10-Q 1 d10q.txt FORM 10-Q UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q QUARTERLY REPORT PURSUANT TO SECTION OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended: September 30, 2001 Commission file number: 33-42286 HENDERSON CITIZENS BANCSHARES, INC. (Exact name of registrant as specified in its charter) Texas 6712 75-2371232 --------------------------------- ---- ---------- (State or other jurisdiction (Primary Standard Industrial (IRS Employer of incorporation or organization) Classification Code Number) Identification No.)
201 West Main Street, P.O. Box 1009 Henderson, Texas 75653-1009 (903) 657-8521 (Address, including ZIP code, and telephone number, including area code, of registrant's principal executive offices) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. X Yes ____No --- At September 30, 2001, 1,994,816 shares of Common Stock, $5.00 par value, were outstanding. 1 HENDERSON CITIZENS BANCSHARES, INC. QUARTER ENDED SEPTEMBER 30, 2001 Table of Contents
PART I - FINANCIAL INFORMATION ITEM 1 - Financial Statements Page ---- Consolidated Balance Sheets................................................ 3 Consolidated Statements of Income.......................................... 4 Consolidated Statements of Changes in Stockholders' Equity................. 5 Condensed Consolidated Statements of Cash Flows............................ 6 Notes to Consolidated Financial Statements................................. 7 ITEM 2 - Management's Discussion and Analysis of Financial Condition and Results of Operations......................................... 10 ITEM 3 - Quantitative and Qualitative Disclosure About Market Risk......... 16 PART II - OTHER INFORMATION................................................ 17 SIGNATURES................................................................. 18
2 Part I. FINANCIAL INFORMATION Item 1. Financial Statements HENDERSON CITIZENS BANCSHARES, INC. Consolidated Balance Sheets (dollars in thousands, except share amounts)
September 30, December 31, 2001 2000 Assets (unaudited) ------ ------------ ------------ Cash and due from banks $ 18,256 11,385 Interest-bearing deposits with financial institutions 24,373 10,403 Federal funds sold 13,470 4,205 ----------- --------- Total cash and cash equivalents 56,099 25,993 Securities available for sale, at fair value 171,858 155,693 Securities held to maturity, estimated fair value of $51,269 in 2001 and $51,010 in 2000 49,978 51,245 ----------- --------- 221,836 206,938 Loans, net 211,461 169,882 Premises and equipment, net 10,706 8,394 Accrued interest receivable 3,728 4,320 Intangible assets 8,428 4,087 Other assets 5,192 4,030 ----------- --------- $ 517,450 423,644 =========== ========= Liabilities and Stockholders' Equity ------------------------------------ Deposits: Demand - non interest-bearing 69,525 53,111 Interest-bearing transaction accounts 82,958 70,852 Money market and savings 85,785 58,361 Certificates of deposit and other time deposits 227,106 196,798 ----------- --------- Total deposits 465,374 379,122 Accrued interest payable 1,760 1,803 Other borrowings 2,131 1,148 Other liabilities 4,572 2,449 ----------- --------- 473,837 384,522 Stockholders' equity: Preferred stock, $5 par value; 2,000,000 shares authorized none issued or outstanding -- -- Common stock, $5 par value; 10,000,000 shares authorized, 2,160,000 issued 10,800 10,800 Additional paid in capital 5,400 5,400 Retained earnings 28,542 25,894 Accumulated other comprehensive income (loss) 1,276 (575) Treasury stock, 165,184 shares in 2001 and 164,784 shares in 2000 at cost (2,405) (2,397) ----------- --------- Total stockholders' equity 43,613 39,122 ----------- --------- $ 517,450 423,644 =========== =========
See accompanying notes to consolidated financial statements. 3 HENDERSON CITIZENS BANCSHARES, INC. Consolidated Statements of Income (unaudited)
Three months Nine months ended September 30, ended September 30, 2001 2000 2001 2000 -------------- ---------- ------------- ------------ Interest income: Loans, including fees $ 4,277 3,363 11,478 9,554 Securities: Taxable - available for sale 2,277 2,252 6,927 6,679 Taxable - held to maturity 125 156 376 527 Tax-exempt - held to maturity 496 506 1,476 1,547 Federal funds sold 155 28 640 198 Interest-bearing deposits with financial institutions 318 102 699 280 ---------- ---------- --------- --------- Total interest income 7,648 6,407 21,596 18,785 ---------- ---------- --------- --------- Interest expense: Deposits: Transaction accounts 318 392 1,034 1,290 Money market and savings 544 455 1,515 1,229 Certificates of deposit and other time deposits 3,021 2,701 9,088 7,553 Other borrowed funds 10 19 30 31 ---------- ---------- --------- --------- Total interest expense 3,893 3,567 11,667 10,103 ---------- ---------- --------- --------- Net interest income 3,755 2,840 9,929 8,682 Provision for loan losses 159 90 389 280 ---------- ---------- --------- --------- Net interest income after provision for loan losses 3,596 2,750 9,540 8,402 ---------- ---------- --------- --------- Noninterest income: Service charges, commissions, and fees 1,287 1,016 3,439 3,004 Income from fiduciary activities 328 270 985 810 Net realized gains on securities transactions 52 - 65 - Other 318 39 783 504 ---------- ---------- --------- --------- Total noninterest income 1,985 1,325 5,272 4,318 ---------- ---------- --------- --------- Noninterest expenses: Salaries and employee benefits 2,444 1,875 6,566 5,612 Occupancy and equipment 607 451 1,574 1,318 Other 1,002 795 2,746 2,640 ---------- ---------- --------- --------- Total other expenses 4,053 3,121 10,886 9,570 ---------- ---------- --------- --------- Income before income tax expense 1,528 954 3,926 3,150 Income tax expense 228 86 598 396 ---------- ---------- --------- --------- Net income $ 1,300 868 3,328 2,754 ========== ========== ========= ========= Basic earnings per common share $ 0.65 0.43 1.67 1.38 ========== ========== ========= ========= Weighted average number of shares outstanding 1,995,016 1,999,162 1,995,149 2,001,496 ========== ========== ========= =========
See accompanying notes to consolidated financial statements. 4 HENDERSON CITIZENS BANCSHARES, INC. Consolidated Statements of Changes in Stockholders' Equity (unaudited) Nine months ended September 30, 2001 and 2000 (dollars in thousands, except share and per share amounts)
Accumulated Other Preferred Common Retained Comprehensive Treasury Stock Stock Surplus Earnings Income (Loss) Stock Total --------- ------ --------- ---------- -------------- --------- ------- Balances at January 1, 2000 $ - 10,800 5,400 23,628 (1,938) (2,119) 35,771 Comprehensive income: Net Income - - - 2,754 - - 2,754 Other comprehensive income: Change in net unrealized gain (loss) on securities available for sale arising during the period, net of tax of $5 - - - - 8 - 8 -------- Total comprehensive income 2,762 Purchase of 12,666 shares of treasury stock - - - - - (221) (221) Cash dividends declared ($.51 per share) - - - (1,021) - - (1,021) -------- -------- ------- --------- --------- -------- -------- Balances at September 30, 2000 $ - 10,800 5,400 25,361 (1,930) (2,340) 37,291 ======== ========= ======= ========= ========= ======== ======== Balances at January 1, 2001 $ - 10,800 5,400 25,894 (575) (2,397) 39,122 Comprehensive income: Net Income - - - 3,328 - - 3,328 Other comprehensive income: Change in net unrealized gain (loss) on securities available for sale, net of tax of $954 - - - - 1,851 - 1,851 -------- Total comprehensive income 5,179 Purchase of 400 shares of treasury stock - - - - - (8) (8) Cash dividends declared ($.34 per share) - - - (680) - - (680) -------- -------- ------- --------- --------- -------- -------- Balances at September 30, 2001 $ - 10,800 5,400 28,542 1,276 (2,405) 43,613 ======== ======== ======= ========= ========= ======== ========
See accompanying notes to consolidated financial statements. 5 HENDERSON CITIZENS BANCSHARES, INC. Condensed Consolidated Statements of Cash Flows (unaudited) Nine months ended September 30, 2001 and 2000 (dollars in thousands)
2001 2000 ---------------- ----------- Net cash provided by operating activities $ 5,476 2,737 Investing activities: Securities available for sale: Sales 12,680 - Purchases (77,547) (21,836) Maturities and repayments 54,371 4,722 Securities held to maturity: Purchases (231) - Maturities and repayments 2,754 5,166 Net change in loans (11,810) (13,406) Proceeds from sale of premises and equipment and other real estate 59 205 Purchases of bank premises, equipment and software (1,537) (1,423) Net cash received from acquisition 9,653 - -------------- ----------- Net cash from investing activities (11,608) (26,572) -------------- ----------- Financing activities: Net increase in deposits 35,603 771 Other borrowed funds 983 - Cash dividends paid (1,018) (1,023) Purchase of treasury stock (8) (204) -------------- ----------- Net cash from financing activities 35,560 (456) -------------- ----------- Change in cash and cash equivalents 30,106 (24,291) Cash and cash equivalents at beginning of period 25,993 38,683 -------------- ----------- Cash and cash equivalents at end of period $ 56,099 14,392 ============== =========== SUPPLEMENTAL DISCLOSURES OF CASH FLOW ACTIVITIES Income taxes paid, net of refunds $ 936 515 ============== =========== Interest paid $ 11,710 6,190 ============== ===========
See accompanying notes to consolidated financial statements. 6 HENDERSON CITIZENS BANCSHARES, INC. Notes to Consolidated Financial Statements September 30, 2001 (1) Basis of Presentation --------------------- The accompanying consolidated financial statements are unaudited, but include all adjustments, consisting of normal recurring accruals, which management considers necessary for a fair presentation of the financial position, results of operations, and cash flows. Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to Securities and Exchange Commission rules and regulations. The consolidated financial statements and footnotes included herein should be read in conjunction with the Company's annual consolidated financial statements as of December 31, 2000 and 1999, and for each of the years in the three year period ended December 31, 2000 included in the Company's 2000 Form 10-K. The accompanying consolidated financial statements of the Company include the accounts of its wholly owned subsidiaries, Citizens National Bank and Peoples State Bank. The financial statements of Citizens National Bank are consolidated with its wholly owned subsidiaries, HCB Insurance Agency, Inc. and Community Development Corporation ("CDC"). Prior to the quarter ended September 30, 2001, Peoples State Bank was not part of the consolidated entity. See Note 3. Certain amounts in the prior financial statements have been reclassified to conform to the current presentation. (2) Recent Accounting Pronouncements -------------------------------- The following pronouncements have been issued, and are listed together with the expected impact on the Company. In July 2001, the Financial Accounting Standards Board issued two statements--SFAS 141, Business Combinations, and SFAS 142, Goodwill and Other Intangible Assets, which will potentially impact the Company's accounting for its reported goodwill and other intangible assets. SFAS 141, Business Combinations--This statement eliminates the pooling method for accounting for business combinations. It requires that intangible assets that meet certain criteria be reported separately from goodwill and that negative goodwill arising from a business combination be recorded as an extraordinary gain. SFAS 142, Goodwill and Other Intangible Assets--This statement eliminates the amortization of goodwill and other intangibles that are determined to have an indefinite life. It requires, at a minimum, annual impairment tests for goodwill and other intangible assets that are determined to have an indefinite life. The Company has not yet completed its full assessment of the effects of these new pronouncements on its financial statements. The standards are generally required to be implemented by the Company in its 2002 financial statements. In accordance with the new standards, goodwill recorded in connection with the Rusk County Bancshares, Inc. acquisition is not being amortized (see Note 3). (3) Acquisition ----------- On July 2, 2001, the Company acquired all of the outstanding shares of Rusk County Bancshares, Inc. Henderson, Texas, ("RCBI") and its wholly owned indirect banking subsidiary, Peoples State Bank for a purchase price of $12,550,000 in cash. The results of operations of Peoples State Bank have been included in the Company's consolidated income statement since that date. This transaction was accounted for using the purchase method of accounting and initially resulted in goodwill of $4,580,000 being recorded. The process of obtaining third-party valuations of certain intangible assets has not been completed; thus, the allocation of the purchase price is subject to refinement. The following is condensed pro- forma information for the acquisition of RCBI. Had this transaction occurred previously on January 1, 2000, net interest income for the periods ended September 30, 2001 and 2000 would have been $11,775,000 and $10,704,000 respectively while net income for the same periods would have been $3,815,000 and $3,250,000. Basic earnings per share for the periods ended September 30, 2001 and 2000 would have been $1.91 and $1.62. 7 (4) Securities ---------- The amortized cost and estimated fair values of securities available for sale at September 30, 2001 and December 31, 2000, are summarized as follows (in thousands of dollars):
September 30, 2001 ----------------------------------------------------------------- Gross Gross Estimated Amortized Unrealized Unrealized Fair Cost Gains Losses Value -------------- ----------- ---------- ---------- U.S. Treasury $ 9,003 339 - 9,342 U.S. Government agencies 51,051 890 (24) 51,917 Mortgage-backed securities and collateralized mortgage 109,789 1,038 (228) 110,599 obligations -------------- ----------- ---------- ---------- $ 169,843 2,267 (252) 171,858 ============= =========== ========== ========== December 31, 2000 ----------------------------------------------------------------- Gross Gross Estimated Amortized Unrealized Unrealized Fair Cost Gains Losses Value -------------- ----------- ---------- ---------- U.S. Treasury $ 18,015 66 (17) 18,064 U.S. Government agencies 63,468 116 (434) 63,150 Mortgage-backed securities and collateralized mortgage 74,578 181 (784) 73,975 obligations Other securities 504 - - 504 -------------- ----------- ---------- ---------- $ 156,565 363 (1,235) 155,693 ============= =========== ========== ==========
The amortized cost and estimated fair values of securities held-to-maturity at September 30, 2001 and December 31, 2000 are summarized as follows (in thousands of dollars):
September 30, 2001 ----------------------------------------------------------------- Gross Gross Estimated Amortized Unrealized Unrealized Fair Cost Gains Losses Value -------------- ----------- ---------- ---------- State and municipal $ 42,190 1,170 (41) 43,319 Mortgage-backed securities and collateralized mortgage 5,570 104 - 5,674 obligations Corporate 2,031 61 - 2,092 Other securities 187 - (3) 184 -------------- ----------- ---------- ---------- $ 49,978 1,335 (44) 51,269 ============= =========== ========== ========== December 31, 2000 ----------------------------------------------------------------- Gross Gross Estimated Amortized Unrealized Unrealized Fair Cost Gains Losses Value -------------- ----------- ---------- ---------- State and municipal $ 42,563 344 (519) 42,388 Mortgage-backed securities and collateralized mortgage 6,423 - (33) 6,390 obligations Corporate 2,047 - (22) 2,025 Other securities 212 - (5) 207 -------------- ----------- ---------- ---------- $ 51,245 344 (579) 51,010 ============= =========== ========== ==========
8 HENDERSON CITIZENS BANCSHARES, INC. Notes to Consolidated Financial Statements September 30, 2001 (5) Loans and Allowance for Loan Losses ----------------------------------- The composition of the Company's loan portfolio is as follows (in thousands of dollars) September 30, December 31, 2001 2000 ------------ ------------ Real estate mortgage $ 112,590 88,055 Commercial and industrial 60,756 51,026 Installment and other 41,065 33,219 ------------ ------------ Total 214,411 172,300 Less: Allowance for loan losses (2,932) (2,355) Unearned discount (18) (63) ------------ ------------ Loans, net $ 211,461 169,882 ============ ============ Changes in the allowance for loan losses for the three months and nine months ended September 30, 2001 and 2000 summarized as follows (in thousands of dollars):
Three months ended Nine months ended September 30, September 30, --------------------------- --------------------------- 2001 2000 2001 2000 --------- -------- -------- ---------- Balance, beginning of period $ 2,376 2,352 $ 2,355 2,200 Provision charged to operating expense 159 90 389 280 Addition from acquisition 536 - 536 9 Charge offs: Commercial, financial, and agriculture - (6) (77) (39) Real estate-mortgage - - (31) (19) Installment loans to individuals (221) (142) (433) (330) Recoveries: Commercial, financial, and agriculture - 17 6 102 Real estate-mortgage - - - - Installment loans to individuals 82 57 187 165 --------- -------- -------- ---------- Balance, September 30 $ 2,932 2,368 $ 2,932 2,368 ========= ======== ======== ==========
9 Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF THE FINANCIAL CONDITION AND RESULTS OF OPERATIONS OF HENDERSON CITIZENS BANCSHARES, INC. FOR THE NINE MONTHS AND THREE MONTHS ENDED SEPTEMBER 30, 2001 AND 2000 The following discussion and analysis of the consolidated financial condition and results of operations of the Company should be read in conjunction with the consolidated financial statements and the notes thereto, and other financial and statistical information appearing elsewhere in this report. Recent Developments ------------------- On July 10, 2001, Citizens National Bank entered into a Branch Purchase and Assumption Agreement with Jefferson Heritage Bank to purchase the Spring Hill and White Oak facilities at Longview and White Oak, Texas. At the close of business on October 5, 2001, these two facilities were converted to full-service branch locations of Citizens National Bank. On July 2, 2001, the Company acquired all of the outstanding shares of Rusk County Bancshares, Inc., Henderson, Texas ("RCBI") common stock (including shares acquired upon exercise of stock options) for a purchase price of $12,550,000 in cash, representing 1.57 times RCBI's book value at December 31, 2000, and 20.95 times 2000 earnings. The transaction was accounted for using the purchase method of accounting and resulted in an increase in total assets of $61,889,000 and total deposits of $50,649,000. The three banking offices of Peoples State Bank, Henderson, Texas, previously a wholly owned subsidiary but separate bank charter, are now being operated as full-service branches of Citizens National Bank since completion of the merger on October 25, 2001. It is not anticipated that the merger will result in any diminution of products and services currently available to customers of Peoples State Bank or Citizens National Bank. It is anticipated, however, that the merger will generate certain operational efficiencies by operating under one bank charter rather than two separate charters regulated by different regulatory authorities. Results of Operations --------------------- Net income for the first nine months of 2001 increased to $3,328,000 compared to $2,754,000 for the same period in 2000. Net interest income for the nine months ended September 30, 2001 was $9,929,000 compared to $8,682,000 for the same period in 2000. The Company made a provision of $389,000 to the allowance for loan losses during the first nine months of 2001. A provision of $280,000 was made for loan losses during the same period in 2000. The Company experienced a net gain on securities transactions of $65,000 in the first nine months of 2001 compared to no net gain or loss on securities transactions in the first nine months of 2000. Noninterest income, excluding net gains on securities transactions, for the first nine months of 2001 was $5,207,000 compared to $4,318,000 for the same period in 2000. Total noninterest expenses for the first nine months of 2001 were $10,886,000 compared to $9,570,000 for the same period in 2000. Income tax expense for the first nine months of 2001 and 2000 was $598,000 and $396,000, respectively. Net Interest Income. For the nine months ended September 30, 2001, net ------------------- interest income was $9,929,000 compared to $8,682,000 for the first nine months of 2000. Interest income was up $2,811,000 during the nine months ended September 30, 2001, primarily due to growth as a result of the acquisition of Peoples State Bank in July of 2001 and an increase in loan volumes. Interest expense increased $1,564,000 due to the higher volume of time deposits in the first nine months of 2001 as compared to the same period in 2000 combined with the growth as a result of the acquisition of Peoples State Bank. Net interest income for the three-month period ended September 30, 2001 was $3,755,000 compared to $2,840,000 in 2000. Interest income was up $1,241,000 for the three months ended September 30, 2001, due largely to the growth from the acquisition of Peoples State Bank in July of 2001 combined with an increase in the volume of loans and interest bearing deposits with other financial institutions. Interest expense increased $326,000 due to growth resulting from the acquisition of Peoples State Bank offset by interest rates that were approximately 64 basis points lower in the three-month period ended September 30, 2001, as compared to the same period in 2000. Provision for Loan Losses. The provision for loan losses was $389,000 ------------------------- for the first nine months of 2001 compared to $280,000 for the first nine months of 2000. See "Management's Discussion and Analysis of the Financial Condition and Results of Operations of the Company--Allowance for Loan Losses" for a more detailed discussion relative to the provision for loan losses. For the three-month period ended September 30, 2001, the Company increased its allowance through a provision of $159,000. The Company increased its allowance for loan losses during the same period in 2000 by a provision of $90,000. 10 Noninterest Income. Noninterest income, excluding securities ------------------ gains/losses, was $5,207,000 for the first nine months of 2001 as compared to $4,318,000 in the first nine months of 2000. This increase is the result of increases in service charges primarily due to an increase in fees collected for insufficient funds and increases in trust fee income. The Company experienced a net gain on securities transactions of $65,000 for the first nine months of 2001 compared to no net gain or loss on securities transactions for the first nine months of 2000. For the three months ended September 30, 2001, noninterest income, excluding securities gains was $1,933,000 compared to $1,325,000 for the same period in 2000. The Company experienced a net gain on securities of $52,000 for the three months ended September 30, 2001, compared to no net gain/loss on securities during the same period in 2000. Noninterest Expenses. Noninterest expenses for the nine-month period -------------------- ended September 30, 2001 were $10,886,000 compared to $9,570,000 during the same period in 2000. The increase in other expenses is due to the increase in salary and related benefits expense resulting from normal year-end salary increases in the current year combined with the continued growth of the Marshall branch that opened in December of 1999, the acquisition of the Preston Insurance Agency in April of 2000, the opening of the Athens branch in December of 2000, and the acquisition of Peoples State Bank in July of 2001. Occupancy expenses continue to increase with the addition of new facilities and the remodeling of existing properties. Noninterest expenses for the three-month period ended September 30, 2001 were $4,053,000 compared to $3,121,000 during the same period in 2000. The increase is a result of the same activities noted in the previous paragraph for the first nine months of 2001. Income Taxes. Income tax expense for the first nine months of 2001 was ------------ $598,000, compared to $396,000 in the same period in 2000. The effective tax rates for the first nine months of 2001 and 2000 were 15.2% and 12.6%. The effective rates are less than the statutory rate of 34% primarily because of tax-free income provided from state and municipal bonds, leases and obligations. Income taxes for the three-month periods ended September 30, 2001 and September 30, 2000 were $228,000 and $86,000 respectively. The effective tax rates for the three-month periods ended September 30, 2001 and September 30, 2000 were 14.9% and 9.0%. Financial Condition ------------------- The Company's total assets at September 30, 2001 of $517,450,000 increased from the total assets at December 31, 2000 of $423,644,000. The acquisition of Peoples State Bank in July of 2001 accounted for approximately $60,146,000 of the increase in total assets. The Company's loan portfolio grew to $211,461,000 at September 30, 2001, up from $169,882,000 at December 31, 2000. The acquisition of Peoples State Bank accounted for $29,266,000 of the increase in total loans. Total deposits were $465,374,000 at September 30, 2001, compared to the December 31, 2000 total of $379,122,000. The acquisition of Peoples State Bank accounted for $48,619,000 of the increase in total deposits as of September 30, 2001. Deposits and Other Borrowings ----------------------------- Total deposits at September 30, 2001 increased from the December 31, 2000 balances by $86,252,000. The acquisition of Peoples State Bank accounted for approximately $48,619,000 of the increase as of September 30, 2001. Growth at the Marshall branch, which opened in December 1999, combined with growth at the Athens branch, which opened in December 2000, accounted for approximately $16,075,000 of this increase. There were also increases to money market accounts and time deposits as customers took advantage of the tiered money market account that is indexed to the three-month Treasury bill. During July 2000, the Company changed from the Treasury Tax and Loan Daily Remittance Option to the Treasury Tax and Loan Note Option, which allows the Company to keep on deposit customer tax payments for short periods of time until withdrawn by the Treasury. At September 30, 2001, amounts payable under this note totaled $2,131,000. Liquidity --------- Liquidity is the ability of the company to fund customers' needs for borrowing and deposit withdrawals. The purpose of liquidity management is to assure sufficient cash flow to meet all of the financial commitments and to capitalize on opportunities for business expansion. This ability depends on the institution's financial strength, asset quality and types of deposit and investment instruments offered by the Company to its customers. The Company's principal sources of funds are deposits, loan and securities repayments, maturities of securities, sales of securities available for sale and other funds provided by operations. The Company also has various federal funds sources from correspondent banks. While scheduled loan repayments and maturing investments are relatively predictable, deposit flows and early loan and mortgage-backed security prepayments are more influenced by interest rates, general economic conditions and competition. The Company maintains investments in liquid assets based upon management's assessment of (1) need for funds, (2) expected deposit flows, (3) yields available on short-term liquid assets and (4) objectives of the asset/liability management program. 11 Cash and cash equivalents increased $30,106,000 from $25,993,000 at December 31, 2000 to $56,099,000 at September 30, 2001. Cash and cash equivalents represented 10.8% of total assets at September 30, 2001 compared to 6.1% of total assets at December 31, 2000. This increase was due mainly to an increase in deposits of $35,603,000 combined with additional deposits of $50,649,000 due to the acquisition of Peoples State Bank. The Company has the ability to borrow federal funds from various correspondent banks should the Company need to supplement its future liquidity needs in order to meet deposit flows, loan demand or to fund investment opportunities. Management believes the Company's liquidity position is strong based on its level of cash and cash equivalents, core deposits, the stability of its other funding sources and the support provided by its capital base. As summarized in the Consolidated Statements of Cash Flows, the most significant transactions that affected the Company's level of cash and cash equivalents, cash flows and liquidity during the first nine months of 2001 were the net increase in deposits of $35,603,000, securities purchases of $77,778,000 and securities maturities and repayments of $57,125,000. Capital Resources ----------------- At September 30, 2001, stockholders' equity totaled $43,613,000, or 8.4% of total assets, compared to $39,122,000, or 9.2% of total assets, at December 31, 2000. The Company and its Bank subsidiary, Citizens National Bank, are subject to regulatory capital requirements administered by federal banking agencies. Bank regulators monitor capital adequacy very closely and consider it an important factor in ensuring the safety of depositors' accounts. As a result, bank regulators have established standard risk based capital ratios that measure the amount of an institution's capital in relation to the degree of risk contained in the balance sheet, as well as off-balance sheet exposure. Federal law requires each federal banking regulatory agency to take prompt corrective action to resolve problems of insured depository institutions including, but not limited to, those that fall below one or more prescribed capital ratios. According to the regulations, institutions whose Tier 1 and total capital ratios meet or exceed 6.0% and 10.0% of risk-weighted assets, respectively, are considered "well capitalized." Tier 1 capital is shareholders' equity excluding the unrealized gain or loss on securities classified as available for sale and intangible assets. Tier 2 capital, or total capital, includes Tier 1 capital plus the allowance for loan losses not to exceed 1.25% of risk weighted assets. Risk weighted assets are the Company's total assets after such assets are assessed for risk and assigned a weighting factor based on their inherent risk. In addition to the risk-weighted ratios, all institutions are required to maintain Tier 1 leverage ratios of at least 5.0% to be considered "well capitalized" and 4.0% to be considered "adequately capitalized." The leverage ratio is defined as Tier 1 capital divided by adjusted average assets for the most recent quarter. The tables below set forth the Consolidated and Citizens National Bank only capital ratios as of September 30, 2001 and December 31, 2000. Consolidated Bank Only ------------- ---------- September 30, 2001 ------------------ Tier 1 capital to risk-weighted assets ratio 13.9% 13.4% Total capital to risk-weighted assets ratio 15.1 14.6 Leverage ratio 6.9 6.4 December 31, 2000 ----------------- Tier 1 capital to risk-weighted assets ratio 17.5% 17.0% Total capital to risk-weighted assets ratio 18.6 18.1 Leverage ratio 8.8 8.7 As of September 30, 2001 and December 31, 2000, Citizens National Bank met the level of capital required to be categorized as well capitalized under prompt corrective action regulations. Management is not aware of any conditions subsequent to September 30, 2001 and December 31, 2000 that would change the Company's or the Citizens National Bank's capital categories. Loans ----- The Company's loan portfolio consists primarily of real estate, commercial and industrial, and consumer loans. Gross loans were $214,411,000 at September 30, 2001 compared to $172,300,000 at December 31, 2000. As can be seen in the table in Note 4 above, an increase of approximately 19.1% in commercial and industrial loans, an increase of approximately 27.9% in real estate loans, and an increase of 23.6% in installment loans occurred during the first nine months of 2001. As of September 30, 2001, the acquisition of Peoples State Bank in July 2001 has contributed to an increase in total loans of approximately $28,760,000. The opening of the Athens branch in December 2000 has contributed to an increase in total loans of approximately $6,477,000. 12 Allowance for Loan Losses ------------------------- The allowance for loan losses at September 30, 2001 and December 31, 2000 was 1.37% and 1.38% of outstanding loans, respectively. By its nature, the process through which management determines the appropriate level of the allowance requires considerable judgment. The determination of the necessary allowance, and correspondingly the provision for loan losses, involves assumptions about projections of national and local economic conditions, the composition of the loan portfolio, and prior loss experience, in addition to other considerations. As a result, no assurance can be given that future losses will not vary from the current estimates. However, the allowance at September 30, 2001 represents management's best estimate of probable losses that have been incurred within the existing portfolio of loans. A migration analysis and an internal classification system for loans also help identify potential problems, if any, which are not identified otherwise. From these analyses, management determines which loans are potential candidates for nonaccrual status, including impaired loan status, or charge-off. Management continually reviews loans and classifies them consistent with the guidelines established by the Office of the Comptroller of Currency to help ensure that an adequate allowance is maintained. The provision for loan losses is determined by management as the amount to be added to the allowance for loan losses after net charge-offs have been deducted to bring the allowance to a level, which is considered adequate to absorb losses inherent in the loan portfolio. The amount of the provision is based on management's review of the loan portfolio, and the consideration of such factors as historical loss experience, general prevailing economic conditions, changes in the size and composition of the loan portfolio and specific borrower considerations, including the ability of the borrower to repay the loan and the estimated value of the underlying collateral. The provision for loan losses for the three and nine months ended September 30, 2001 totaled $159,000 and $389,000 compared to $90,000 and $280,000 for the three and nine months ended September 30, 2000. Management anticipates it will continue its provisions to the allowance for loan losses at current levels for the near future, providing the volume of nonperforming loans remains insignificant, to compensate for loan growth, particularly higher risk commercial and installment loans. Non Accrual, Past Due and Restructured Loans -------------------------------------------- The Company's policy is to discontinue the accrual of interest income on loans whenever it is determined that reasonable doubt exists with respect to timely collectibility of interest and principal. Loans are placed on nonaccrual status if either material deterioration occurs in the financial position of the borrower, payment in full of interest or principal is not anticipated, payment in full of interest or principal is past due 90 days or more unless well secured, payment in full of interest or principal on a loan is past due 180 days or more, regardless of collateral, or the loan in whole or in part is classified as doubtful. A loan may remain on accrual status if it is in the process of collection and is either guaranteed or well secured. When a loan is placed on nonaccrual status, interest is no longer accrued or included in interest income and previously accrued income is reversed. The following is a summary of the Company's problem loans as of September 30, 2001 and December 31, 2000. September 30, December 31, 2001 2000 ------------- ------------ (dollars in thousands) Nonaccrual loans $ 74 241 Restructured loans - 1,216 Other impaired loans - - Loans past due 90+ days and still accruing 95 18 ------------- ------------ Total non-performing loans $ 169 1,475 ============= ============ Other potential problem loans $ -- -- ============= ============ Other non-performing assets, other real estate owned $ 90 10 ============= ============ 13 Concentration of Credit Risk ---------------------------- The Company grants real estate, commercial, and industrial loans to customers primarily in Henderson, Texas, and surrounding areas of east Texas. Although the Company has a diversified loan portfolio, a substantial portion (approximately 52.5% at September 30, 2001) of its loans are secured by real estate and its ability to fully collect its loans is dependent upon the real estate market in this region. The Company typically requires collateral sufficient in value to cover the principal amount of the loan. Such collateral is evidenced by mortgages on property held and readily accessible to the Company. See additional information related to the composition of the Company's loan portfolio included in Note 4 to the consolidated financial statements. Securities ---------- The Investment Committee, under the guidance of the Company's Investment Policy, assesses the short and long-term needs of the Company after consideration of loan demand, interest rate factors, and prevailing market conditions. Recommendations for purchases and other transactions are then made considering safety, liquidity, and maximization of return to the Company. Management determines the proper classification of securities at the time of purchase. Securities that management does not intend to hold to maturity or that might be sold under certain circumstances are classified as available for sale. If management has the intent and the Company has the ability at the time of purchase to hold the securities until maturity, the securities will be classified as held to maturity. The management strategy for securities is to maintain a very high quality portfolio with generally short duration. The quality of the portfolio is maintained with 80% of the total as of September 30, 2001 comprised of U.S. Treasury, federal agency securities, and agency issued mortgage securities. The collateralized mortgage obligations (CMOs) and mortgage backed securities (MBS) held by the company are backed by agency collateral which consists of loans issued by the Federal Home Loan Mortgage Corporation (FHLMC), Federal National Mortgage Corporation (FNMA), and the Government National Mortgage Association (GNMA) with a blend of fixed and floating rate coupons. Credit risk is minimized through agency backing, however, there are other risks associated with MBS and CMOs. These other risks include prepayment, extension, and interest rate risk. MBS are securities that represent an undivided interest in a pool of mortgage loans. CMOs are structured obligations that are derived from a pool of mortgage loans or agency mortgage backed securities. CMOs in general have widely varying degrees of risk, which results from the prepayment risk on the underlying mortgage loans and its effect on the cash flows of the security. Prepayment risk is the risk of borrowers paying off their loans sooner than expected in a falling rate environment by either refinancing or curtailment. Extension risk is the risk that the underlying pool of loans will not exhibit the expected prepayment speeds thus resulting in a longer average life and slower cash flows than anticipated at purchase. Interest rate risk is based on the sensitivity of yields on assets that change in a different time period or in a different proportion from that of current market interest rates. Changes in average life due to prepayments and changes in interest rates in general will cause the market value of MBS and CMOs to fluctuate. The Company's MBS portfolio consists of fixed rate balloon maturity pools with short stated final maturities and adjustable rate mortgage (ARM) pools with coupons that reset annually and have longer maturities. Investments in CMOs consist mainly of Planned Amortization Classes (PAC), Targeted Amortization Classes (TAC), and sequential classes. As of September 30, 2001, floating rate securities made up 74% of the CMO portfolio. Support and liquidity classes with longer average lives and floating rate coupons comprise a relatively small portion of the portfolio. To maximize after-tax income, investments in tax-exempt municipal securities are utilized but with somewhat longer maturities. Securities are the Company's single largest interest-earning asset representing approximately 43% of total assets at September 30, 2001. The investment portfolio totaled $221,836,000 at September 30, 2001, up from $206,938,000 at December 31, 2000. This increase resulted due to the combination of excess cash and fed funds being invested in available for sale securities for increased yields and the acquisition of Peoples State Bank. 14 Recent Accounting Pronouncements --------------------------------- The following pronouncements have been issued, and are listed together with the expected impact on the Company. In July 2001, the Financial Accounting Standards Board issued two statements-- SFAS 141, Business Combinations, and SFAS 142, Goodwill and Other Intangible Assets, which will potentially impact the Company's accounting for its reported goodwill and other intangible assets. SFAS 141, Business Combinations--This statement eliminates the pooling method for accounting for business combinations. It requires that intangible assets that meet certain criteria be reported separately from goodwill and that negative goodwill arising from a business combination be recorded as an extraordinary gain. SFAS 142, Goodwill and Other Intangible Assets--This statement eliminates the amortization of goodwill and other intangibles that are determined to have an indefinite life. It requires, at a minimum, annual impairment tests for goodwill and other intangible assets that are determined to have an indefinite life. The Company has not yet completed its full assessment of the effects of these new pronouncements on its financial statements. The standards are generally required to be implemented by the Company in its 2002 financial statements. In accordance with the new standards, goodwill of $4,580,000 recorded in connection with the Rusk County Bancshares, Inc. acquisition is not being amortized. SFAS 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities--This Statement replaces SFAS 125 and resolves various implementation issues while carrying forward most of the provisions of SFAS 125 without change. SFAS 140 revises standards for transfers of financial assets by clarifying criteria and expanding guidance for determining whether the transfers of financial assets by clarifying criteria and expanding guidance for determining whether the transferor has relinquished control and the transfer is therefore accounted for as a sale. SFAS 140 also adopts new accounting requirements for pledged collateral and requires new disclosures about securitization and pledge collateral. SFAS 140 is effective for transfers occurring after March 31, 2001 and for disclosures relating to securitization transactions and collateral for fiscal years ending after December 15, 2000. Management does not expect this standard to have a material effect on the Company's consolidated financial statements. Corporate Objectives -------------------- It is the philosophy of the Company to continue to remain independent in ownership, to foster its image as the community leader in banking, to increase its market share through selected acquisitions and aggressive marketing, to maintain a sound earning-asset portfolio, and to assess liquidity needs while maximizing its profitability and return to its shareholders. Forward-Looking Information --------------------------- Statements and financial discussion and analysis by management contained throughout this Form 10-Q that are not historical facts are forward-looking statements made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Forward-looking statements involve a number of risks and uncertainties. Various factors could cause actual results to differ materially from the forward-looking statements, including, without limitation, changes in interest rates and economic conditions, increased competition for deposits and loans adversely affecting rates and terms, changes in availability of funds increasing costs or reducing liquidity, changes in applicable statutes and governmental regulations, and the loss of any member of senior management or operating personnel and the potential inability to hire qualified personnel at reasonable compensation levels. 15 Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The Company's primary market risk exposures are interest rate risk and, to a lesser extent, liquidity risk. The Company does not maintain a trading account for any class of financial instrument and the Company is not affected by foreign currency exchange rate risk or commodity price risk. Interest rate risk is the risk that the Company's financial condition will be adversely affected due to movements in interest rates. The Company, like other financial institutions, is subject to interest rate risk to the extent that its interest-earning assets reprice differently than its interest-bearing liabilities. The income of financial institutions is primarily derived from the excess of interest earned on interest-earning assets over the interest paid on interest-bearing liabilities. A high ratio of interest sensitive liabilities tends to benefit net interest income during periods of falling interest rates as the average rate paid on interest-bearing liabilities declines faster than the average rate earned on interest-earning assets. The opposite holds true during periods of rising interest rates. One of the Company's principal financial objectives is to achieve long-term profitability while reducing its exposure to fluctuations in interest rates. Management recognizes certain risks are inherent and that the goal is to measure the effect on net interest income and to adjust the balance sheet to minimize the risk while at the same time maximize income. Accordingly, the Company places great importance on monitoring and controlling interest rate risk. There are several methods employed by the Company to monitor and control interest rate risk. One such method is using a simulation model to analyze net interest income sensitivity to movements in interest rates. The simulation model projects net interest income based on both an immediate rise or fall in interest rates (rate shock) over a twelve-month period. The model is based on the actual maturity and repricing characteristics of interest rate sensitive assets and liabilities. The repricing can occur due to changes in rates on variable rate products as well as maturities of interest-earning assets and interest-bearing liabilities. The model incorporates assumptions regarding the impact of changing interest rates on the prepayment rate of certain assets and liabilities as well as projections for anticipated activity levels by product lines offered by the Company. The simulation model also takes into account the Company's historical core deposits. Management considers the Company's market risk to be acceptable at this time. One strategy used by the Company to reduce the volatility of its net interest income is to originate variable rate loans tied to market indices. Such loans reprice on an annual, quarterly, monthly or daily basis as the underlying market index change. Currently, approximately 10% of the Company's loan portfolio reprices on at least an annual basis. The Company has also structured the securities portfolio so that most of the mortgage-backed securities reprice on at least an annual basis. The Company also maintains most of its securities in the available for sale portfolio to take advantage of changes in interest rates and to maintain liquidity for loan funding and deposit withdrawals. The mortgage-backed and related securities also provide the Company with a constant cash flow stream from principal repayments. The Company invests short-term excess funds in overnight federal funds that mature and reprice on a daily basis. The Company's 2000 annual report details a table that provides information about the Company's financial instruments that are sensitive to changes in interest rates as of December 31, 2000. The table is based on information and assumptions set forth in the discussion. The Company believes the assumptions utilized are reasonable. Management believes that no events have occurred since December 31, 2000 which would significantly change the ratio of rate sensitive assets to rate sensitive liabilities for the given time horizons in the table. 16 Part II - OTHER INFORMATION Item 1. Legal Proceedings None Item 2. Changes in Securities and Use of Proceeds None Item 3. Defaults Upon Senior Securities None Item 4. Submission of Matters to a Vote of Security Holders None Item 5. Other Information None Item 6. Exhibits and Reports on Form 8-K Form 8-K, reflecting the acquisition of Rusk County Bancshares, Inc. and its subsidiary Peoples State Bank, was filed on July 16, 2001, and Form 8-KA was filed on September 20, 2001. Form 8-K, reflecting the Company's change in accountant, was filed on October 26, 2001. 17 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 duly authorized. HENDERSON CITIZENS BANCSHARES, INC. Date: November 13, 2001 By: /s/ Milton S. McGee, Jr. ----------------- ------------------------------ Milton S. McGee, Jr., CPA President Date: November 13, 2001 By: /s/ Rebecca G. Tanner ----------------- ------------------------------- Rebecca G. Tanner, CPA Vice President, Treasurer, Chief Financial Officer and Chief Accounting Officer 18