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 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended: March 31, 2002 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 March 31, 2002, 1,994,218 shares of Common Stock, $5.00 par value, were outstanding. 1 HENDERSON CITIZENS BANCSHARES, INC. QUARTER ENDED MARCH 31, 2002 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 ................................................ 11 ITEM 3 - Quantitative and Qualitative Disclosure About Market Risk ................ 17 PART II - OTHER INFORMATION ....................................................... 18 SIGNATURES ........................................................................ 19
2 Part I. FINANCIAL INFORMATION Item 1. Financial Statements HENDERSON CITIZENS BANCSHARES, INC. Consolidated Balance Sheets (dollars in thousands, except share amounts) (unaudited)
March 31, December 31, Assets 2002 2001 ------ --------------- --------------- Cash and due from banks $ 11,522 14,390 Interest-bearing deposits with financial institutions 8,455 11,946 Federal funds sold 15,540 16,860 -------------- --------------- Total cash and cash equivalents 35,517 43,196 Securities available for sale, at fair value 166,576 185,410 Securities held to maturity, estimated fair value of $95,446 in 2002 and $57,171 in 2001 95,555 57,170 -------------- --------------- 262,131 242,580 Loans, net 214,441 212,665 Premises and equipment, net 11,163 11,302 Accrued interest receivable 3,432 4,157 Intangible assets 10,024 9,449 Other assets 3,991 2,836 -------------- --------------- $ 540,699 526,185 ============== =============== Liabilities and Stockholders' Equity ------------------------------------ Deposits: Demand - non interest-bearing 69,647 70,527 Interest-bearing transaction accounts 90,626 87,781 Money market and savings 95,410 94,844 Certificates of deposit and other time deposits 232,914 220,578 -------------- --------------- Total deposits 488,597 473,730 Accrued interest payable 1,269 1,394 Other borrowings 2,702 4,098 Other liabilities 3,535 3,029 -------------- --------------- 496,103 482,251 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 Surplus 5,400 5,400 Retained earnings 30,788 29,243 Accumulated other comprehensive income 25 903 Treasury stock, 165,782 shares in 2002 and 165,582 shares in 2001 at cost (2,417) (2,412) -------------- --------------- Total stockholders' equity 44,596 43,934 -------------- --------------- $ 540,699 526,185 ============== ===============
See accompanying notes to consolidated financial statements. 3 HENDERSON CITIZENS BANCSHARES, INC. Consolidated Statements of Income (dollars in thousands, except share amounts) (unaudited)
Three months ended March 31, 2002 2001 --------------- --------------- Interest income: Loans, including fees $ 3,962 3,576 Securities: Taxable - available for sale 1,937 2,360 Taxable - held to maturity 530 131 Tax-exempt - held to maturity 484 492 Federal funds sold 104 275 Interest-bearing deposits with financial institutions 94 185 --------------- --------------- Total interest income 7,111 7,019 --------------- --------------- Interest expense: Deposits: Transaction accounts 274 397 Money market and savings 359 505 Certificates of deposit and other time deposits 2,345 3,052 Other borrowed funds 17 10 --------------- --------------- Total interest expense 2,995 3,964 --------------- --------------- Net interest income 4,116 3,055 Provision for loan losses 260 110 --------------- --------------- Net interest income after provision for loan losses 3,856 2,945 --------------- --------------- Noninterest income: Service charges, commissions, and fees 1,390 1,019 Income from fiduciary activities 369 329 Net realized gains on securities transactions 862 3 Other 262 215 --------------- --------------- Total noninterest income 2,883 1,566 --------------- --------------- Noninterest expenses: Salaries and employee benefits 2,660 2,044 Occupancy and equipment 566 481 Other 1,001 863 --------------- --------------- Total other expenses 4,227 3,388 --------------- --------------- Income before income tax expense 2,512 1,123 Income tax expense 628 160 --------------- --------------- Net income $ 1,884 963 =============== =============== Basic earnings per common share $ 0.94 0.48 =============== =============== Weighted average number of shares outstanding 1,994,293 1,995,216 =============== ===============
See accompanying notes to consolidated financial statements. 4 HENDERSON CITIZENS BANCSHARES, INC. Consolidated Statements of Changes in Stockholders' Equity (unaudited)
Three months ended March 31, 2002 and 2001 (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, 2001 $ - 10,800 5,400 25,894 (575) (2,397) 39,122 Comprehensive income: Net Income - - - 963 - - 963 Other comprehensive income: Change in net unrealized gain (loss) on securities available for sale, net of tax of $525 - - - - 1,018 - 1,018 ------------ Total comprehensive income 1,981 Cash dividends declared ($.17 per share) - - - (339) - - (339) ---------- ---------- ---------- ----------- ---------------- ----------- ------------ Balances at March 31, 2001 $ - 10,800 5,400 26,518 443 (2,397) 40,764 ========== ========== ========== =========== ================ =========== ============ Balances at January 1, 2002 $ - 10,800 5,400 29,243 903 (2,412) 43,934 Comprehensive income: Net Income - - - 1,884 - - 1,884 Other comprehensive income: Change in net unrealized gain (loss) on securities available for sale arising during the period, net of tax of $(452) - - - - (878) - (878) ------------ Total comprehensive income 1,006 Purchase of 200 shares of treasury stock - - - - - (5) (5) Cash dividends declared ($.17 per share) - - - (339) - - (339) ---------- ---------- ---------- ----------- ---------------- ----------- ------------ Balances at March 31, 2002 $ - 10,800 5,400 30,788 25 (2,417) 44,596 ========== ========== ========== =========== ================ =========== ============
See accompanying notes to consolidated financial statements. 5 HENDERSON CITIZENS BANCSHARES, INC. Condensed Consolidated Statements of Cash Flows (unaudited) Three months ended March 31, 2002 and 2001 (dollars in thousands)
2002 2001 ------------- ------------- Net cash provided by operating activities $ 1,808 1,112 Investing activities: Securities available for sale: Sales 49,953 5,009 Purchases (45,096) (35,571) Maturities and repayments 13,360 23,772 Securities held to maturity: Purchases (41,284) - Maturities and repayments 2,852 777 Net change in loans (2,036) (835) Proceeds from sale of premises and equipment and other real estate 97 27 Purchases of bank premises, equipment and software (121) (543) ------------- ------------- Net cash from investing activities (22,275) (7,364) ------------- ------------- Financing activities: Net increase in deposits 14,867 36,746 Other borrowed funds (1,396) 804 Cash dividends paid (678) (682) Purchase of treasury stock (5) - ------------- ------------- Net cash from financing activities 12,788 36,868 ------------- ------------- Change in cash and cash equivalents (7,679) 30,616 Cash and cash equivalents at beginning of period 43,196 25,993 ------------- ------------- Cash and cash equivalents at end of period $ 35,517 56,609 ============= ============= SUPPLEMENTAL DISCLOSURES OF CASH FLOW ACTIVITIES Income taxes paid, net of refunds $ - 50 ============= ============= Interest paid $ 3,120 3,930 ============= =============
See accompanying notes to consolidated financial statements. 6 HENDERSON CITIZENS BANCSHARES, INC. Notes to Consolidated Financial Statements March 31, 2002 (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 accounting principles generally accepted in the United States of America 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, 2001 and 2000, and for each of the years in the three year period ended December 31, 2001 included in the Company's 2001 Form 10-K. The accompanying consolidated financial statements of the Company include the accounts of its wholly owned subsidiary, Citizens National Bank. The financial statements of Citizens National Bank are consolidated with its wholly owned subsidiaries, HCB Insurance Agency, Inc. and Community Development Corporation ("CDC"). Certain amounts in the prior financial statements have been reclassified to conform to the current presentation. (2) Recent Accounting Pronouncements -------------------------------- In July 2001, the Financial Accounting Standards Board issued two statements--SFAS 141, Business Combinations, and SFAS 142, Goodwill and Other Intangible Assets, which impacts 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 standards have been applied by the Company, beginning January 1, 2002. The Company has not yet completed its initial impairment test, which must be completed by June 30, 2002. However, management believes no significant impairment exists. In accordance with the new standards, goodwill of $65,000 is no longer being amortized. Following is a reconciliation of reported net income and basic earnings per common share to the adjusted amounts assuming the new standards were applied effective January 1, 2001 (in thousands, except per share amounts): Three Months Ended March 31, 2002 2001 ---- ---- Reported net income $ 1,884 $ 963 Add back goodwill amortization - 65 --------- ---------- Adjusted net income $ 1,884 $ 1,028 ========= ========== Reported earnings per share $ 0.94 $ 0.48 Goodwill amortization - .03 --------- ---------- Adjusted earnings per share $ 0.94 $ 0.51 ========= ========== 7 HENDERSON CITIZENS BANCSHARES, INC. Notes to Consolidated Financial Statements (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. Of the $4,737,000 of goodwill and other intangible assets acquired, approximately $2,659,000 has been assigned to core deposit intangibles and is being amortized using the straight-line method over seven years. The residual of approximately $2,078,000 has been recorded as unidentified goodwill and is not being amortized, but is subject to annual impairment tests. The following is condensed pro-forma information for the acquisition of RCBI. Had this transaction occurred previously on January 1, 2001, net interest income for the three months ended March 31, 2001 would have been $3,706,000, while net income for the same period would have been $1,106,000. Basic earnings per share for the three months ended March 31, 2001 would have been $0.55. (4) Securities ---------- The amortized cost and estimated fair values of securities available for sale at March 31, 2002 and December 31, 2001, are summarized as follows (in thousands of dollars):
March 31, 2002 ----------------------------------------------------------------------- Gross Gross Estimated Amortized Unrealized Unrealized Fair Cost Gains Losses Value ------------- --------------- -------------- ----------------- U.S. Government agencies $ 20,812 164 (216) 20,760 Mortgage-backed securities and collateralized mortgage obligations 145,726 619 (529) 145,816 ------------- --------------- -------------- ----------------- $ 166,538 783 (745) 166,576 ============= =============== ============== ================= December 31, 2001 ---------------------------------------------------------------------- Gross Gross Estimated Amortized Unrealized Unrealized Fair Cost Gains Losses Value ------------- ------------- --------------- ----------------- U.S. Treasury $ 8,002 301 - 8,303 U.S. Government agencies 57,483 779 (139) 58,123 Mortgage-backed securities and collateralized mortgage obligations 118,555 742 (313) 118,984 ------------- ------------- --------------- ----------------- $ 184,040 1,822 (452) 185,410 ============= ============= =============== =================
8 HENDERSON CITIZENS BANCSHARES, INC. Notes to Consolidated Financial Statements The amortized cost and estimated fair values of securities held-to- maturity at March 31, 2002 and December 31, 2001 are summarized as follows (in thousands of dollars):
March 31, 2002 ------------------------------------------------------------------------- Gross Gross Estimated Amortized Unrealized Unrealized Fair Cost Gains Losses Value ------------- ------------------ ---------------- ------------------ U.S. Government agencies $ 24,403 1 (238) 24,166 State and municipal 41,684 644 (351) 41,977 Mortgage-backed securities and collateralized mortgage obligations 27,289 40 (255) 27,074 Corporate 2,020 53 - 2,073 Other securities 159 - (3) 156 ------------- ------------------ ---------------- ------------------ $ 95,555 738 (847) 95,446 ============= ================== ================ ================== December 31, 2001 ------------------------------------------------------------------------- Gross Gross Estimated Amortized Unrealized Unrealized Fair Cost Gains Losses Value ------------- ----------------- -------------------- ------------------ U.S. Government agencies $ 4,975 - - 4,975 State and municipal 42,137 501 (611) 42,027 Mortgage-backed securities and collateralized mortgage obligations 7,852 48 - 7,900 Corporate 2,025 67 - 2,092 Other securities 181 - (4) 177 ------------- -------------- -------------------- ------------------ $ 57,170 616 (615) 57,171 ============= ============== ==================== ==================
9 HENDERSON CITIZENS BANCSHARES, INC. Notes to Consolidated Financial Statements March 31, 2002 (5) Loans and Allowance for Loan Losses ----------------------------------- The composition of the Company's loan portfolio is as follows (in thousands of dollars)
March 31, December 31, 2002 2001 ---------------- -------------- Real estate mortgage $ 115,417 114,175 Commercial and industrial 65,200 62,619 Installment and other 37,154 39,093 ---------------- -------------- Total 217,771 215,887 Less: Allowance for loan losses (3,319) (3,205) Unearned discount (11) (17) ---------------- -------------- Loans, net $ 214,441 212,665 ================ ==============
Changes in the allowance for loan losses for the three months ended March 31, 2002 and 2001 summarized as follows (in thousands of dollars):
Three months ended March 31, ----------------------------------- 2002 2001 ----------------- -------------- Balance, beginning of period $ 3,205 2,355 Provision charged to operating expense 260 110 Charge offs: Commercial, financial, and agriculture (34) (58) Real estate-mortgage - (31) Installment loans to individuals (178) (113) Recoveries: Commercial, financial, and agriculture 9 4 Real estate-mortgage - - Installment loans to individuals 57 57 ----------------- -------------- Balance, March 31 $ 3,319 2,324 ================= ==============
10 Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF THE FINANCIAL CONDITION AND RESULTS OF OPERATIONS OF HENDERSON CITIZENS BANCSHARES, INC. FOR THE THREE MONTHS ENDED MARCH 31, 2002 AND 2001 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 December 14, 2001, the Bank entered into a Branch Purchase and Assumption Agreement with Cedar Creek Bank, Seven Points, Texas, to purchase two facilities in Corsicana, Texas. On February 20, 2002, Bank received approval from the Office of the Comptroller of Currency for the purchase and assumption of the two branches. These two facilities were converted to full-service branches of the Bank at the close of business on April 26, 2002. Results of Operations --------------------- Net income for the first three months of 2002 increased to $1,884,000 compared to $963,000 for the same period in 2001. Net interest income for the three months ended March 31, 2002 was $4,116,000 compared to $3,055,000 for the same period in 2001. The Company made a provision of $260,000 to the allowance for loan losses during the first three months of 2002. A provision of $110,000 was made for loan losses during the same period in 2001. The Company experienced a net gain on securities transactions of $862,000 in the first three months of 2002 compared to a net gain on securities transactions of $3,000 in the first three months of 2001. Noninterest income, excluding net gains on securities transactions, for the first three months of 2002 was $2,021,000 compared to $1,563,000 for the same period in 2001. Total noninterest expenses for the first three months of 2002 were $4,227,000 compared to $3,388,000 for the same period in 2001. Income tax expense for the first three months of 2002 and 2001 was $628,000 and $160,000, respectively. Net Interest Income. For the three months ended March 31, 2002, ------------------- net interest income was $4,116,000 compared to $3,055,000 for the first three months of 2001. Interest income was up $92,000 during the three months ended March 31, 2002, primarily due to growth as a result of the acquisition of Peoples State Bank in July of 2001. Even though volumes increased on interest-bearing liabilities, interest expense decreased by $969,000 during the three months ended March 31, 2002. This decrease was due to a combination of sharp declines in interest rates paid and, also, as a result of the change in the composition of interest-bearing liabilities due to time deposits representing five percent less of total interest-bearing liabilities at March 31, 2002, than at March 31, 2001. Provision for Loan Losses. The provision for loan losses was ------------------------- $260,000 for the first three months of 2002 compared to $110,000 for the first three months of 2001. 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. Noninterest Income. Noninterest income, excluding securities ------------------ gains/losses, was $2,021,000 for the first three months of 2002 as compared to $1,563,000 in the first three months of 2001. This increase is largely attributable to increases in service charges primarily due to the growth in fees collected for insufficient funds, which is largely attributable to the Peoples State bank acquisition. Increases in trust fee income and increases in mortgage-servicing income realized from the sale of FHLMC loans also contributed to the rise in noninterest income. The Company experienced a net gain on securities transactions of $862,000 for the first three months of 2002 compared to a net gain on securities transactions of $3,000 for the first three months of 2001. Given the level of interest rates on securities maturing in an 18 month period, the Company elected to capture the gain in anticipation of rising interest rates. Noninterest Expenses. Noninterest expenses for the three-month -------------------- period ended March 31, 2002, were $4,227,000 compared to $3,388,000 during the same period in 2001. 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 acquisition of Peoples State Bank in July of 2001and the acquisition of two former Jefferson Heritage branches in October of 2001. Occupancy expenses continue to increase with the addition of new facilities and the remodeling of existing properties. 11 Income Taxes. Income tax expense for the first three months of ------------ 2002 was $628,000, compared to $160,000 in the same period in 2001. The effective tax rates for the first three months of 2002 and 2001 were 25.0% and 14.2%. 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. Financial Condition ------------------- The Company's total assets at March 31, 2002 of $540,699,000 increased from the total assets at December 31, 2001 of $526,185,000. The Company's loan portfolio grew to $214,441,000 at March 31, 2002, up slightly from $212,665,000 at December 31, 2001. Total deposits were $488,597,000 at March 31, 2002, compared to the December 31, 2001 total of $473,730,000. Deposits and Other Borrowings ----------------------------- Total deposits at March 31, 2002 increased from the December 31, 2001 balances by $14,867,000. This increase was due mostly to an increase in public funds that is partially offset by a decrease in the volume of certificates of deposit. 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 March 31, 2002, amounts payable under this note totaled $2,702,000. 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. Cash and cash equivalents decreased $7,679,000 from $43,196,000 at December 31, 2001 to $35,517,000 at March 31, 2002. Cash and cash equivalents represented 6.6% of total assets at March 31, 2002 compared to 8.2% of total assets at December 31, 2001. This decrease was due mainly to excess cash and fed funds being invested in mortgage-backed securities and government agency securities for increased yields. 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 three months of 2002 were the net increase in deposits of $14,867,000, securities purchases of $86,380,000, securities sales of $49,953,000 and securities maturities and repayments of 16,212,000. Capital Resources ----------------- At March 31, 2002, stockholders' equity totaled $44,596,000, or 8.2% of total assets, compared to $43,934,000, or 8.3% of total assets, at December 31, 2001. 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 12 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 March 31, 2002 and December 31, 2001. Consolidated Bank Only ------------ --------- March 31, 2002 -------------- Tier 1 capital to risk-weighted assets ratio 14.4% 14.3% Total capital to risk-weighted assets ratio 15.7 15.6 Leverage ratio 6.7 6.6 December 31, 2001 ----------------- Tier 1 capital to risk-weighted assets ratio 13.9% 13.7% Total capital to risk-weighted assets ratio 15.1 15.0 Leverage ratio 6.7 6.7 As of March 31, 2002 and December 31, 2001, 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 March 31, 2002 and December 31, 2001 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 $217,771,000 at March 31, 2002 compared to $215,887,000 at December 31, 2001. As can be seen in the table in Note 5 above, an increase of approximately 4.1% in commercial and industrial loans, an increase of approximately 1.1% in real estate loans, and a decrease of 5.0% in installment loans occurred during the first three months of 2002. Allowance for Loan Losses ------------------------- The allowance for loan losses at March 31, 2002 and December 31, 2001 was 1.52% and 1.48% 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 March 31, 2002 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 months ended March 31, 2002 totaled $260,000 compared to $110,000 for the three months ended March 31, 2001. 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. 13 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 March 31, 2002 and December 31, 2001. March 31, December 31, 2002 2001 ------------ ---------- (dollars in thousands) Nonaccrual loans $ 74 74 Restructured loans - - Other impaired loans 492 475 Loans past due 90+ days and still accruing 232 18 ------------ ---------- Total non-performing loans $ 798 567 ============ ========== Other potential problem loans $ - - ============ ========== Other non-performing assets, other real estate owned $ - 90 ============ ========== 14 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 53.0% at March 31, 2002) 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 5 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 83% of the total as of March 31, 2002 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 March 31, 2002, floating rate securities made up 38% 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 48% of total assets at March 31, 2002. The investment portfolio totaled $262,131,000 at March 31, 2002, up from $242,580,000 at December 31, 2001. This increase resulted due to an increase in deposits combined with excess cash and fed funds being invested in mortgage-backed securities and government agency securities for increased yields. 15 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. 16 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 15% 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 2001 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, 2001. 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, 2001 which would significantly change the ratio of rate sensitive assets to rate sensitive liabilities for the given time horizons in the table. 17 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 On April 9, 2002, the Company held its annual meeting of shareholders. At the meeting, the following directors were elected for a term of one year. David Alford Jim Kangerga Landon Alford Milton S. McGee, Jr. R. M. Ballenger J. Mark Mann S. M. Bonner, Jr. Charles Richardson D. J. Burks Tony Wooster Billy Crawford William E. Wylie Sheila Smith Gresham Item 5. Other Information None Item 6. Exhibits and Reports on Form 8-K None. 18 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: May 7, 2002 By: /s/ Milton S. McGee, Jr. ----------- ------------------------------ Milton S. McGee, Jr., CPA President Date: May 7, 2002 By: /s/ Rebecca G. Tanner ----------- ------------------------------ Rebecca G. Tanner, CPA Vice President, Treasurer, Chief Financial Officer and Chief Accounting Officer 19