Table of Contents
**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, 2004
/  /     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 mark whether theregistrant is an accelerated filer (as defined in Rule 12b-2 of the ExchangeAct.    Yes  ̈    No  þ   
APPLICABLE ONLY TO CORPORATE ISSUERS

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as ofAugust 1, 2004;2,139,087

**COMMUNITY BANKSHARES, INC.****ANDSUBSIDIARIES****INDEX**
 
Page No.
**PART I. FINANCIAL INFORMATION**
 
**Item 1.**

**Financial Statements**
   
Consolidated Balance Sheets - 

 3 
June 30, 2004 and December 31, 2003
  
Consolidated Statements of Income

 4 
and Comprehensive Income for Three 
 
Months Ended June 30, 2003 and 2003
 
and Six Months Ended June 30, 2004 and 2003
  
Consolidated Statements of Cash Flows - 

 5 
Six Months Ended June 30, 2004 and 2003
  
Notes to Consolidated Financial Statements

6 
**Item 2.**

**Management’s Discussion and Analysis of**

 10** **
**Financial Condition and Results of Operations**
 
**Item 3.**

**Quantitative and Qualitative Disclosures about Market Risk**

 15 
**Item 4.**

**Controls and Procedures**

 16 
**PART II. OTHER INFORMATION**

 16 **Item 1.  ****Legal Proceedings**
 16 **Item 4.  ****Submission of Matters to a Vote of Security Holders**
 16** **** **
 
**Item 6.**

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

 16  
31.1 and 31.2 - Rule 13a-15(e) and 15d-15(e) Certifications

   
32 - Certification of Chief Executive Officer and Chief FinancialOfficer,Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 9-6 of theSarbanes-Oxley Act of 2002.

   
Signatures

 17
**PART I - FINANCIAL INFORMATION**

**ITEM1.                  FINANCIALSTATEMENTS**

**COMMUNITY BANKSHARES, INC.AND SUBSIDIARIES**

**CONSOLIDATED BALANCE SHEETSJUNE 30, 2004 AND DECEMBER 31, 2003(Dollars in thousands)**
  
(Unaudited)
   
Assets                                                                       

                                                                      2004
           
                                                                      2003

Cash and due from banks

$

                                                                      39,373 

 
$

44,729 

Interest-bearing deposits in                                                                      banks
 
                                                                      634 
  
429 

Federal funds sold                                                                       
 
                                                                      15,600 
  
19,600 

Securities available-for-sale
 
                                                            90,033   
103,458 

Securities held-to-maturity (fair                                                                      value     $22,959 and                                                                      $24,352)
 
                                                            21,802   
22,628 

Restricted equity securities, at                                                                      cost
 
1,451 
  
1,243 

Loans, net of unearned income
 
                                                            606,212   
545,466 

          Less allowance for loan losses
 
                                                            8,935   
 7,561 

                                                                               Loans, net
 
                                                            597,277   
537,905 
      
Premises and equipment, net
 
                                                            17,106   
15,239 

Intangible assets, net
 
954   
1,090 

Goodwill
 
968 
  
968 

Other real estate
 
                                                                      4,769 
  
5,272 

Other assets
 
14,051 
  
13,624 
      
                                                                               **Total assets**

$

                                                                      804,018 
 
$

766,185 

**Liabilities, Redeemable Common Stock                                                                      and Shareholders’ Equity**
     
Liabilities:
     
  Deposits:
     
                                                                         Noninterest-bearing

$

                                                                      124,428 
 
$

111,562 

    Interest-bearing                                                                      demand
 
168,997 
  
174,070 

    Savings
 
39,788 
  
35,157 

    Time, $100,000 and                                                                      over
 
131,819 
  
123,975 

    Other time
 
231,453 
  
225,840 

         **Total deposits**
 
696,485 
  
670,604 

Other borrowings
 
25,935 
  
16,153 

Other liabilities
 
                                                                      7,928 
  
                                                                      7,986 

                                                                                **Total                                                                      liabilities**
 
730,348 
  
694,743 

Redeemable common stock held by ESOP,                                                                      net of unearned ESOP shares related to    ESOP debt                                                                      guarantee of $799 and $974, at                                                                      June 30, 2004    and                                                                      December 31, 2003 respectively
 
                                                                       

15,614 
  
                                                                       

15,783 

Shareholders' equity
     
    Common stock, par       value $1; 5,000,000 shares authorized;                   2,206,830 and 2,204,330 shares issued  at June 30, 2004 and          December 31, 2003, respectively
 
2,207 
  
2,204 

    Capital                                                                      surplus
 
6,437 
  
6,342 

    Retained                                                                      earnings
 
                                                                      51,981 
  
48,069 

    Accumulated other                                                                      comprehensive income
 
                                                                      333 
  
1,607 

                                                                             Less cost of                                                                      67,743 and 60,135 shares of treasury stock at                                                                      June 30, 2004                                                                      and        December 31, 2003,                                                                      respectively
 
(2,902)
  
(2,563)

           **Total shareholders' equity**
 
58,056 
  
55,659 
      
  **Total liabilities,                                                                      redeemable common stock and shareholders' equity**

$

                                                                      804,018 
 
$

766,185 
       
                                                                       
     
See Notes to Consolidated Financial Statements

3
**COMMUNITY BANKSHARES, INC.AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF INCOMEAND COMPREHENSIVE INCOMETHREE MONTHS ENDED JUNE 30, 2004 AND 2003 ANDSIX MONTHS ENDED JUNE 30, 2004 AND 2003(Dollars in thousands, except per share amounts)(Unaudited)**
 
Three Months EndedJune 30,

Six Months EndedJune 30,
  
2004

2003

2004

2003

 

Interest income:
 
 
 
  
   Loans, including fees

$   

9,807 
$

 9,431 
$ 

19,711 
$

18,747 
 

   Taxable securities

531 

613 

1,147 

1,247 

 

   Nontaxable securities

667 

763 

1,358 

1,522 

 

   Interest-bearing deposits in other banks

3 

3 

5 

5 

 

   Federal funds sold

42 

70 

77 

137 

 

          Total interest income

11,050 

10,880 

22,298 

21,658 

 
Interest expense:     
   Deposits

2,788 

3,211 

5,531 

6,671 

 

   Other borrowings

220 

197 

429 

394 

 

     Total interest expense

3,008 

3,408 

5,960 

7,065 

 

     Net interest income

8,042 

7,472 

16,338 

14,593 

 

Provision for loan losses

829 

594 

1,958 

1,140 

 

     Net interest income after         Provision for loan losses

7,213 

6,878 

14,380 

13,453 

 
   Other income:     
   Service charges on deposit accounts

2,573 

1,326 

4,843 

2,606 

 

   Other service charges, commissions and fees

547 

467 

1,077 

997 

 

   Gains on sale of loans

150 

32 

161 

87 

 

   Nonbank subsidiary income

1,637 

655 

3,131 

1,536 

 

   Security gains, net

27 

0 

63 

0 

 

   Other operating income

199 

179 

347 

297 

 

          Total other income

5,133 

2,659 

9,622 

5,523 

 
Other expenses:     
   Salaries and employee benefits

5,229 

4,286 

10,095 

8,624 

 

   Equipment expense

874 

828 

1,688 

1,661 

 

   Occupancy expense

571 

499 

1,095 

979 

 

   Other operating expenses

2,491 

2,364 

5,676 

4,457 

 

          Total other expenses

9,165 

7,977 

18,554 

15,721 

 

          Income before income taxes

3,181 

1,560 

5,448 

3,255 

 

Income tax expense

1,014 

307 

1,558 

624 

 

          Net income

$

 2,167 
$      1,253 

$

3,890 
$

 2,631 
 

Other comprehensive income (loss):   Unrealized gains (losses) on securities available for sale:          Unrealized gains (losses) arising during               the period, net of taxes

(1,819)

831 

(1,236)

730 

 

          Reclassification adjustment               for gains realized in net               income, net of taxes

(16)

0 

(38)

0 

 

Total other comprehensive income (loss)

(1,835)

831 

(1,274)

730 

 

Comprehensive income

$ 

 332 
$

2,084 
$

2,616 
$

 3,361 
 

Basic earnings per common share

$

1.01 
$ 

.58 
$

1.82 
$ 

 1.22 
 

Diluted earnings per common share

$

1.01 
$

.58 
$ 

 1.81 
$

  1.22 
 

Cash dividends per share of common stock

$

.08 
$  

 .07 
$ 

16 
$ 

 0.14 
 

 
        
  

See Notes to Consolidated Financial Statements

4
**COMMUNITY BANKSHARES, INC.AND SUBSIDIARIES**

**CONSOLIDATED STATEMENTS OF CASH FLOWSSIX MONTHS ENDED JUNE 30, 2004 AND 2003(Dollars in thousands)(Unaudited)**
 
2004

2003
OPERATING ACTIVITIES  
Net income

$    3,890

$     2,631
Adjustments to reconcile net income to   net cash provided by operating   activities:  
   Depreciation and amortization

1,469

1,582

   Provision for loan losses

1,958

1,140

   Deferred income taxes

(1,346)

418

   Net realized gains on securities     available-for-sale

(63)

0

   Net (gains) losses on sale of other real estate

(20)

21

   (Increase) decrease in interest receivable

(45)

146

   Increase (decrease) in interest payable

155

(247)

   Increase (decrease) in taxes payable

(143)

65

   Increase in accounts      Receivable of nonbank subsidiary

(468)

(27)

   Decrease in work in     process of nonbank subsidiary

140

196

   Increase (decrease) in accruals and     payables of nonbank subsidiary

344

(1,473)

Net other operating activities

1,679

(703)

          Net cash provided by          operating activities

7,550

3,749

INVESTING ACTIVITIES  
   Purchases of securities available-for-sale

(4,484)

(16,312)

   Proceeds from sales of securities     available-for-sale

9,850

0

   Proceeds from maturities of securities     available-for-sale

5,792

12,860

   Proceeds from maturities of securities     held-to-maturity

826

3,192

   Net (increase) decrease in Federal funds sold

4,000

(1,560)

   Net (increase) decrease in interest-bearing     deposits in banks

(205)

63

   Net increase in loans

(63,581)

(25,818)

   Purchase of premises and equipment

(3,151)

(534)

   Proceeds from sales of other real estate

2,773

2,195

   Net cash used in     investing activities

(48,180)

(25,914)

FINANCING ACTIVITIES  
   Net increase in deposits

25,881

26,460

   Increase in FHLB advances

10,075

75

   Repayment of other borrowings

(293)

(293)

   Proceeds from exercise of options

293

(1,105)

   Purchase of treasury stock

(339)

(1,105)

   Dividends paid

(343)

(301)

5 
          Net cash provided by financing activities

$

35,274
$

24,836
Net increase (decrease) in cash and   due from banks

  $

(5,356)
$ 

2,671
Cash and due from banks at beginning of the period

44,729

44,966

Cash and due from banks at end of the period

$ 

39,373
$

47,637
SUPPLEMENTAL DISCLOSURES  
   Cash paid for:     Interest

$ 

5,805
$  

7,312
     Income taxes

$ 

1,831
$ 

628
NONCASH TRANSACTIONS  
   Principal balances on loans     Transferred to other real estate

$ 

 2,250
$ 

 4,652
6
COMMUNITY BANKSHARES, INC.AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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 six monthperiod endingJune 30, 2004 are not necessarilyindicative of the results to be expected for the full year.

NOTE 2.           STOCK COMPENSATION PLAN

The Company has a stock-based employee compensationplan. 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 all optionsgranted under the plan had an exercise price equal to the market value of the underlying stock on the date ofgrant. 

There were no options granted during the three and six months ended June 30, 2004 and 2003and all outstanding options were fully vested as of June 30, 2004 and 2003. Therefore, there would be no proforma effect on netincome, earnings per share if the Company had applied the fair value recognitionprovisions of Statement ofFinancial AccountingStandards (SFAS) No. 123, Accounting for Stock-Based Compensation, to stock-basedemployee compensation.

7
NOTE3.                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, 2004(Dollars and shares in Thousands,except per shareamounts)
 
NetIncome(Numerator)

Weighted-AverageShares(Denominator)

Per Share Amount
    
Basic EPS
 
$2,167  
2,139  
$1.01  
Effect of Dilutive Securities     Stock options
 
0
  
5
  
0
           
Diluted EPS
 
$2,167
  
2,144
  
$1.01 
               
Three Months Ended June 30, 2003(Dollars and shares inThousands, except per share amounts)
 
NetIncome(Numerator)
Weighted-AverageShares(Denominator)
Per ShareAmount        
Basic EPS
 
$1,253  
2,151  
$0.58  
Effect of Dilutive Securities    Stock options
 
0
  
6
  
0.00 
           
Diluted EPS
 
$1,253
  
2,157
  
$0.58 

 
              
 

8 
Six Months Ended June 30, 2004(Dollars and shares inThousands, except per share amounts)
 
NetIncome(Numerator)
Weighted-AverageShares(Denominator)
Per ShareAmount        
Basic EPS
 
$3,890  
2,139  
$1.82  
Effect of Dilutive Securities    Stock options
 
0
  
5
  
(.01)
           
Diluted EPS
 
$3,890
  
2,144
  
$1.81 

 
              
 
 
Six Months Ended June 30, 2004(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
  
0.00 
           
Diluted EPS
 
$2,631
  
2,162
  
$1.22 

 
              
 

9
NOTE4.                SEGMENT INFORMATION

Selected segment information by industry segment for the three and six month periods endedJune 30, 2004 and 2003 is as follows:
 
Reportable Segments(Dollars inthousands)

For the  three month period ended June 30, 2004
 
Banking
 
FinancialSupermarkets
 
AllOther
 
Total
             
Revenue from external customers
 
$
14,552  
$
1,387  
$
302  
$
16,241
Intersegment revenues (expenses)
  
(32)  
92   
779   
839
Segment profit (loss)
  
2,321   
203   
(380)  
2,144
Segment assets
  $
815,611   $
15,144   $
4,529   $
835,284
 
 
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  six month period ended June 30, 2004
 
Banking
 
FinancialSupermarkets
 
AllOther
 
Total
             
Revenue from external customers
 
$
28,798  
$
2,761  
$
468  
$
32,027
Intersegment revenues (expenses)
  
(63)  
182   
1,272   
1,391
Segment profit (loss)
  
4,284   
335   
(776)  
3,843
Segment assets
  $
815,611   $
15,144   $
4,529   $
835,284
 
 
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
 

9
 
 
For the Three Months EndedJune 30     
For the Six Months EndedJune 30  
2004
 
2003
 
2004
 
2003
              
Net Income
                           
Total profit for reportable segments

$

2,524  
$

1,537 
 
$

4,619  
$

3,204 
 
Non-reportable segment loss
  
(380)
  
(308)
   
(776)
  
(620)
 
Elimination of intersegment (gains)losses
  
23 
  
24  
   
47 
  
47  
 
Total consolidated net income

$

2,167 
 
$

1,253 
 
$

3,890 
 
$

2,631 
 
 

 

2004
   Total Assets     
Total assets for reportable segments

$

830,755 

Non-reportable segment assets
 
4,529 

Elimination of intersegment assets
 
(31,266)

Total consolidated assets

$

804,018 

 

 

10
COMMUNITY BANKSHARES, INC.AND SUBSIDIARIES

ITEM 2. MANAGEMENT DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION ANDRESULTS OF OPERATIONS

Our discussion below is based on the more detailed discussions about our business,operations and financial condition included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2003, underItem 7. Our discussions here focus on our results during or as of the quarter and six months ended June 30, 2004, and thecomparable period of 2003, and, to the extent applicable, any material changes from the information discussed in that Form 10-K orother important intervening developments or information since that time.These discussions should be read inconjunction with that 10-K for more detailed and background information.

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 underlying theforward-looking statements contained in the discussion are reasonable, any of the assumptions could be inaccurate, and therefore,no assurance can be made that any of the forward-looking statements included in this discussion will be accurate. Factors thatcould cause actual results to differ from results discussed in forward-­looking statements include, but are not limited to:economic conditions (both generally and in the markets where the Company operates); competition from other providers of financialservices; government regulation and legislation; changes in interest rates; and material unforeseen changesin the financial stability and liquidity of the Company’s credit customers; allof which are difficult to predict and which may be beyond the control of the Company. The Company undertakes no obligation torevise forward-looking statements to reflect events or changes after the date of this discussionor to reflect the occurrence of unanticipated events.

Critical Accounting Policies

The accounting principles theCompany follows and its methods of applying these principles conform with accounting principles generally accepted in the UnitedStates and with general practices within the banking industry.  In connection with the application of those principles, theCompany has made judgments and estimates that, in the case of the determination of the allowance for loan losses have been criticalto the determination of the Company’s financial position, results of operations and cash flows.

Management’s judgment in determining the adequacy of the allowance for loan lossesis based on evaluations of the collectibility of loans in the portfolio.  The allowance is an amount that management believeswill be adequate to absorb estimated losses in the loan portfolio.  The allowance for loan losses is evaluated on a regularbasis by management and is based upon management’s periodic review of the collectibility of the loans in light of historicalexperience, the nature and volume of the loan portfolio, particular circumstances that may affect the borrower’s ability torepay, estimated value of any underlying collateral and prevailing economic conditions.  This evaluation is inherentlysubjective as it requires estimates that are susceptible to significant revision as more information becomes available.  Whilemanagement uses the best information available to make its evaluation, future adjustments to the allowance may be necessary ifthere are significant changes in economic conditions.  In addition, regulatory agencies, as an integral part of theirexamination process, periodically review the Company’s allowance for loan losses, and may require the Banks to make additionsto the allowance based on their judgment about information available to them at the time of their examinations.

Financial Condition

For the quarter ended June 30, 2004, we experienced growth in total assets, total loansand total deposits as compared to December 31, 2003. Total assets, loans, and deposits increased by 4.94%, 11.14% and 3.86%respectively. The growth in total assets. loans, and deposits, is consistent with management’sexpectations. The growth in deposits is attributable to increased loan demand.  The growth in loanswas funded by the maturity and sale of securities, advances from Federal Home Loan Bank, the growth in deposits and retention ofearnings.  Management expects the growth to continue in the future.

11
Liquidity

As of June 30, 2004, the liquidity ratio was 20.15% which is within our target range of 20- 25%.   Liquidity is measured by the ratio of net cash, short term and marketable securities to net deposits and short termliabilities.

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 2% of net interest income; therefore, weare within policy guidelines. We have attempted to position ourselves to minimize the impact of further changes in rates in eitherdirection.

12
Capital

Banking regulations require the Company and the banks to maintain minimum capital levelsin relation to our assets. At June 30, 2004, the bank’s capital ratios were considered wellcapitalized based on regulatory capital requirements. The minimum capital requirements and the actualconsolidated capital ratios are as follows:
  
Actual

Regulatory Minimum
     
    Leverage

    8.96%

4.00               
 
    Core Capital

11.46%

4.00               
 
    Total Capital

12.71%

8.00               
    
Off Balance Sheet Arrangements

Our financial statements do not reflect various commitments and contingent liabilitiesthat arise in the normal course of business. These off-balance sheet financial instruments include commitments to extend credit andstandby letters of credit. Such financial instruments are included in the financial statements when funds are distributed or theinstruments become payable. Our exposure to credit loss in the event of nonperformance by the other party to the financialinstrument for commitments to extend credit and standby letters of credit is represented by the contractual amount of thoseinstruments. We use the same credit policies in making commitments as we do for on ­balance sheet instruments. Although theseamounts do not necessarily represent future cash requirements, a summary of our commitments as of June 30, 2004 and December 31,2003 are as follows:
                                                                 
June 30, 2004(Dollars in Thousands)
                 
December 31, 2003(Dollars in Thousands)
      
Commitments to extend credit

$

71,168
 
$

52,733

Financial standby letters of credit
 
4,663
  
4,077

The Company is currently constructing a main banking center inClayton, Georgia.  The cost of this facility is estimated to beapproximately $2,000,000 and will be placed into service no later than the firstquarter of 2005.

**A. Results of Operation**

*Net Income*

Net income for the six month period ended June 30, 2004, was $3,890,000 or an increase of47.85% compared to the same period for 2003 and for the three month period ended June 30, 2004, was $2,167,000 or an increase of72.95% over the same period for 2003.  These increases are directly attributed to the increase in revenue of the non-banksubsidiary, increase in net interest income and the increase in service charges on deposit accounts, net of increased provisionsfor loan losses and increased other expenses.

 *Net Interest Income*

Net interest income for the six month period ended June 30, 2004 was up 11.96% over thesame period for 2003, from $14,593,000  to $16,338,000 andwas up 7.63% for the three month period ending June 30, 2004 from $7,472,000 in the same period in 2003 to $8,042,000 for2004.  These increases were due to an increase in interest earned on earning assets and a decrease in interest expense. Interest income was up by 2.96% for the six month period ending June 30, 2004 from $21,658,000 to $22,298,000 and up 1.56% for thethree month period ending June 30, 2004 from $10,880,000 to $11,050,000.  The increases were caused by the increase in earningassets.  Earning assets increased by 12.77% or $83,332,000 at June 30, 2004 as compared to June 30, 2003.  The largestincrease in earning assets since June 30, 2003 was the increase in loans of $95,071,000 or 18.6%.  The primary reason for theincrease in loans is our opening of a  stand-alone branch and a loan production office during the later part of 2003.  Securitiesdecreased by $16,777,000 while federal funds increased by $4,840,000, during the same period.  Interestexpense was down 15.64% or $1,105,000 for the six month period ended June 30, 2004, over the same period in 2003 and down11.74 % or $400,000 for the three month period ending June 30, 2004, as compared to 2003.  Although total depositsincreased, interest expense decreased due to the continued re-pricing of deposit.

13
The Company’s net interest margin was 4.74% for the six month period ended June 30,2004 compared to 4.84% for the same period in 2003. Management anticipates a stable net interest margin over the next twelvemonths. Any increase in rates would have a slight positive effect on our net interest margin.

*Other Income*

Other income increased by $4,099,000 or 74.22% during the six month period ended June 30,2004 as compared to the same period for 2003 and the three month period ending June 30, 2004 showed an increase of $2,474,000 or93.04% for the same three month period in 2003.  There  increases are primarily due to increased service charges on depositaccounts of $2,237,000 or 85.84% for the six month period ended June 30, 2004 as compared to the same period in 2003 and increasedsales of $1,384,000 or 103.21% by Financial Supermarkets, Inc. (“FSI”), a nonbank subsidiary, as compared to the sameperiod in 2003. Service charges on deposits increased primarily as a result of the bank’s adding the new carefree checkprogram which allows customers to overdraw their account, up to a specific limit.  The increase in FSI's sales is attributedto the increase in the number of sales compared to the prior year due to the expansion of our sales efforts nation-wide and theresale of supermarket bank units in space released by the Canadian Imperial Bank of Commerce.

*Other Expenses*

Other expenses increased by 18.02% or $2,833,000 for the six month period ending June 30,2004 compared to the sameperiod in 2003 and increased 14.89% or $1,188,000 for the three month period endingJune 30, 2004 compared to the same period in 2003.   These increases are primarily attributable to an increase in full timeequivalent employees from 395 at the end of June 2003 to 412 at the end of June 2004. The increase in full time equivalentemployees was due to the addition of two new supermarket banking centers  one new stand-alone branchand a loan production office during the later part of2003 as well as the overall growth of the Company’s banking operations. In addition, the incentive commissions related tosales activity at FSI has increased due to increased sales over the previous year. These increases caused salaries and benefits toincrease by 17.06% or $1,471,000 for the six month period ended June 30, 2004 and 22% or $943,000 for the three month period endedJune 30,2004, as compared to the same period in 2003.

Also attributable to the two new banking centers and new stand-alone branch, equipmentand occupancy expenses were up by 5.42% or $143,000 for the six month period ending June 30, 2004, and 8.89% or $118,000 for thethree month period ended June 30, 2004, as compared to the same period in 2003.

Other operating expenses increased by 27.35% or $1,219,000 for the six month period endingJune 30, 2004 as compared to the same period in 2003. The single largest item included in this increase is attributed to the$297,000 expenses and related losses associated with the new carefree check program started in 2004.   In addition, legal feesincreased by $95,000 or 76% as compared to the same period in 2003 due to legal services related to past due loans and other realestate owned.   Data processing expense increased by $199,000 or 38.05% as compared to the same periodin 2003 due to growth of the banks and improvement in our technology platform.   Advertising and marketing increased by$97,000 or 26.65% and travel expense increased by $57,000 or 10.54% as compared to the same period in 2003. These increases areattributed to the increased marketing and sales activity of FSI.  Lossesrelated to customer forgeries and fraud increased by $87,000 or 116% as comparedto the same period in 2003.  Director and advisory director fees increasedby $56,000 or 29.95% as compared to the same period in 2003. The Board ofDirectors added advisory directors for most of the counties that we havesignificant banking activity.  Our postage expense increased by 76,000 or28.04%, and our printing and office supplies increased by $52,000 or 12.18% ascompared to the same period in 2003.  These increases are attributed to thegrowth in banking operations and activity.

For the three month period ended June 30, 2004, other operating expenses increased by5.33% or $126,000 compared to the same period in 2003.  Data processing expenseincreased by $114,000 or 39.455% as compared to the same period in 2003 due to growth of the banks and improvement in ourtechnology platform.  Advertising and marketing increased by $43,000 or 21.94% as compared to the same period in 2003. Thisincrease was attributed to the increased marketing and sales activity of FSI. Losses related to customer forgeries andfraud increased by $107,000 or 195% as compared to the same period in 2003.  Director and advisory director fees increased by$53,000 or 56.99% as compared to the same period in 2003. Our postage expense increased by 54,000 or 45.73%, and our printing andoffice supplies increased by $37,000 or 17.54% as compared to the same period in 2003.  These increases are attributed to thegrowth in banking operations and activity.  The above expenses were partially offset by a  recovery of $236,000 inestimated carefree losses related to our carefree checking program. 

14
*Income Taxes*

We incurred income tax expenses of $1,014,000 which represents an effective rate of 31.88%for the three month period ended June 30, 2004 as compared to $307,000 which represents an effective tax rate of 19.68% for thesame period in 2003.  In addition, we incurred income tax expenses of $1,558,000 which represents an effective rate of 28.60%for the six month period ended June 30, 2004 as compared to $624,000 which represents an effective tax rate of 19.17% for the sameperiod in 2003.  These effective rate increases are due to a larger portion of our income being fully taxable, which isdirectly attributable to our nonbank subsidiary

We are not aware of any other known trends, events or uncertainties, that will have orthat are reasonably likely to have a material effect on its liquidity, capital resources or operations. Weare also not aware of any current recommendations by the regulatory authorities which, if they wereimplemented, would have such an effect.

**B. Asset Quality**

*Provision for Loan Loss*

The provision for loan losses was $1,958,000 and $1,140,000 for the first six months of2004 and 2003 respectively.  For the three month period ended June 30, 2004, and 2003, respectively, the provision for loanlosses was $829,000 and $594,000.  Approximately 50% of these increaseswere due to loan growth.  The reserve at June 30,2004 represented 201% of non-accrual loans while the reserve at June 30, 2003 represented 523% of non-accrual loans. Non accrualloans have increased from $1,432,000 at June 30, 2003 to $4,439,000 as of June 30, 2004.  The increase in non-accrual loanswas mostly due to the addition of one loan of $2.3 million.  Past due loans greater than 90 days and accruing interest havedecreased from $2,093,000 in 2003 to $1,789,000 in 2004.

Repossessed real estate owned by the bank decreased 9.54% from $5,272,000 at December 31,2003, to $4,769,000 in June 2004. Other real estate is carried in the books at the lesser of cost or fair market value, lessestimated costs to sell, with no significant losses anticipated.

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 securingthese loans. As of June 30, 2004, non-accrual loans and other real estate owned totaled approximately$9,208,000 as compared to $7,355,000 as of June 30, 2003. The ratio of the loan loss reserve balance to thetotal loan balance at June 30, 2004 was 1.47% as compared to 1.39% at December 31, 2003.   As of June 30, 2004,management considered our allowance for loan losses adequate to cover any anticipated losses.

*Non-accrual, Past Due and Restructured Debt*

The following table, dollars in thousands,is a summary of nonaccrual, past due and restructured debt

June 30, 2004
 
**Non-accrual**
**Past Due**
**Restructured** 
**Loans**
**90 days**
**Debt**  
**Still accruing**     
Commercial Loans

$  528 
$   150 
$239 
Real Estate Loans

3,651 
1,152 
637 
Consumer Loans
 
260
  
487
  
--
        
Total
 
$4,659
  
$1,789
  
$876
     
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
 
15
The Banks’ policy is to discontinue the accrual of interest income when, in theopinion of management, collection of such interest becomes doubtful. This status is accorded such interest when (1) there is asignificant deterioration in the financial condition of the borrower and full repayment of principal and interest is not expectedand (2) the principal or interest is more than ninety days past due, unless the loan is both well-secured and in the process ofcollection.  Accrual of interest on such loans is resumed, in management’s judgment, when the collection of interest andprincipal become probable.  Loans classified for regulatory purposes as substandard or special mention that have not beenincluded in the table above do not represent or result from trends or uncertainties which management reasonably expects willmaterially effect future operating results, liquidity or capital resources. These classified loans do not represent materialcredits about which management is aware and which causes management to have serious doubts as to the ability of such borrowers tocomply with the loan repayment terms.

*Allowance for Loan Loss*

The following table, dollars in thousands, furnishes information on the loan loss reservefor the current six month reporting period and the same period for 2003.
 
2004
 
2003
 
(Dollars in Thousands)     
Beginning Balance

$  7,561  
$  7,742     
Less Charge Offs:
   
     Commercial Loans

(163) 
(181)
     Real Estate Loans

(280) 
(859)
     Consumer Loans

(345)
 
(474)
     
(788)
 
(1,514)    
Plus Recoveries:
   
     Commercial Loans

54  
16 
     Real Estate Loans

49  
12 
     Consumer Loans

101 
 
94 
     
204 
 
122 
    
Net Charge-offs

(584) 
(1,392)    
Provision for loan loss

1,958 
 
1,140 

Ending Balance

$ 8,935 

 
$  7,490 

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 bankruptcyfilings.

 

16
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES 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 any tradinginstruments nor does it classify any portion of the investment portfolio as held for trading. The Company does not engage in anyhedging activities or enter into any derivative instruments other than mortgage backed securities, which are commonly pass throughsecurities. Finally, the Company has no exposure to foreign currency exchange rate risk, commodity price risk, and other marketrisks.

Interest rates play a major part in the net interest income of a financial institution.The sensitivity to rate changes is known as “interest rate risk”. The repricing of interest earning assets andinterest-bearing liabilities can influence the changes in net interest income. As part of the Company’s asset/liabilitymanagement program, the timing of repriced assets and liabilities is referred to as Gap management.

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 primarily throughgrowth of core deposits within the banks’ market areas.

The Company’s asset/liability mix is monitored regularly witha report reflecting the interest rate sensitive assets and interest rate sensitive liabilities that is prepared and presented tothe Board of Directors of each bank on at least a quarterly basis. Management’s objective is to monitorinterest rate sensitive assets and liabilities so as to minimize the impact on earnings of substantialfluctuations in interest rates. An asset or liability is considered to be interest rate-sensitive if it will reprice or maturewithin the time period analyzed, usually one year or less. The interest rate-sensitivity gap is the difference between the interest-earning assets and interest-bearing liabilities scheduled to mature or repricewithin the relevant period. A gap is considered positive when the amount of interest rate-­sensitiveassets exceeds the amount of interest rate-sensitive liabilities. A gap is considered negative when theamount of interest rate­-sensitive liabilities exceeds the interest rate-sensitive assets. During aperiod of rising interest rates, a negative gap would tend to adversely affect net interest income,while a positive gap would tend to result in an increase in net interest income.Conversely, during a period of falling interest rates, a negative gap would tend to result in an increase in net interest income,while a positive gap would tend to adversely affect net interest income. If the Company’s assets and liabilities were equallyflexible and moved concurrently, the impact of any increase or decrease in interest rates on net interest income would beminimal.

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, whileinterest-bearing transaction accounts are by their terms immediately repricable, competitive conditions andother circumstances usually preclude repricing such deposits proportionately with changes in rates affecting interest-earningassets.

Accordingly, the Company also evaluates how changes in interest rates impacts therepayment of particular assets and liabilities. Income associated with interest-earning assets and costs associated withinterest-bearing liabilities may not be affected uniformly by changes in interest rates. In addition, the magnitude and duration ofchanges in interest rates may significantly affect net interest income. For example, although certain assetsand liabilities may have similar maturities or periods of repricing, they may react in different degrees tochanges in market interest rates. Interest rates on certain types of assets and liabilities fluctuate in advance of changes in general market rates, while interest rates on other types may lag behind changes ingeneral market 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 deviate significantlyfrom those reflected in the interest rate gap. The Company prepares a report monthly that measures the potential impact on netinterest margin by rising or falling rates. This report is reviewed monthly by theAsset/Liability Committee and quarterly by each Board of Director.

At June 30, 2004, the Company’s cumulative interest rate sensitivity gap ratio forthe next twelve months was 106.30% which was within its targeted range of 80% to 120%.

16
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 money marketrates are more stable than loans tied to a “Prime” rate and thus respond with less volatility to a market rate change.Thus, the Company uses a simulation model to monitor changes in net interest income due to changes in market rates. The model ofrising, falling and stable interest rate scenarios allows management to monitor and adjust interest rate sensitivity to minimizethe impact of market rate swings. The analysis of impact on net interest margins as well as market value of equity over a twelvemonth period is subjected to a 200 basis point increase and decrease in rate. The June 2004 model reflects an increase of 1.64% innet interest income and a 1.28% decrease in market value equity for a 200 basis point increase in rates. The same model shows a  1.69% decrease in net interest income and a 1.17% increase in market value equity for a 200 basis point decrease in rates.The Company’s policy is to allow no more than +-8% change in net interest income and no more than +-25% change in marketvalue equity for these scenarios. Therefore, the Company is within its policy 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 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 isrecorded, processed, summarized and reported within the time periods specified in the Securities and ExchangeCommission 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.

17
PART II – OTHER INFORMATION

 

**ITEM 1.  LEGALPROCEEDINGS**

The Company was named in a lawsuit inthe Superior Court of Greene County, Georgia on May 18, 2004.  The case wasremoved to the Middle District of Georgia in June 2004.  The plaintiff inthe case is seeking class action certification for owners of self-directedindividual retirement accounts at the Company's Georgia bank subsidiary thatincluded investments in securities issued by Stewart Finance Company, NationalFinance Company or D&E Acquisitions, Inc.  These issuing companies arebankrupt and have defaulted on the securities.  The plaintiff claims thatthe Company aided and abetted and conspired with the issuing companies inissuing unregistered securities, committing acts in violation of the Georgiaracketeering statute and in committing common law fraud.  Although theplaintiff has not made a specific claim for damages, he is claiming that theproposed class is entitled to the amount of the lost investment in thesecurities and treble and punitive damages.  The Company denied liabilityin this case and does not believe the case will have a material adverse effecton the Company.

**ITEM 5.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS**

The Annual Meeting of the Shareholders of the Company was held on April 14, 2004. Total shares outstanding amounted to 2,139,087.  A total of 1,683,276 shares  (78.69%) were represented by shareholdersin attendance or by proxy.  The following slate of directors were re-elected to serve for a one-year term.  The resultsof the election were as follows:

Shares Voted:

For

Against

Abstain

Steven C. Adams

1,683,276

0

0

Edwin B. Burr

1,683,276

0

0

H. Calvin Stovall, Jr.

1,683,276

0

0

Dean C. Swanson

1,683,276

0

0

George D. Telford

1,683,276

0

0

Dr. A. Dan Windham

1,683,276

0

0

J. Alton Wingate

1,683,276

0

0

Lois M. Wood-Schroyer

1,683,276

0

0

18
PART II – OTHER INFORMATION

ITEM6.                 EXHIBITS AND REPORTS ON FORM8-K

(a)Exhibits

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

32 - Certification of Chief Executive Officer and Chief Financial Officer, Pursuant to 18U.S.C. Section 1350, as Adopted Pursuant To Section 906 of the Sarbanes- Oxley Act of 2002.

(b)Reports on Form 8-K None.
 
 

 

 

 

 

 

19
SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto dulyauthorized. 

 
 
COMMUNITY BANKSHARES, INC.

 

 

DATE: August  16, 2004

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