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**UNITED STATES****SECURITIES AND EXCHANGECOMMISSION****WASHINGTON, D. C. 20549****FORM 10-Q**
/X/     QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THESECURITIES EXCHANGE ACT OF 1934For the quarter period endedSeptember 30, 2003
/  /     TRANSITION REPORT PURSUANT TOSECTION 13 OR 15 (d) OF THESECURITIES EXCHANGE ACT OF 1934For thetransition period from _______ to _______
Commission File Number:33-81890
**Community Bankshares, Inc.**(Exact name ofregistrant as specified in its charter)
**Georgia**
 
**58-1415887**

*(State or other jurisdiction of* 
*(IRS Employer*
*incorporation or organization)* 
*Identification No.)*
 

**448 North Main Street,**  
**Cornelia, Georgia** 
**30531**
*(Address of principal executive offices)* 
*(Zip Code)*
**(706) 778-2265***(Registrant’s telephone number, including areacode)*
**N/A***(Former name, former address and former fiscal**year,if changed since last report)*
Indicate by check mark whether the registrant has (1) has  filed all reportsrequired to be filed by Section 13 or  15 (d) of the Securities Exchange Act of1934 during  the preceding 12 months (or for such shorter period  that theregistrant was required to file such reports)  and (2) has been subject to suchfiling requirements  for the past 90 days. Yes  þ   No   ̈
Indicate the number of shares outstanding of each of the issuer’s classesof common stock, as of November 5, 2003:  2,144,195
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**COMMUNITY BANKSHARES, INC.****ANDSUBSIDIARIES****INDEX**
 
Page No.
**PART I. FINANCIAL INFORMATION**
 
**Item 1.**

**Financial Statements**
   
Consolidated Balance Sheets - 

 3 
September 30, 2003 and December 31, 2002
  
Consolidated Statements of Income

 4 
and Comprehensive Income for Three 
 
Months Ended September 30, 2003 and 2002
 
and Nine Months Ended September 30, 2003
 
and 2002
  
Consolidated Statements of Cash Flows - 

 5 
Nine Months Ended September 30, 2003 and 2002
  
Notes to Consolidated Financial Statements

6 
**Item 2.**

**Management’s Discussion and Analysis of**

 11** **
**Financial Condition and Results of Operations**
 
**Item 3.**

**Quantitative and Qualitative Disclosures about Market Risk**

 13 
**Item 4.**

**Controls and Procedures**

 18 
**PART II. OTHER INFORMATION**

  
**Item 6.**

**Exhibits and Reports on Form 8 - K**

 18  
31.1 and 31.2 Rule 13a-15(e) and 15d-15(e) Certifications

   
32.1 and 32.2 Certification of Chief Executive Officer, ChiefFinancial Officer, Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant toSection 9-6 of the Sarbanes-Oxley Act of 2002.

   
Signatures

 19
 

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PART I - FINANCIAL INFORMATION

**ITEM 1.  FINANCIAL STATEMENTS**

COMMUNITY BANKSHARES, INC.

AND SUBSIDIARIES
 
CONSOLIDATEDBALANCE SHEETS

SEPTEMBER 30, 2003 AND DECEMBER 31, 2002

(Dollars in thousands)
    
(Unaudited)
   
Assets

 2003 
  2002
      
Cash and due from banks

$

35,730
 
$

44,966

Interest-bearing deposits in banks
 
491
  
499

Federal funds sold
 
25,150
  
9,200

Securities available-for-sale
 
105,252
  
100,356

Securities held-to-maturity (fair value     $24,762 and $28,681)
 
23,010
  
27,016

Restricted equity securities
 
1,243
  
1,215
      
Loans
 
517,127
  
491,368

Less allowance for loan losses
 
7,896
  
 7,742

          Loans, net
 
509,231
  
483,626
      
Premises and equipment
 
15,105
  
16,295

Other assets
 
20,022
  
17,073
      
          Totalassets

$ 

735,234
 
$

700,246
      
Liabilities, Redeemable Common Stock and Shareholders’Equity
           
Deposits
     
    Noninterest-bearing demand

$

106,272
 
$

87,650

    Interest-bearing demand
 
145,918
  
146,092

    Savings
 
35,176
  
30,228

    Time, $100,000 and over
 
126,591
  
123,991

    Other time
 
227,076
  
219,394

          Totaldeposits
 
641,033
  
607,355

Other borrowings
 
16,300
  
16,665

Other liabilities
 
8,314
  
 9,181

          Totalliabilities
 
665,647
  
633,201
      
Redeemable common stock held by ESOP, net of unearned ESOP shares related toESOP debt guarantee of $1,224,575 and $1,363,831at September 30, 2003     and December 31, 2002, respectively
 
15,438
  
15,194
       
 Shareholders'equity
     
    Commonstock, par value $1; 5,000,000        Shares authorized; 2,204,330 and2,201,330        Shares issued at September 30, 2003and December 31, 2002
 
2,204
  
2,201

   Capital surplus
 
6,341
  
6,315

   Retained earnings
 
46,607
  
42,802

   Accumulated other comprehensive income           net of tax
 
1,560
  
1,962

    Lesscost of 60,135 and 34,573 shares of treasury    stock at September 30, 2003 and December 31, 2002
 
(2,563)
  
(1,429)

         Total shareholders' equity
 
54,149
  
51,851
      
  Total liabilities,redeemable common stock and shareholders' equity

$

735,234
 
$

700,246
      
See Notes to ConsolidatedFinancial Statements.
      
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COMMUNITY BANKSHARES, INC.AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF INCOMEAND COMPREHESIVE INCOMETHREE MONTHS ENDED SEPTEMBER 30, 2003 AND 2002 ANDNINE MONTHS ENDED SEPTEMBER 30, 2003 AND 2002(Dollars in thousands, except per share amounts)(Unaudited)
           
Three Months Ended
  
Nine Months Ended
  
September 30,
  
September 30,
  
2003
  
2002
  
2003
  
  2002

Interest income
           
    Loans

$

9,442 
 
$

9,395
 
$

28,189   
 
$

28,098 

    Taxable securities
 
575 
  
720
  
1,822 
  
2,086 

    Nontaxable securities
 
746 
  
774
  
2,268 
  
2,213 

    Deposits in banks
 
1 
   
3
  
6 
  
9 

    Federal funds sold
 
49 
  
61
  
186 
  
272 

          Total interestincome
 
10,813 
  
10,953
  
32,471 
  
32,678 
            
Interest expense
           
    Deposits
 
2,985 
  
3,837
  
9,656 
  
12,101 

    Other borrowings
 
198 
  
181
  
592 
  
518 

           Total interestexpense
 
3,183 
  
4,018
  
10,248 
  
12,619 
            
          Net interestincome
 
7,630 
  
6,935
  
22,223 
  
20,059 

Provision for loan losses
 
546 
  
641
  
1,686 
  
1,694 

          Net interest incomeafter               Provision for loan losses
 
7,084 
  
6,294
  
20,537 
  
18,365 
            
Other income
           
    Service charges on deposit accounts
 
1,404 
  
1,325
  
4,010 
  
3,816 

    Other service charges and fees
 
478 
  
448
  
1,475 
  
1,150 

    Gains on sale of loans
 
93 
  
108
  
180 
  
155 

    Nonbank subsidiary non-interest income
 
627 
  
3,029
  
2,163 
  
7,186 

    Security transactions, net
 
-- 
  
--
  
-- 
  
139 

    Other operating income
 
159 
  
159
  
456 
  
552 

          Total otherincome
 
2,761 
  
5,069
  
8,284 
  
12,998 
            
Other expenses
           
    Salaries and employee benefits
 
4,316 
  
4,332
  
12,940 
  
13,007 

    Equipment expense
 
822 
  
819
  
2,483 
  
2,384 

    Occupancy expense
 
497 
  
477
  
1,476 
  
1,380 

    Other operating expenses
 
2,348 
  
2,194
  
6,805 
  
6,569 

          Total otherexpenses
 
7,983 
  
7,822
  
23,704 
  
23,340 
            
          Income before incometaxes
 
1,862 
  
3,541
  
5,117 
  
8,023 
            
Income tax expense
 
437 
  
1,006
  
1,061 
  
2,259 
             
          Net income

$

1,425 
 
$

2,535
 
$

4,056 
 
$

5,764 
             
Other comprehensive income :
           
     Unrealized gains on securities:          Unrealized holdinggains arising during          period, net oftax
 
(1,132)
  
1,331
  
(402)
  
2,294 

     Less: reclassification adjustment for(gains)             lossesrealized in net income, net of tax 
 
-- 
  
--
  
-- 
  
(83)

     Total other comprehensive income 
 
(1,132)
  
1,331
  
(402)
  
2,211 
             
          Comprehensiveincome

$

293 
 
$

3,866
 
$

3,654 
 
$

7,975 
            
Basic earnings per common share

$

.67 
 
$

1.17
 
$

1.89 
 
$

2.64 

Diluted earnings per common share
 
.66 
  
1.16
  
1.88 
  
2.64 

Cash dividends per share of common stock

$

.07 
 
$

.06
 
$

.21 
 
$

.18 

 
           
See Notes to Consolidated Financial Statements.
           
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COMMUNITY BANKSHARES, INC.

AND SUBSIDIARIES
 
CONSOLIDATED STATEMENTS OFCASH FLOWS

FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2003 AND2002

(Dollars in thousands)

(Unaudited)
   
2003
  
2002
      
OPERATING ACTIVITIES
     
    Net income

$

4,056 
 
$

5,764 

    Adjustments to reconcile net income to        net cash provided byoperating        activities:
     
        Depreciation andamortization
 
2,330 
  
2,406 

        Provision for loanlosses
 
1,686 
  
1,694 

        Deferred income taxes
 
(513)
  
1,116 

        Net realized gains onsecurities          
 
-- 
  
(139)

        Net losses on sale of other realestate
 
49 
  
32 

        Decrease in interestreceivable
 
272 
  
640 

        Increase  in interestpayable
 
(985)
  
(3,029)

        Increase in taxespayable
 
586 
  
250 

        (Increase) Decrease inaccounts          receivable ofnonblank subsidiary   
 
(142)
  
633 

        Decrease in work in           Process of nonbanksubsidiary
 
319 
  
135 

        Decrease in accrualsand          payables of nonbanksubsidiary
 
(668)
  
(654)

        Net other operatingactivities
 
55 
  
(1,718)
     
              Net cash provided by                 operatingactivities
 
7,044 
  
7,130 
     
INVESTING ACTIVITIES
     
    Purchases of securities available-for-sale
 
(25,311)
  
(32,233)

    Proceeds from sales of securities      Available-for-sale
 
-- 
  
5,188 

    Proceeds from maturities of securities       Available-for-sale
 
19,717 
  
8,494 

    Proceeds from maturities of securities      Held-to-maturity
 
4,006 
  
1,724 

    Net (increase) in Federal funds sold
 
(15,950)
  
10,265 

    Net (increase) in interest-bearing     Deposits in banks
 
8 
  
(128)

    Net (increase) in loans
 
(32,936)
  
(29,038)

    Purchase of premises and equipment
 
(826)
  
(1,985)

    Proceeds from sale of premises and equipment
 
-- 
  
8 

    Proceeds from sales of other real estate
 
3,254 
  
3,302 
     
  Net cash used in        investing activities
 
(48,038)
  
(34,403)
      
FINANCING ACTIVITIES
     
    Net increase in deposits
 
33,677 
  
26,140 

    Net increase in other borrowings
 
75 
  
5,000 

    Repayment of other borrowings
 
(440)
  
(259)

    Purchase of TreasuryStock
 
(1,134)
  
(1,305)

    Proceeds from exercise of stock options
 
30 
  
-- 

    Dividends paid
 
(451)
  
(392)
      
              Net cash provided by                Financing activities

 

31,757 
 
 

29,184 

Net (decrease) in cash and   due from banks

$

(9,236)
 
$

1,911 
      
Cash and due from banks at beginning of the period
 
44,966 
  
 37,182 
      
Cash and due from banks at end of the period

$ 

35,730 
 
$

39,093 
      
SUPPLEMENTAL DISCLOSURES
     
    Cash paid for:
     
        Interest

$

11,233 
 
$

15,648 
      
        Income taxes

$

1,498 
 
$

2,183 
      
NONCASH TRANSACTIONS
           
    Principal balances on loans        Transferred to other      real estate

 $

5,644 

$

4,041 
            
 See Notes to Consolidated Financial Statements

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COMMUNITY BANKSHARES, INC.AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIALSTATEMENTS

NOTE 1.             BASIS OFPRESENTATION

The consolidated financial information included herein is unaudited; however, suchinformation reflects all adjustments (consisting solely of normal recurring adjustments) which are, in opinion of management,necessary for a fair statement of results for the interim periods.

The results of operations for the three and nine month periods ending September 30, 2003are not necessarily indicative of the results to be expected for the full year.

NOTE 2.  STOCK COMPENSATION PLAN

As of September 30, 2003, the Company had a stock-based employee compensation plan. The Company accounts for the plan under the recognition and measurement principles of APB Opinion No. 25, Accounting for StockIssued to Employees, and related Interpretations.  No stock-based employee compensation cost is reflected in net income, asall options granted under the plan had an exercise price equal to the market value of the underlying stock on the date ofgrant.  The following table illustrates the effect on net income and earnings per share, dollars in thousands, if the Companyhad applied the fair value recognition provisions of Statement of Financial Accounting Standards (SFAS) No. 123, Accounting forStock-Based Compensation, to stock-based employee compensation.
 
**Three Months Ended****Sept.  30**
 
**Six Months Ended****Sept.  30**
 
2003
 
2002
 
2003
 
2002

Net Income, as reported

$
1,425 
$
2,535 
$
4,056 
$
5,764            
Deduct:    Total stock-based employeecompensation     expense determined under fairvalue based     method for all awards, net ofrelated tax effects 
  0   0  
0  
0            
Pro forma net income 

$
 1,425 
$
2,535 
$
4,056 
$
5,764            
Basic - as reported 

$
.67 
$
1.17 
$
1.89 
$
2.64            
Basic - pro forma 

$
.67 
$
1.17 
$
1.89 
$
2.64            
Diluted - as reported 

$
.66 
$
1.16 
$
1.88 
$
2.64            
Diluted - pro forma

$
.66 
$
1.16 
$
1.88 
$
2.64
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NOTE 3.             EARNINGS PER COMMON SHARE

The following is a reconciliation of net income (the numerator) and weighted-averageshares outstanding (the denominator) used in determining basic and diluted earnings per common share (EPS).
 
Three Months Ended September 30, 2003(Dollars and shares in Thousands,except per shareamounts)
 
NetIncome(Numerator)

Weighted-AverageShares(Denominator)

Per Share Amount
    
Basic EPS
 
$1,425  
2,142  
$.67  
Effect of Dilutive Securities     Stock options
 
-0-
  
7
  
(.01)
           
Diluted EPS
 
$1,425
  
2,149
  
$.66 
               
Three Months Ended September 30,2002(Dollars and shares inThousands, except per share amounts)
 
NetIncome(Numerator)
Weighted-AverageShares(Denominator)
Per ShareAmount        
Basic EPS
 
$2,535  
2,175  
$1.17  
Effect of Dilutive Securities    Stock options
 
0
  
15
  
(.01)
           
Diluted EPS
 
$2,535
  
2,190
  
$1.16 

 
              
 
 
Nine Months Ended September 30, 2003(Dollars and shares inThousands,except per share amounts)
 
NetIncome(Numerator)
Weighted-AverageShares(Denominator)
Per ShareAmount        
Basic EPS
 
$4,056  
2,151  
$1.89  
Effect of Dilutive Securities    Stock options
 
0
  
4
  
(.01)
           
Diluted EPS
 
$4,056
  
2,155
  
$1.88 

 
          
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Nine Months Ended September 30,2002(Dollars and shares inThousands,except per share amounts)
 
NetIncome(Numerator)
Weighted-AverageShares(Denominator)
Per ShareAmount        
Basic EPS
 
$5,764  
2,180  
$2.64 
Effect of Dilutive Securities    Stock options
 
0
  
1
  
0
           
Diluted EPS
 
$5,764
  
2,181
  
$2.64

 
          
NOTE 4.            SEGMENTINFORMATION

Selected segment information by industry segment for the three and nine month periodsended September 30, 2003 and 2002 is as follows:
 
Reportable Segments(Dollars inthousands)

For the three month period endedSeptember 30, 2003
 
Banking
 
FinancialSupermarkets
 
AllOther
 
Total
             
Revenue from external customers
 
$
12,974  
$
595  
$
119  
$
13,688
Intersegment revenues (expenses)
  
(34)  
90   
585   
641
Segment profit (loss)
  
2,218   
(522)  
(236)  
1,460
Segment assets
  
745,419   
14,873   
4,047   
764,339
 
 
Reportable Segments(Dollars inthousands)

For the three month period endedSeptember 30, 2002
 
Banking
 
FinancialSupermarkets
 
AllOther
 
Total
             
Revenue from external customers
 
$
12,996  
$
3,004  
$
103  
$
16,103
Intersegment revenues (expenses)
  
(59)  
54   
550   
545
Segment profit (loss)
  
1,790   
879   
(261)  
2,509
Segment assets
  
679,917   
17,549   
5,591   
703,057
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Reportable Segments(Dollars inthousands)

For the nine month period endedSeptember 30, 2003
 
Banking
 
FinancialSupermarkets
 
AllOther
 
Total
             
Revenue from external customers
 
$
38,640  
$
1,959  
$
404  
$
41,003
Intersegment revenues (expenses)
  
(109)  
281   
1,756   
1,928
Segment profit (loss)
  
5,728   
(828)  
(856)  
4,044
Segment assets
  
745,419   
14,873   
4,047   
764,339
 
 
Reportable Segments(Dollars inthousands)

For the nine month period ended September 30, 2002
 
Banking
 
FinancialSupermarkets
 
AllOther
 
Total
             
Revenue from external customers
 
$
38,506  
$
7,208  
$
351  
$
46,065
Intersegment revenues (expenses)
  
(302)  
492   
1,646   
1,836
Segment profit (loss)
  
4,888   
1,838   
(939)  
5,787
Segment assets
  
679,917   
17,549   
5,591   
703,057 
For the Three Months Ended Sept. 30

For the Nine Months Ended Sept. 30

 
 
2003
 
2002

          2003

     2002
          
 

Net Income
          
 
          
 

Total profit for reportable segments

$

1,696  
$

2,770 

$

4,900 
$

6,726 
 

Non-reportable segment loss
  
(236)
  
(261)
 
(856)
 
(939)

 

Elimination of intersegment (gains) losses
  
(35)
  
26 
 
12  
 
(23)

 

Total consolidated net income

$

1,425 
 
$

2,535 

$

4,056  

$

5,764 

 

 

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2003
   Total Assets     
Total assets for reportable segments

$

760,292 

Non-reportable segment assets
 
4,047 

Elimination of intersegment assets
 
(29,105)

Total consolidated assets

$

735,234 

NOTE 5.  RECENT DEVELOPMENTS

Recent Developments

In November 2002, the Financial Accounting Standards Board (“FASB”) issuedFASB Interpretation No. 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including IndirectGuarantees of Indebtedness of Others”.  The interpretation addresses the disclosures to be made by a guarantor in itsinterim and annual financial statements about its obligations under guarantees.  The interpretation also clarifies therequirements related to the recognition of a liability by a guarantor at the inception of a guarantee, for the fair value of theobligation undertaken in issuing the guarantee.  The initial recognition and initial measurement provisions of theinterpretation are to be applied to guarantees issued or modified after December 31, 2002.  As of September 30, 2003, theinterpretation has not had a material effect on the financial condition or results of operations, and there are no guaranteesrequired to disclose. 

 

 

 

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COMMUNITY BANKSHARES, INC.AND SUBSIDIARIES

ITEM 2.  MANAGEMENTDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION ANDRESULTS OF OPERATIONS

Forward Looking Statements

This discussion contains forward-looking statements under the Private SecuritiesLitigation Reform Act of 1995 that involve risks and uncertainties.  Although the Company believes the assumptions underlyingthe forward-looking statements contained in the discussion are reasonable, any of the assumptions could be inaccurate, andtherefore, no assurance can be made that any of the forward-looking statements included in this discussion will be accurate. Factors that could cause actual results to differ from results discussed in forward-looking statements include, but are not limitedto:  economic conditions (both generally and in the markets where the Company operates); competition from other providers offinancial services; government regulation and legislation; changes in interest rates; and material unforeseen changes in thefinancial stability and liquidity of the Company’s credit customers; all of which are difficult to predict and which may bebeyond the control of the Company.  The Company undertakes no obligation to revise forward-looking statements to reflectevents or changes after the date of this discussion or to reflect the occurrence of unanticipated events.

Management’s Discussion and Analysis

The following is management’s discussion and analysis of certain significant factorswhich have affected our financial position and operating results during the periods included in the accompanying consolidatedfinancial statements.

Financial Condition

As of September 30, 2003, we continue to experience growth in total assets, total loansand total deposits as compared to December 31, 2002.  Total assets, loans, and deposits increased by 5.0%, 5.24% and 5.55%respectively.  The growth in total assets and deposits, although less than the same period in 2002, is consistent withmanagement’s expectations.  The growth in assets is attributable to growth in deposits and retention of earnings. Management expects the growth to continue in the future.

Liquidity

As of September 30, 2003, the liquidity ratio was 21.76% which is within our target rangeof 20 - 25%.    Liquidity is measured by the ratio of net cash, short term and marketable securities to net depositsand short term Liabilities.  Our Banks have available lines of credit to meet unexpected liquidity needs.

Interest Rate Risk

Our guideline is to allow no more than 8% change in net interest income when interestrates rise or fall 200 basis points or more.  Our overall interest rate risk was less than 4% of net interest income;therefore, we are within policy guidelines.  We have attempted to position ourselves to minimize the impact of further changesin rates in either direction.

Capital

Banking regulation requires the Company and the Banks to maintain minimum capital levelsin relation to our assets.  At September 30, 2003, the Company’s and the Bank’s capital ratios were consideredwell capitalized based on regulatory minimum capital requirements.  The minimum capital requirements and the actualconsolidated capital ratios at September 30, 2003 were as follows:

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Actual

Regulatory Minimum
         
    Leverage

    8.98%

4.00               
 
    Core Capital

12.23%

4.00               
 
    Total Capital

13.49%

8.00               
        
A.  Results of Operation

*Net Income*

Net income for the nine month period ended September 30, 2003, was $4,056,000 or adecrease of 29.62% and for the three month period ended September 30, 2003 was $1,425,000 or a decrease of 43.79% over the sameperiod for 2002.  These decreases are directly attributable to the decrease in revenue of our nonbank subsidiary.

*Net Interest Income*

Net interest income for the nine month period ended September 30, 2003 is up 10.79% overthe same period for 2002, from $20,059,000 to $22,223,000, and is up 10.02% for the three month period ending September 30, 2003from $6,935,000 in the same period in 2002 to $7,630,000 for 2003.   Interest income was down by .63% for the nine monthperiod ending September 30, 2003 from $32,678,000 to $32,471,000 and down 1.28% for the three month period ending September 30,2003 from $10,953,000 to $10,813,000.  The decrease was caused by the continued decline in the yield on earning assets from7.39% during the first nine months of 2002 to 6.31% during the first nine months of 2003 offset by the increase in the volume ofearning assets.  Earning assets had increased by 9.188% or $56,573,000 at September 30, 2003 as compared to September 30,2002.  The largest increase in earning assets since September 30, 2002 was the increase in loans of $37,498,000 or7.82%.  Securities increased by $67,000 while federal funds increased by $19,055,000.

Interest expense was down 18.79% or $2,371,000 for the nine month period ended September30, 2003, over the same period in 2002 and down 20.28% or $835,000 for the three month period ending September 30, 2003, ascompared to 2002.  These decreases were related directly to the lower interest rate environment.

The Company’s net interest margin was 4.72% for the nine month period endedSeptember 30, 2003 compared to 4.64% for the same period in 2002.  Management anticipates a stable net interest margin overthe next twelve months.  Any increase in rates would have a slight positive effect on our net interest margin.

*Other Income*

Other income decreased by $4,714,000 or 36.27% during the nine month period endedSeptember 30, 2003 as compared to the same period for 2002 and the three month period ending September 30, 2003 showed a decreaseof  $2,308,000 or 45.53% for the same three month period in 2002.  This decrease is primarily due to the termination ofan agreement to establish banking pavilions between Financial Supermarkets, Inc. (“FSI”), a nonbank subsidiary, and theCanadian Imperial Bank of Commerce (“CIBC”).  It will take time and approximately 150-200 new unit sales toreplace this income.  At this time, management is uncertain as to when this may be accomplished.  Management anticipatesfewer sales of supermarket bank units and thus anticipates no revenue from this segment of our business during 2003.

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Service charges on deposit accounts increased by $194,000 or 5.08% for the nine monthperiod ended September 30, 2003 as compared to the same period in 2002.  Service charges on deposits increased primarily as aresult of the Company’s continued growth in checking accounts.  Other service charges, commissions and fees increased by28.26% or $325,000 for the nine month period ending September 30, 2003 and 6.70% or $30,000 for the three month period duringSeptember 30, 2003 compared to the same periods in 2002.  The majority of this increase is attributed to the renegotiation offees with our debit card service provider and the increase in volume of debit card transactions.  The gains on sale of loansincreased by $25,000 during the nine month period ending September 30, 2003 as compared to the same period for2002. 

*Non Interest Expenses*

Non interest expenses increased by 1.56% or $364,000 for the nine month period endingSeptember 30, 2003 and 2.06% or $161,000 for the three month period ending September 30, 2003 compared to the same periods in2002.  Full time equivalent employees increased from 387 at the end of  September 2002 to 396 at the end of September2003.  The increase in full time equivalent employees was influenced by the addition of two new supermarket banking centersand one new stand-alone branch during the past year as well as the overall growth of the Company’s banking operations. The decline in salaries and benefits by 1.01% or $37,000 was a result of a reduced level of accrual of incentive compensationassociated with the reduced level of sales activity at FSI.   Due to ongoing branching activity, equipment and occupancyexpenses were up by 5.18% or $195,000 for the nine month period ending September 30, 2003 and 1.78% or $23,000 for the three monthperiod ending September 30, 2003 as compared to the same periods in 2002.  Other operating expenses increased by 3.59% or$236,000 for the nine month period ending September 30, 2003 and 7.02% or $154,000 for the three month period ending September 30,2003 as compared to the same periods in 2002.  The majority of this increase is attributed to the change in our fee structurewith our debit card provider and an increased effort in business development and marketing of our nonbank subsidiary.  Inaddition, legal fees have increased by $53,000 or 42.74% due to legal services related to past due loans and other real estateowned.

*Income Taxes*

We incurred income tax expenses of $437,000 which represents an effective rate of 23.47%for the three month period ended September 30, 2003 as compared to $1,006,000 which represents an effective tax rate of 28.41% forthe same period in 2002.  In addition, we incurred income tax expenses of $1,061,000 which represents an effective rate of20.73% for the nine month period ended September 30, 2003 as compared to $2,259,000 which represents an effective tax rate of28.16% for the same period in 2002.  The decrease is due to a smaller portion of our income being fully taxable.

We are not aware of any other known trends, events or uncertainties, other than the effectof events as described above, that will have or that are reasonably likely to have a material effect on its liquidity, capitalresources or operations.  We are also not aware of any current recommendations by the regulatory authorities which, if theywere implemented, would have such an effect.

B.  Asset Quality

*Provision for Loan Loss*

The provision for loan losses was $1,686,000 and $1,694,000 for the first nine months of2003 and 2002 respectively.  The provision for loan losses for the nine month period ended September 30, 2003 represented98.83% of net charge offs for the same period, while the provision for the first nine months of 2002 represented 127.5% of the netcharge offs recorded in that period.  The reserve at September 30, 2003 represented 476% of non-accrual loans while thereserve at September 30, 2002 represented 180% of non-accrual loans.  Non accrual loans have decreased from $3,997,000 atSeptember 30, 2002 to $1,658,000 as of September 30, 2003.  Past due loans greater than 90 days and accruing interest havedecreased from $2,367,000 in 2002 to $2,270,000 in 2003.

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Repossessed real estate owned by the bank increased from $3,751,000 in September 2002 to$5,828,000 in September 2003 or 55%.  Other real estate is carried in the books at the lesser of cost or fair market valuewith no loss anticipated.  During early April 2003 the Company moved approximately $2,000,000 from non-accrual loan status toother real estate. 

*Non-accrual, Past Due and Restructured Debt*

The following table is a summary, dollars in thousands, of Non Accrual, Past due andRestructured Debt

September 30, 2003
 
**Non-accrual**
**Past Due**
**Restructured** 
**Loans**
**90 days**
**Debt**  
**Still accruing**     
Commercial Loans

$  249 
$   508 
$   14 
Real Estate Loans

1,287 
1,216 
889 
Consumer Loans
 
122
  
546
  
--
        
Total
 
$1,658
  
$2,270
  
$903
     
September 30, 2002
 
**Non-accrual**
**Past Due**
**Restructured** 
**Loans**
**90 days**
**Debt**  
**Still accruing**     
Commercial Loans

$  556 
$    456 
$  134 
Real Estate Loans

531 
1,691 
965 
Consumer Loans
 
 
  
220
  
58
        
Total
 
$3,997
  
$2,367
  
$1,157
 
Loans classified for regulatory purposes as loss, doubtful, substandard, or specialmention that have not been included in the table above do not represent or result from trends or uncertainties which managementreasonably expects will materially impact future operating results, liquidity or capital resources.  These classified loans donot represent material credits about which management is aware of any information which causes management to have doubts concerningthe collectibility of such credits.

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The accrual of interest on loans is discontinued when, in management’s opinion, theborrower may be unable to meet payments as they become due, unless the loan is well-secured.  All interest accrued but notcollected for loans that are placed on nonaccrual or charged off is reversed against interest income.  Interest income onnonaccrual loans is subsequently recognized only to the extent cash payments are received, until the loans are returned to accrualstatus.

*Allowance for Loan Loss*

The loan loss reserve is evaluated monthly and adjusted to reflect the risk in theportfolio in the following manner.  We use two different methods of measuring risk in the portfolio:  we evaluate the (a)risk in our watch list of loans and past due ratios and (b) percentage of classified loans.  We then compare results toreserve balances to assure any and all identified risk is covered.

The following table furnishes information on the loan loss reserve for the current ninemonth reporting period and the same period for 2002.
 
2003
 
2002
 
(Dollars in Thousands)     
Beginning Balance

$  7,742  
$  6,652     
Less Charge Offs:
   
     Commercial Loans

(263) 
(167)
     Real Estate Loans

(906) 
(618)
     Consumer Loans

(537)
 
(544)
     
(1,706)
 
(1,329)    
Plus Recoveries:
   
     Commercial Loans

18  
19 
     Real Estate Loans

17  
17 
     Consumer Loans

139 
 
133 
     
174 
 
169 
    
Net Charge-offs

(1,532) 
(1,160)    
Provision for loan loss

1,686 
 
1,694 

Ending Balance

$  7,896 
 
$  7,186 

The increase in charged off real estate loan is due primarily to three loans totalingapproximately $343,000.

Our Company operates in three distinct markets, northeast Georgia, midwest Georgia andmideast Alabama.  Each of these markets has seen a modest increase in unemployment and bankruptcy filings.  Theseincreases however have been lower than those experienced by the national economy as a whole.

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Management has reviewed the non-accrual loans individually and determined that thelikelihood of any significant loss of principal is mitigated due to the value of the collateral securing these loans.  As ofSeptember 30, 2003, non-accrual loans and other real estate owned totaled approximately $7,486,000 as compared to $7,748,000 as ofSeptember 30, 2002.  The ratio of the loan loss reserve balance to the total loan balance at September 30, 2003 was 1.53% ascompared to 1.50% at September 30, 2002.  As of  September 30, 2003, management considered our allowance for loan lossesadequate to cover any anticipated losses.

 

 

 

 

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   ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKETRISK

The Company is exposed only to U.S. dollar interest rate changes and the Company managesthis exposure by considering the possible changes in the net interest margin.  The Company does not have any tradinginstruments nor does it classify any portion of the investment portfolio as held for trading.  The Company does not engage inany hedging activities or enter into any derivative instruments other than mortgage backed securities, which are commonly passthrough securities.   Finally, the Company has no exposure to foreign currency exchange rate risk, commodity price risk,and other market risks. 

Interest rates play a major part in the net interest income of a financialinstitution.  The sensitivity to rate changes is known as “interest rate risk”.  The repricing of interestearning assets and interest-bearing liabilities can influence the changes in net interest income.  As part of theCompany’s asset/liability management program, the timing of repriced assets and liabilities is referred to as Gapmanagement. 

The Company’s objective in Gap management is to manage assets and liabilities tomaintain satisfactory and consistent profitability.  Officers of each bank are charged with monitoring policies and proceduresdesigned to ensure an acceptable asset/liability mix.  Management’s philosophy is to support asset growth primarilythrough growth of core deposits within the banks’ market areas.

The Company’s asset/liability mix is monitored regularly with a report reflectingthe interest rate sensitive assets and interest rate sensitive liabilities that is prepared and presented to the Board of Directorsof each bank on at least a quarterly basis.  Management’s objective is to monitor interest rate sensitive assets andliabilities so as to minimize the impact on earnings of substantial fluctuations in interest rates.  An asset or liability isconsidered to be interest rate-sensitive if it will reprice or mature within the time period analyzed, usually one year orless.  The interest rate-sensitivity gap is the difference between the interest-earning assets and interest-bearingliabilities scheduled to mature or reprice within the relevant period.  A gap is considered positive when the amount ofinterest rate-sensitive assets exceeds the amount of interest rate-sensitive liabilities.  A gap is considered negative whenthe amount of interest rate-sensitive liabilities exceeds the interest rate-sensitive assets.  During a period of risinginterest rates, a negative gap would tend to adversely affect net interest income, while a positive gap would tend to result in anincrease in net interest income.  Conversely, during a period of falling interest rates, a negative gap would tend to resultin an increase in net interest income, while a positive gap would tend to adversely affect net interest income.  If theCompany’s assets and liabilities were equally flexible and moved concurrently, the impact of any increase or decrease ininterest rates on net interest income would be minimal.

A simple interest rate “gap” analysis by itself may not be an accurateindicator of how net interest income will be affected by changes in interest rates.  For example, while interest-bearingtransaction accounts are by their terms immediately repricable, competitive conditions and other circumstances usually precluderepricing such deposits proportionately with changes in rates affecting interest-earning assets.  Accordingly, the Companyalso evaluates how changes in interest rates impacts the repayment of particular assets and liabilities.  Income associatedwith interest-earning assets and costs associated with interest-bearing liabilities may not be affected uniformly by changes ininterest rates.  In addition, the magnitude and duration of changes in interest rates may significantly affect net interestincome.  For example, although certain assets and liabilities may have similar maturities or periods of repricing, they mayreact in different degrees to changes in market interest rates.  Interest rates on certain types of assets and liabilitiesfluctuate in advance of changes in general market rates, while interest rates on other types may lag behind changes in generalmarket rates.  In addition, certain assets have features (generally referred to as “interest rate caps andfloors”) which limit changes in interest rates.  Also, prepayments and early withdrawal levels could deviatesignificantly from those reflected in the interest rate gap.  The Company prepares a report monthly that measures thepotential impact on net interest margin by rising or falling rates.  This report is reviewed monthly by the Asset/LiabilityCommittee and quarterly by each Board of Director.

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At September 30, 2003, the Company’s cumulative interest rate sensitivity gap ratiofor the next twelve months was 112% which was within its targeted range of 80% to 120%.

Gap management alone is not enough to properly manage interest rate sensitivity becauseinterest rates do not respond at the same speed or at the same level to market rate changes.  For example, savings and moneymarket rates are more stable than loans tied to a “Prime” rate and thus respond with less volatility to a market ratechange.  Thus, the Company uses a simulation model to monitor changes in net interest income due to changes in marketrates.  The model of rising, falling and stable interest rate scenarios allows management to monitor and adjust interest ratesensitivity to minimize the impact of market rate swings.  The analysis of impact on net interest margins as well as marketvalue of equity over a twelve-month period is subjected to a 200 basis point increase and decrease in rate.  The September2003 model reflects an increase of  2.75% in net interest income and a 15.36% decrease in market value equity for a 200 basispoint increase in rates.  The same model shows a 3.63% decrease in net interest income and a 20.58% increase in market valueequity for a 200 basis point decrease in rates.  The Company’s policy is to allow no more than +-8% change in netinterest income and no more than +-25% change in market value equity for these scenarios. Therefore, the Company is within itspolicy guidelines.

 

ITEM4.                CONTROLS &PROCEDURES

Our management, including the chief executive and chief financial officers, supervised andparticipated in an evaluation of our disclosure controls and procedures (as defined in federal securities rules) as of the end ofthe period covered by this report.  Based on, and as of the date of,  that evaluation, our CEO and CFO have concludedthat our disclosure controls and procedures are effective in accumulating and communicating information to our management,including our  CEO and CFO, as appropriate to allow timely decisions regarding required disclosures of that information underthe Securities and Exchange Commission rules and forms and that our disclosure controls and procedures are designed to ensure thatthe information we are required to disclose in reports that we file or submit under all applicable federal securities laws isrecorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission rules andforms.

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

                                                                   PART II – OTHER INFORMATION

ITEM 6.  Exhibits and Reports on Form 8-K

(a)  Exhibits

           31.1 and 31.2 - Rule 13a-15(e) and 15d-15(e)Certifications

           32.1 and 32.2 - Certifications of Chief Executive Officer,and Chief Financial Officer,                   Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant To Section 906 of the Sarbanes- Oxley Act of2002.

     

(b)  Reports on Form 8-K

      None.
 
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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant hasduly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
 
COMMUNITY BANKSHARES, INC.

 

 

DATE: November  14, 2003

BY:  /s/ Harry L. StephensHarry L. Stephens, Executive Vice Presidentand Chief Financial Officer