financial position and of its results of operations.

 

**Recently Issued AccountingStandards**

 

Norecent authoritative pronouncements that affect accounting, reporting, anddisclosure of financial information by us have occurred during the quarterending September 30, 2004, other than the items described below.

 

InMarch 2004, the FASB issued an exposure draft on “Share-Based Payment”.  The proposed Statement addresses theaccounting for transactions in which an enterprise receives employee servicesin exchange for (a) equity instruments of the enterprise or (b) liabilitiesthat are based on the

 

5

----

 

fairvalue of the enterprise’s equity instruments or that may be settled by theissuance of such equity instruments. This proposed Statement would eliminate the ability to account for share-basedcompensation transactions using APB Opinion No. 25, “Accounting for StockIssued to Employees”, and generally would require instead that suchtransactions be accounted for using a fair-value-based method.  This Statement, if approved, was scheduled tobe effective for awards that are granted, modified, or settled in fiscal yearsbeginning after a) December 15, 2004 for public entities and nonpublicentities that used the fair-value-based method of accounting under the originalprovisions of Statement 123 for recognition or pro forma disclosure purposesand b) December 15, 2005 for all other nonpublic entities*.*On October 16, 2004, the FASB delayed the effectivedate of this proposal by six months and anticipates it will be effective for bythe third quarter of 2005. Retrospective application of this Statement is notpermitted.  The adoption of thisStatement, if approved, could have an impact on the Company’s financialposition or results of operations.

 

InMarch 2004, the Securities and Exchange Commission staff released StaffAccounting Bulletin (SAB) No. 105, “Application of Accounting Principles toLoan Commitments.” This SAB disallows the inclusion of expected future cashflows related to the servicing of a loan in the determination of the fair valueof a loan commitment. Further, no other internally developed intangible assetshould be recorded as part of the loan commitment derivative. Recognition ofintangible assets would only be appropriate in a third-party transaction, suchas a purchase of a loan commitment or in a business combination. The SAB iseffective for all loan commitments entered into after March 31, 2004, butdoes not require retroactive adoption for loan commitments entered into on orbefore March 31, 2004. Adoption of this SAB did not have a material effecton the Company’s Condensed Consolidated Financial Statements.

 

In March 2004, the FASBapproved certain additional provisions of the Emerging Issues Task Force (EITF)Issue No. 03-1, “*The Meaning of Other-Than-Temporary Impairmentand Its Application to Certain Investments*”, including measurementguidance for evaluating whether an “other than temporary impairment” hasoccurred for marketable securities and cost method investments.  Additional disclosures are also required forcost method investments, effective at the end of the current fiscal year. Theguidance for determining the amount of impairment was scheduled to be effectivefor periods ending after June 15, 2004, but has been delayed indefinitelypending implementation guidance by the FASB. The adoption of this EITF is notexpected to have a material effect on the Company’s Consolidated FinancialStatements.

 

Otheraccounting standards that have been issued or proposed by the FASB or otherstandards-setting bodies that do not require adoption until a future date arenot expected to have a material impact on the consolidated financial statementsupon adoption.

 

6

----

 

**2. STOCK BASED COMPENSATION**

 

The Company’s as reported and pro forma information,including stock-based compensation expense as if the fair-value based methodhad been applied, is illustrated in the following table (in thousands):

 
| ** **                                                                              | ** ** | **For the three months  ended September 30,** | ** ** | **For the nine months ended  September 30,** | ** ** |
|-----------------------------------------------------------------------------------------|------------|----------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                                                              | ** ** | **2004**                                           | ** ** | **2003**                                          | ** ** | **2004** | ** ** | **2003** | ** ** |
|                                                                                    |       |                                               |       |                                              |       |   |   |   |   |
| As reported  net income available to common stockholders                                |       | $                                                  | 381        |                                              | $          | 569 |   | $ | 1,658 |   | $ | 1,892 |   |
| Less:  stock-based compensation expense determined under fair value method, net of  tax |       | (8                                                 | )          | (4                                                | )          | (22 | ) | (12 | ) |
|                                                                                    |       |                                               |       |                                              |       |   |   |   |   |
| Pro forma  net income                                                                   |       | $                                                  | 373        |                                              | $          | 565 |   | $ | 1,636 |   | $ | 1,880 |   |
|                                                                                    |       |                                               |       |                                              |       |   |   |   |   |
| As reported  earnings per share                                                         |       | $                                                  | 0.18       |                                              | $          | 0.27 |   | $ | 0.80 |   | $ | 0.91 |   |
| Pro forma  earnings per share                                                           |       | $                                                  | 0.18       |                                              | $          | 0.27 |   | $ | 0.79 |   | $ | 0.91 |   |
| As reported  earnings per diluted share                                                 |       | $                                                  | 0.18       |                                              | $          | 0.27 |   | $ | 0.80 |   | $ | 0.91 |   |
| Pro forma  earnings per diluted share                                                   |       | $                                                  | 0.18       |                                              | $          | 0.27 |   | $ | 0.79 |   | $ | 0.91 |   |

 

Compensation expense in the pro forma disclosures isnot indicative of future amounts, as options vest over several years andadditional grants could be made each year.

 

**3. INTANGIBLE ASSETS**

 

Finite lived intangible assets of the Companyrepresent deposit assumption premiums recorded upon the purchase of certainassets and liabilities from other financial institutions.  Deposit assumption premiums are amortizedover seven years, the estimated average lives of the deposit bases acquired,using the straight-line method and are included within other assets on theConsolidated Balance Sheets.

 

The Company applies a fair value-based impairmenttest to the carrying value of goodwill on an annual basis and on an interimbasis if certain events or circumstances indicate that an impairment loss mayhave been incurred.

 

7

----

 

The following table presents information about theCompany’s intangible assets at (in thousands):

 
| ** **                     | ** ** | **September 30, 2004** | ** ** | **December 31, 2003**    | ** ** |
|--------------------------------|------------|-----------------------------|------------|-------------------------------|------------|
| ** **                     | ** ** | **Gross Carrying  Amount**  | ** ** | **Accumulated  Amortization** | ** ** | **Gross Carrying  Amount** | ** ** | **Accumulated  Amortization** | ** ** |
|                           |       |                        |       |                          |       |   |   |   |   |
| Unamortized  intangible asset: |       |                        |       |                          |       |   |   |   |   |
| Goodwill                       |       | $                           | 362        |                          | $          | — |   | $ | 362 |   | $ | — |   |
|                           |       |                        |       |                          |       |   |   |   |   |
| Amortized  intangible assets:  |       |                        |       |                          |       |   |   |   |   |
| Core deposit  intangibles      |       | $                           | 2,836      |                          | $          | 1,688 |   | $ | 2,836 |   | $ | 1,385 |   |

 

The following table presents information aboutaggregate amortization expense (in thousands):

 
| ** **                                                                                                    | ** ** | **For the 3  months ended  September 30,  2004** | ** ** | **For the 9  months ended  September 30,  2004** | ** ** | **For the 3  months ended  September 30,  2003** | ** ** | **For the 9  months ended  September 30,  2003** | ** ** |
|---------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------|------------|-------------------------------------------------------|------------|-------------------------------------------------------|------------|-------------------------------------------------------|------------|
|                                                                                                          |       |                                                  |       |                                                  |       |                                                  |       |                                                  |       |
| Aggregate  amortization expense of core deposit intangibles:                                                  |       | $                                                     |  101  |                                                  | $          |  303                                             |       | $                                                     |  101  |   | $ |  286 |   |
|                                                                                                          |       |                                                  |       |                                                  |       |                                                  |       |                                                  |       |
| Estimated aggregate  amortization expense of core deposit intangibles for the years ending  December 31: |       |                                                  |       |                                                  |       |                                                  |       |                                                  |       |
|                                                                                                          |       |                                                  |       |                                                  |       |                                                  |       |                                                  |       |
| 2004                                                                                                          |       | $                                                     |  405  |                                                  |       |                                                  |       |                                                  |       |   |
| 2005                                                                                                          |       | $                                                     |  405  |                                                  |       |                                                  |       |                                                  |       |   |
| 2006                                                                                                          |       | $                                                     |  405  |                                                  |       |                                                  |       |                                                  |       |   |
| 2007                                                                                                          |       | $                                                     |  112  |                                                  |       |                                                  |       |                                                  |       |   |
| 2008 and  thereafter                                                                                          |       | $                                                     | 124        |                                                  |       |                                                  |       |                                                  |       |   |
|                                                                                                               |            |                                                       |            |                                                       |            |                                                       |            |                                                       |            |  |  |  |  |

 

**4. COMPREHENSIVE INCOME**

 

Comprehensive income includes: (1) reported netincome and (2) unrealized gains and losses on marketable securities.  The following table shows our comprehensiveincome for the three and nine month periods ended September 30, 2004 and2003 (in thousands):

 
| ** **                         | ** ** | **Three Months Ended September 30,** | ** ** | **Nine Months Ended September 30,** | ** ** |
|------------------------------------|------------|-------------------------------------------|------------|------------------------------------------|------------|
| ** **                         | ** ** | **2004**                                  | ** ** | **2003**                                 | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                         | ** ** | ** **                                | ** ** | ** **                               | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net Income                         |       | $                                         | 381        |                                     | $          | 569 |   | $ | 1,658 |   | $ | 1,892 |   |
|                               |       |                                      |       |                                     |       |   |   |   |   |
| Other  comprehensive income (loss) |       | 1,102                                     |       | (1,325                                   | )          | 4 |   | (571 | ) |
|                               |       |                                      |       |                                     |       |   |   |   |   |
| Comprehensive  income              |       | $                                         | 1,483      |                                     | $          | (756 | ) | $ | 1,662 |   | $ | 1,321 |   |

 

8

----

 

**5.  NET INCOME PERCOMMON AND COMMON EQUIVALENT SHARE**

 

Basic and diluted net income per common andpotential common share has been calculated based on the weighted average numberof shares outstanding.  The following schedule reconcilesthe numerator and denominator of the basic and diluted net income per commonand potential common share for the nine months ended September 30, 2004and 2003 (in thousands, except per share data):

 
| ** **                                                        | ** ** | **Net Income**  | ** ** | **Shares**        | ** ** | **Per Share** | ** ** |
|-------------------------------------------------------------------|------------|-----------------|------------|-------------------|------------|---------------|------------|
| ** **                                                        | ** ** | **(Numerator)** | ** ** | **(Denominator)** | ** ** | **Amount**    | ** ** |
|                                                              |       |            |       |              |       |          |       |
| **Three  Months ended September 30, 2004**                   |       |            |       |              |       |          |       |
|                                                              |       |            |       |              |       |          |       |
| Basic earnings  per share                                         |       | $               | 381        |              | 2,075      |          | $          | 0.18 |   |
| Effect of  dilutive securities: options to purchase common shares |       | —          |       | 5                 |       | $             | —     |   |
|                                                              |       |            |       |              |       |          |       |
| Diluted  earnings per share                                       |       | $               | 381        |              | 2,080      |          | $          | 0.18 |   |
|                                                              |       |            |       |              |       |          |       |
|                                                              |       |            |       |              |       |          |       |
| **Three  Months ended September 30, 2003**                   |       |            |       |              |       |          |       |
|                                                              |       |            |       |              |       |          |       |
| Basic  earnings per share                                         |       | $               | 569        |              | 2,073      |          | $          | 0.27 |   |
| Effect of  dilutive securities: options to purchase common shares |       | —          |       | —            |       | —        |       |
|                                                              |       |            |       |              |       |          |       |
| Diluted  earnings per share                                       |       | $               | 569        |              | 2,073      |          | $          | 0.27 |   |
|                                                              |       |            |       |              |       |          |       |
| **Nine  Months ended September 30, 2004**                    |       |            |       |              |       |          |       |
|                                                              |       |            |       |              |       |          |       |
| Basic  earnings per share                                         |       | $               | 1,658      |              | 2,074      |          | $          | 0.80 |   |
| Effect of  dilutive securities: options to purchase common shares |       | —          |       | 6                 |       | $             | —     |   |
|                                                              |       |            |       |              |       |          |       |
| Diluted  earnings per share                                       |       | $               | 1,658      |              | 2,080      |          | $          | 0.80 |   |
|                                                              |       |            |       |              |       |          |       |
|                                                              |       |            |       |              |       |          |       |
| **Nine  Months ended September 30, 2003**                    |       |            |       |              |       |          |       |
|                                                              |       |            |       |              |       |          |       |
| Basic  earnings per share                                         |       | $               | 1,892      |              | 2,077      |          | $          | 0.91 |   |
| Effect of  dilutive securities: options to purchase common shares |       | —          |       | —            |       | —        |       |
|                                                              |       |            |       |              |       |          |       |
| Diluted  earnings per share                                       |       | $               | 1,892      |              | 2,077      |          | $          | 0.91 |   |

 

**RECLASSIFICATIONS**

 

Certain 2003 amounts have been reclassifiedto conform to the 2004 presentation.

 

9

----

 

**ITEM 2.****                                                                                                                                                                            ****MANAGEMENT’S DISCUSSION ANDANALYSIS**

 

**INTRODUCTION**

 

Citizens Bancshares Corporation (the “Company”) is aholding company that provides a full range of commercial banking and mortgagebrokerage services to individuals and corporate customers in its primary marketareas, metropolitan Atlanta and Columbus, Georgia, and Birmingham and Eutaw, Alabamathrough its wholly owned subsidiary, Citizens Trust Bank (the “Bank”).  The Bank is a member of the Federal ReserveSystem and operates under a state charter. The Company serves its customers through 12 full-service branches inGeorgia and Alabama.

 

**Forward Looking Statements**

 

In addition to historical information, this reporton Form 10-Q may contain forward-looking statements. For this purpose, anystatements contained herein, including documents incorporated by reference,that are not statements of historical fact may be deemed to be forward-lookingstatements. Forward-looking statements are subject to numerous assumptions,risks and uncertainties. Without limiting the foregoing, the words “believe,” “anticipates,”“plan,” expects,” and similar expressions are intended to identifyforward-looking statements.

 

Forward-looking statements are based on currentmanagement expectations and, by their nature, are subject to risk anduncertainties because of the possibility of changes in underlying factors andassumptions. Actual conditions, events or results could differ materially fromthose contained in or implied by such forward-looking statements for a varietyof reasons, including: sharp and/or rapid changes in interest rates;significant changes in the economic scenario from the current anticipatedscenario which could materially change anticipated credit quality trends andthe ability to generate loans and gather deposits; significant delay in orinability to execute strategic initiatives designed to grow revenues and/orcontrol expenses; unanticipated issues during the integration of acquisitions;and significant changes in accounting, tax or regulatory practices orrequirements. The Company undertakes no obligation to, nor does it intend to,update forward-looking statements to reflect circumstances or events that occurafter the date hereof or to reflect the occurrence of unanticipated events.

 

The following discussion is of the Company’sfinancial condition as of September 30, 2004 and the changes in thefinancial condition and results of operations for the three and nine monthperiods ended September 30, 2004 and 2003.

 

**Critical Accounting Policies**

 

In response to the Securities and ExchangeCommission’s (“SEC”) Release No. 33-8040, Cautionary Advice RegardingDisclosure About Critical Accounting Policies, the Company has identified thefollowing as the most critical accounting policies upon which its financialstatus depends.  The critical policieswere determined by considering accounting policies that involve the mostcomplex or subjective decisions or assessments. The Company’s most critical accounting policies relate to:

 

**InvestmentSecurities**- The Company classifies investments in one ofthree categories based on management’s intent upon purchase: held to maturitysecurities which are reported at amortized cost, trading securities which arereported at fair value with unrealized holding gains and losses included inearnings, and available for sale securities which are recorded at fair value withunrealized holding gains and losses included as a component of accumulatedother

 

10

----

 

comprehensive income.  The Company had no investment securitiesclassified as trading securities during 2004 or 2003.

 

Premiums and discounts onavailable for sale and held to maturity securities are amortized or accretedusing a method which approximates a level yield.

 

Gains and losses on sales ofinvestment securities are recognized upon disposition, based on the adjustedcost of the specific security.  A declinein market value of any security below cost that is deemed other than temporaryis charged to earnings resulting in the establishment of a new cost basis forthe security.

 

**Loans**  - Loans are reported at principal amountsoutstanding less unearned income and the allowance for loan losses.  Interest income on loans is recognized on alevel-yield basis. Loan fees and certain direct origination costs are deferredand amortized over the estimated terms of the loans using the level-yieldmethod.  Discounts on loans purchased areaccreted using the level-yield method over the estimated remaining life of theloan purchased.

 

**Allowancefor Loan Losses** - TheCompany provides for estimated losses on loans receivable when any significantand permanent decline in value occurs. These estimates for losses are based, not only on individual assets andtheir related cash flow forecasts, sales values, and independent appraisals,but also on the volatility of certain real estate markets, and the concern fordisposing of real estate in distressed markets. For loans that are pooled for purposes of determining the necessaryprovisions, estimates are based on loan types, history of charge-offs, and otherdelinquency analyses.  Therefore, thevalue used to determine the provision for losses is subject to thereasonableness of these estimates.  Theadequacy of the allowance for loan losses is reviewed on a monthly basis bymanagement and the Board of Directors. On a quarterly basis a comprehensive review of the adequacy of theallowance for loan losses is performed. This assessment is made in the context of historical losses as well asexisting economic conditions, and individual concentrations of credit.  Loans are charged against the allowance when,in the opinion of management, such loans are deemed uncollectible andsubsequent recoveries are added to the allowance.

 

A description of other accounting policies aresummarized in Note 1, Summary of Significant Accounting Policies in the Notesto Consolidated Financial Statements of the Company’s Annual Report on Form10-K for the year ended December 31, 2003. The Company has followed those policies in preparing this report.

 

**FINANCIAL CONDITION**

 

Citizens Bancshares Corporation’s total assets at September 30,2004 were $325,617,000, a decrease of $34,826,000 or 10% compared to$360,443,000 at December 31, 2003. This decrease is due to the plannedeffort of the Company’s management to reposition the Company’s balance sheet,reduce its exposure to interest rate risk and benefit from continuing interestrate increases.  The Company may takeadvantage of additional opportunities as they arise to further improve assetyields and/or reduce long-term funding costs during the fiscal year.

 

At September 30, 2004, the Company maintained abalance of cash and due from banks of $9,576,000 representing a decrease of$2,118,000 from December 31, 2003. Interest bearing deposits with banks increased to $314,000 from $108,000at December 31, 2003.  Certificatesof Deposit decreased $2,183,000 as the Company’s commitment in the CommunityDevelopment Financial Institution Program (the CDFI) expires.  The CDFI program required the Company toplace

 

11

----

 

certificates of deposit in other CDFI institutionsto fund economic development in local communities.  The Company is not renewing thesecertificates of deposit as they mature.

 

Investment securities classified as available forsale and held to maturity also decreased $19,729,000 and $472,000,respectively, since December 31, 2003. In March 2004, the Company sold approximately $11,400,000 ofinvestments available for sale for a gain of $58,000 to restructure and reducethe interest rate risk of its investment portfolio.  The remaining decrease in investmentsavailable for sale is attributed to called securities and pay-downs ofmortgage-backed securities in the investment portfolio.

 

Loans receivable, net decreased $8,772,000 to$200,042,000 for the period ended September 30, 2004 compared to$208,814,000 at December 31, 2003. In June 2004, the Company sold approximately $2,400,000 of itsmortgage loan portfolio in its effort to reduce the interest rate risk andimprove asset quality.  The Company brokeeven on the sale of those mortgage loans.

 

Total liabilities decreased $36,213,000 to$300,286,000 at September 30, 2004 compared to $336,499,000 at December 31,2003. Total deposits, a component of total liabilities, decreased $9,410,000from $276,779,000 at December 31, 2003 to $267,369,000 at September 30,2004.  The decrease in deposits ispartially attributed to a planned decline in interest-bearing deposits withgovernmental customers.  The Companyelected not to renew several certificates of deposit due to the requiredcollateralization of the deposits in the form of pledged investmentsecurities.  By not renewing some of itsgovernmental deposits, the Company mitigated its exposure to rising interestrates by reducing its investment portfolio and effectively, its cost of fundsby relying more on deposits acquired through the open market.  Another significant component of totalliabilities, advances from Federal Home Loan Bank decreased $22,461,000 to$24,500,000 at September 30, 2004 compared to $46,961,000 at December 31,2003.

 

**INVESTMENT SECURITIES**

 

The Company invests a portion of its assets in U.S.treasury bills and notes, U.S. government sponsored agency securities, mortgagebacked bonds, as well as certain equity securities.  At September 30, 2004 and December 31,2003, the Company’s investment securities portfolio represented approximately27% and 31% of total assets, respectively.

 

Investment securities available for sale aresummarized as follows (in thousands):

 
| **At September 30, 2004**           | ** ** | **Amortized  Cost** | ** ** | **Gross  Unrealized  Gains** | ** ** | **Gross  Unrealized  Losses** | ** ** | **Fair Value** | ** ** |
|------------------------------------------|------------|---------------------|------------|------------------------------|------------|-------------------------------|------------|----------------|------------|
|                                     |       |                |       |                         |       |                          |       |           |       |
| U.S.  Treasury and                       |       |                |       |                         |       |                          |       |           |       |
| U.S.  Government agencies                |       | $                   | 9,902      |                         | $          | 42                            |       | $              | 4          |   | $ | 9,940 |   |
| State,  county, and municipal securities |       | 13,093              |       | 518                          |       | 3                             |       | $              | 13,608     |   |
| Mortgage-backed  securities              |       | 53,035              |       | 145                          |       | 286                           |       | $              | 52,894     |   |
| Equity  securities (1)                   |       | 1,400               |       | —                       |       | 270                           |       | 1,130          |       |
| Totals                                   |       | $                   | 77,430     |                         | $          | 705                           |       | $              | 563        |   | $ | 77,572 |   |

 

12

----

 
| **At December 31, 2003**            | ** ** | **Amortized  Cost** | ** ** | **Gross  Unrealized  Gains** | ** ** | **Gross  Unrealized  Losses** | ** ** | **Fair Value** | ** ** |
|------------------------------------------|------------|---------------------|------------|------------------------------|------------|-------------------------------|------------|----------------|------------|
|                                     |       |                |       |                         |       |                          |       |           |       |
| U.S.  Treasury and                       |       |                |       |                         |       |                          |       |           |       |
| U.S.  Government agencies                |       | $                   | 14,820     |                         | $          | 95                            |       | $              | 8          |   | $ | 14,907 |   |
| State,  county, and municipal securities |       | 13,602              |       | 450                          |       | 14                            |       | 14,038         |       |
| Mortgage-backed  securities              |       | 67,343              |       | 241                          |       | 397                           |       | 67,187         |       |
| Equity  securities (1)                   |       | 1,400               |       | —                       |       | 231                           |       | 1,169          |       |
| Totals                                   |       | $                   | 97,165     |                         | $          | 786                           |       | $              | 650        |   | $ | 97,301 |   |

 

----

(1) The equity securitiesrepresent agency dividends received deduction (DRD) preferred stock issued byFNMA and FHLMC.  These securities arecallable at par, the interest rates reprice periodically and the interestearned is 70 percent tax free.

 

Investment securities held to maturity aresummarized as follows (in thousands):

 
| **At September 30, 2004**           | ** ** | **Amortized  Cost** | ** ** | **Gross  Unrealized  Gains** | ** ** | **Gross  Unrealized  Losses** | ** ** | **Fair Value** | ** ** |
|------------------------------------------|------------|---------------------|------------|------------------------------|------------|-------------------------------|------------|----------------|------------|
|                                     |       |                |       |                         |       |                          |       |           |       |
| U.S.  Treasury and                       |       |                |       |                         |       |                          |       |           |       |
| U.S.  Government agencies                |       | $                   | 3,000      |                         | $          | 2                             |       | $              | 16         |   | $ | 2,986 |   |
| State,  county, and municipal securities |       | 5,390               |       | 229                          |       | —                        |       | 5,619          |       |
| Mortgage-backed  securities              |       | 1,691               |       | 5                            |       | 31                            |       | 1,665          |       |
|                                     |       |                |       |                         |       |                          |       |           |       |
| Totals                                   |       | $                   | 10,081     |                         | $          | 236                           |       | $              | 47         |   | $ | 10,270 |   |

 
| **At December 31, 2003**            | ** ** | **Amortized  Cost** | ** ** | **Gross  Unrealized  Gains** | ** ** | **Gross  Unrealized  Losses** | ** ** | **Fair Value** | ** ** |
|------------------------------------------|------------|---------------------|------------|------------------------------|------------|-------------------------------|------------|----------------|------------|
|                                     |       |                |       |                         |       |                          |       |           |       |
| U.S.  Treasury and                       |       |                |       |                         |       |                          |       |           |       |
| U.S.  Government agencies                |       | $                   | 3,000      |                         | $          | 9                             |       | $              | 23         |   | $ | 2,986 |   |
| State,  county, and municipal securities |       | 5,549               |       | 213                          |       | —                        |       | 5,762          |       |
| Mortgage-backed  securities              |       | 2,004               |       | 10                           |       | 35                            |       | 1,979          |       |
|                                     |       |                |       |                         |       |                          |       |           |       |
| Totals                                   |       | $                   | 10,553     |                         | $          | 232                           |       | $              | 58         |   | $ | 10,727 |   |

 

13

----

 

**LOANS**

 

Loans outstanding, by classification, are summarizedas follows (in thousands):

 
| ** **                               | ** **                  | **September 30,** | ** ** | **December 31,** | ** ** |
|------------------------------------------|-----------------------------|------------------------|------------|-----------------------|------------|
| ** **                               | ** **                  | **2004**               | ** ** | **2003**              | ** ** |
|                                     |                        |                   |       |                  |       |
| Commercial,  financial, and agricultural |                        | $                      | 13,623     |                  | $          | 16,919 |   |
| Installment                              |                        | 6,517                  |       | 13,342                |       |
| Real estate -  mortgage                  |                        | 133,872                |       | 135,194               |       |
| Real estate -  construction              |                        | 19,011                 |       | 15,381                |       |
| Other                                    |                        | 31,069                 |       | 32,379                |       |
|                                     |                        | 204,092                |       | 213,215               |       |
| Less:                                    | Net deferred  loan fees     |                   | 532        |                  | 589        |   |
|                                     | Allowance  for loan losses  |                   | 3,108      |                  | 3,240      |   |
|                                     | Discount on  loans acquired |                   | 410        |                  | 572        |   |
|                                     |                        |                   |       |                  |       |
| Loans  receivable, net                   |                        | $                      | 200,042    |                  | $          | 208,814 |   |
|                                          |                             |                        |            |                       |            |  |  |  |  |  |

 

**NONPERFORMING ASSETS**

 

Nonperforming assets include nonperforming loans,real estate acquired through foreclosure, and repossessed assets.  Nonperforming loans consist of loans that arepast due with respect to principal or interest more than 90 days or have beenplaced on nonaccrual status.

 

With the exception of the loans included withinnonperforming assets in the table below, management is not aware of any loansclassified for regulatory purposes as loss, doubtful, substandard, or specialmention that have not been disclosed which (1) represent or result from trendsor uncertainties which management reasonably expects will materially impactfuture operating results, liquidity, or capital resources, or (2) represent anyinformation on material credits which management is aware that causesmanagement to have serious doubts as to the abilities of such borrowers tocomply with the loan repayment terms.

 

Nonperforming assets decreased by $2,840,000 to $5,690,000at September 30, 2004 from $8,530,000 at December 31, 2003.  Nonperforming assets represents 2.78% ofloans, net of unearned income, discounts, and real estate acquired throughforeclosure at September 30, 2004 as compared to 3.98% at December 31,2003.  Improved monitoring and oversightof loans have contributed to this decline.

 

14

----

 

The table below presents a summary of the Company’snonperforming assets at September 30, 2004 and December 31, 2003.

 
| ** **                                                                                                       | ** ** | **September 30,**                       | ** ** | **December 31,** | ** ** |
|------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------|------------|-----------------------|------------|
| ** **                                                                                                       | ** ** | **2004**                                     | ** ** | **2003**              | ** ** |
| ** **                                                                                                       | ** ** | **(in thousands, except  financial ratios)** | ** ** |
| ** **                                                                                                       | ** ** | ** **                                   | ** ** | ** **            | ** ** |
| Nonperforming  assets:                                                                                           |       |                                         |       |                  |       |
| Nonperforming  loans:                                                                                            |       |                                         |       |                  |       |
| Nonaccrual  loans                                                                                                |       | $                                            | 4,272      |                  | $          | 6,477 |   |
| Past-due  loans of 90 days or more                                                                               |       | —                                       |       | —                |       |
| Nonperforming  loans                                                                                             |       | 4,272                                        |       | 6,477                 |       |
|                                                                                                             |       |                                         |       |                  |       |
| Real estate  acquired through foreclosure                                                                        |       | 1,418                                        |       | 2,053                 |       |
| Total  nonperforming assets                                                                                      |       | $                                            | 5,690      |                  | $          | 8,530 |   |
|                                                                                                             |       |                                         |       |                  |       |
| Ratios:                                                                                                          |       |                                         |       |                  |       |
| Nonperforming  loans to loans, net of unearned income and discount on loans                                      |       | 2.10                                         | %          | 3.05                  | %          |
|                                                                                                             |       |                                         |       |                  |       |
| Nonperforming  assets to loans, net of unearned income, discounts, and real estate acquired  through foreclosure |       | 2.78                                         | %          | 3.98                  | %          |
|                                                                                                             |       |                                         |       |                  |       |
| Nonperforming  assets to total assets                                                                            |       | 1.75                                         | %          | 2.37                  | %          |
|                                                                                                             |       |                                         |       |                  |       |
| Allowance  for loan losses to nonperforming loans                                                                |       | 72.75                                        | %          | 50.02                 | %          |
|                                                                                                             |       |                                         |       |                  |       |
| Allowance  for loan losses to nonperforming assets                                                               |       | 54.62                                        | %          | 37.98                 | %          |

 

15

----

 

**ALLOWANCE FOR LOAN LOSSES**

 

The allowance for loan losses is primarily availableto absorb losses inherent in the loan portfolio. Credit exposures deemeduncorrectable are charged against the allowance for loan losses. Recoveries ofpreviously charged-off amounts are credited to the allowance for loan losses.

 

The Company provides for estimated losses on loansreceivable when any significant and permanent decline in value occurs.  These estimates for losses are based onindividual assets and their cash flow forecasts, sales values, independentappraisals, the volatility of certain real estate markets, and concern fordisposing of real estate in distressed markets. For loans that are pooled for purposes of determining the necessaryprovisions, estimates are based on loan types, history of charge-offs, andother delinquency analyses.  Therefore,the value used to determine the provision for losses is subject to thereasonableness of these estimates. The adequacy of the allowance for loanlosses is reviewed on a monthly basis by management and the Board ofDirectors.  On a quarterly basis acomprehensive review of the adequacy of allowance for loan losses isperformed.  This assessment is made inthe context of historical losses as well as existing economic conditions, andindividual concentrations of credit.

 

Loans are charged against the allowance when, in theopinion of management, such loans are deemed uncollectible and subsequentrecoveries are added to the allowance. For the nine month period ended September 30, 2004 provisions forloan losses totaled $775,000 compared to $380,000 for the same period in 2003.

 

The allowance for loan losses at September 30,2004 was approximately $3,108,000, representing 1.53% of total loans, net ofunearned income and discounts compared to approximately $3,240,000 at December 31,2003, which also represented 1.53% of total loans, net of unearned income anddiscounts.

 

Management believes the allowance for loan losses isadequate. While management uses available information to recognize losses onloans, future additions to the allowance may be necessary based on changes ineconomic conditions, particularly in the metropolitan Atlanta area. Inaddition, regulatory agencies, as an integral part of their examinationprocess, periodically review the Company’s allowance for loan losses. Suchagencies may require the Company to recognize additions to the allowance basedon their judgments about information available to them at the time of theirexamination.

 

A substantial portion of the Company’s loanportfolio is secured by real estate in the metropolitan Atlanta market,including a concentration of loans to churches and convenience stores.  The Company’s outstanding church loans wereapproximately $49.5 million at September 30, 2004 and $51.1 million at December 31,2003.  The Company’s loans to areaconvenience stores were approximately $24.9 million at September 30, 2004and $27.3 million at December 31, 2003. Accordingly, the ultimate collectability of the substantial portion ofthe Company’s loan portfolio is susceptible to changes in market conditions inthe metropolitan Atlanta area.

 

16

----

 

The following table summarizes loans, changes in theallowance for loan losses arising from loans charged off, recoveries on loanspreviously charged off by loan category, and additions to the allowance whichhave been charged to operating expense as of and for the nine month periodended September 30, 2004 (amount in thousands, except financial ratios):

 
| ** **                                                                                                              | ** ** | **2004** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------|------------|----------|------------|
|                                                                                                                    |       |     |       |
| Loans, net  of unearned income and discounts                                                                            |       | $        | 203,150    |   |
|                                                                                                                    |       |     |       |
| Average  loans, net of unearned income, discounts and the allowance for loan losses                                     |       | $        | 209,425    |   |
|                                                                                                                    |       |     |       |
| Allowance  for loans losses at the beginning of period                                                                  |       | $        | 3,240      |   |
|                                                                                                                    |       |     |       |
| Loans  charged off:                                                                                                     |       |     |       |
| Commercial,  financial, and agricultural                                                                                |       | 919      |       |
| Real estate -  loans                                                                                                    |       | 324      |       |
| Installment  loans to individuals                                                                                       |       | 151      |       |
| Total loans  charged off                                                                                                |       | 1,394    |       |
|                                                                                                                    |       |     |       |
| Recoveries  of loans previously charged off:                                                                            |       |     |       |
| Commercial,  financial, and agricultural                                                                                |       | 166      |       |
| Real estate -  loans                                                                                                    |       | 94       |       |
| Installment  loans to individuals                                                                                       |       | 227      |       |
| Total loans  recovered                                                                                                  |       | 487      |       |
|                                                                                                                    |       |     |       |
| Net loans  charged off                                                                                                  |       | 907      |       |
|                                                                                                                    |       |     |       |
| Additions to  allowance for loan losses charged to operating expense                                                    |       | 775      |       |
|                                                                                                                    |       |     |       |
| Allowance  for loan losses at period end                                                                                |       | $        | 3,108      |   |
|                                                                                                                    |       |     |       |
| Ratio of net  loans charged off to average loans, net of unearned income, discounts, and  the allowance for loan losses |       | 0.43     | %          |
|                                                                                                                    |       |     |       |
| Ratio of  allowance for loan losses to loans, net of unearned income and discounts                                      |       | 1.53     | %          |
|                                                                                                                         |            |          |            |  |  |

 

17

----

 

**DEPOSITS**

 

Deposits are the Company’s primary source of fundingloan growth.  Total deposits for the ninemonth period ended September 30, 2004 decreased by 3.4% or $9,410,000 to$267,369,000.  Noninterest-bearingdeposits increased by $1,333,000 or 2.4%, while interest-bearing depositsdecreased by $10,743,000 or 4.9%.  Thedecrease in total deposits is primarily attributed to Corporate andGovernmental customers who make significant monthly deposits and withdrawalsbased on their budgetary needs and the Company’s decision to not renew severalgovernmental customer deposits.

 

The following is a summary of interest-bearingdeposits (in thousands):

 
| ** **                         | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                         | ** ** | **2004**               | ** ** | **2003**              | ** ** |
|                               |       |                   |       |                  |       |
| NOW and  money market accounts     |       | $                      | 55,354     |                  | $          | 54,840 |   |
| Savings  accounts                  |       | 43,970                 |       | 43,524                |       |
| Time  deposits of $100,000 or more |       | 65,739                 |       | 77,187                |       |
| Other time  deposits               |       | 45,141                 |       | 45,396                |       |
|                               |       | $                      | 210,204    |                  | $          | 220,947 |   |

 

**OTHER BORROWED FUNDS**

 

While the Company continues to emphasize fundingearning asset growth through deposits, the Company has relied on otherborrowings as a supplemental funding source. Other borrowings consist of Federal Home Loan Bank (the “FHLB”) advancesand short-term borrowings.  The Bank hadoutstanding advances from the FHLB of $24,500,000 at September 30, 2004and $46,961,000 at December 31, 2003.  The following advances are collateralized by a blanket lien on theCompany’s 1-4 family mortgage loans.

 
| **Maturity**                         | ** ** | **Callable** | ** ** | **Type** | ** ** | **September 30, 2004** | ** ** | **December 31, 2003** | ** ** |
|--------------------------------------|------------|--------------|------------|----------|------------|-----------------------------|------------|----------------------------|------------|
|                                 |       |         |       |     |       |                        |       |                       |       |   |   |   |   |
| April 2010                      |       | Quarterly    |       | Fixed    |       | 5.82                        | %          | $                          | 10,000,000 |   | 5.82 | % | $ | 10,000,000 |   |
| July 2005                       |       | Daily        |       | Variable |       | 2.15                        | %          | 9,500,000                  |       | 1.15 | % | 36,961,000 |   |
| September 2006                  |       | Monthly      |       | Variable |       | 1.83                        | %          | 5,000,000                  |       | — |   | — |   |
|                                 |       |         |       |     |       |                        |       |                       |       |   |   |   |   |
| Total  Principal Outstanding         |       |         |       |     |       |                        |       | $                          | 24,500,000 |   |   |   | $ | 46,961,000 |   |
|                                 |       |         |       |     |       |                        |       |                       |       |   |   |   |   |
| Weighted  Average Rate at Period End |       |         |       |     |       | 3.58                        | %          |                       |       | 1.24 | % |   |   |
|                                      |            |              |            |          |            |                             |            |                            |            |  |  |  |  |  |  |  |  |

 

The Company had an unsecured note payable ofapproximately $540,000 at September 30, 2004 and December 31,2003.  The note bears interest at thelender’s prime rate minus 50 basis points.

 

During2002, The Company issued $5 million of pooled trust preferred securitiesthrough one issuance by a wholly owned subsidiary grantor trust, Citizens (GA)Statutory Trust I (the “Trust”). The trust preferred securities accrue and paydistributions periodically at an annual rate as provided in the indentures ofthe London Interbank Offered Rate plus 3.45%. The Trust used the net proceedsfrom the offering to purchase a like amount of Junior Subordinated Debentures(the “Debentures”) of the

 

18

----

 

Company.The trust preferred securities are redeemable upon the maturity of theDebentures on June 26, 2032, or upon earlier redemption as provided in theindentures beginning June 26, 2007. The Company has the right to redeem the Debentures in whole or in partor after specific dates, at a redemption price specified in the indentures plusany accrued but unpaid interest to the redemption date.  At September 30, 2004, the interest rateon the trust preferred securities was 5.04%.

 

**RESULTS OFOPERATIONS**

 

**Net Interest Income:**

 

Net interest income is the principalcomponent of a financial institution’s income stream and represents thedifference, or spread, between interest and fee income generated from earningassets and the interest expense paid on deposits and borrowed funds.  Fluctuations in interest rates as well asvolume and mix changes in earning assets and interest bearing liabilities canmaterially impact net interest income.

 

For the nine months ended September 30,2004, the Company’s net interest income increased 8% or $813,000 to $11,393,000compared to $10,580,000 for the nine months ended September 30, 2003.  Total interest income increased $353,000 or3% to $14,326,000 for the nine months ended September 30, 2004 compared to$13,973,000 for the nine months ended September 30, 2003.  This increase is attributed to interestincome on loans which increased $472,000 partially offset by: 1) a decrease of$17,000 in investment income resulting from the bank’s decision to repositionthe investment portfolio; 2) a decrease of $10,000 in federal funds sold; and3) a decrease of $92,000 in interest bearing deposits.  In addition, total interest expense decreased$460,000 as the Company lowered its funding cost by reducing the outstandingbalances of interest-bearing deposits and other borrowings over the nine monthcomparative periods ended September 30, 2004 and 2003.

 

Net interest income increased $52,000 or1% for the three month period ended September 30, 2004 as compared withthe same period of the previous year. The increase in net interest income resulted primarily from the decreaseof $55,000 or 7% in interest expense on deposits for the three month comparativeperiods ended September 30, 2004 and 2003. For the three month period ending September 30, 2004, averageinterest-bearing deposits decreased $10,882,000 to $202,849,000.  Interest expense paid on other borrowingsincreased $15,000 due to an increase in the weighted average interest rate paidon borrowings over the comparative three month periods ended September 30,2004 and 2003.  As a result ofrepositioning its investment portfolio to reduce interest rate risk and tobenefit from the increase in interest rates, interest income on investmentsecurities increased $36,000 for the three month period ended September 30,2004.

 

**Provision for loan losses**

 

The provision for loan losses for the three months ended September 30,2004 was $225,000 compared to $100,000 for the same period in 2003.  The allowance for loan losses and theresulting provision for loan losses are based on changes in the size andcharacter of the Company’s loan portfolio, changes in nonperforming and pastdue loans, the existing risk of individual loans, concentrations of loans tospecific borrowers or industries, and economic conditions.  For the nine months ended September 30,2004, the loan loss provision was $775,000 compared to $380,000 for the sameperiod last year.  The increase in theloan loss provision is primarily due to weaknesses experienced in the Company’scommercial real estate sector during the nine months period which includeschurches and convenient stores.  Alsoduring the nine month period, the Company charged-off

 

19

----

 

the remaining $919,000 of a $2.2 million loan that was in default at December 31,2003.  Management believes that theallowance for loans at September 30, 2004 is adequate.

 

**Noninterest income:**

 

Noninterest income consists of revenuesgenerated from a broad range of financial services and activities, includingfee-based services, and profits and commissions earned through securities andinsurance sales.  In addition, gains andlosses realized from the sale of investment portfolio securities and sales ofassets are included in noninterest income. For the nine month period ended September 30,2004, noninterest income totaled $4,330,000, an increase of $72,000 or 2%compared to the nine month period ended September 30, 2003.  This increase is attributed to a $490,000increase in other operating income which includes a $262,000 recovery offraudulent items written-off in 2001, a $139,000 increase in gains on sale ofassets and an increase of $92,000 in deposits and service fees, partially offsetby a $649,000 decrease in gains on sale of securities.

 

Noninterest income totaled $1,444,000 forthe three month period ended September 30, 2004, a decrease of $273,000 or16% compared with the same period ended September 30, 2003.  This decrease is attributed to a $489,000reduction in gains on the sale of securities partially offset by a $52,000increase in deposit and service fee income, a $65,000 increase in gains fromthe sale of assets and a $99,000 increase in other non-interest income.

 

**Noninterest expense**:

 

Noninterest expense totaled $12,842,000 for the nine month period endedSeptember 30, 2004, an increase of $788,000 or 7% compared to the sameperiod last year.  The increase, in largepart, is due to salaries and employees benefits, and other operating expenses.

 

Salaries and employee benefits increased$631,000 or 12% for the nine month period ended September 30, 2004compared to the same period in 2003. Average full-time equivalent employees for the nine month period were167 at September 30, 2004 compared to 157 at September 30 2003.  This increase in full-time equivalentemployees is primarily the result of the acquisition of a financial institutionin February 2003.  For the threemonth period ending September 30, 2004, salaries and employee benefitsincreased $179,000 or 10%.  Theseincreases are due to the hiring of several loan officers to market commercialloans at the Alabama Division. Commercial lending products are new to the Company’s customers in theAlabama market.  As a result of theadditional staffing in the Alabama and retail divisions, the average full-timeequivalent employees for the three month ending September 30, 2004 was 170compared to 163 at September 30, 2003.

 

Other operating expenses increased $116,000 or 3% to$4,728,000 for the nine month period ended September 30, 2004 compared to$4,612,000 for the nine month period ending September 30, 2003.   This increase is due in large part to OtherReal Estate write-downs of $202,000 and higher collection costs resulting frommanagement’s aggressive collection efforts. For the three month period ended September 30,2004, other operating expenses decreased $295,000 when compared to the sameperiod ended September 30, 2003. This decrease is primarily the result of a $250,000 jury award for whichthe Company recorded a contingent loss in September 2003.  The Company is appealing this judgment.

 

20

----

 

**INTEREST RATE SENSITIVITYMANAGEMENT**

 

Interest rate sensitivity management involvesmanaging the potential impact of interest rate movements on net interest incomewithin acceptable levels of risk.  TheCompany seeks to accomplish this by structuring the balance sheet so thatrepricing opportunities exist for both assets and liabilities in equivalentamounts and time intervals.  Imbalancesin these repricing opportunities at any point in time constitute a financialinstitution’s interest rate risk.  TheCompany’s ability to reprice assets and liabilities in the same dollar amountsand at the same time minimizes interest rate risk.

 

One method of measuring the impact of interest ratesensitivity is the cumulative gap analysis. The difference between interest rate sensitive assets and interest ratesensitive liabilities at various time intervals is referred to as the gap.  The Company is liability sensitive on ashort-term basis as reflected in the following table.  Generally, a net liability sensitive positionindicates that there would be a negative impact on net interest income in anincreasing rate environment.  However,interest rate sensitivity gap does not necessarily indicate the impact ofgeneral interest rate movements on the net interest margin, since all interestrates and yields do not adjust at the same velocity and the repricing ofvarious categories of assets and liabilities is subject to competitivepressures and the needs of the Company’s customers.  In addition, various assets and liabilitiesindicated as repricing within the same period may in fact reprice at differenttimes within such period and at different rates. The following table shows thecontractual maturities of all investment securities at September 30,2004.  Expected maturities may differfrom contractual maturities because issuers may have the right to call or prepayobligations with or without call or prepayment penalties.  For conservative purposes, the Company hasincluded demand deposits such as NOW, money market, and savings accounts in thethree month category.  However, theactual repricing of these accounts may extend beyond twelve months.  The interest rate sensitivity gap is only ageneral indicator of potential effects of interest rate changes on net interestincome.

 

The following table sets forth the distribution ofthe repricing of the Company’s interest rate sensitive assets and interest ratesensitive liabilities as of September 30, 2004.

 

21

----

 
| ** **                                                              | ** ** | **Cumulative amounts as of  September 30, 2004  Maturing and repricing within** | ** ** |
|-------------------------------------------------------------------------|------------|--------------------------------------------------------------------------------------|------------|
| ** **                                                              | ** ** | **3  Months**                                                                        | ** ** | **3 to 12  Months** | ** ** | **1 to 5  Years** | ** ** | **Over  5 Years** | ** ** | **Total** | ** ** |
| ** **                                                              | ** ** | **(amounts in thousands, except  ratios)**                                           | ** ** |
| Interest-sensitive  assets:                                             |       |                                                                                 |       |   |   |   |   |   |   |   |   |
| Investments                                                             |       | $                                                                                    | 481        |   | $ | 2,468 |   | $ | 20,228 |   | $ | 64,476 |   | $ | 87,653 |   |
| Certificates  of deposit                                                |       | —                                                                               |       | 100 |   | 700 |   | — |   | 800 |   |
| Loans                                                                   |       | 73,262                                                                               |       | 6,808 |   | 67,550 |   | 56,472 |   | 204,092 |   |
| Interest-bearing  deposits with other banks                             |       | 314                                                                                  |       | — |   | — |   | — |   | 314 |   |
| Total  interest-sensitive assets                                        |       | $                                                                                    | 74,057     |   | $ | 9,376 |   | $ | 88,478 |   | $ | 120,948 |   | $ | 292,859 |   |
|                                                                    |       |                                                                                 |       |   |   |   |   |   |   |   |   |
| Interest-sensitive  liabilities:                                        |       |                                                                                 |       |   |   |   |   |   |   |   |   |
| Deposits (a)                                                            |       | $                                                                                    | 134,787    |   | $ | 55,522 |   | $ | 19,764 |   | 131 |   | $ | 210,204 |   |
| Notes  payable                                                          |       | 540                                                                                  |       | — |   | — |   | — |   | 540 |   |
| Trust  preferred securities                                             |       | —                                                                               |       | — |   | 5,000 |   | — |   | 5,000 |   |
| Other  borrowings                                                       |       | 14,500                                                                               |       | — |   | — |   | 10,000 |   | 24,500 |   |
| Total  interest-sensitive liabilities                                   |       | $                                                                                    | 149,827    |   | $ | 55,522 |   | $ | 24,764 |   | $ | 10,131 |   | $ | 240,244 |   |
|                                                                    |       |                                                                                 |       |   |   |   |   |   |   |   |   |
| Interest-sensitivity  gap                                               |       | $                                                                                    | (75,770    | ) | $ | (46,146 | ) | $ | 63,714 |   | $ | 110,817 |   | $ | 52,615 |   |
|                                                                    |       |                                                                                 |       |   |   |   |   |   |   |   |   |
| Cumulative  interest-sensitivity gap to total interest-sensitive assets |       | (25.87                                                                               | )%         | (41.63 | )% | (19.87 | )% | 17.97 | % | 17.97 | % |

 

----

(a) Savings, Now, and moneymarket deposits totaling  $99,234 areincluded in the maturing in 3 months classification. 

 

**LIQUIDITY**

 

Liquidity is the ability of the Company to convertassets into cash or cash equivalents without significant loss and to raiseadditional funds by increasing liabilities. Liquidity management involvesmaintaining the Company’s ability to meet the day-to-day cash flow requirementsof its customers, whether they are depositors wishing to withdraw funds orborrowers requiring funds to meet their credit needs.  Without proper liquidity management, theCompany would not be able to perform the primary function of a financialintermediary and would, therefore, not be able to meet the needs of thecommunities it serves.  Additionally, theBank holding company requires cash for various operating needs including:dividends paid to shareholders; business combinations; capital injections toits subsidiaries; the servicing of debt; and the payment of general corporateexpenses.

 

The primary source of liquidity for the Bank holdingcompany is dividends from the Bank. The amount of dividends paid by the Bank tothe Company is limited by various banking regulatory agencies.  The Georgia Department of Banking and Financeregulates dividend payments and must approve payments that exceed 50% of theBank’s net income for the prior year. The total dividends that could be paid bythe Bank to the Company in 2004 without prior regulatory approval is approximately$970,000, of which it paid $311,000 during the second quarter.  Also, the Company has access to variouscapital markets. The Company does not anticipate any liquidity requirements inthe near future that it will not be able to meet.

 

Asset and liability management functions not onlyserve to assure adequate liquidity in order to meet the needs of the Company’scustomers, but also to maintain an appropriate balance betweeninterest-sensitive assets and interest-sensitive liabilities so that theCompany can earn a return that meets the

 

22

----

 

investment requirements of its shareholders.  Daily monitoring of the sources and uses offunds is necessary to maintain an acceptable cash position that meets bothrequirements.

 

The asset portion of the balance sheet providesliquidity primarily through loan principal repayments, maturities of investmentsecurities and, to a lesser extent, sales of investment securities availablefor sale.  Other short-term investments suchas federal funds sold and maturing interest bearing deposits with other banksare additional sources of liquidity funding.

 

The liability portion of the balance sheet providesliquidity through various customers’ interest bearing and noninterest bearingdeposit accounts. Federal funds purchased and other short-term borrowings areadditional sources of liquidity and, basically, represent the Company’sincremental borrowing capacity. These sources of liquidity are short-term innature and are used as necessary to fund asset growth and meet short-termliquidity needs.

 

**CAPITAL RESOURCES**

 

Stockholders’ equity increased $1,387,000 for thenine months ended September 30, 2004, primarily due to the changes inretained earnings.  Retained earningsincreased by $1,347,000 to $17,461,000 due to net earnings of $1,658,000 duringthe nine month period, reduced by dividends of $311,000 paid in the secondquarter.  In May 2004, the Companyapproved cash dividends of $0.15 per share to be paid to shareholders on recordas of April 12, 2004.

 

Quantitative measures established by regulation toensure capital adequacy require the Company to maintain minimum amounts andratios of total and Tier 1 capital to risk weighted assets, and Tier 1 capitalto average assets.  As of September 30,2004, the Bank’s total and Tier 1 capital to risk weighted assets and Tier 1 toaverage assets were 15%, 13%, and 9% respectively, compared with 14%, 13% and8% respectively, at December 31, 2003. As of September 30, 2004, the Company met all capital adequacyrequirements to which it is subject.

 

**OTHER INFORMATION**

 

Effective September 28, 2004, CitizensBancshares Corporation elected to change its designation from a FinancialHolding Company to a Bank Holding Company. The Financial Holding Company wascreated under the Title I of the Gramm-Leach-Bliley Act (“GLB Act”), but theCompany had not exercised any powers exclusive to a Financial HoldingCompany.  Management has determined thatbeing designated as a Bank Holding Company better supports the future strategyfor the Company.

 

23

----

 

**ITEM 3.****                            ****QUANTITATIVE AND QUALITATIVEDISCLOSURES ABOUT MARKET RISK**

 

Market risk is the risk of loss from adverse changesin market prices and interest rates.  Ourmarket risk arises principally from interest rate risk inherent in our lending,deposit, and borrowing activities. Although we manage certain other risks, such as credit quality andliquidity risk, in the normal course of business we consider interest rate riskto be our most significant market risk and the risk that could potentially havethe largest material effect on our financial condition and results ofoperations.  We do not maintain a tradingportfolio or deal in international instruments, and therefore, other types ofmarket risks, such as foreign currency risk and commodity price risk, do notarise in the normal course of our business activities.

 

Quantitative information about the Company’s marketrisk at September 30, 2004 is as follows (in thousands):

 
| ** **                            | ** ** | **2004**     | ** ** |
|---------------------------------------|------------|--------------|------------|
| ** **                            | ** ** | **Carrying** | ** ** | **Estimated** | ** ** | **Down** | ** ** | **Up** | ** ** |
| ** **                            | ** ** | **Value**    | ** ** | **Fair Value** | ** ** | **100 bp** | ** ** | **100 bp** | ** ** |
| ** **                            | ** ** | ** **   | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Financial  assets:                    |       |         |       |   |   |   |   |   |   |
| Interest-bearing  deposits with banks |       | $            | 314        |   | $ | 314 |   | — | % | — | % |
| Certificates  of deposit              |       | 800          |       | 800 |   | — |   | — |   |
| Investment  securities                |       | 87,653       |       | 87,842 |   | 1.89 |   | (3.46 | ) |
| Loans  receivable, net                |       | 204,092      |       | 203,194 |   | 1.51 |   | (1.74 | ) |
|                                  |       |         |       |   |   |   |   |   |   |
| Financial  liabilities:               |       |         |       |   |   |   |   |   |   |
| Interest-bearing  deposits            |       | 210,204      |       | 201,599 |   | 1.47 |   | (1.35 | ) |
| Notes  payable                        |       | 540          |       | 540 |   | — |   | — |   |
| Advances  from Federal Home Loan Bank |       | 24,500       |       | 25,405 |   | 2.16 |   | (2.05 | ) |
| Trust  preferred securities           |       | 5,000        |       | 5,063 |   | — |   | — |   |
|                                       |            |              |            |  |  |  |  |  |  |  |  |

 

The Company has adopted an asset/liabilitymanagement program to monitor the Company’s interest rate sensitivity and toensure that the Company is competitive in the loan and deposit markets.  Management seeks to manage the relationshipbetween interest-sensitive assets and liabilities in order to protect againstwide interest rate fluctuations, including those resulting from inflation.  The Company has not entered into anyderivative financial instruments such as futures, forwards, swaps oroptions.  Additionally, refer to ourinterest rate sensitivity management and liquidity disclosures within Part 1,Item 2, of this Form 10-Q.

 

**ITEM 4.****                            ****CONTROLS AND PROCEDURES**

 

Based on the evaluation of our disclosure controlsand procedures conducted at the end of the period covered by this report, theCompany’s Chief Executive Officer, Chief Operating Officer, and Chief FinancialOfficer have concluded that our disclosure controls and procedures wereeffective as of September 30, 2004 in timely alerting them to materialinformation required to be included in our reports filed with or furnished tothe Securities and Exchange Commission. There have been no changes in the Company’s internal controls overfinancial reporting that occurred during the quarter

 

24

----

 

ended September 30, 2004 that have materiallyaffected, or are reasonably likely to materially affect, our internal controlover financial reporting.

 

**PART II.  OTHER INFORMATION**

 

**ITEM 1.**          **LEGAL PROCEEDINGS**

 

The Company is not aware ofany material pending legal proceedings to which the Company or its subsidiaryis a party or to which any of their property is subject.

 

**ITEM 2.**          **CHANGES IN SECURITIES**

 

On October 12, 2004,the Company issued 1,322 shares of unregistered stock which was purchasedpursuant to the Company’s Employee Stock Purchase Plan at a price of $8.49 pershare.  Also, on this date, the Companyissued 1,158 shares of unregistered stock upon the exercise of options bysenior management.  These shares wereissued at $7.00 per share pursuant to the applicable option agreement withsenior management.

 

**ITEM 3.**          **DEFAULTS UPON SENIORSECURITIES**

 

None

 

**ITEM 4.**          **SUBMISSION OF MATTERS TOVOTE OF SECURITY HOLDERS**

 

None

 

**ITEM 5.**          **OTHER INFORMATION**

 

None

 

**ITEM 6.**          **EXHIBITS**

 

**Exhibit 31**

 

Section 302Certification by the Company’s executive officers with respect to the Company’sQuarterly Report on Form 10-Q for the quarter ended September 30, 2004.

 

**Exhibit 32**

 

Section 906Certification pursuant to Section 1350 of Chapter 63 of Title 18 U.S.C. bythe Company’s executive officers with respect to the Company’s Quarterly Reporton Form 10-Q for the quarter ended September 30, 2004.

 

25

----

 

**SIGNATURES**

 

In accordance with the requirements of the ExchangeAct, the registrant caused this report to be signed on its behalf by theundersigned, thereunto duly authorized.

 

**CITIZENSBANCSHARES CORPORATION**

 

 
| Date:   November 15,  2004 | By:                                               | /s/ James E. Young   |   |
|-------------------------------------------|---------------------------------------------------|----------------------|--------|
|                                      | James E. Young                                    |
|                                      | President and Chief Executive Officer             |
|                                      |                                              |
| Date:   November 15,  2004 | By:                                               | /s/ Willard C. Lewis |   |
|                                      | Willard C. Lewis                                  |
|                                      | Senior Executive Vice President and               |
|                                      | Chief Operating Officer                           |
|                                      |                                              |
| Date:  November 15,  2004       | By:                                               | /s/ Samuel J. Cox    |   |
|                                      | Samuel J. Cox                                     |
|                                      | Senior Vice President and Chief Financial Officer |
|                                           |                                                   |                      |        |  |  |

 

26

----