**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

Washington, D.C. 20429

**FORM 10-QSB**

**[X]  QUARTERLY REPORT UNDER SECTION 13 OR 15(d)OF THE SECURITIES EXCHANGE ACT OF 1934**

For the Quarterly Period Ended September 30,2003

** [   ]  TRANSITION REPORT UNDER SECTION 13 OR15(d)OF THE EXCHANGE ACT**

For the Transition Period from                  to             

Commission File number 000-25267

| Oconee Financial Corporation                           |
|--------------------------------------------------------|
| (Exact name of registrant as specified in its charter) |

  

| Georgia                                    |             | 58-2442250                           |
|--------------------------------------------|--------------------------------------------------------------------|--------------------------------------|
|                                            |                                                                    |                                      |
| (State of Incorporation)                   |                                                               | (I.R.S. Employer Identification No.) |
|                                       |                                                               |                                 |
|                                       |                                                               |                                 |
| 35 North Main Street Watkinsville, Georgia |                                                               | 30677                                |
|                                            |                                                                    |                                      |
| (Address of principal executive offices)   |                                                               | (Zip Code)                           |

706-769-6611(Telephone Number)

            Check whether theissuer (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 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 thepast 90 days.                 Yes****   S        No ****  ̈

State the number of shares outstanding of each of the issuer’s classes of commonequity, as of the latest practicable date: 899,885 shares of Common Stock, par value $2.00, outstanding as of November 14, 2003.

----

###### **OCONEE FINANCIAL CORPORATION AND SUBSIDIARY**

###### **INDEX**

|                            |                                                                                       | Page No. |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------|--------------------------------------------------------------------------------------------|----------|
| PART I                                                                                                                                                       | FINANCIAL INFORMATION                                                                      |     |
|                                                                                                                                                         |                                                                                       |     |
| Item 1.                                                                                                                             | Financial Statements                                                                       |     |
|                                                                                                                                                         |                                                                                       |     |
|                                                                                                                                                         | Consolidated Balance Sheet (unaudited) at September 30, 2003                               | 3        |
|                                                                                                                                                         |                                                                                       |     |   |
|                                                                                                                                                         | Consolidated Statements of Earnings (unaudited) for the Three Months and the NineMonths    |     |
|                                                                                                                                                         |        Ended September 30, 2003 and 2002                | 4        |
|                                                                                                                                                         |                                                                                       |     |
|                                                                                                                                                         | Consolidated Statements of Comprehensive Income (unaudited) for the Three Monthsand        |     |
|                                                                                                                                                         |        the Nine Months Ended September 30, 2003 and2002 | 5        |
|                                                                                                                                                         |                                                                                       |     |
|                                                                                                                                                         | Consolidated Statements of Cash Flows (unaudited) for the Nine Months                      |     |
|                                                                                                                                                         |        Ended September 30, 2003 and 2002                | 6-7      |
|                                                                                                                                                         |                                                                                       |     |
|                                                                                                                                                         | Notes to Financial Statements (unaudited)                                                  | 8-9      |
|                                                                                                                                                         |                                                                                       |     |
| Item 2.                                                                                                                             | Management's Discussion and Analysis of Financial                                          |     |
|                                                                                                                                                         |        Condition and Results of Operations              | 10-13    |
|                                                                                                                                                         |                                                                                       |     |
| Item 3.                                                                                                                             | Controls and Procedures                                                                    | 14       |
|                                                                                                                                                         |                                                                                       |     |
| PART II                                                                                                                                                      | OTHER INFORMATION                                                                          |     |
|                                                                                                                                                         |                                                                                       |     |
| Item 1.                                                                                                                             | Legal Proceedings                                                                          | 15       |
|                                                                                                                                                         |                                                                                       |     |
| Item 2.                                                                                                                             | Changes in Securities and Use of Proceeds                                                  | 15       |
|                                                                                                                                                         |                                                                                       |     |
| Item 3.                                                                                                                             | Defaults Upon Senior Securities                                                            | 15       |
|                                                                                                                                                         |                                                                                       |     |
| Item 4.                                                                                                                             | Submission of Matters to a Vote of Security Holders                                        | 15       |
|                                                                                                                                                         |                                                                                       |     |
| Item 5.                                                                                                                             | Other Information                                                                          | 15       |
|                                                                                                                                                         |                                                                                       |     |
| Item 6.                                                                                                                             | Exhibits and Reports on Form 8-K                                                           | 15       |

 

----

###### **PART I.  FINANCIAL INFORMATION**

Item 1.  Financial Statements

**OCONEE FINANCIAL CORPORATION AND SUBSIDIARY**

Consolidated Balance SheetSeptember 30, 2003(Unaudited)

| Assets                                                                                                                                                            |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                                                                                                                                                              |   |
| Cash and due from banks, including reserve requirements of $2,877,000                                                                                             | $ | 6,104,820 |
| Federal funds sold                                                                                                                                                | 19,399,000 |
|                                                                                                                                                              |   |
|                    Cash and cashequivalents                             | 25,503,820 |
|                                                                                                                                                              |   |
| Investment securities available for sale                                                                                                                          | 41,579,749 |
| Other investments                                                                                                                                                 | 1,090,429 |
| Mortgage loans held for sale                                                                                                                                      | 2,874,180 |
|                                                                                                                                                              |   |
| Loans                                                                                                                                                             | 173,926,326 |
| Less: Allowance for loan losses                                                                                                                                   | 2,535,106 |
|                                                                                                                                                              |   |
|                    Loans,net                                       | 171,391,220 |
|                                                                                                                                                              |   |
| Premises and equipment, net                                                                                                                                       | 4,078,126 |
| Accrued interest receivable and other assets                                                                                                                      | 3,013,823 |
|                                                                                                                                                              |   |
|                    TotalAssets                                     | $ | 249,531,347 |
|                                                                                                                                                              |   |
| Liabilities and Stockholders’ Equity                                                                                                                        |
|                                                                                                                                                              |   |
| Liabilities:                                                                                                                                                      |   |
|        Deposit*s*                                                                                                              |   |
|             Noninterest-bearing                                                                       | $ | 27,064,695 |
|             Interest-bearing                                                                          | 199,665,507 |
|                                                                                                                                                              |   |
|                    TotalDeposits                                   | 226,730,202 |
|                                                                                                                                                              |   |
|        Securities sold under repurchaseagreements                                                                              | 845,031 |
|        Accrued interest payable and otherliabilities                                                                           | 1,101,607 |
|                                                                                                                                                              |   |
|                    TotalLiabilities                                | 228,676,840 |
|                                                                                                                                                              |   |
| Stockholders’ equity:                                                                                                                                       |   |
|        Common stock, $2 par value;                                                                                             |   |
|              authorized1,500,000 shares;                                                         |   |
|              issued andoutstanding 899,885 shares                                                | 1,799,770 |
|        Additional paid-in capital                                                                                              | 4,246,832 |
|        Retained earnings                                                                                                       | 14,340,724 |
|        Accumulated other comprehensiveincome                                                                                   | 467,181 |
|                                                                                                                                                              |   |
|                    Totalstockholders’ equity                 | 20,854,507 |
|                                                                                                                                                              |   |
|                    Totalliabilities and stockholders’ equity | $ | 249,531,347 |

See accompanying notes to financial statements.

3
**OCONEE FINANCIAL CORPORATION AND SUBSIDIARY**

Consolidated Statements of EarningsFor the Three Months and the Nine Months Ended September 30, 2003 and 2002(Unaudited)

 

** **

**Three Months Ended**

** **

**Nine Months Ended**

 

** **

**2003**

** **

**2002**

** **

**2003**

** **

**2002**

Interest Income:

 

 

    

 

    

 

    

 

     Loans

 $

3,084,974

 

3,391,329

 

9,562,684

 

9,716,146

     Investment securities:

 

 

 

 

 

 

 

 

          Tax exempt

 

200,879

 

178,227

 

575,838

 

537,625

          Taxable

 

261,398

 

229,796

 

698,832

 

829,548

     Federal funds sold and other

 

60,656

 

31,057

 

164,697

 

93,775

             Total interestincome

 

3,607,907

 

3,830,409

 

11,002,051

 

11,177,094

 

 

 

 

 

 

 

 

 

Interest Expense:

 

 

 

 

 

 

 

 

     Deposits

 

1,191,778

 

1,359,220

 

3,799,850

 

4,055,606

     Other

 

132,527

 

221,557

 

565,231

 

655,993

             Total interestexpense

 

1,324,305

 

1,580,777

 

4,365,081

 

4,711,599

 

 

 

 

 

 

 

 

 

             Net interestincome

 

2,283,602

 

2,249,632

 

6,636,970

 

6,465,495

 

 

 

 

 

 

 

 

 

Provision for loan losses

 

171,000

 

105,000

 

513,000

 

315,000

 

 

 

 

 

 

 

 

 

                   Netinterest income after provision for loan losses

 

2,112,602

 

2,144,632

 

6,123,970

 

6,150,495

 

 

 

 

 

 

 

 

 

Other Income:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

     Service charges on deposit accounts

 

263,643

 

251,680

 

809,208

 

724,313

     Mortgage banking income

 

430,994

 

265,052

 

1,298,086

 

758,018

     Securities gains, net

 

0

 

0

 

0

 

4,357

     Other operating income

 

125,824

 

84,894

 

334,177

 

287,254

             Total otherincome

 

820,461

 

601,626

 

2,441,471

 

1,773,942

 

 

 

 

 

 

 

 

 

 Other Expense:

 

 

 

 

 

 

 

 

     Salaries and other personnel expense

 

1,182,546

 

1,075,515

 

3,649,732

 

3,190,814

     Net occupancy and equipment expense

 

247,913

 

216,682

 

741,328

 

672,454

     Other operating expense

 

468,163

 

421,462

 

1,382,773

 

1,261,927

             Total otherexpense

 

1,898,622

 

1,713,659

 

5,773,833

 

5,125,195

 

 

 

 

 

 

 

 

 

             Earnings beforeincome taxes

 

1,034,441

 

1,032,599

 

2,791,608

 

2,799,242

 

 

 

 

 

 

 

 

 

Income taxes

 

311,506

 

323,090

 

834,251

 

854,536

 

 

 

 

 

 

 

 

 

             Netearnings 

 $

722,935

 

709,509

 

1,957,357

 

1,944,706

 

 

 

 

 

 

 

 

 

Earnings per common share based on average

 

 

 

 

 

 

 

 

     outstanding shares of 899,885 in 2003 and 2002:

 $

0.80

 

0.79

 

2.18

 

2.16

See accompanying notes to financial statements.

4
**OCONEE FINANCIAL CORPORATION AND SUBSIDIARY**

Consolidated Statements of Comprehensive Income

For the Three Months and the Nine Months Ended September 30, 2003 and2002(Unaudited)

 

** **

**Three Months Ended**

** **

**Nine Months Ended**

 

** **

**2003**

** **

**2002**

 

**2003**

** **

**2002**

 

 

 

    

 

    

 

    

 

Net earnings 

$

  722,935 

 

709,509 

 

1,957,357 

 

1,944,706 

 

 

 

 

 

 

 

 

 

Other comprehensive income, net of tax:

 

 

 

 

 

 

 

 

     Unrealized gains on securities available for sale:

 

 

 

 

 

 

 

 

          Holding gains (losses) arisingduring period, net of tax (benefit)

 

 

 

 

 

 

 

 

             of ($335,286),$167,174, ($70,887), and $365,778

 

(547,975)

 

273,220 

 

(115,854)

 

597,810 

          Reclassification adjustments forgains included in net 

 

 

 

 

 

 

 

 

             earnings, net oftax of $0, $0, $0, and ($1,654)

 

0 

 

0 

 

0 

 

(2,703)

 

 

 

 

 

 

 

 

 

          Total other comprehensiveincome

 

(547,975)

 

273,220 

 

(115,854)

 

595,107 

 

 

 

 

 

 

 

 

 

          Comprehensive income

$

174,960 

 

982,729 

 

1,841,503

 

2,539,813 

****

****

****

****

****

****

****

****

****

****

****

****

See accompanying notes to financial statements.

5
**OCONEE FINANCIAL CORPORATION AND SUBSIDIARY**

Consolidated Statements of Cash Flows

For the Nine Months Ended September 30, 2003 and 2002(Unaudited)
 
** **

**2003**

** **

**2002**

Cash flows from operating activities:

 
 
 
 
     Net earnings

$

1,957,357 

    

1,944,706 

         Adjustments to reconcile netearnings to net

 
 
 

 

            cash provided byoperating activities:

 
 
 

 

                Provision for loanlosses

 

513,000 

 

315,000 

                Depreciation, amortizationand accretion

 

356,835 

 

334,139 

                Gain on sale of investmentsecurities

 

0 

 

(4,357)

                Change in assets andliabilities:
 
   
                    Interestreceivable and other assets

 

634,270 

 

489,157 

                    Interestpayable and other liabilities

 

(222,846)

 

(153,240)

                    Mortgageloans held for sale

 

3,968,277 

 

1,428,591 
 
 

 

 
 
                           Netcash provided by operating activities

 

7,206,893 

 

4,353,996 
 
 

 

 
 
Cash flows from investing activities:

 

 

 
 
     Proceeds from sale of investment securities

 

0 

 

999,688 

     Proceeds from calls, maturities, and paydowns of

 

 

 
 
         investment securities available forsale
 
36,679,302 
 
8,241,843 

     Purchases of investment securities available forsale

 

(39,533,894)

 

(2,069,529)

     Investment in unconsolidated subsidiary

 

0 

 

  (325,000)

     Net change in loans

 

4,800,236 

 

(30,039,669)

     Purchases of premises and equipment

 

(993,439)

 

  (1,578,999)

     Proceeds from sale of other real estate owned
 
209,715 
 
0 
 
 

 

 
 
                           Net cash provided (used) by investing activities

 

1,161,920 

 

  (24,771,666)
 
 

 

 

 

Cash flows from financing activities:

 

 

 

 

     Net change in deposits

 

15,366,858 

 

20,612,944 

     Net change in securities sold under repurchaseagreements

 

102,635 

 

597,964 

     Repayment of Federal Home Loan Bank Advance

 

(13,300,000)

 

0 

     Dividends paid

 

(899,885)

 

(899,885)
 
 

 

 
 
                           Netcash provided by financing activities

 

1,269,608 

 

20,311,023 
 
 
 
 

 

Net increase (decrease) in cash and cash equivalents

 

9,638,421 

 

(106,647)
 
 
 
 

 

Cash and cash equivalents at beginning of period

 

15,865,399 

 

13,938,077 
 
 
 
 

 

Cash and cash equivalents at end of period

$

25,503,820 

 

13,831,430 

6
**OCONEE FINANCIAL CORPORATION AND SUBSIDIARY**

Consolidated Statements of Cash Flows, continued

For the Nine Months Ended September 30, 2003 and 2002(Unaudited)
  
**2003**** **
**2002**     Supplemental cash flow information    
     Cash paid for interest

$

4,411,626 

     $

4,178,665

     Cash paid for taxes

$

949,500 

$

951,000
     
Noncash investing and financing activities:
    
     Transfer from loans to other real estate owned

$

796,216 

$

165,500

      Financed sale of other real estate owned

$

46,965 

$

0

     Change in dividends payable

$

899,885 

$

899,885

     Change in net unrealized gain on investmentsecurities
    
        available for sale, net of tax

$

(115,854)

$

595,107
          
** **

** **

** **

** **

** **

** **

** **

** **

See accompanying notes to financial statements.

7
**OCONEE FINANCIAL CORPORATION AND SUBSIDIARY**

Notes to Consolidated Financial Statements(Unaudited)

(1)           Basis ofPresentation

The financial statements include the accounts of Oconee Financial Corporation (the“Corporation”) and its wholly-owned subsidiary, Oconee State Bank (the “Bank”).  All significantintercompany accounts and transactions have been eliminated in consolidation.

In September 2002, OSB Services, Inc., a wholly owned subsidiary of the Bank, acquired anownership interest in Community Insurance Group, LLC through an initial capital contribution of $325,000.  Community InsuranceGroup, LLC was formed for the purpose of offering insurance products and services.  The investment in Community InsuranceGroup, LLC is accounted for using the cost method of accounting.

The consolidated financial information furnished herein reflects all adjustments whichare, in the opinion of management, necessary to present a fair statement of the results of operations and financial position forthe periods covered herein.  All such adjustments are of a normal recurring nature.

Operating results for the three and nine-month periods ended September 30, 2003 are notnecessarily indicative of the results that may be expected for the year ending December 31, 2003.  For further information,refer to the financial statements and footnotes included in the Corporation’s annual report included on Form 10-KSB for theyear ended December 31, 2002.

Critical Accounting Policies

The Corporation’s accounting policies are fundamental to understandingmanagement’s discussion and analysis of results of operations and financial condition.  Some of the Corporation’saccounting policies require significant judgment regarding valuation of assets and liabilities and/or significant interpretation ofthe specific accounting guidance.  A description of the Corporation’s significant accounting policies can be found inNote 1 of the Notes to Consolidated Financial Statements in the Company’s 10-KSB for the year ended December 31,2002. 

Many of the Corporation’s assets and liabilities are recorded using variousvaluation techniques that require significant judgment as to recoverability.  The collectibilityof loans is reflected through the Corporation’s estimate of the allowance forloan losses.  The Corporation performs periodic detailed reviews of itsloan portfolio in order to assess the adequacy of the allowance for loan lossesin light of anticipated risks and loan losses.  In addition, investmentsecurities and mortgage loans held for sale are reflected at their estimatedfair value in the consolidated financial statements.  Such amounts arebased on either quoted market prices or estimated values derived by theCorporation using dealer quotes or market comparisons. 

  (2)          Cash and CashEquivalents

For presentation in the financial statements, cash and cash equivalents include cash onhand and amounts due from banks, and federal funds sold.

(3)          NetEarnings Per Common Share

Net earnings per common share are based on the weighted average number of common sharesoutstanding during the period.

  

8 
**OCONEE FINANCIAL CORPORATION AND SUBSIDIARY**

Notes to Consolidated Financial Statements, continued(Unaudited)

(4)           Allowance for LoanLosses

               Changes in the allowance for loan losses were as follows:

 

** **

**2003**

** **

**2002**

 

 

 

 

 

Balance at beginning of year

$

2,098,691 

 

1,812,041 

Amounts charged off

 

(98,773)

 

(97,961)

Recoveries on amounts previously charged off

 

22,188 

 

27,973 

Provision for loan losses

 

513,000 

 

315,000 

 

 

 

 

 

Balance at September 30

$

2,535,106 

 

2,057,053 

 

9  Item 2.
**MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIALCONDITION AND RESULTS OF OPERATIONS**
**Forward-Looking Statements**
**               **Thisdiscussion contains forward-looking statements under the private Securities Litigation Reform Act of 1995 that involve risk anduncertainties.  Although the Corporation believes that the assumptions underlying the forward-looking statements contained inthe discussion are reasonable, any of the assumptions could be inaccurate, and therefore, no assurance can be made that any of theforward-looking statements included in this discussion will be accurate.  Factors that could cause actual results to differfrom results discussed in forward-looking statements include, but are not limited to: economic conditions (both generally and inthe markets where the Corporation operates); competition from other providers of financial services offered by the Corporation;government regulations and legislation; changes in interest rates; material unforeseen changes in the financial stability andliquidity of the Corporation’s credit customers, all of which are difficult to predict and which may be beyond the control ofthe Corporation.  The Corporation undertakes no obligation to revise forward-looking statements to reflect events or changesafter the date of this discussion or to reflect the occurrence of unanticipated events.

**Financial Condition**

                Total assets at September30,2003were $249,531,347, representing a $2,888,264 (1.17%) increase from December 31,2002.  Deposits increased $15,366,858 (7.27%) from December 31, 2002.  The growth in deposits is attributable toincreases in savings accounts of $17,339,657 and noninterest-bearing checking accounts of $3,073,324, offset by decreases ininterest-bearing checking accounts of $3,876,927, time deposits of $716,805, and money market accounts of $452,391.  Loansdecreased $5,626,072 (3.13%) from December 31, 2002 as a result of a decrease in loan demand, tightened credit standards put inplace by the Bank in response to the slow economy, and the payoff of a $3,000,000 motel loan during the first nine months of2003.  Investment securities increased $2,680,512 (6.89%) from December 31, 2002.  The allowance for loan losses atSeptember 30, 2003 was $2,535,106, compared to the December 31, 2002 balance of $2,098,691, representing 1.46% of total loans atSeptember 30, 2003, compared to 1.17% of total loans at December 31, 2002. Cash and cash equivalents increased $9,638,421 fromDecember 31, 2002.  This increase is primarily due to deposit growth outpacing loan growth.  These excess funds areinvested in Federal Funds sold, as the low interest rate market in investment securities was not deemed to be an attractivealternative.  During the third quarter of 2003, the Corporation’s $13,300,000 advance with the Federal Home Loan Bankmatured and was repaid.

               The total amount of nonperforming assets, which includes nonaccruing loans, other real estate owned, repossessed collateral andloans for which payments are more than 90 days past due was $1,339,455 at September 30, 2003, representing a decrease of $1,559,107(53.79%) from December 31, 2002.  This decrease is primarily attributable to a decrease of  $2,074,842 in nonaccrualloans, offset by an increase of $524,004 in other real estate owned.  As a result of the decrease, total nonperforming assetswere 0.77% of total loans at September 30, 2003 compared to 1.61% of total loans at December 31, 2002.  Nonperforming loansrepresented 0.54% of total assets at September 30, 2003, compared to 1.18% of total assets at December 31, 2002.  Nonaccrualloans represented 0.30% of total loans outstanding at September 30, 2003, compared to 1.45% of total loans outstanding at December31, 2002.  The decrease in nonaccrual loans is primarily due to the payoffs of three loans that were on nonaccrual status atDecember 31, 2002.  The increase in other real estate owned is a result of the Bank foreclosing on six properties during 2003that had not been sold as of September 30, 2003.  There were no related party loans which were considered to be nonperformingat June 30, 2003.

                At September 30, 2003, the Corporation had loan concentrations in the housing industry and inthe hotel and motel industry.  As of September 30, 2003, the Corporation had total funded and unfunded commitments forconstruction and development loans of $66,872,908, of which $44,770,501 was funded and outstanding.  Total funded and unfundedcommitment amounts for hotel and motel loans were $28,519,281 at September 30, 2003.  Of the total commitments for hotel andmotel loans, $28,279,092 was funded and outstanding at September 30, 2003.  The Corporation monitorsthese concentrations on a monthly basis.  The primary risk relating to the concentration in the housing industry is a downturnin the economy which would adversely affect construction of new homes and developments of new housing communities.  TheCorporation’s construction and development lending slowed somewhat during the first three quarters of2003.  The Corporation’s primary risk relating to the hotel and motel industry is a slowdownin the travel and tourism industry.  The Corporation has established $30,000,000 as the maximumdollar amount of hotel and motel loans that it is willing to fund.  Management of the Corporation isconfident that all of the Corporation’s hotel and motel loans are adequately collateralized in theunforeseen event that cash flows from operations of the hotels and motels are not sufficient to meet the terms of repaymentoutlined in the loan agreements.

10
**Results of Operations**

                Net interest income increased$171,475 (2.65%) in the first nine months of 2003 compared to the same period for 2002.  Interest income for the first ninemonths of 2003 was $11,002,051, representing a decrease of $175,043 (1.57%) as compared to the same period in 2002.  For thequarter ended September 30, 2003, interest income on loans decreased $306,355 (9.03%) compared to the quarter ended September 30,2003.  Interest expense for the first nine months of 2003 decreased  $346,518 (7.35%)compared tothe same period in 2002.  The decrease in interest income during the first nine months of 2003 compared tothe same period in 2002 is primarily attributable to a decrease in the volume of loans offset by an increase in investmentsecurities.  The decrease in interest expense is primarily attributable to a lower interest rate environment during the firstnine months of 2003 as compared to the same period in 2002.

                The Bank’s net interestmargin for the first nine months of 2003 was 3.72%, compared to 4.31% for the same time period during 2002.  Yield on interestearning assets for the nine-month period ending September 30, 2003 was 6.06%, compared to 7.32% for the nine-month period endingSeptember 30, 2002.  Average rate paid on interest bearing liabilities was 2.75% for the nine months ending September 30,2003, compared to 3.57% for the same period during 2002.  Although net interest income increased 2.65%, the Bank’s netinterest margin decreased due to a $40,211,718 (19.43%) increase in average interest earning assets from September 30, 2002 toSeptember 30, 2003.  The components of the increase in interest earning assets were a $11,179,435 increase in loansoutstanding, an increase of $4,054,118 in mortgage loans originated and held for sale, a $12,349,483 increase in investmentsecurities, and a $12,628,682 increase in federal funds sold.  Another major contributor to the reduction of the Bank’snet interest margin was the continued low rate environment, which was further affected by a 0.25% reduction in the prime rate ofinterest during the first nine months of 2003.  However, during the third quarter of 2003, the Bank became liabilitysensitive.  Any further reductions in the prime rate would be expected to produce an increase in the Bank’s net interestincome.

               The Bank analyzes its allowance for loan losses on a monthly basis.  Additions to the allowance for loan losses are made bycharges to the provision for loan losses.  Loans deemed to be uncollectible are charged against theallowance for loan losses.  Recoveries of previously charged off amounts are credited to the allowance for loan losses. For the nine months ended September 30, 2003, the provision for loan losses was $513,000, compared to $315,000for the same period in 2002.  The increase in the provision for loan losses is primarily attributable to an increase in thelevel of classified loans due to the current economic environment.** ** The nature of the process by which the Corporationdetermines the appropriate allowance for loan losses requires the exercise of considerable judgment.  It ismanagement’s belief that the allowance for loan losses is adequate to absorb possible losses in the portfolio.

               Other income for the first nine months of 2003 increased $667,529 (37.63%) compared to the first ninemonths of 2002.  This increase is primarily attributable to a $540,068 increase in fee income on mortgageloans originated and sold and an increase in non-sufficient funds (NSF) charges of $78,534.  The increase in fee income onmortgage loans is due to an increase in the volume of mortgage loans that the Bank originated during the first nine months of 2003as a result of the continued low mortgage interest rates and strong refinancing demand.  However, with mortgage rates rising,it is anticipated that the income produced in association with these types of loans will return to their historically normal levelsduring the third quarter of 2003.  The increase in NSF charges is primarily due to growth in the number of transactionaccounts.

                Other expenses for the first ninemonths of 2003 increased $648,638 (12.66%) compared to the first nine months in 2002. The increase is primarily attributable to a $458,918 (14.38%) increase insalaries and benefits expense primarily due to an increase in commissions paid to the bank’s mortgage loan originator due toa substantial increase in the volume of mortgage loans originated and merit increases for other employees based onperformance.

                The Bank’s effective taxrate was 30% for the nine months ended September 30, 2003 and 2002.

**Interest rate sensitivity**

**               **Interest rate sensitivity is a function of the repricing characteristics of the Bank’s portfolio of assets andliabilities.  These repricing characteristics are the time frames within which the interest earning assets and liabilities aresubject to change in interest rates either at replacement, repricing or maturity during the life of the instruments.  Onemethod to measure interest rate sensitivity is through a repricing gap.  The gap is calculated by taking all assets thatreprice or mature within a given time frame and subtracting all liabilities that reprice or mature during that time frame.  Anegative gap (more liabilities repricing than assets) generally indicates that the Bank’s net interest income will decreaseif interest rates rise and will increase if interest rates fall.  A positive gap generally indicates that the Bank’s netinterest income will decrease if rates fall and will increase if rates rise. 

11
           The Bank also measures its short-term exposure to interest rate risk by simulating the impact to net interest income underseveral rate change levels.  Interest-earning assets and interest-bearing liabilities are rate shocked to stress test theimpact to the Bank’s net interest income and margin.  The rate shock levels span three 100 basis point increments up anddown from current interest rates.  This information is used to monitor interest rate exposure risk relative to anticipatedinterest rate trends.  Asset/liability management strategies are developed based on this analysis in an effort to limit theBank’s exposure to interest rate risk.

               The Bank tracks its interest rate sensitivity on a monthly basis using a model, which applies betas to various types ofinterest-bearing deposit accounts.  The betas represent the Bank’s inclination to repricedeposit rates based on historical data provided from a call report drivendatabase.  The betas are used because it is not likely that deposit rateswould change the full amount of a prime rate increase or decrease. 

               At September 30, 2003, the difference between the Bank’s liabilities and assets repricing or maturing within one year, afterapplying the betas, was $3,433,057, indicating that the Bank was liability sensitive.  Rate shock data show that theBank’s net interest income would decrease $85,589 on an annual basis if rates increased 100 basis points, and would increase$85,589 on an annual basis if rates fell 100 basis points.  Prior to the third quarter of 2003, the Bank was asset sensitive,which would explain why the reduction in interest rates had a negative impact on the Bank’s net interest margin.

               Certain shortcomings are inherent in the method of analysis presented in the foregoing paragraph.  For example, althoughcertain assets and liabilities may have similar maturities or periods to repricing, they may react in different degrees or atdifferent points in time to changes in market interest rates.  Additionally, certain assets, such as adjustable-ratemortgages, have features that restrict changes in interest rates, both on a short-term basis and over the life of the asset. Changes in interest rates, prepayment rates, early withdrawal levels and the ability of borrowers to service their debt, amongother factors, may change significantly from the assumptions made above.  In addition, significant rate decreases would notlikely be reflected in the liability repricing and therefore would make the Bank more sensitive in a falling rateenvironment.
**Liquidity**
                The Corporation must maintain, ona daily basis, sufficient funds to cover the withdrawals from depositors’ accounts and to supply new borrowers withfunds.  To meet these obligations, the Corporation keeps cash on hand, maintains account balances with its correspondentbanks, and purchases and sells federal funds and other short-term investments.  Asset and liability maturities are monitoredin an attempt to match these to meet liquidity needs.  It is the policy of the Corporation to monitor its liquidity to meetregulatory requirements and its local funding requirements.

                The Corporation monitors itsliquidity position monthly.  The primary tool used in this analysis is an internal calculation of a liquidity ratio. This ratio is calculated by dividing the Corporation’s short-term and marketable assets, including cash, federal funds sold,and unpledged investment securities by the sum of the Corporation’s deposit liabilities and securities sold under agreementto repurchase.  At September 30, 2003, the Corporation’s liquidity ratio was20.4%.  This level of liquidity is within the Bank’s stated guidelines of 15-35%.

                The Corporation maintainsrelationships with correspondent banks that can provide funds to it on short notice, if needed.  Presently, the Corporationhas arrangements with a commercial bank for short term unsecured advances up to $5,600,000.  Additional liquidity is providedto the Corporation through available Federal Home Loan Bank advances, none of which were outstanding at September 30,2003.

               During the first nine months of 2003, cash and cash equivalents increased $9,638,421 to a total of $25,503,820at September 30, 2003.  Cash inflows from operations totaled $7,206,893 during the first nine months of 2003, while inflowsfrom financing activities totaled $1,269,608, most of which were net deposit increases during the first nine months of $15,366,858, offset by cash dividends paid during the first nine months of 2003 of $899,885, as well as the repayment of a$13,300,000 advance from the Federal Home Loan Bank in August of 2003.

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                Investing activities provided$1,161,920 of cash and cash equivalents, consisting of purchases of investment securities of $39,533,894 and purchases of premisesand equipment of $993,439, offset by net repayments of loans by customers of $4,800,236 and proceeds from the sales, calls,maturities and paydowns of investment securities totaling $36,679,302.  At September 30, 2003, the Bank had $41,579,749 ofinvestment securities available for sale.
**Contractual Obligations and Commitments**
               The Corporation is party to financial instruments with off-balance sheet risk in the normal course ofbusiness to meet the financing needs of its customers.  These financial instruments include commitments to extend credit,standby letters of credit and financial guarantees.  These instruments involve, to varying degrees, elements of credit risk inexcess of the amount recognized on the balance sheet.  The contract amounts of these instruments reflect the extent ofinvolvement the Corporation has in particular classes of financial instruments.  AtSeptember 30, 2003, the contractual amounts of the Corporation’s commitments to extend creditand standby letters of credit were $38,331,000and$1,134,000, respectively.

                Commitments to extend credit areagreements to lend to a customer as long as there is no violation of any condition established in the contract.  Commitmentsgenerally have fixed expiration dates and because they may expire without being drawn upon, the total commitment amount of$38,331,000 does not necessarily represent future cash requirements.  Standby letters of credit and financial guaranteeswritten are conditional commitments issued by the Corporation to guarantee the performance of a customer to a thirdparty.

**Capital**

               The following tables present Oconee State Bank’s regulatory capital position at September 30,2003, based on the regulatory capital requirements of federal banking agencies.  The capital ratios of the Corporation areessentially the same as those of the Bank at September 30, 2003 and thereforeonly the Bank’s ratios are presented.

Risk-Based Capital Ratios

 

Tier 1 Capital, Actual

 

11.4%

Tier 1 Capital minimum requirement

 

4.0%

 

 

 

Excess

 

7.4%

 

 

 

Total Capital, Actual

 

12.6%

Total Capital minimum requirement

 

8.0%

 

 

 

Excess

 

4.6%

 

 

 

Leverage Ratio

 

 

 

 

 

Tier 1 Capital to adjusted total assets

 

7.7%

Minimum leverage requirement

 

 3.0%

 

 

 

Excess

 

4.7%

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Item 3.

**CONTROLS AND PROCEDURES**

               Our management, including the chief executive and chief financial officers, supervised and participated in an evaluation of ourdisclosure controls and procedures (as defined in federal securities rules) as of June 30, 2003. Based on that evaluation, our CEOand CFO have concluded that our disclosure controls and procedures are effective in accumulating and communicating information toour management, including our President and CEO and CFO, as appropriate to allow timely decisions regarding required disclosures ofthat information under the Securities and Exchange Commission’s rules and forms and that our disclosure controls andprocedures are designed to ensure that the information we are required to disclose in reports that we file or submit under allapplicable federal securities law is recorded, processed, summarized and reported within the time periods specified in theSecurities and Exchange Commission’s rules and forms.

               There were no significant changes in our internal controls or in other factors that could significantly affect these controlssubsequent to the date of their evaluation.
 
 

 

 

 

 

14
**PART II.  OTHER INFORMATION**

**OCONEE FINANCIAL CORPORATION AND SUBSIDIARY**

Item 1.     LegalProceedings

                         None

Item 2.     Changes inSecurities and Use of Proceeds

                         None

Item 3.     Defaults UponSenior Securities

                         None

Item 4.    Submission of Matters to a Vote of Security Holders

                         None

Item 5.     OtherInformation

                         None

Item 6.    Exhibits andReports on Form 8-K

(a)  

Exhibits

 

 

31.1

Certification by B. Amrey Harden, CEO and President of the Corporation, asadopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

 

31.2

Certification by Jerry K. Wages, Executive Vice President and ChiefFinancial Officer of the Corporation, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

 

32

Joint Certification of the Chief Executive Officer and the Chief Financial Officerpursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

                             (b)  

Reports on Form 8-K

 

There were no 8-K filings during the quarter for which this report isfiled.

15 
**OCONEE FINANCIAL CORPORATION AND SUBSIDIARY**

**SIGNATURES**

****

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

 

          OCONEE FINANCIALCORPORATION

 

 

By:  /s/ B. Amrey Harden                                                       B. Amrey Harden, President and CEO        (Principal Executive Officer)

  

Date:      November 14, 2003                                                

  

By:   /s/ Jerry K. Wages                                                           Jerry K. Wages        Executive Vice-President and CFO        (Principal Accounting Officer)

 

 Date:      November 14,2003