Table ofContents

**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 endedJune 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 by check whether the registrant is an accelerated filer(as defined in Rule 12b-2 of the Exchange Act). Yes   ̈  No þ
Indicate the number of shares outstanding of each of the issuer’s classesof common stock, as of August 7, 2003:   2,141,860
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**COMMUNITY BANKSHARES, INC.****ANDSUBSIDIARIES****INDEX**
 
Page No.
**PART I. FINANCIAL INFORMATION**
 
**Item 1.**

**Financial Statements**
   
Consolidated Balance Sheets - 

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

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

 5 
Six Months Ended June 30, 2003 and 2002
  
Notes to Consolidated Financial Statements

6 
**Item 2.**

**Management’s Discussion and Analysis of**

 8** **
**Financial Condition and Results of Operations**
 
**Item 3.**

**Quantitative and Qualitative Disclosures about Market Risk**

 13 
**Item 4.**

**Controls and Procedures**

  
**PART II. OTHER INFORMATION**

  
**Item 4.**

**Submission of Matters to a Vote of Security Holders**

  
**Item 6.**

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

   
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

 
 

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PART I - FINANCIAL INFORMATION

**ITEM 1.  FINANCIAL STATEMENTS**

COMMUNITY BANKSHARES, INC.

AND SUBSIDIARIES
 
CONSOLIDATEDBALANCE SHEETS

JUNE 30, 2003 AND DECEMBER 31, 2002

(Dollars in thousands)
  
(Unaudited)
   
Assets
 
 2003
  
2002
      
Cash and due from banks

$

47,637 
 
$

44,966 

Interest-bearing deposits in banks
 
436 
  
499 

Federal funds sold
 
10,760 
  
9,200 

Securities available-for-sale
 
104,996 
  
100,356 

Securities held-to-maturity (fair value $26,004 and $28,681)
 
23,824 
  
27,016 

Restricted equity securities
 
1,243 
  
1,215 
      
Loans
 
511,141 
  
491,368 

Less allowance for loan losses
 
7,490 
  
7,742 

          Loans, net
 
503,651 
  
483,626 
      
Premises and equipment
 
15,458 
  
16,295 

Other assets
 
19,224 
  
17,073 
      
          Totalassets

$

727,229 
 
$

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

$

105,201 
 
$

87,650 

    Interest-bearing demand
 
152,571 
  
146,092 

    Savings
 
33,373 
  
30,228 

    Time, $100,000 and over
 
117,888 
  
123,991 

    Other time
 
224,782 
  
219,394 

          Totaldeposits
 
633,815 
  
607,355 

Other borrowings
 
16,446 
  
16,665 

Other liabilities
 
7,771 
  
9,181 

          Totalliabilities
 
658,032 
  
633,201 
      
Redeemable common stock held by ESOP, net of unearned ESOP sharesrelated toESOP debt guarantee of $1,371,225 and $1,363,831at June 30,2003 and December 31, 2002, respectively
 
15,389 
  
15,194 

 
 

Shareholders' equity
     
    Common stock, par value $1; 5,000,000        Shares authorized;2,201,330        Shares issued
 
2,201 
  
2,201 

    Capital surplus
 
6,315 
  
6,315 

    Retained earnings
 
45,133 
  
42,802 

    Accumulated other comprehensiveincome           net of tax
 
2,692 
  
1,962 

    Less cost of 59,470 and 34,573 shares oftreasury    stock at June 30, 2003 and December 31, 2002
 
(2,533)
  
(1,429)

          Total shareholders'equity
 
53,808 
  
51,851 
      
  Total liabilities, redeemable common stock and shareholders'equity

$

727,229 
 
$

700,246 
      
See Notes to Consolidated Financial Statements.
            
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COMMUNITY BANKSHARES, INC.AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF INCOMEAND COMPREHENSIVE INCOMETHREE MONTHS ENDED JUNE 30, 2003 AND 2002 ANDSIX MONTHS ENDED JUNE 30, 2003 AND 2002(Dollars in thousands, except per share amounts)(Unaudited)
  
Three Months EndedJune 30, 
Six Months EndedJune 30,
Interest income
 
2003  
 2002  
2003  
 2002
    Loans

$

9,431
 
$

9,307 
 
$

18,747
 
$

18,703 

    Taxable securities
 
613
  
739 
  
1,247
  
1,366 

    Nontaxable securities
 
763
  
742 
  
1,522
  
1,439 

    Deposits in banks
 
3
  
3 
  
5
  
6 

    Federal funds sold
 
70
  
107 
  
137
  
211 

          Total interestincome
 
10,880
  
10,898 
  
21,658
  
21,725 
            
Interest expense
           
    Deposits
 
3,211
  
3,985 
  
6,671
  
8,264 

    Other borrowings
 
197
  
169 
  
394
  
337 

           Total interestexpense
 
3,408
  
4,154 
  
7,065
  
8,601 
            
          Net interestincome
 
7,472
  
6,744 
  
14,593
  
13,124 

Provision for loan losses
 
594
  
524 
  
1,140
  
1,053 

          Net interest incomeafter               Provision for loan losses
  
6,878
  
6,220 
  
13,453
  
12,071 
            
Other income
           
    Service charges on deposit accounts
 
1,326
  
1,326 
  
2,606
  
2,491 

    Other service charges and fees
 
467
  
365 
  
997
  
702 

    Gains on sale of loans
 
32
  
33 
  
87
  
47 

    Nonbank subsidiary non-interest income
 
655
  
2,218 
  
1,536
  
4,157 

    Security transactions, net
 
0
  
(6)
    
0
  
139 

    Other operating income
 
179
  
177 
  
297
  
393 

          Total otherincome
 
2,659
  
4,113 
  
5,523
  
7,929 
              
Other expenses
           
    Salaries and employee benefits
 
4,286
  
4,281 
  
8,624
  
8,675 

    Equipment expense
 
828
  
796 
  
1,661
  
1,565 

    Occupancy expense
 
499
  
450 
  
979
  
903 

    Other operating expenses
 
2,364
  
2,165 
  
4,457
  
4,375 

          Total otherexpenses
 
7,977
  
7,692 
  
15,721
  
15,518 
                        
          Income before incometaxes
 
1,560
  
2,641 
  
3,255
  
4,482 
            
Income tax expense
 
307
  
768 
  
624
  
1,253 
            
          Net income

$ 

1,253
 
$

1,873 
 
$

2,631
 
$

3,229 

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Other comprehensive income :

            
     Unrealized gains on securities:          Unrealized holdinggains arising during           period, net of tax

 
831
  
1,184 
  
730
  
963 

     Less:  reclassification adjustment for(gains)                losses realized in net income,                net of tax

 
0
  
4 
  
0
  
(83)

     Total other comprehensive income 

831
  
1,188 
  
730
  
880 
           
          Comprehensiveincome

$

2,084
 
$

3,061 
 
$

3,361
 
$

4,109 
            
Basic earnings per common share

$

.58
 
$

.87 
 
$

1.22
 
$

      1.48 

Diluted earnings per common share

.58
  
.86 
  
1.22
  
1.47 

Cash dividends per share of common stock

$

.07
 
$

.06 
 
$

.14
 
$

.12 
              
See Notes to Consolidated Financial Statements.
                                 
 

 

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COMMUNITY BANKSHARES, INC.

AND SUBSIDIARIES
 
CONSOLIDATED STATEMENTS OF CASH FLOWS

FOR THE SIX MONTHS ENDED JUNE 30, 2003 AND 2002

(Dollars in thousands)

(Unaudited)
  
2003
 
2002
      
OPERATING ACTIVITIES
     
    Net income

$

2,631 
 
$

3,229 

    Adjustments to reconcile net income to net cashprovided         by operating activities:
     
        Depreciation andamortization
 
1,582 
  
1,616 

        Provision for loanlosses
 
1,140 
  
1,053 

        Deferred income taxes
 
418 
  
449 

       Net realized gains on securities
 
0 
  
(139)

        Net losses on sale of other realestate
 
21 
  
34 

        Decrease in interestreceivable
 
146 
  
544 

        Increase  in interestpayable
 
(247)
  
(1,091)

        Increase in taxespayable
 
65 
  
93 

        (Increase) Decrease in accountsreceivable of nonblank             subsidiary   
 
(27)
  
559 

        Decrease in work in process ofnonbank subsidiary
 
196 
  
174 

        Decrease in accruals and payables of nonbank subsidiary
 
(1,473)
  
(1,107)

        Net other operatingactivities
 
(703)
  
(2,018)
      
              Net cash provided by operating activities
 
3,749 
  
3,396 
       
INVESTING ACTIVITIES
     
    Purchases of securities available-for-sale
 
(16,312)
  
(25,642)

    Proceeds from sales of securitiesavailable-for-sale
 
0 
  
5,119 

    Proceeds from maturities of securitiesavailable-for-sale
 
12,860 
  
5,548 

    Proceeds from maturities of securitiesheld-to-maturity
 
3,192 
  
1,170 

    Net (decrease) in Federal funds sold
 
(1,560)
  
2,850 

    Net decrease in interest-bearing deposits inbanks
 
63 
  
101 

    Net (increase) in loans
 
(25,818)
  
(12,147)

    Purchase of premises and equipment
 
(534)
  
(880)

    Proceeds from sale of premises and equipment
 
0 
  
8 

    Proceeds from sales of other real estate
 
2,195 
  
2,500 
      
         Net cash used in investing activities
 
(25,914)
  
(21,373)
      
FINANCING ACTIVITIES
     
    Net increase  in deposits
 
26,460 
  
19,132 

    Net increase in FHLB Borrowings
 
75 
  
0 

    Repayment of other borrowings
 
(293)
  
(112)

    Purchase of TreasuryStock
 
(1,105)
  
(451)

    Dividends paid
 
(301)
  
(262)

 

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              Net cash provided by financingactivities
 
24,836 
  
18,307 
      
Net increase in cash and de from banks

$

2,671 
 
$

330 
      
Cash and due from banks at beginning of the period
 
44,966 
  
37,182 
      
Cash and due from banks at end of the period

$

47,637 
 
$

37,512 
      
SUPPLEMENTAL DISCLOSURES
     
    Cash paid for:
     
        Interest

$

7,311 
 
$

9,693 
      
        Income taxes

$

628 
 
$

1,291 
      
NONCASH TRANSACTIONS
                 
    Principal balances on loans transferred to other realestate

$

4,652 
 
$

3,433 
      
See Notes to Consolidated Financial Statements

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COMMUNITY BANKSHARES, INC.AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIALSTATEMENTS

 

NOTE 1.  BASIS OF PRESENTATION

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 six month periods ending June 30, 2003 are notnecessarily indicative of the results to be expected for the full year.

NOTE 2.  STOCK COMPENSATION PLAN

At June 30, 2003, the Company has a stock-based employee compensation plan.  TheCompany accounts for the plan under the recognition and measurement principles of APB Opinion No. 25, Accounting for Stock Issuedto Employees, and related Interpretations.  No stock-based employee compensation cost is reflected in net income, as alloptions granted under the plan had an exercise price equal to the market value of the underlying stock on the date of grant. The following table illustrates the effect on net income and earnings per share if the Company had applied the fair valuerecognition provisions of Statement of Financial Accounting Standards (SFAS) No. 123, Accounting for Stock-Based Compensation, tostock-based employee compensation.
 
**Three Months Ended****June 30**
 
**Six Months Ended****June 30**
 
2003
 
2002
 
2003
 
2002

Net Income, as reported

$
1,253 
$
1,873 
$
2,631 
$
3,229            
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 

$
 1,253 
$
 1,873 
$
 2,631 
$
 3,229            
Basic - as reported 

$
.58 
$
.87 
$
1.22 
$
1.48            
Basic - pro forma 

$
.58 
$
.87 
$
1.22 
$
1.48            
Diluted - as reported 

$
.58 
$
.86 
$
1.22 
$
1.47            
Diluted - pro forma

$
.58 
$
.86 
$
1.22 
$
1.47 
 

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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 June 30, 2003(Dollars and shares in Thousands, except per shareamounts)
 
NetIncome(Numerator)

Weighted-AverageShares(Denominator)

Per Share Amount
    
Basic EPS
 
$1,253  
2,151  
$.58 
Effect of Dilutive Securities     Stock options
 
-0-
  
6
  
0
           
Diluted EPS
 
$1,253
  
2,157
  
$.58
               
Three Months Ended June 30,2002(Dollars and shares inThousands, except per share amounts)
 
NetIncome(Numerator)
Weighted-AverageShares(Denominator)
Per ShareAmount        
Basic EPS
 
$1,873  
2,156  
$.87 
Effect of Dilutive Securities    Stock options
 
0
  
6
  
.01
           
Diluted EPS
 
$1,873
  
2,162
  
$.86

 
              
 
 
Six Months Ended June 30, 2003(Dollars and shares inThousands, except per share amounts)
 
NetIncome(Numerator)
Weighted-AverageShares(Denominator)
Per ShareAmount        
Basic EPS
 
$2,631  
2,156  
$1.22 
Effect of Dilutive Securities    Stock options
 
0
  
6
  
0
           
Diluted EPS
 
$2,631
  
2,162
  
$1.22

 
          
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Six Months Ended June 30,2002(Dollars and shares inThousands, except per share amounts)
 
NetIncome(Numerator)
Weighted-AverageShares(Denominator)
Per ShareAmount        
Basic EPS
 
$3,229  
2,186  
$1.48 
Effect of Dilutive Securities    Stock options
 
0
  
15
  
.01
           
Diluted EPS
 
$3,229
  
2,201
  
$1.47

 
          
NOTE 4  . SEGMENT INFORMATION

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

For the three month period ended June 30, 2003
 
Banking
 
FinancialSupermarkets
 
AllOther
 
Total
             
Revenue from external customers
 
$
12,886  
$
541  
$
177  
$
13,604
Intersegment revenues (expenses)
  
(35)  
96   
585   
646
Segment profit (loss)
  
1,766   
(229)  
(308)  
1,229
Segment assets
  
730,088   
14,503   
3,691   
748,282
 
 
Reportable Segments(Dollars inthousands)

For the three month period ended June 30, 2002
 
Banking
 
FinancialSupermarkets
 
AllOther
 
Total
             
Revenue from external customers
 
$
12,798  
$
2,228  
$
131  
$
15,157
Intersegment revenues (expenses)
  
(112)  
210   
548   
646
Segment profit (loss)
  
1,661   
577   
(341)  
1,897
Segment assets
  
668,076   
15,672   
5,882   
689,630
 
 
Reportable Segments(Dollars inthousands)

For the six month period ended June 30, 2003
 
Banking
 
FinancialSupermarkets
 
AllOther
 
Total
             
Revenue from external customers
 
$
25,666  
$
1,364  
$
285  
$
27,315
Intersegment revenues (expenses)
  
(75)  
191   
1,171   
1,287
Segment profit (loss)
  
3,510   
(306)  
(620)  
2,584
Segment assets
  
730,088   
14,503   
3,691   
748,282
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Reportable Segments(Dollars inthousands)

For the six month period ended June 30, 2002
 
Banking
 
FinancialSupermarkets
 
AllOther
 
Total
             
Revenue from external customers
 
$
25,510  
$
4,204  
$
248  
$
29,962
Intersegment revenues (expenses)
  
(243)  
438   
1,096   
1,291
Segment profit (loss)
  
3,098   
858   
(678)  
3,278
Segment assets
  
668,076   
15,672   
5,882   
689,630 
For the Three Months Ended June 30

For the Six Months Ended June 30

 
 
2003
 
2002

          2003

     2002
          
 

Net Income
          
 
          
 

Total profit for reportable segments

$

1,538 
 
$

2,238 

$

3,204 

$

3,956 

 

Non-reportable segment loss
  
(309)
  
(341)
 
(621)
 
(678)

 

Elimination of intersegment (gains) losses
  
24 
  
(24)
 
48 
 
(49)

 

Total consolidated net income

$

1,253 
 
$

1,873 

$

2,631 

$

3,229 

 
 
2003
Total Assets     
Total assets for reportable segments

$

744,591 

Non-reportable segment assets
 
3,691 

Elimination of intersegment assets
 
(21,053)

Total consolidated assets

$

727,229 

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 June 30, 2003, theinterpretation has not had a material effect on the financial condition or results of operations, and there are no guaranteesrequired to disclosed. 

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COMMUNITY BANKSHARES, INC.AND SUBSIDIARIES

**ITEM2.               MANAGEMENT DISCUSSION AND ANALYSISOF                              FINANCIAL CONDITION AND RESULTS OFOPERATIONS**

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 Company’s control.  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 June 30, 2003, we continue to experience growth in total assets, total loans andtotal deposits as compared to December 31, 2002.  Total assets, loans, and deposits increased by 3.85%, 4.02% and 4.36%,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 June 30, 2003, our liquidity ratio was 21.34%, which is within our target range of20 - 25%.  Liquidity is measured by the ratio of net cash, short term and marketable securities to net deposits and short termliabilities banks.  Our 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 capital levels inrelation to our assets.  At June 30, 2003, the Company’s and the banks capital ratios were considered well capitalizedbased on regulatory minimum capital requirements.  The minimum capital requirements and the actual consolidated capital ratiosat June 30, 2003 were as follows:

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Actual
Regulatory Minimum       
Leverage

   8.91%
4.00%  
     Risked Based Capital ratios:
    
     Core Capital

12.12%
4.00%  
     Total Capital

13.37%
8.00%           
Results of Operation

*Net Income*

Net income for the six month period ended June 30, 2003, was $2,631,000 or a decrease of18.52%  and for the three month period ended June 30, 2003, was $1,253,000 or a decrease of 33.10% over the same period for2002.   These decreases are directly attributable to the decrease in revenue of the nonbank subsidiary.

*Net Interest Income*

Net interest income for the six month period ended June 30, 2003 is up 11.19% over thesame period for 2002, from $13,124,000 to $14,593,000, and is up 10.80% for the three month period ending June 30, 2003 from$6,744,000 in the same period in 2002 to $7,472,000 for 2003.  Interest income was down by 0.31% for the six month periodending June 30, 2003 from $21,725,000 to $21,658,000 and down .17% for the there month period ending June 30, 2003 from $10,898,000to $10,880,000. The decrease was caused by the continued decline in the yield on earning assets from 7.46% during the first sixmonths of 2002 to 6.55% during the first six months of 2003 offset by the increase in the volume of earning assets.  Earningassets had increased by 8.44% or $50,785,000 at June 30, 2003 as compared to June 30, 2002.  The largest increase in earningassets since June 30, 2002 was the increase in loans of $47,473,000 or 10.24%.  Securities increased by $5,934,000 whilefederal funds decreased by $2,750,000.

Interest expense was down 17.86% or $1,536,000 for the six month period ended June 30,2003, over the same period in 2002 and down 17.96% or $746,000 for the three month period ending June 30, 2003, as compared to2002.  These decreases were related directly to the lower rate environment.

The Company’s net interest margin was 4.84% for the six month period ended June 30,2003 compared to 4.61% for the same period in 2002.  Our net interest margin has continued to improve during the past year asinterest bearing liabilities have continued to reprice due to the Company being in an asset sensitive position.  Managementanticipates a stable net interest margin over the next twelve months.  Any increase in rates would have a slight positiveeffect on our net interest margin.

*Provision for Loan Loss*

The provision for loan losses was $1,140,000 and $1,053,000 for the first six months of2003 and 2002 respectively.  The provision for loan losses for the six month period ended June 30, 2003 represented 75% ofcharge offs for the same period, while the provision for the first six months of 2002 represented 113% of the charge offs recordedin that period.  The reserve at June 30, 2003 represented 523% of non-accrual loans while the reserve at June 30, 2002represented 214% of non-accrual loans. Non accrual loans have decreased from $3,202,000 at June 30, 2002 to $1,432,000 as of June30, 2003.  Past due loans greater than 90 days and accruing interest have increased from $1,199,000 in 2002 to $2,093,000 in2003. 

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*Non-accrual, Past Due and Restructured Debt*

The following table is a summary of Non-accrual, Past Due and RestructuredDebt:

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

$   251 
$   548 
$   14 
Real Estate Loans

1,035 
1,213 
898 
Consumer Loans
 
146
  
332
  
0
        
Total
 
$1,432
  
$2,093
  
$912
     

June 30, 2002
 
**Non-accrual**
**Past Due**
**Restructured** 
**Loans**
**90 days**
**Debt**  
**Still accruing**     
Commercial Loans

$  346 
$  276 
$  134 
Real Estate Loans

2,378 
662 
973 
Consumer Loans
 
478
  
261
  
58
        
Total
 
$3,202
  
$1,199
  
$1,165
 
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.

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 non accrual or charged off is reversed against interest income.  Interest income on nonaccrual 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.

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The following table furnishes information on the loan loss reserve for the current sixmonth reporting period and the same period for 2002.
 
2003
 
2002
    
Beginning Balance

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

(181) 
(93)
     Real Estate Loans

(859) 
(368)
     Consumer Loans

(474)
 
(468)
     
(1,514)
 
(929)    
Plus Recoveries:
   
     Commercial Loans

16  
1 
     Real Estate Loans

12  
5 
     Consumer Loans

94 
 
86 
     
122 
 
92 
    
Net Charge-offs

(1,392) 
(837)    
Provision for loan loss

1,140 
 
1,053 

Ending Balance

$  7,490
 
$  6,868 

The increase in charged off real estate loans is due primarily to the charge off of threeloans totaling approximately $343,000.

Our Company operates in three distinct markets, northeast Georgia,midwest Georgia and mideast 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.

Management is aware of a deterioration in loan quality.  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 ofJune 30, 2003, non-accrual loans and other real estate owned totaled approximately $7,355,000 as compared to $8,845,000 as of June30, 2002.  The ratio of the loan loss reserve balance to the total loan balance at June 30, 2003 was 1.47% as compared to1.48% at June 30, 2002.  As of June 30, 2003, management considered our allowance for loan losses adequate to cover anyanticipated losses.

 Repossessed real estate owned by the bank increased from $3,987,000 in June 2002 to$5,923,000 in June 2003 or 48.56%.  This real estate is carried in the books at the lesser of cost or fair market value withno loss anticipated.  During early April 2003 the Company moved approximately $2,000,000 from non-accrual loan status to otherreal estate. 

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*Other Income*

Other income decreased by $2,406,000 or 30.34% during the six month period ended June 30,2003 as compared to the same period for 2002 and the three month period ending June 30, 2003 showed a decrease of  $1,454,000or 35.35% for the same three month period in 2002.  This decrease is primarily due to the termination of an agreement toestablish banking pavilions between Financial Supermarkets, Inc. (“FSI”), a nonbank subsidiary, and the CanadianImperial Bank of Commerce (“CIBC”).  It will take time and approximately 150-200 new unit sales to replace thisincome.  At this time, management is uncertain as to when this may be accomplished.  Due to slowing economic conditions,management anticipates fewer sales of supermarket bank units and thus anticipates a decline in revenue during 2003 as compared to2002. 

Service charges on deposit accountsincreased by $115,000 or 4.62% for the six month period ended June 30, 2003 ascompared to the same period in 2002.  Service charges on deposits increasedprimarily as a result of the Company’s continued growth in checking accounts. Other service charges, commissions and fees increased by 42% or $295,000 for thesix month period ending June 30, 2003 and 27.95% or $102,000 for the three monthperiod during June 30, 2003 compared to the same periods in 2002. The majorityof this increase is attributed to the renegotiation of fees with our debit cardservice provider and the increase in volume of debit card transactions. The gains on sale of loans increased by $40,000 during the six month periodending June 30, 2003 as compared to the same period for 2002.

Noninterest expenses increased by 1.31% or $203,000 for the six month period ending June30, 2003 and 3.71% or $285,000 for the three month period ending June 30, 2003 compared to the same periods in 2002.  Fulltime equivalent employees increased from 378 at the end of June 2002 to 395 at the end of June 2003.  The increase in fulltime equivalent employees was influenced by the addition of two new supermarket banking centers and one new stand-alone branchduring the past year as well as the overall growth of the Company’s banking operations.  The decline in salaries andbenefits was a result of a reduced level of accrual of incentive compensation associated with the reduced level of sales activityat FSI.  Equipment and occupancy expenses were up by 6.97% or $172,000 for the six month period ending June 30, 2003 and 6.51%or $81,000 for the three month period ending June 30, 2003 as compared to the same periods in 2002.  Other operating expensesincreased by 1.83% or $82,000 for the six month period ending June 30, 2003 and 9.19% or $199,000 for the three month period endingJune 30, 2003 as compared to the same periods in 2002.  The increase is attributed to the change in our fee structure with ourdebit card provider and an increased effort in business development and marketing of our nonbank subsidiary.

*Income Taxes*

We incurred income tax expenses of $307,000 which represents an effective rate of 19.68%for the three month period ended June 30, 2003 as compared to $768,000 which represents an effective tax rate of 29% for the sameperiod in 2002.  In addition, we incurred income tax expenses of $1,253,000 which represents an effective rate of 19.17% forthe six month period ended June 30, 2003 as compared to $1,253,000 which represents an effective tax rate of 28% for the sameperiod 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.

 

 

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**ITEM3.               QUANTITATIVE AND QUALITATIVEDISCLOSURES ABOUT MARKET                             RISK**

The Company is exposed only to U.S. dollar interest rate changes and accordingly, theCompany manages exposure by considering the possible changes in the net interest margin.  The Company does not have anytrading instruments nor does it classify any portion of the investment portfolio as held for trading.  The Company does notengage in any hedging activities or enter into any derivative instruments other than mortgage backed securities, which are commonlypass through 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 Directors. 

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At June 30, 2003, the Company’s cumulative interest rate sensitivity gap ratio forthe next twelve months was 104%, 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 June 2003model reflects an increase of  2.53% in net interest income and a 17.83% decrease in market value equity for a 200 basis pointincrease in rates.  The same model shows a 3.49% decrease in net interest income and a 23.18% increase in market value equityfor a 200 basis point decrease in rates.  The Company’s policy is to allow no more than +- 8% change in net interestincome and no more than +- 25% change in market value equity for these scenarios.  Therefore, the Company is within its policyguidelines.

**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 concluded that ourdisclosure controls and procedures are effective in accumulating and communicating information to our management, including our CEOand CFO, as appropriate to allow timely decisions regarding required disclosures of that information under the Securities andExchange Commission rules and forms and that our disclosure controls and procedures are designed to ensure that the information weare required to disclose in reports that we file or submit under all applicable federal securities laws is recorded, processed,summarized and reported within the time periods specified in the Securities and Exchange Commission rules and forms.

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.

 

 

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PART II – OTHER INFORMATION

**ITEM4.               SUBMISSION OF MATTERS TO A VOTE OFSECURITY HOLDERS**

The Annual Meeting of the Shareholders of the Company was held on April 9, 2003. Total shares outstanding amounted to 2,151,858.  A total of 1,651,067 (76.70%) were represented by shareholders in attendanceor by proxy.  The following directors were re-elected to serve for a one-year term.  The results of the election were asfollows:
 
Shares Voted:
 
For

Against

Abstain
    
Steven C. Adams

1,651,067

0

0

Edwin B. Burr

1,651,067

0

0

H. Calvin Stovall, Jr.

1,651,067

0

0

Dean C. Swanson

1,651,067

0

0

George D. Telford

1,651,067

0

0

Dr. A. Dan Windham

1,651,067

0

0

J. Alton Wingate

1,651,067

0

0

Lois M. Wood-Schroyer

1,651,067

0

0

**ITEM6.               EXHIBITS AND REPORTS ON FORM8-K**

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,andChief Financial Officer,Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant To Section 906 of the Sarbanes- Oxley Act of 2002.

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: August 13, 2003

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