Form 10-K
Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D. C. 20549

 


FORM 10-K

 


 

x ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

FOR THE FISCAL YEAR ENDED DECEMBER 31, 2005

or

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission file number: 000-25221

 


CITIZENS HOLDING COMPANY

(Exact Name of Registrant as Specified in Its Charter)

 


 

MISSISSIPPI   64-0666512

(State or Other Jurisdiction of

Incorporation or Organization)

 

(I.R.S. Employer

Identification Number)

521 Main Street, Philadelphia, MS   39350
(Address of Principal Executive Offices)   (Zip Code)

Registrant’s telephone number, including area code: 601-656-4692

 


Securities registered pursuant to Section 12(b) of the Act:

 

Title of Each Class

 

Name of Each Exchange on Which Registered

Common Stock, $.20 par value

  American Stock Exchange

Securities registered pursuant to section 12(g) of the Act:

None

 


Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    YES  ¨    NO  x

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act.    YES  ¨    NO  x

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.    YES  x    NO  ¨

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.

Large accelerated filer  ¨                                 Accelerated filer  x                                Non-accelerated filer  ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    YES  ¨    NO  x

As of June 30, 2005, the aggregate market value of the registrant’s common stock, $.20 par value, held by non-affiliates of the registrant was $99,564,864 based on the closing sale price as reported on the American Stock Exchange for such date.

Indicate the number of shares outstanding of each of the registrant’s classes of common stock, as of the latest practicable date.

 

Class

 

Outstanding at March 7, 2006

Common stock, $.20 par value

  5,012,278 Shares

DOCUMENTS INCORPORATED BY REFERENCE

Portions of Citizens Holding Company’s Annual Report to Shareholders for the fiscal year ended December 31, 2005 are incorporated by reference into Part II of this Annual Report on Form 10-K.

Portions of Citizens Holding Company’s definitive proxy statement with respect to its 2006 Annual Meeting of Shareholders are incorporated by reference into Part III of this Annual Report on Form 10-K.

 



Table of Contents

CITIZENS HOLDING COMPANY

FORM 10-K

INDEX

 

         PAGE
  PART I   
ITEM 1.   BUSINESS    1
ITEM 1A.   RISK FACTORS    9
ITEM 1B.   UNRESOLVED STAFF COMMENTS    18
ITEM 2.   PROPERTIES    18
ITEM 3.   LEGAL PROCEEDINGS    20
ITEM 4.   SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS    20
  PART II   
ITEM 5.   MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES    20
ITEM 6.   SELECTED FINANCIAL DATA    20
ITEM 7.   MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS    20
ITEM 7A.   QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK    21
ITEM 8.   FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA    21
ITEM 9.   CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE    21
ITEM 9A.   CONTROLS AND PROCEDURES    21
ITEM 9B   OTHER INFORMATION    22
  PART III   
ITEM 10.   DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT    22
ITEM 11.   EXECUTIVE COMPENSATION    22
ITEM 12.   SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS    22
ITEM 13.   CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS    23
ITEM 14.   PRINCIPAL ACCOUNTING FEES AND SERVICES    23
  PART IV   
ITEM 15.   EXHIBITS, FINANCIAL STATEMENT SCHEDULES    24
SIGNATURES    26


Table of Contents

CITIZENS HOLDING COMPANY

FORM 10-K

PART I

In addition to historical information, this report contains statements which constitute forward-looking statements and information which are based on management’s beliefs, plans, expectations, assumptions and on information currently available to management. The words “may,” “should,” “expect,” “anticipate,” “intend,” “plan,” “continue,” “believe,” “seek,” “estimate” and similar expressions used in this report that do not relate to historical facts are intended to identify forward-looking statements. These statements appear in a number of places in this report, including, but not limited to, statements found in Item 1, “Business,” and in Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” Citizens Holding Company (the “Company”) notes that a variety of factors could cause the actual results or experience to differ materially from the anticipated results or other expectations described or implied by such forward-looking statements. The risks and uncertainties that may affect the operation, performance, development and results of the business of the Company and the Company’s majority-owned subsidiary, The Citizens Bank of Philadelphia, Mississippi (the “Bank”), include, but are not limited to, the following:

 

    the risk of adverse changes in business conditions in the banking industry generally and in the specific markets in which the Company operates;

 

    changes in the legislative and regulatory environment that negatively impact the Company and the Bank through increased operating expenses;

 

    increased competition from other financial institutions;

 

    the impact of technological advances;

 

    expectations about the movement of interest rates, including actions that may be taken by the Federal Reserve Board in response to changing economic conditions;

 

    changes in asset quality and loan demand;

 

    expectations about overall economic strength and the performance of the economy in the Company’s market area; and

 

    other risks detailed from time to time in the Company’s filings with the Securities and Exchange Commission.

The Company does not undertake any obligation to update or revise any forward-looking statements subsequent to the date on which they are made. Please also refer to Item 1A, “Risk Factors,” for a detailed discussion of the risks related to the Company in particular and the banking industry generally.

ITEM 1. BUSINESS

BACKGROUND

The Company is a one-bank holding company that holds 97.86% of the outstanding shares of the Bank. The Company was incorporated under Mississippi law on February 16, 1982, at the direction of the Board of Directors of the Bank in order to facilitate the Bank’s adoption of a one-bank holding company structure.


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The Bank was opened on February 8, 1908 as The First National Bank of Philadelphia. In 1917, the Bank surrendered its national charter and obtained a state charter, at which time the name of the Bank was changed to The Citizens Bank of Philadelphia, Mississippi. At December 31, 2005, the Bank was the largest bank headquartered in Neshoba County, Mississippi, with total assets of $607,709,136 and total deposits of $475,326,560. For more information regarding the assets, revenue and profits of the Company, refer to the Consolidated Financial Statements of the Company contained in Item 8 of this Annual Report on Form 10-K.

The principal executive offices of both the Company and the Bank are located at 521 Main Street, Philadelphia, Mississippi 39350, and the main telephone number is (601) 656-4692. All references hereinafter to the activities or operations of the Company reflect the Company’s activities or operations through the Bank.

The Company acquired by merger CB&T Capital Corporation and its subsidiary Citizens Bank & Trust Company in Louisville, Mississippi, in the second quarter of 2002. This acquisition added approximately $70 million in assets to the Company. The purchase price of the net assets totaled approximately $12.3 million in cash and was based on a multiple of approximately 1.505 times the book value, subject to certain adjustments, of the acquired company.

In July 2001, the Company purchased two branches of Union Planters National Bank located in Forest and Decatur, Mississippi. This acquisition had the effect of adding $30,506,745 in assets, including $11,703,517 in loans and $30,284,185 in deposits.

OPERATIONS

Through its ownership of the Bank, the Company engages in a wide range of commercial and personal banking activities, including accepting demand deposits, savings and time deposit accounts, making secured and unsecured loans, issuing letters of credit, originating mortgage loans, and providing personal and corporate trust services. The Company also provides certain services that are closely related to commercial banking such as credit life insurance and title insurance for its loan customers.

Revenues from the Company’s lending activities constitute the largest component of the Company’s operating revenues. Revenue from loan interest and fees made up 68.2% of gross revenues in 2005, 68.0% in 2004 and 67.6% in 2003. Such lending activities include commercial, real estate, installment (direct and indirect) and credit card loans. The Company’s primary lending area is East Central Mississippi, specifically Neshoba, Newton, Leake, Scott, Attala, Lauderdale, Winston and Kemper counties and contiguous counties. On a very limited basis, the Company extends out-of-area credit only to borrowers who are considered to be low risk. The Company is not dependent upon any single customer or small group of customers, and it has no foreign operations.

The Company’s eight county market area is mainly rural, with Meridian, population 41,036, being the largest city. Agriculture and some light industry comprise a significant portion of the economy of this area. The largest employer in the Company’s service area is the Mississippi Band of Choctaw Indians; their schools, manufacturing plants and their main source of income, The Pearl River Resort (the “Resort”), generate a significant number of jobs in the area. The Resort and its related services employ approximately 5,000 people within the Company’s market area.

 

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The Company has historically made, and intends to continue to make, most types of real estate loans, including, but not limited to, single and multi-family housing, farm, residential and commercial construction and commercial real estate loans. Historically, approximately 68.7% of the Company’s loan portfolio has been attributed to this category of lending. Another 13.5% of the Company’s loan portfolio is comprised of commercial, industrial and agricultural production loans. Consumer loans make up the remaining 17.8% of the total loan portfolio.

The Company’s loan personnel have the authority to extend credit under guidelines established and approved by the Company’s Board of Directors. Any aggregate credit that exceeds the authority of the loan officer is forwarded to the Board’s loan committee for approval. The loan committee is composed of various Company directors, including the Chairman of the Board. All aggregate credits that exceed the loan committee’s lending authority are presented to the full Board of Directors for ultimate approval or denial. The loan committee not only acts as an approval body to ensure consistent application of the Company’s loan policy, but also provides valuable insight through the communication and pooling of knowledge, judgment and experience of its members.

All loans in the Company’s portfolio are subject to risk based on the state of both the local and national economy. However, because the Company’s local economy in the past few years has been strong, with unemployment at historic lows, and is projected to remain strong in the near future, management believes that general risk levels are low.

In addition to lending services, the Company provides limited trust services. The Company serves as custodian of cemetery upkeep funds and insurance trusts. The Company also offers discount brokerage services through First Tennessee Bank.

Through such innovations as its VISA Checkcard program, the 24 Hour Phone Teller and its Internet site (http://www.thecitizensbankphila.com), the Company’s customers have easy and convenient access to their funds and account balances 24 hours a day, 7 days a week. Additionally, the Internet site enables the Company’s customers to review their accounts in detail, make transfers between their accounts and pay bills from anywhere in the world.

EXECUTIVE OFFICERS OF THE REGISTRANT

Greg L. McKee, who is 44 years old, has been employed by the Bank since 1984. He was named President and Chief Executive Officer of the Company and Chief Executive Officer of the Bank in January 2003. He has served as President of the Bank since January 2002 and served as Chief Operating Officer of the Bank from January 2002 until December 31, 2002. He has also been a member of the Board of Directors of both the Company and the Bank since 2001. Mr. McKee served as Executive Vice-President of the Bank from 2001 to 2002, Senior Vice-President of the Bank from 2000 to 2001, Vice-President of the Bank from 1992 to 2000, Assistant Vice-President of the Bank from 1989 to 1992, and Assistant Cashier of the Bank from 1984 to 1989.

Robert T. Smith, who is 54 years old, has been employed by the Bank since 1986. He has served as Senior Vice-President and Chief Financial Officer since January 2001. Prior to January 2001, Mr. Smith held the title of Vice-President and Controller from 1987 until 2001 and Assistant Vice-President from 1986 to 1987. In addition to his position with the Bank, Mr. Smith has served as Treasurer of the Company since February 1996.

 

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EMPLOYEES

The Company has no employees other than three Bank officers who provide services to the Company. These officers receive no compensation from the Company for their services to it; their entire salary is paid by the Bank. At December 31, 2005, the Bank employed 213 full-time employees and 37 part-time employees. The Bank is not a party to any collective bargaining agreements, and employee relations are considered to be good.

SUPERVISION AND REGULATION

The Bank is chartered under the banking laws of the State of Mississippi and is subject to the supervision of, and is regularly examined by, the Mississippi Department of Banking and Consumer Finance and the Federal Deposit Insurance Corporation (“FDIC”). The Company is a registered bank holding company within the meaning of the Bank Holding Company Act of 1956, as amended (the “BHC Act”), and is subject to the supervision of the Federal Reserve Board (“FRB”). Certain legislation and regulations affecting the businesses of the Company and the Bank are discussed below.

General.

The FRB requires the Company to maintain certain levels of capital and to file an annual report with the FRB. The FRB also has the authority to conduct examinations of the Company and the Bank and to take enforcement action against any bank holding company that engages in any unsafe or unsound practice or that violates certain laws, regulations, or conditions imposed in writing by the FRB.

Capital Standards.

The FRB, FDIC and other federal banking agencies have established risk-based capital adequacy guidelines. These guidelines are intended to provide a measure of a bank’s capital adequacy that reflects the degree of risk associated with a bank’s operations.

A banking organization’s risk-based capital ratios are obtained by dividing its qualifying capital by its total risk-adjusted assets and off-balance sheet items. Since December 31, 1992, the federal banking agencies have required a minimum ratio of qualifying total capital to risk-adjusted assets and off-balance sheet items of 8%, and a minimum ratio of Tier 1 capital to risk-adjusted assets and off-balance sheet items of 4%.

In addition to the risk-based guidelines, federal banking regulators require banking organizations to maintain a minimum amount of Tier 1 capital to total assets, referred to as the leverage ratio. For a banking organization rated in the highest of the five categories used by regulators to rate banking organizations, the minimum leverage ratio of Tier 1 capital to total assets is 3%. The Company’s leverage capital ratio at December 31, 2005 was 10.11%.

 

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Prompt Corrective Action and Other Enforcement Mechanisms.

The Federal Deposit Insurance Corporation Improvement Act of 1991 (“FDICIA”) requires each federal banking agency to take prompt corrective action to resolve the problems of insured depository institutions, including but not limited to those that fall below one or more of the prescribed minimum capital ratios. The law requires each federal banking agency to promulgate regulations defining the following five categories in which an insured depository institution will be placed, based on the level of its capital ratios: well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized, and critically undercapitalized. The Company and Bank are classified as well capitalized under the guidelines promulgated by the Federal Reserve Bank under Regulation H and Regulation Y.

Safety and Soundness Standards.

FDICIA also implemented certain specific restrictions on transactions and required the regulators to adopt overall safety and soundness standards for depository institutions related to internal control, loan underwriting and documentation, and asset growth. Among other things, FDICIA limits the interest rates paid on deposits by undercapitalized institutions, the use of brokered deposits and the aggregate extension of credit by a depository institution to an executive officer, director, principal shareholder or related interest, and reduces deposit insurance coverage for deposits offered by undercapitalized institutions for deposits by certain employee benefits accounts.

Restrictions on Dividends and Other Distributions.

The Company’s ability to pay dividends depends in large part on the ability of the Bank to pay dividends to the Company. The power of the board of directors of an insured depository institution to declare a cash dividend or other distribution with respect to capital is subject to federal statutory and regulatory restrictions which limit the amount available for such distribution depending upon the earnings, financial condition and cash needs of the institution, as well as general business conditions.

The approval of the Mississippi Department of Banking and Consumer Finance is also required prior to the Bank paying dividends. The department’s regulations limit dividends to earned surplus in excess of three times the Bank’s capital stock. At December 31, 2005, the maximum amount available for transfer from the Bank to the Company in the form of a dividend was $60,342,000, or 10% of the Bank’s consolidated net assets.

FRB regulations limit the amount the Bank may loan to the Company unless those loans are collateralized by specific obligations. At December 31, 2005, the maximum amount available for transfer from the Bank in the form of cash dividends and loans was $120,620,765, or 20% of the Bank’s consolidated net assets.

FDIC Insurance Assessments.

The FDIC has established several mechanisms to increase funds to protect deposits insured by the Bank Insurance Fund (“BIF”) and the Savings Association Insurance Fund (“SAIF”), both of which are administered by the FDIC. The Bank’s deposits are insured through BIF except for those deposits the Bank acquired from the Resolution Trust Corporation in April, 1994. This acquisition consisted of one branch of the former Security Federal Savings and Loan in Kosciusko, Mississippi, and these deposits remain insured through the SAIF.

 

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Deposit insurance premiums for banks and savings associations were increased as a result of The Financial Institutions Reform, Recovery and Enforcement Act of 1989. Losses incurred by the FDIC in connection with the default or assistance of troubled federally insured financial institutions are required to be reimbursed by other federally insured financial institutions.

Other BHC Act Provisions

The BHC Act requires a bank holding company to obtain the prior approval of the FRB before acquiring direct or indirect ownership or control of more than 5% of the voting shares of any bank that is not already majority-owned by such bank holding company. The BHC Act provides that the FRB shall not approve any acquisition, merger or consolidation which would result in a monopoly or which would be in furtherance of any combination or conspiracy to monopolize or attempt to monopolize the business of banking. The FRB also will not approve any other transactions in which the effect might be to substantially lessen competition or in any manner be a restraint on trade, unless the anti-competitive effects of the proposed transaction are clearly outweighed by the public interest in the probable effect of the transaction in meeting the convenience and needs of the community to be served.

The BHC Act also prohibits a bank holding company, with certain exceptions, from itself engaging in or from acquiring direct or indirect control of more than 5% of the voting shares of any company engaged in non-banking activities. The principal exception to this rule is for engaging in or acquiring shares of a company whose activities are found by the FRB to be so closely related to banking or managing banks as to be a proper incident thereto. In making such determinations, the FRB is required to consider whether the performance of such activities by a bank holding company or its subsidiaries can reasonably be expected to produce benefits to the public such as greater convenience, increased competition, or gains in efficiency of resources that outweigh the risks of possible adverse effects such as decreased or unfair competition, conflicts of interest, or unsound banking practices.

The BHC Act prohibits the acquisition by a bank holding company of more than 5% of the outstanding voting shares of a bank located outside the state in which the operations of its banking subsidiaries are principally conducted, unless such an acquisition is specifically authorized by statute of the state in which the bank to be acquired is located.

The Company and the Bank are subject to certain restrictions imposed by the Federal Reserve Act and the Federal Deposit Insurance Act on any extensions of credit to the Company or the Bank, on investments in the stock or other securities of the Company or the Bank, and on taking such stock or other securities as collateral for loans of any borrower.

The BHC Act was amended in 2000 by the Gramm-Leach-Bliley Financial Services Modernization Act of 1999 to permit “financial holding companies” to engage in a broader range of nonbanking financial activities, such as underwriting and selling insurance, providing financial or investment advice, and dealing and making markets in securities and merchant banking. In order to qualify as a financial holding company, the Company must declare to the FRB its intention to become a financial holding company and certify that the Bank meets the capitalization management requirements and that it has at least a satisfactory rating under the Community Reinvestment Act of 1997. As of December 31, 2005, we had not elected to become a financial holding company.

 

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Interstate Banking and Branching.

On September 29, 1994, the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 (the “Interstate Act”) was signed into law. The Interstate Act effectively permits nationwide banking by removing territorial restrictions on interstate bank mergers.

Interstate branching by merger with, or acquisition or consolidation of, banks located in different states was permitted beginning June 1, 1997, except in states that have passed legislation prior to that date “opting-out” of interstate branching. If a state opted-out prior to June 1, 1997, then banks located in that state can not participate in interstate branching. Effective May 1, 1997, Mississippi “opted in” to the interstate branching provision of the Interstate Act.

Community Reinvestment Act.

The Community Reinvestment Act of 1997, as amended (“CRA”), requires the assessment by the appropriate regulatory authority of a financial institution’s record in meeting the credit needs of the local community, including low and moderate-income neighborhoods. The regulations promulgated under CRA emphasize an assessment of actual performance in meeting local credit needs, rather than of the procedures followed by a bank, to evaluate compliance with the CRA. CRA compliance is also a factor in evaluations of proposed mergers, acquisitions and applications to open new branches or facilities. Overall CRA compliance is rated across a four-point scale from “outstanding” to “substantial noncompliance.” Different evaluation methods are used depending on the asset size of the bank.

The FDIC examined the Bank on August 21, 2001 and again most recently on August 17, 2004, for its performance under the CRA. The Bank was rated Satisfactory during both of these examinations. No discriminatory practices or illegal discouragement of applications were found.

Anti-Money Laundering Efforts.

The Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001 (“USA PATRIOT Act”) requires financial institutions to establish anti-money laundering programs and due diligence policies, procedures and controls with respect to bank accounts involving foreign individuals and certain foreign banks, and to avoid establishing and maintaining accounts in the United States for, or on the behalf of, foreign banks that do not have a physical presence in any country.

Corporate Governance.

The Sarbanes-Oxley Act of 2002 (“Sarbanes Act”) requires publicly traded companies such as the Company to adhere to several directives designed to prevent corporate misconduct. Additional duties have been placed on officers, directors, auditors and attorneys of public companies. The Sarbanes Act requires certifications regarding financial statement accuracy and internal control adequacy by the chief executive officer and the chief financial officer to accompany periodic reports filed with the Securities and Exchange Commission (“SEC”). The Sarbanes Act also accelerates Section 16 insider reporting obligations, restricts certain executive officer and director transactions, imposes new obligations on corporate audit committees and provides for enhanced review by the SEC.

 

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Impact of Monetary Policies.

Banking is a business that substantially depends on interest rate differentials. In general, the difference between the interest paid by a bank on its deposits and other borrowings and the interest rate earned by banks on loans, securities and other interest-earning assets comprises the major source of banks’ earnings. Thus, the earnings and growth of banks are subject to the influence of economic conditions generally, both domestic and foreign, and also to the monetary and fiscal policies of the United States and its agencies including the FRB. The nature and timing of any future changes in such policies and their impact on the Company cannot be predicted.

COMPETITION

The banking business is highly competitive. The Company’s market area consists principally of Neshoba, Newton, Leake, Scott, Attala, Lauderdale, Winston and Kemper counties in Mississippi. The Company competes with other financial institutions in these counties and in surrounding counties in Mississippi in obtaining deposits and providing many types of financial services. The Company also competes with larger regional banks for the business of companies located in the Company’s market area.

All financial institutions, including the Company, compete for customers’ deposits. The Company competes with savings and loan associations, credit unions, production credit associations, federal land banks, finance companies, personal loan companies, money market funds and other non-depository financial intermediaries. Many of these financial institutions have resources many times greater than those of the Company. In addition, new financial intermediaries such as money-market mutual funds and large retailers are not subject to the same regulations and laws that govern the operation of traditional depository institutions. The Company believes it benefits from a good reputation in the community and from the significant length of time it has provided needed banking services to its customers. Also, as a locally owned financial institution, the Company believes it is able to respond to the needs of the community with services tailored to the particular demands of its customers. Furthermore, as a local institution, the Company believes it can provide these services faster than a larger institution not based in the Company’s market area.

Recent changes in federal and state law have resulted in, and are expected to continue to result in, increased competition. The reductions in legal barriers to the acquisition of banks by out-of-state bank holding companies resulting from implementation of the Interstate Act and other recent and proposed changes in banking laws and regulations are expected to continue to further stimulate competition in the markets in which the Company operates, although it is not possible to predict the extent or timing of such increased competition.

Currently, there are approximately fourteen different financial institutions in the Company’s market area competing for the same customer base. As of June 30, 2005, the Company’s market share in its market area was approximately 16.3%. The Company competes in its market for loan and deposit products, along with many of the other services required by today’s banking customer, on the basis of availability, quality and pricing. The Company believes it is able to compete favorably in its markets, in terms of both the rates we offer and the level of service that we provide to our customers.

 

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AVAILABILITY OF INFORMATION

The Company’s annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to any of the foregoing are not currently available on the Company’s website, http://www.thecitizensbankphila.com. The Company is in the process of launching a new corporate website and, after its completion, the Company’s annual, quarterly and current reports will be available on this website. Upon request, the Company will provide to any record holder or beneficial holder of its shares a copy of such reports without charge. Requests should be made to Robert T. Smith, Treasurer and Chief Financial Officer, Citizens Holding Company, 521 Main Street, Philadelphia, Mississippi 39350.

ITEM 1A. RISK FACTORS

In addition to the other information contained in or incorporated by reference into this Annual Report on Form 10-K and the exhibits hereto, the following risk factors should be considered carefully in evaluating our business. The risks disclosed below, either alone or in combination, could materially adversely affect the business, financial condition or results of operations of the Company. Additional risks not presently known to us, or that we currently deem immaterial, may also adversely affect our business, financial condition or results of operations.

Risks Related To Our Business and Industry

We are subject to interest rate risk.

Our earnings and cash flows are largely dependent upon the net interest income of the Company. Net interest income is the difference between interest earned on assets, such as loans and securities, and the cost of interest-bearing liabilities, such as deposits and borrowed funds. Interest rates are highly sensitive to many factors that are beyond our control, including general economic conditions and policies of various governmental and regulatory agencies and, in particular, the FRB. Changes in monetary policy, including changes in interest rates, could influence not only the interest we receive on loans and securities and the amount of interest we pay on deposits and borrowings, but such changes could also affect (i) our ability to originate loans and obtain deposits, which could reduce the amount of fee income generated, (ii) the fair value of our financial assets and liabilities, and (iii) the average duration of our mortgage-backed securities portfolio. If the interest rates paid on deposits and other borrowings increase at a faster rate than the interest rates received on loans and other investments, our net interest income could be adversely affected, which in turn could negatively affect our earnings. Earnings could also be adversely affected if the interest rates received on loans and other investments fall more quickly than the interest rates paid on deposits and other borrowings.

Although management believes it has implemented effective asset and liability management strategies to reduce the potential effects of changes in interest rates on the results of operations of the Company, any substantial, unexpected, prolonged change in market interest rates could have a material adverse effect on our financial condition and results of operations. Volatility in interest rates may also result in disintermediation, which is the flow of funds away from financial

 

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institutions into direct investments, such as U.S. Government and Agency securities and other investment vehicles, including mutual funds, which generally pay higher rates of return than financial institutions because of the absence of federal insurance premiums and reserve requirements. Disintermediation could also result in material adverse effects on our financial condition and results of operations.

A discussion of the policies and procedures used to identify, assess and manage certain interest rate risk is set forth in Item 7A, “Qualitative and Quantitative Disclosures about Market Risk.”

We are subject to lending risk.

There are inherent risks associated with our lending activities. These risks include, among other things, the impact of changes in interest rates and changes in the economic conditions in the markets where we operate as well as those across the United States. Increases in interest rates and/or weakening economic conditions could adversely impact the ability of borrowers to repay outstanding loans or the value of the collateral securing these loans.

As of December 31, 2005, approximately 82% of our loan portfolio consisted of commercial, construction and commercial real estate loans. These types of loans are generally viewed as having more risk of default than residential real estate loans or consumer loans due primarily to the large amounts loaned to individual borrowers. Because the loan portfolio contains a significant number of commercial, construction and commercial real estate loans with relatively large balances, the deterioration of one or a few of these loans could cause a significant increase in non-performing loans. An increase in non-performing loans could result in a net loss of earnings from these loans, an increase in the provision for possible loan losses and an increase in loan charge-offs, all of which could have a material adverse effect on our financial condition and results of operations.

The allowance for possible loan losses may be insufficient.

Although we try to maintain diversification within our loan portfolio in order to minimize the effect of economic conditions within a particular industry, management also maintains an allowance for loan losses, which is a reserve established through a provision for loan losses charged to expense, to absorb probable credit losses inherent in the entire loan portfolio. The appropriate level of the allowance is based on management’s quarterly analysis of the loan portfolio and represents an amount that management deems adequate to provide for inherent losses, including collective impairment. Among other considerations in establishing the allowance for loan losses, management considers economic conditions reflected within industry segments, the unemployment rate in our markets, loan segmentation, and historical losses that are inherent in the loan portfolio. The determination of the appropriate level of the allowance for loan losses inherently involves a high degree of subjectivity and requires management to make significant estimates of current credit risks and future trends, all of which may undergo material changes. Changes in economic conditions affecting borrowers, new information regarding existing loans, identification of additional problem loans and other factors, both within and outside of the our control, may require an increase in the allowance for loan losses.

 

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In addition, bank regulatory agencies periodically review the allowance for loan losses and may require an increase in the provision for loan losses or the recognition of further loan charge-offs, based on judgments different than those of management. In addition, if charge-offs in future periods exceed the allowance for loan losses, we will need additional provisions to increase the allowance for loan losses. Any increases in the allowance for loan losses will result in a decrease in net income and, possibly, capital, and may have a material adverse effect on our financial condition and results of operations. A discussion of the policies and procedures related to management’s process for determining the appropriate level of the allowance for loan losses is set forth in Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

Bank holding companies depend on the accuracy and completeness of information about customers and counterparties.

In deciding whether to extend credit or enter into other transactions, we often rely on information furnished by or on behalf of customers and counterparties, including financial statements, credit reports and other financial information. We may also rely on representations of those customers, counterparties or other third parties, such as independent auditors, as to the accuracy and completeness of that information. Reliance on inaccurate or misleading financial statements, credit reports or other financial information could have a material adverse impact on our business and, in turn, our financial condition and results of operations.

We are subject to environmental liability risk associated with lending activities.

A significant portion of the loan portfolio is secured by real property. During the ordinary course of business, we may foreclose on and take title to properties securing certain loans. In doing so, there is a risk that hazardous or toxic substances could be found on these properties. If hazardous or toxic substances are found, we may be liable for remediation costs, as well as for personal injury and property damage. Environmental laws may require us to incur substantial expenses and may materially reduce the affected property’s value or limit the ability of the Company to use or sell the affected property. In addition, future laws or more stringent interpretations or enforcement policies with respect to existing laws may increase our exposure to environmental liability. Although management has policies and procedures to perform an environmental review during the loan application process and also before initiating any foreclosure action on real property, these reviews may not be sufficient to detect all potential environmental hazards. The remediation costs and any other financial liabilities associated with an environmental hazard could have a material adverse effect on our financial condition and results of operations.

The profitability of the Company depends significantly on economic conditions in the State of Mississippi.

Our success depends primarily on the general economic conditions of the State of Mississippi and the specific local markets in which we operate. Unlike larger national or other regional banks that are more geographically diversified, we provide banking and financial services to customers primarily in East Central Mississippi. The local economic conditions in this area have a significant impact on the demand for our products and services as well as the ability of our customers to repay loans, the value of the collateral securing loans and the stability of our deposit funding sources.

 

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The earnings of bank holding companies are significantly affected by general business and economic conditions.

In addition to the risks associated with the general economic conditions in the markets in which we operate, our operations and profitability are also impacted by general business and economic conditions in the United States and abroad. These conditions include short-term and long-term interest rates, inflation, money supply, political issues, legislative and regulatory changes, fluctuations in both debt and equity capital markets, broad trends in industry and finance, and the strength of the U.S. economy and the local economies in which we operate, all of which are beyond our control. A deterioration in economic conditions could result in an increase in loan delinquencies and non-performing assets, decreases in loan collateral values and a decrease in demand for our products and services, among other things, any of which could have a material adverse impact on our financial condition and results of operations.

We operate in a highly competitive industry and market area.

We face substantial competition in all areas of our operations from a variety of different competitors, many of which are larger and may have more financial resources. Such competitors primarily include national, regional and community banks within the various markets in which we operate. We also face competition from many other types of financial institutions, including savings and loans, credit unions, finance companies, brokerage firms, insurance companies, factoring companies and other financial intermediaries. The information under the heading “Competition” in Item 1, “Business,” provides more information regarding the competitive conditions in our markets.

Our industry could become even more competitive as a result of legislative, regulatory and technological changes and continued consolidation. Banks, securities firms and insurance companies can merge under the umbrella of a financial holding company, which can offer virtually any type of financial service, including banking, securities underwriting, insurance (both agency and underwriting) and merchant banking. Also, technology has lowered barriers to entry and made it possible for non-banks to offer products and services traditionally provided by banks, such as automatic transfer and automatic payment systems. Many of our competitors have fewer regulatory constraints and may have lower cost structures. Additionally, many of our competitors have substantially greater resources than us, including higher total assets and capitalization, greater access to capital markets and a broader offering of financial services.

Our ability to compete successfully depends on a number of factors, including, among other things:

 

    The ability to develop, maintain and build upon long-term customer relationships based on top quality service, high ethical standards and safe, sound assets.

 

    The ability to expand the Company’s market position.

 

    The scope, relevance and pricing of products and services offered to meet customer needs and demands.

 

    The rate at which we introduce new products and services relative to our competitors.

 

    Customer satisfaction with our level of service.

 

    Industry and general economic trends.

 

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Failure to perform in any of these areas could significantly weaken our competitive position, which could adversely affect our growth and profitability, which, in turn, could have a material adverse effect on our financial condition and results of operations.

We are subject to extensive government regulation and supervision.

The Company and the Bank are subject to extensive federal and state regulation and supervision. Banking regulations are primarily intended to protect depositors’ funds, federal deposit insurance funds and the banking system as a whole, not the economic or other interests of shareholders. These regulations affect our lending practices, capital structure, investment practices, dividend policy and growth, among other things. Changes to statutes, regulations or regulatory policies, including changes in interpretation or implementation of the foregoing, could affect the Company and/or the Bank in substantial and unpredictable ways. Such changes could subject us to additional costs, limit the types of financial services and products we may offer and/or increase the ability of non-banks to offer competing financial services and products, among other things.

Under regulatory capital adequacy guidelines and other regulatory requirements, the Company and the Bank must meet guidelines that include quantitative measures of assets, liabilities and certain off-balance sheet items, subject to qualitative judgments by regulators about components, risk weightings and other factors. If we fail to meet these minimum capital guidelines and other regulatory requirements, our financial condition would be materially and adversely affected. Our failure to maintain the status of “well capitalized” under our regulatory framework could affect the confidence of our customers in us, thus compromising our competitive position. In addition, failure to maintain the status of “well capitalized” under our regulatory framework or “well managed” under regulatory examination procedures could compromise our status as a bank holding company and related eligibility for a streamlined review process for acquisition proposals.

We are also subject to laws, regulations and standards relating to corporate governance and public disclosure, including the Sarbanes Act and new SEC regulations. These laws, regulations and standards are subject to varying interpretations in many cases, and as a result, their application in practice may evolve over time as new guidance is provided by regulatory and governing bodies, which could result in continuing uncertainty regarding compliance matters and higher costs necessitated by ongoing revisions to disclosure and governance practices. We are committed to maintaining high standards of corporate governance and public disclosure. As a result, our efforts to comply with evolving laws, regulations and standards have resulted in, and are likely to continue to result in, increased expenses and a diversion of management time and attention.

Failure to comply with laws, regulations or policies could also result in sanctions by regulatory agencies and/or civil money penalties, which could have a material adverse effect on our business, financial condition and results of operations. While we have policies and procedures designed to prevent any such violations, there can be no assurance that such violations will not occur. The information under the heading “Supervision and Regulation” in Item 1, “Business,” and Note 14, “Regulatory Matters” to the Consolidated Financial Statements of the Company in Item 8, “Financial Statements and Supplementary Data,” provides more information regarding the regulatory environment in which we and our Bank operate.

 

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Our controls and procedures may fail or be circumvented.

Management regularly reviews and updates our internal control over financial reporting, disclosure controls and procedures and corporate governance policies and procedures. Any system of controls, however well designed and operated, has inherent limitations, including the possibility that a control can be circumvented or overridden, and misstatements due to error or fraud may occur and not be detected. Also, because of changes in conditions, internal control effectiveness may vary over time. Accordingly, even an effective system of internal control will provide only reasonable assurance with respect to our adherence to financial reporting, disclosure and corporate governance policies and procedures.

Slower than anticipated growth in new branches and new product and service offerings could result in reduced income.

We have placed a strategic emphasis on expanding our branch network and product offerings. Executing this strategy carries risks of slower than anticipated growth both in new branches and new products. New branches and products require a significant investment of both financial and personnel resources. Lower than expected loan and deposit growth in new investments can decrease anticipated revenues and net income generated by those investments, and opening new branches and introducing new products could result in more additional expenses than anticipated and divert resources from current core operations.

We are substantially dependent on dividends from the Bank for our revenues.

The Company is a separate and distinct legal entity from the Bank, and it receives substantially all of its revenue from dividends from the Bank. These dividends are the principal source of funds to pay dividends on our common stock and interest and principal on debt. Various federal and/or state laws and regulations limit the amount of dividends that the Bank may pay to the Company. In the event the Bank is unable to pay dividends to us, we may not be able to service debt, pay obligations or pay dividends on our common stock. The inability to receive dividends from the Bank could have a material adverse effect on our business, financial condition and results of operations. The information under the heading “Supervision and Regulation” in Item 1, “Business,” provides a discussion about the restrictions governing the Bank’s ability to transfer funds to us.

Potential acquisitions may disrupt the our business and dilute shareholder value.

We seek merger or acquisition partners that are culturally similar and have experienced management and possess either significant market presence or have potential for improved profitability through financial management, economies of scale or expanded services. Acquiring other banks, businesses or branches involves various risks commonly associated with acquisitions, including, among other things:

 

    Potential exposure to unknown or contingent liabilities of the target company.

 

    Exposure to potential asset quality issues of the target company.

 

    Difficulty and expense of integrating the operations and personnel of the target company.

 

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    Potential disruption to our business.

 

    Potential diversion of management’s time and attention.

 

    The possible loss of key employees and customers of the target company.

 

    Difficulty in estimating the value of the target company.

 

    Potential changes in banking or tax laws or regulations that may affect the target company.

We regularly evaluate merger and acquisition opportunities and conduct due diligence activities related to possible transactions with other financial institutions. As a result, merger or acquisition discussions and, in some cases, negotiations may take place and future mergers or acquisitions involving cash, debt or equity securities may occur at any time. Acquisitions typically involve the payment of a premium over book and market values, and, therefore, some dilution of our tangible book value and net income per common share may occur in connection with any future transaction. Furthermore, failure to realize the expected revenue increases, cost savings, increases in geographic or product presence, and/or other projected benefits from an acquisition could have a material adverse effect on our financial condition and results of operations.

We may not be able to attract and retain skilled people.

Our success depends in part on our ability to retain key executives and to attract and retain additional qualified personnel who have experience both in sophisticated banking matters and in operating a bank of our size. Competition for such personnel is strong in the banking industry, and we may not be successful in attracting or retaining the personnel we require. The unexpected loss of one or more of our key personnel could have a material adverse impact on our business because of their skills, knowledge of our markets, years of industry experience and the difficulty of promptly finding qualified replacements. We expect to effectively compete in this area by offering financial packages that are competitive within the industry.

Our information systems may experience an interruption or breach in security.

We rely heavily on communications and information systems to conduct our business. Any failure, interruption or breach in security of these systems could result in failures or disruptions in our customer relationship management, general ledger, deposit, loan and other systems. While we have policies and procedures designed to prevent or limit the effect of the failure, interruption or security breach of our information systems, there can be no assurance that any such failures, interruptions or security breaches will not occur or, if they do occur, that they will be adequately addressed. The occurrence of any failures, interruptions or security breaches of our information systems could damage our reputation, result in a loss of customer business, subject us to additional regulatory scrutiny, or expose us to civil litigation and possible financial liability, any of which could have a material adverse effect on the financial condition and results of operations of the Company.

We continually encounter technological change.

Our industry is continually undergoing rapid technological change with frequent introductions of new technology-driven products and services. The effective use of technology increases efficiency and enables financial institutions to better serve customers and reduce costs.

 

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Our future success depends, in part, upon our ability to address the needs of our customers by using technology to provide products and services that will satisfy customer demands, as well as to create additional efficiencies in our operations. Many of our competitors have substantially greater resources to invest in technological improvements. We may not be able to effectively implement new technology-driven products and services or be successful in marketing these products and services to our customers. Failure to successfully keep pace with technological change affecting our industry could have a material adverse impact on our business and, in turn, our financial condition and results of operations.

Consumers may decide not to use banks to complete their financial transactions.

While we continually attempt to use technology to offer new products and services, at the same time, technology and other changes are allowing parties to complete financial transactions that historically have involved banks through alternative methods. For example, consumers can now maintain funds in brokerage accounts or mutual funds that would have historically been held as bank deposits. Consumers can also complete transactions such as paying bills and/or transferring funds directly without the assistance of banks. The process of eliminating banks as intermediaries, known as disintermediation, could result in the loss of fee income, as well as the loss of customer deposits and the related income generated from those deposits. The loss of these revenue streams and the lower cost deposits as a source of funds could have a material adverse effect on our financial condition and results of operations.

Severe weather, natural disasters, acts of war or terrorism and other external events could significantly impact our business.

Severe weather, natural disasters, acts of war or terrorism and other adverse external events could have a significant impact on the ability of the Company to conduct business. Such events could affect the stability of our deposit base, impair the ability of borrowers to repay outstanding loans, impair the value of collateral securing loans, cause significant property damage, result in loss of revenue and/or cause us to incur additional expenses. For example, during 2005, Hurricanes Katrina and Rita made landfall and subsequently caused extensive flooding and destruction along the coastal areas of the Gulf of Mexico. Although our operations were not disrupted by these hurricanes or their aftermath, other severe weather or natural disasters, acts of war or terrorism or other adverse external events may occur in the future. Although management has established disaster recovery policies and procedures, the occurrence of any such event could have a material adverse effect on our business, which, in turn, could have a material adverse effect on our financial condition and results of operations.

Risks Associated With Our Common Stock

Our stock price can be volatile.

Stock price volatility may make it more difficult for you to resell your common stock when you want and at prices you find attractive. Our stock price can fluctuate significantly in response to a variety of factors including, among other things:

 

    Actual or anticipated variations in quarterly results of operations.

 

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    Recommendations by securities analysts.

 

    Operating and stock price performance of other companies that investors deem comparable to the Company.

 

    News reports relating to trends, concerns and other issues in the banking and financial services industry.

 

    Perceptions in the marketplace regarding us and/or our competitors.

 

    New technology used, or services offered, by competitors.

 

    Significant acquisitions or business combinations, strategic partnerships, joint ventures or capital commitments by or involving us or our competitors.

 

    Failure to integrate acquisitions or realize anticipated benefits from acquisitions.

 

    Changes in government regulations.

 

    Geopolitical conditions such as acts or threats of terrorism or military conflicts.

General market fluctuations, industry factors and general economic and political conditions and events, such as economic slowdowns or recessions, interest rate changes or credit loss trends, could also cause our stock price to decrease regardless of operating results.

The trading volume in our common stock is less than that of other larger bank holding companies.

Our common stock is listed for trading on the American Stock Exchange; the average daily trading volume in our common stock is low, generally less than that of many of the our competitors and other larger bank holding companies. A public trading market having the desired characteristics of depth, liquidity and orderliness depends on the presence in the marketplace of willing buyers and sellers of our common stock at any given time. This presence depends on the individual decisions of investors and general economic and market conditions over which we have no control. Given the lower trading volume of our common stock, significant sales of our common stock, or the expectation of these sales, could cause volatility in the price of our common stock.

An investment in our common stock is not an insured deposit.

Our common stock is not a bank deposit and, therefore, is not insured against loss by the FDIC, any deposit insurance fund or by any other public or private entity. Investment in our common stock is inherently risky for the reasons described in this “Risk Factors” section and elsewhere in this report and is subject to the same market forces that affect the price of common stock in any company. As a result, if you acquire our common stock, you may lose some or all of your investment.

Our Articles of Incorporation and Bylaws, as well as certain banking laws, may have an anti-takeover effect.

Provisions of our Articles of Incorporation and Bylaws, which are exhibits to this Annual Report on Form 10-K, and federal banking laws, including regulatory approval requirements, could make it more difficult for a third party to acquire the Company, even if doing so would be perceived to be beneficial to our shareholders. The combination of these provisions impedes a non-negotiated merger or other business combination, which, in turn, could adversely affect the market price of our common stock.

 

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ITEM 1B. UNRESOLVED STAFF COMMENTS

None.

ITEM 2. PROPERTIES

The Company, through the Bank, currently operates from its main office in downtown Philadelphia, and from 18 additional branches in Neshoba, Newton, Leake, Scott, Attala, Lauderdale, Winston and Kemper counties, Mississippi. Information about these branches is set forth in the table below:

 

NAME OF OFFICE

 

LOCATION/TELEPHONE NUMBER

 

BANKING FUNCTIONS OFFERED

Main Office  

521 Main Street

Philadelphia, Mississippi

(601) 656-4692

 

Full Service;

Trust

Eastside Branch  

585 East Main Street

Philadelphia, Mississippi

(601) 656-4976

  Drive-up
Westside Branch  

912 West Beacon Street

Philadelphia, Mississippi

(601) 656-4978

 

Full Service;

24 Hour Teller

Northside Branch  

802 Pecan Avenue

Philadelphia, Mississippi

(601) 656-4977

 

Deposits;

24 Hour Teller

Pearl River Branch  

110 Choctaw Town Center

Philadelphia, Mississippi

(601) 656-4971

 

Full Service;

24 Hour Teller

Union Branch  

Corner of Horne & Bank

Union, Mississippi

(601) 774-9231

  Full Service
Carthage Main Office  

219 West Main Street

Carthage, Mississippi

(601) 267-4525

  Full Service
Crossroads Branch  

Highways 35 & 16

Carthage, Mississippi

(601) 267-4525

  Drive-up

 

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Madden Branch  

Highway 488

Madden, Mississippi

(601) 267-7366

  Deposits
Sebastopol Branch  

24 Pine Street

Sebastopol, Mississippi

(601) 625-7447

 

Full Service;

24-Hour Teller

DeKalb Branch  

Corner of Main & Bell

DeKalb, Mississippi

(601) 743-2115

  Full Service
Kosciusko Branch  

775 North Jackson Avenue

Kosciusko, Mississippi

(662) 289-4356

 

Full Service;

24-hour Teller

Scooba Branch  

1048 Johnston Street

Scooba, Mississippi

(662) 476-8431

  Full Service
Meridian Branch  

1825 Highway 39 North

Meridian, Mississippi

(601) 693-8367

 

Full Service;

24-Hour Teller

Decatur Branch  

15330 Highway 15 South

Decatur, Mississippi

(601) 635-2321

 

Full Service;

24-Hour Teller

Forest Branch  

247 Woodland Drive

North Forest, Mississippi

(601) 469-3424

 

Full Service;

24-Hour Teller

Louisville Main Branch  

100 East Main Street

Louisville, MS

(662) 773-6261

  Full Service
Industrial Branch  

803 South Church Street

Louisville, MS

(662) 773-6261

  Drive-Up
Noxapater Branch  

45 East Main Street

Noxapater, MS

(662) 724-4261

  Deposits

The Bank owns its main office and its branch offices, except for the Pearl River branch office, which is leased. The main office facility, originally occupied in 1966, is used solely by the Company and the Bank. This facility contains approximately 20,000 square feet and houses the executive offices and all operations-related departments of the Company. The other branches range in size from nearly 4,000 square feet to 1,000 square feet.

 

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ITEM 3. LEGAL PROCEEDINGS

There are no material pending legal proceedings, other than routine litigation incidental to their business, to which either the Company or the Bank is a party or to which any of their property is subject.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

There were no matters submitted to the Company’s shareholders during the fourth quarter of 2005.

PART II

ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

Information required in partial response to this Item 5 can be found under the heading “Market Price and Dividend Information” in the 2005 Annual Report to Shareholders, a copy of which is filed as an Exhibit to this Annual Report on Form 10-K. Such information in incorporated herein by reference.

The information appearing under the caption “Equity Compensation Plan Information” in Item 12 of this Form 10-K is incorporated herein by reference.

ITEM 6. SELECTED FINANCIAL DATA

Information required in response to this Item 6 can be found under the heading “Management’s Discussion and Analysis of Financial Condition and Results of Operations as of December 31, 2005, 2004 and 2003 - Selected Financial Data” in the 2005 Annual Report to Shareholders, a copy of which is filed as an Exhibit to this Annual Report on Form 10-K. Such information is incorporated herein by reference.

ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Information required in response to this Item 7 can be found under the heading “Management’s Discussion and Analysis of Financial Condition and Results of Operations as of December 31, 2005, 2004 and 2003” in the 2005 Annual Report to Shareholders, a copy of which is filed as an Exhibit to this Annual Report on Form 10-K. Such information is incorporated herein by reference.

 

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ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Information required in response to this Item 7A can be found under the headings “Quantitative and Qualitative Disclosures about Market Risk” in the 2005 Annual Report to Shareholders, a copy of which is filed as an Exhibit to this Annual Report on Form 10-K. Such information is incorporated herein by reference.

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

Information required in response to this Item 8 can be found under the heading “Consolidated Financial Statements” and “Quarterly Financial Trends” in the 2005 Annual Report to Shareholders, a copy of which is filed as an Exhibit to this Annual Report on Form 10-K. Such information is incorporated herein by reference.

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

None.

ITEM 9A. CONTROLS AND PROCEDURES

Disclosure Controls and Procedures

Within the 90 days prior to the date of this Annual Report on Form 10-K, the Company’s principal executive officer and principal financial officer carried out an evaluation of the effectiveness of the design and operation of the Company’s disclosure controls and procedures, as defined in Rule 13a-15(e) and Rule 15d-15(e) promulgated under the Securities Exchange Act of 1934, as amended. Based on this evaluation, the Company’s principal executive officer and principal financial officer concluded that, as of December 31, 2005, the Company’s disclosure controls and procedures are effective in timely alerting them to material information required to be included in the Company’s SEC reports. There have been no significant changes in the Company’s internal controls or in other factors that could significantly affect internal controls subsequent to the date the Company carried out its evaluation.

Management’s Annual Report on Internal Control over Financial Reporting and Attestation Report of Independent Registered Public Accounting Firm

Information required in response to this item can be found under the headings “Management’s Assessment of Internal Control over Financial Reporting” and “Report of Independent Registered Public Accounting Firm (Internal Control)” in the Company’s Consolidated Financial Statements contained in its 2005 Annual Report to Shareholders, a copy of which is filed as an Exhibit to this Annual Report on Form 10-K. Such information is incorporated herein by reference.

 

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Changes in Internal Control over Financial Reporting

There were no changes to the internal control over financial reporting in the fourth quarter of 2005 that materially affected, or are reasonably likely to materially affect, internal control over financial reporting.

ITEM 9B. OTHER INFORMATION

None.

PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

Information required in partial response to this Item 10 can be found under the heading “Executive Officers of the Registrant” in Item 1 of this Annual Report on Form 10-K and under the headings “Stock Ownership” and “Board of Directors” in the Company’s Definitive Proxy Statement to be filed with the SEC on or about March 21, 2006, relating to its 2006 Annual Meeting of Shareholders. Such information is incorporated herein by reference.

Code of Ethics

The Company has adopted a code of business ethics in compliance with Item 406 of Regulation S-K for the Company’s principal executive officer, principal financial officer, principal accounting officer and controller. A copy of the Company’s Code of Ethics was filed as an exhibit to the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2003, filed on March 26, 2004 and is incorporated herein by reference.

ITEM 11. EXECUTIVE COMPENSATION

Information required in response to this Item 11 can be found under the headings “Board of Directors,” “Executive Officers and Executive Compensation,” “Report of the Compensation Committee,” “Compensation Committee Interlocks and Insider Participation” and “Stock Performance Graph” in the Company’s Definitive Proxy Statement to be filed with the SEC on or about March 21, 2006, relating to its 2006 Annual Meeting of Shareholders. Such information is incorporated herein by reference.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS

Information required in partial response to this Item 12 can be found under the heading “Stock Ownership” in the Company’s Definitive Proxy Statement to be filed with the SEC on or about March 21, 2006, relating to its 2006 Annual Meeting of Shareholders. Such information is incorporated herein by reference.

 

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Equity Compensation Plan Information

The following table provides additional information about the Company’s equity compensation plans as of December 31, 2005.

Equity Compensation Plan Information

 

Plan category

  

(a)

Number of securities
to be issued upon
exercise of
outstanding options,
warrants and rights

  

(b)

Weighted-average
exercise price of
outstanding options,
warrants and rights

  

(c)

Number of securities
remaining available for
future issuance under
equity compensation plans
(excluding securities

in column (a))

 

Equity compensation plans approved by security holders(1)

   256,050    $ 16.68    249,962 (2)

Equity compensation plans not approved by security holders

   -0-    $ 0.00    -0-  

Total

   256,050    $ 16.68    249,962  

(1) Two equity compensation plans have been approved by the shareholders: the 1999 Directors’ Stock Compensation Plan and the 1999 Employees’ Long-Term Incentive Plan.
(2) Includes 97,200 shares that remain available for future issuance under the 1999 Directors’ Stock Compensation Plan. Also includes 152,762 shares available for future issuance under the 1999 Employees’ Long-Term Incentive Plan (“LTIP”). Under the terms of the LTIP, the number of shares that may be issued cannot exceed 7% of the total number of shares issued and outstanding from time to time. In addition to stock options, restricted stock may be awarded under the LTIP. No restricted stock has been awarded under the LTIP.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

Information required in response to this Item 13 can be found under the heading “Board of Directors” in the Company’s Definitive Proxy Statement to be filed with the SEC on or about March 21, 2006, relating to its 2006 Annual Meeting of Shareholders. Such information is incorporated herein by reference.

ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES

Information required in response to this Item 14 can be found under the heading “Proposal No. 3- Appointment of HORNE LLP as the Company’s Independent Registered Public Accounting Firm” in the Company’s Definitive Proxy Statement to be filed with the SEC on or about March 21, 2006, relating to its 2006 Annual Meeting of Shareholders. Such information is incorporated herein by reference.

 

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PART IV

ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES

 

 

(a)

   Financial Statements   
     1.    Consolidated Financial Statements and Supplementary Information for years ended December 31, 2003, 2004 and
2005, which include the following:
  
        (i)   Report of Independent Registered Public Accounting Firm (Financial Statements)   
        (ii)   Report of Independent Registered Public Accounting Firm (Internal Control)   
        (iii)   Management’s Assessment of Internal Control over Financial Reporting   
        (iv)   Consolidated Balance Sheets   
        (v)   Consolidated Statements of Income   
        (vi)   Consolidated Statements of Comprehensive Income   
        (vii)   Consolidated Statements of Changes in Shareholders’ Equity   
        (viii)   Consolidated Statements of Cash Flows   
        (ix)   Notes to Consolidated Financial Statements   
     2.    Financial Statement Schedules   
        None.   
     3.    Exhibits required by Item 601 of Regulation S-K   
        3(i)   Amended Articles of Incorporation of the Company    *
        3(ii)   Amended and Restated Bylaws of the Company    *
        4   Rights Agreement between Citizens Holding Company and The Citizens Bank of Philadelphia, Mississippi    *
        10(a)   Directors’ Deferred Compensation Plan - Form of Agreement    *†
        10(b)   Citizens Holding Company 1999 Directors’ Stock Compensation Plan    *†
        10(c)   Citizens Holding Company 1999 Employees’ Long-Term Incentive Plan    *†
        10(d)   Change in Control Agreement dated December 10, 2002 between the Company and Greg L. McKee    **†
        10(f)   Supplemental Executive Retirement Plan    ***†
        13   2005 Annual Report to Shareholders   
        14   Code of Ethics    ****
        21   Subsidiaries of Registrant   
        23   Consent of Independent Registered Public Accounting Firm   
        31.1   Rule 13a-14(a)/15d-14(a) Certification of Chief Executive Officer   
        31.2   Rule 13a-14(a)/15d-14(a) Certification of Chief Executive Officer   
        32.1   Section 1350 Certification of Chief Executive Officer   
        32.2   Section 1350 Certification of Chief Financial Officer   

* Filed as an exhibit to the Form 10 Registration Statement of the Company (File No. 000-25221) filed on December 30, 1998 and incorporated herein by reference, and also filed as an exhibit to Amendment No. 1 to Form 10 Registration Statement of the Company (File No. 000-25221) filed on June 21, 1999 and incorporated herein by reference.

 

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** Filed as an exhibit to the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2002 (File No. 000-25221) filed on March 31, 2003 and incorporated herein by reference.
*** Filed as an exhibit to the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2004 (File No. 000-25221) filed on March 16, 2005 and incorporated herein by reference.
**** Filed as an exhibit to the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2003 (File No. 000-25221) filed on March 26, 2004 and incorporated herein by reference.
Management contract or compensatory plan or arrangement required to be filed as an exhibit to this Form 10-K pursuant to Item 15(b) of this report.

 

25


Table of Contents

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) 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.

 

     CITIZENS HOLDING COMPANY

Date: March 7, 2006

   By:  

/s/ Greg L. McKee

     Greg L. McKee
     President and Chief Executive Officer

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons on behalf of the Registrant and in the capacities and on the dates indicated:

 

SIGNATURES

  

CAPACITIES

 

DATE

/s/ Donald L. Kilgore

Donald L. Kilgore

  

Director

  March 7, 2006

/s/ Karl Brantley

Karl Brantley

  

Director

  March 7, 2006

/s/ David A. King

David A. King

  

Director

  March 7, 2006

/s/ Herbert A. King

Herbert A. King

  

Director

  March 7, 2006

/s/ Don L. Fulton

Don L. Fulton

  

Director

  March 7, 2006

/s/ David P. Webb

David P. Webb

  

Director

  March 7, 2006

/s/ A. T. Williams

A.T. Williams

  

Director

  March 7, 2006

/s/ Greg L. McKee

Greg L. McKee

  

Director, President and Chief Executive Officer

  March 7, 2006

/s/ Robert T. Smith

Robert T. Smith

  

Treasurer, Chief Financial Officer and Controller

  March 7, 2006

/s/ William M. Mars

William M. Mars

  

Chairman of the Board

  March 7, 2006

 

26


Table of Contents

EXHIBIT INDEX

 

Exhibit
Number
 

Description of Exhibit

13   2005 Annual Report to Shareholders
21   Subsidiaries of Registrant
23   Consent of Independent Registered Public Accounting Firm
31.1   Rule 13a-14(a)/15d-14(a) Certification of Chief Executive Officer
31.2   Rule 13a-14(a)/15d-14(a) Certification of Chief Executive Officer
32.1   Section 1350 Certification of Chief Executive Officer
32.2   Section 1350 Certification of Chief Financial Officer

 

27

2005 Annual Report to Shareholders

Exhibit 13

Exhibit 13 – 2005 Annual Report to Shareholders


Dear Stockholder:

As we look back at 2005, it is obvious that many of our neighbors and colleagues within our markets and across our state suffered grievously this year. A natural disaster such as Hurricane Katrina affects many facets of many lives. I am thankful that as a company we were fortunate to be able to offer assistance to many of these individuals and financial institutions. I am glad we were able to consider positive changes and remodeling instead of replacing destroyed properties. I would like to mention a few of the things that have been done to better employ our capital and further maximize the value of your investment.

We are in the process of remodeling the Main Office in order to make our facility more up-to-date in regard to customer service. The Eastside Branch has been remodeled and enlarged to be a full-service branch. This branch will now have a lender, ATM and other services available as we attempt to provide service to the prevailing traffic flows in our markets. We have the architect’s renderings of our new branch in Starkville, Ms. This project will soon be underway. We are anxious to offer our type of full-service banking in this dynamic, growing market.

The past year brought about changes, not only in buildings but in personnel and their functions. We continue to realign employees and functions that make for a stronger, more efficient organization.

During the year, the composition of your Board of Directors changed. Two long-time, devoted directors retired from their positions. Steve Webb served many years as a Director, CEO and finally as Chairman of the Board. W. W. Dungan also served many years as a Director and an active participant on various board committees. I personally thank these men for their time and efforts that have helped make this company what it is today.

The Board’s newest member, A. T. (Tommy) Williams, has a background of bank accounting that will provide sound, prudent advice in the years to come. We thank Tommy for his willingness to serve.

The attached financials show net income increased by 5.6% over 2004. This equates to a basic per share earnings of $1.59 compared to $1.51 for 2004. The assets of The Citizens Bank grew approximately 3.5%. We are very pleased to report these positive trends.

It is obvious we are pleased with the Company’s accomplishments for the year 2005. With your continued interest and support, we will attempt to maximize your investment in this great company with every decision made and every action taken.

 

/s/ Greg L. McKee

Greg L. McKee
President and Chief Executive Officer


CITIZENS HOLDING COMPANY

AND SUBSIDIARY

Philadelphia, Mississippi

Consolidated Financial Statements

Years Ended December 31, 2005, 2004 and 2003


CONTENTS

 

Report of Independent Registered Public Accounting Firm (Financial Statements)

   1

Report of Independent Registered Public Accounting Firm (Internal Control)

   2 – 3

Management’s Assessment of Internal Control over Financial Reporting

   4

Consolidated Financial Statements

  

Consolidated Balance Sheets

   5

Consolidated Statements of Income

   6

Consolidated Statements of Comprehensive Income

   7

Consolidated Statements of Changes in Stockholders’ Equity

   8

Consolidated Statements of Cash Flows

   9 – 10

Notes to Consolidated Financial Statements

   11 –42


LOGO

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors & Stockholders

Citizens Holding Company

Philadelphia, Mississippi

We have audited the consolidated balance sheets of Citizens Holding Company and Subsidiary (the “Company”) as of December 31, 2005 and 2004, and the related consolidated statements of income, comprehensive income, changes in stockholders’ equity and cash flows for each of the three years in the period ended December 31, 2005. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provided a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Citizens Holding Company and Subsidiary as of December 31, 2005 and 2004, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2005, in conformity with U.S. generally accepted accounting principles.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of Citizens Holding Company and Subsidiary’s internal control over financial reporting as of December 31, 2005, based on criteria established in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”) and our report dated March 2,2006 expressed an unqualified opinion on management’s assessment of the effectiveness of Citizens Holding Company and Subsidiary’s internal control over financial reporting and an unqualified opinion on the effectiveness of Citizens Holding Company and Subsidiary’s internal control over financial reporting.

/s/ Horne LLP

Jackson, Mississippi

March 2, 2006

 

1


LOGO

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors & Stockholders

Citizens Holding Company

Philadelphia, Mississippi

We have audited management’s assessment, included in the accompanying Management’s Assessment of Internal Control over Financial Reporting, that Citizens Holding Company and Subsidiary (the “Company”) maintained effective internal control over financial reporting as of December 31, 2005, based on criteria established in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”). The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management’s assessment and an opinion on the effectiveness of the Company’s internal control over financial reporting based on our audit.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those polices and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

 

2


To the Board of Directors

Citizens Holding Company

Page Two

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

In our opinion, management’s assessment that Citizens Holding Company and Subsidiary maintained effective internal control over financial reporting as of December 31, 2005, is fairly stated, in all material respects, based on criteria established in Internal Control – Integrated Framework issued by COSO. Also in our opinion, Citizens Holding Company and Subsidiary maintained, in all material respects, effective internal control over financial reporting as of December 31, 2005, based on criteria established in Internal Control - Integrated Framework issued by COSO.

We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated financial statements of Citizens Holding Company and Subsidiary and our report dated March 2, 2006 expressed an unqualified opinion.

/s/ Horne LLP

Jackson, Mississippi

March 2, 2006

 

3


Citizens Holding Company

Philadelphia, MS 39350

MANAGEMENT’S ASSESSMEMT OF INTERNAL CONTROL OVER FINANCIAL REPORTING

Management of Citizens Holding Company (the “Company”) is responsible for establishing and maintaining adequate internal control over financial reporting. Internal control over financial reporting is a process designed under the supervision of the Company’s principal executive and principal financial officers to provide reasonable assurance regarding the reliability of financial reporting and the preparation of the Company’s financial statements for external purposes in accordance with accounting principles generally accepted in the United States of America.

Management assessed the Company’s internal control over financial reporting as of December 31, 2004 based on the criteria for effective internal control over financial reporting established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this assessment, management believes that, as of December 31, 2005, the Company maintained effective internal control over financial reporting.

The Company’s internal control over financial reporting includes policies and procedures that (i) pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of the assets of the Company, (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company, and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Projections of any evaluation of effectiveness to future periods are subject to risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

HORNE LLP, the Company’s Independent Registered Public Accounting Firm, has audited management’s assessment of the Company’s internal control over financial reporting as of December 31, 2005, as stated in their report, appearing on pages 2 and 3, which expresses unqualified opinions on management’s assessment and on the effectiveness of the Company’s internal control over financial reporting as of December 31, 2005.

 

/s/ Greg L. McKee

    

/s/ Robert T. Smith

Greg L. McKee      Robert T. Smith
President and Chief Executive Officer      Treasurer and Chief Financial Officer

March 2, 2006

 

4


CITIZENS HOLDING COMPANY AND SUBSIDIARY

Consolidated Balance Sheets

December 31, 2005 and 2004

 

      2005     2004

ASSETS

    

Cash and due from banks

   $ 26,743,200     $ 16,837,433

Interest bearing deposits with other banks

     312,825       818,716

Federal funds sold

     —         11,000,000

Securities available for sale, at fair value (amortized cost of $163,778,332 in 2005 and $151,095,249 in 2004)

     162,203,117       151,716,083

Loans, net of allowance for loan losses of $4,561,817 in 2005 and $4,720,875 in 2004

     374,964,316       364,868,117

Bank premises, furniture, fixtures and equipment, net

     9,894,215       9,772,213

Real estate acquired by foreclosure

     2,975,047       2,786,716

Accrued interest receivable

     4,695,147       4,385,892

Cash value of life insurance

     16,045,673       15,504,829

Intangible assets

     5,290,076       5,827,579

Other assets

     4,585,520       3,721,413
              

Total assets

   $ 607,709,136     $ 587,238,991
              

LIABILITIES AND STOCKHOLDERS’ EQUITY

    

Deposits

    

Non-interest bearing demand deposits

   $ 87,333,891     $ 78,070,820

Interest bearing NOW and money market accounts

     148,434,618       148,617,480

Interest bearing savings deposits

     35,579,157       38,151,914

Interest bearing time deposits

     202,464,568       209,623,530
              

Total deposits

     473,812,234       474,463,744

Federal funds purchased

     1,600,000       —  

Federal Home Loan Bank advances

     60,048,818       46,118,566

Accrued interest payable

     798,667       620,590

Deferred compensation payable

     2,366,592       2,157,041

Other liabilities

     3,950,890       2,221,390
              

Total liabilities

     542,577,201       525,581,331
              

Commitments and contingencies

     —         —  

Minority interest

     1,357,830       1,466,435
              

Stockholders’ equity

    

Common stock, $.20 par value, authorized 22,500,000 shares; 5,009,278 shares issued at 2005 and 5,000,278 at 2004

     1,001,856       1,000,056

Additional paid-in capital

     3,386,248       3,150,246

Accumulated other comprehensive income (loss), net of taxes of ($587,555) in 2005 and $211,084 in 2004

     (966,542 )     399,921

Retained earnings

     60,352,543       55,641,002
              

Total stockholders’ equity

     63,774,105       60,191,225
              

Total liabilities and stockholders’ equity

   $ 607,709,136     $ 587,238,991
              

The accompanying notes are an integral part of these financial statements.

 

5


CITIZENS HOLDING COMPANY AND SUBSIDIARY

Consolidated Statements of Income

Years Ended December 31, 2005, 2004 and 2003

 

     2005     2004     2003  

Interest income

      

Interest and fees on loans

   $ 26,435,191     $ 24,159,391     $ 23,693,234  

Interest on securities

      

Taxable

     3,022,520       2,846,951       3,760,630  

Non-taxable

     3,406,130       2,882,402       2,237,257  

Other

     179,863       82,967       33,814  
                        

Total interest income

     33,043,704       29,971,711       29,724,935  
                        

Interest expense

      

Deposits

     7,431,479       5,772,547       6,605,373  

Other borrowed funds

     2,415,801       1,764,422       1,583,075  
                        

Total interest expense

     9,847,280       7,536,969       8,188,448  
                        

Net interest income

     23,196,424       22,434,742       21,536,487  

Provision for loan losses

     (1,084,326 )     (1,067,443 )     (2,002,570 )
                        

Net interest income after provision for loan losses

     22,112,098       21,367,299       19,533,917  
                        

Non-interest income

      

Service charges on deposit accounts

     3,556,824       3,391,188       3,235,400  

Other service charges and fees

     585,288       670,582       895,375  

Net gains on investment securities sales

     —         7,020       467,210  

Other income

     1,594,811       1,505,841       725,713  
                        

Total non-interest income

     5,736,923       5,574,631       5,323,698  
                        

Non-interest expense

      

Salaries and employee benefits

     9,523,367       8,607,066       7,925,908  

Occupancy expense

     1,163,219       1,199,437       1,177,346  

Equipment expense

     1,739,751       1,738,348       1,567,289  

Earnings applicable to minority interest

     198,872       189,395       167,730  

Other expense

     4,891,696       4,978,710       4,203,714  
                        

Total non-interest expense

     17,516,905       16,712,956       15,041,987  
                        

Income before income taxes

     10,332,116       10,228,974       9,815,628  

Income tax expense

     2,365,984       2,682,889       2,844,699  
                        

Net income

   $ 7,966,132     $ 7,546,085     $ 6,970,929  
                        

Net income per share – basic

   $ 1.59     $ 1.51     $ 1.40  
                        

Net income per share – diluted

   $ 1.57     $ 1.49     $ 1.39  
                        

Average shares outstanding

      

Basic

     5,006,493       4,992,792       4,974,910  
                        

Diluted

     5,066,165       5,056,637       5,019,759  
                        

The accompanying notes are an integral part of these financial statements.

 

6


CITIZENS HOLDING COMPANY AND SUBSIDIARY

Consolidated Statements of Comprehensive Income

Years Ended December 31, 2005, 2004 and 2003

 

     2005     2004     2003  

Net income

   $ 7,966,132     $ 7,546,085     $ 6,970,929  
                        

Other comprehensive income (loss)

      

Unrealized holding gains (losses) during year

     (2,196,048 )     (1,661,064 )     (1,808,269 )

Income tax effect

     798,637       562,385       624,185  
                        

Net unrealized gains (losses)

     (1,397,411 )     (1,098,679 )     (1,184,084 )
                        

Reclassification adjustment for gains included in net income

     —         (7,020 )     (467,210 )

Income tax effect

     —         2,377       161,273  
                        

Net gains included in net income

     —         (4,643 )     (305,937 )
                        

Change in minority interest in net unrealized gains

     30,948       33,205       28,385  
                        

Total other comprehensive loss

     (1,366,463 )     (1,070,117 )     (1,461,636 )
                        

Comprehensive income

   $ 6,599,669     $ 6,475,968     $ 5,509,293  
                        

The accompanying notes are an integral part of these financial statements.

 

7


CITIZENS HOLDING COMPANY AND SUBSIDIARY

Consolidated Statements of Changes in Stockholders’ Equity

Years Ended December 31, 2005, 2004 and 2003

 

    

Number

of Shares
Issued

   Common
Stock
   Additional
Paid-In
Capital
   Accumulated
Other
Comprehensive
Income (Loss)
    Retained
Earnings
    Total  

Balance, December 31, 2002

   4,974,578    $ 994,916    $ 2,899,331    $ 2,931,674     $ 46,956,638     $ 53,782,559  

Net income

   —        —        —        —         6,970,929       6,970,929  

Dividends paid ($0.57 per share)

   —        —        —        —         (2,835,769 )     (2,835,769 )

Options exercised

   5,050      1,010      44,983      —         —         45,993  

Other comprehensive (loss), net

   —        —        —        (1,461,636 )     —         (1,461,636 )
                                           

Balance, December 31, 2003

   4,979,628      995,926      2,944,314      1,470,038       51,091,798       56,502,076  

Net income

   —        —        —        —         7,546,085       7,546,085  

Dividends paid ($0.60 per share)

   —        —        —        —         (2,996,881 )     (2,996,881 )

Options exercised

   20,650      4,130      205,932      —         —         210,062  

Other comprehensive (loss), net

   —        —        —        (1,070,117 )     —         (1,070,117 )
                                           

Balance, December 31, 2004

   5,000,278      1,000,056      3,150,246      399,921       55,641,002       60,191,225  

Net income

   —        —        —        —         7,966,132       7,966,132  

Dividends paid ($0.65 per share)

   —        —        —        —         (3,254,591 )     (3,254,591 )

Options exercised, including tax benefit of $106,192

   9,000      1,800      236,002      —         —         237,802  

Other comprehensive (loss), net

   —        —        —        (1,366,463 )     —         (1,366,463 )
                                           

Balance, December 31, 2005

   5,009,278    $ 1,001,856    $ 3,386,248    $ (966,542 )   $ 60,352,543     $ 63,774,105  
                                           

The accompanying notes are an integral part of these financial statements.

 

8


CITIZENS HOLDING COMPANY AND SUBSIDIARY

Consolidated Statements of Cash Flows

Years Ended December 31, 2005, 2004 and 2003

 

     2005     2004     2003  

Cash flows from operating activities

      

Net income

   $ 7,966,132     $ 7,546,085     $ 6,970,929  

Adjustments to reconcile net income to net cash provided by operating activities

      

Depreciation

     1,024,320       1,056,647       1,020,645  

Amortization of intangibles

     537,503       537,503       537,503  

Amortization of premiums and accretion of discounts on investment securities

     1,182,298       1,387,598       (55,128 )

Provision for loan losses

     1,084,326       1,067,443       2,002,570  

Realized investment securities gains

     —         (7,020 )     (467,210 )

Deferred income tax expense (benefit)

     (310,432 )     11,432       (472,691 )

Net earnings applicable to minority interest

     198,872       189,395       167,730  

Earnings from equity method of investment

     (131,664 )     (188,911 )     (78,389 )

Write downs of real estate acquired by foreclosure

     —         233,610       149,605  

Increase in accrued interest receivable

     (309,255 )     (179,788 )     (94,905 )

Increase in cash value life insurance

     (540,844 )     (624,211 )     (313,618 )

Increase (decrease) in accrued interest payable

     178,077       (47,948 )     (287,182 )

Increase in deferred compensation liability

     209,551       324,830       649,805  

Net change in other operating assets and liabilities

     2,212,319       973,112       (161,766 )
                        

Net cash provided by operating activities

     13,301,203       12,279,777       9,567,898  
                        

Cash flows from investing activities

      

Proceeds from maturities of securities available-for-sale

     37,496,514       38,276,877       62,778,307  

Proceeds from sales of securities available-for-sale

     —         22,515,102       58,103,673  

Purchases of securities available-for-sale

     (51,638,423 )     (72,448,447 )     (103,672,153 )

Purchases of bank premises, furniture, fixtures and equipment

     (1,146,322 )     (829,887 )     (1,619,676 )

Proceeds from sale of real estate acquired by foreclosure

     2,043,687       1,381,344       733,274  

Net (increase) decrease in interest bearing deposits with other banks

     505,891       (720,680 )     1,267,613  

Net increase in loans

     (13,412,543 )     (17,705,207 )     (50,278,536 )

Net (increase) decrease in federal funds sold

     11,000,000       (11,000,000 )     2,300,000  

Cash paid for acquisitions, net

     —         25,398       (114,209 )

Purchase of company owned life insurance

     —         —         (11,404,152 )
                        

Net cash used by investing activities

     (15,151,196 )     (40,505,500 )     (41,905,859 )
                        

 

9


CITIZENS HOLDING COMPANY AND SUBSIDIARY

Consolidated Statements of Cash Flows

Years Ended December 31, 2005, 2004 and 2003

Page 2 of 2

 

     2005     2004     2003  

Cash flows from financing activities

      

Net increase in deposits

   $ (651,511 )   $ 35,766,446     $ 5,929,123  

Net increase (decrease) in federal funds purchased

     1,600,000       (1,500,000 )     1,500,000  

Proceeds from exercise of stock options

     131,610       210,062       45,993  

Dividends paid to stockholders

     (3,254,591 )     (2,996,881 )     (2,835,769 )

Federal Home Loan Bank advance proceeds

     25,000,000       13,500,000       24,000,000  

Federal Home Loan Bank advance payments

     (11,069,748 )     (15,018,281 )     (969,288 )
                        

Net cash provided by financing activities

     11,755,760       29,961,346       27,670,059  
                        

Net increase (decrease) in cash and due from banks

     9,905,767       1,735,623       (4,667,902 )

Cash and due from banks, beginning of year

     16,837,433       15,101,810       19,769,712  
                        

Cash and due from banks, end of year

   $ 26,743,200     $ 16,837,433     $ 15,101,810  
                        

Supplemental disclosures of cash flow information

      

Cash paid for Interest

   $ 9,669,203     $ 7,584,917     $ 8,475,630  
                        

Income taxes

   $ 786,026     $ 2,762,059     $ 2,478,332  
                        

Non-cash disclosures

      

Real estate acquired by foreclosure

   $ 2,232,018     $ 3,706,652     $ 291,488  
                        

Unrealized loss on investments

   $ (2,196,048 )   $ (1,661,064 )   $ (1,808,269 )
                        

The accompanying notes are an integral part of these financial statements.

 

10


CITIZENS HOLDING COMPANY AND SUBSIDIARY

Years Ended December 31, 2005, 2004 and 2003

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 1. Summary of Significant Accounting Policies

Basis of Financial Statement Presentation

The accounting policies of Citizens Holding Company and Subsidiary conform to accounting principles generally accepted in the United States of America and to general practices within the banking industry. The consolidated financial statements of Citizens Holding Company include the accounts of its 97.86 percent-owned subsidiary, The Citizens Bank of Philadelphia, Mississippi (collectively referred to as the “Company”). All significant intercompany transactions have been eliminated in consolidation.

Nature of Business

The Citizens Bank of Philadelphia, Mississippi (the “Bank”) operates under a state bank charter and provides general banking services. As a state bank, the Bank is subject to regulations of the Mississippi Department of Banking and Consumer Finance and the Federal Deposit Insurance Corporation. Citizens Holding Company is subject to the regulations of the Federal Reserve. The area served by the Bank is Neshoba County, Mississippi and the immediately surrounding areas. Services are provided at several branch offices.

Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

Estimates that are particularly susceptible to significant change relate to the determination of the allowance for loan losses and the valuation of real estate acquired in connection with foreclosures or in satisfaction of loans. In connection with the determination of the allowance for loan losses and valuation of foreclosed real estate, management obtains independent appraisals for significant properties.

While management uses available information to recognize losses on loans and foreclosed real estate, future additions to the allowance may be necessary based on changes in local economic conditions. In addition, regulatory agencies, as an integral part of their examination process, periodically review the Company’s allowances for loan losses and foreclosed real estate. Such agencies may require the Company to recognize additions to the allowances based on their judgments about information available to them at the time of their examination. Because of these factors, it is reasonably possible that the allowance for loan losses and valuation of foreclosed real estate may change materially in the near term.

 

11


CITIZENS HOLDING COMPANY AND SUBSIDIARY

Years Ended December 31, 2005, 2004 and 2003

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 1. Continued

Cash and Due from Banks

For the purpose of reporting cash flows, cash and due from banks include cash on hand and demand deposits. Cash flows from loans originated by the Company, deposits, and federal funds purchased and sold are reported net in the statement of cash flows. The Company is required to maintain average reserve balances with the Federal Reserve Bank based on a percentage of deposits. The average reserve required by the Federal Reserve Bank at December 31, 2005 and 2004 was $837,000 and $911,000, respectively.

Interest-bearing deposits in banks mature within one year and are carried at cost.

At December 31, 2005 and 2004, the Company had deposits in financial institutions in excess of federally insured limits. Management monitors the soundness of the financial institutions and believes there is minimal risk.

Investment Securities

In accordance with Statement of Financial Accounting Standards (“SFAS”) No. 115, “Accounting for Certain Investments in Debt and Equity Securities,” securities are classified as “available-for-sale,” “held-to-maturity” or “trading”. Fair values for securities are based on quoted market prices where available. If quoted market prices are not available, fair values are based on quoted market prices of comparable instruments. Gains or losses on the sale of securities are determined using the specific identification method. Currently, the Company has no held-to-maturity or trading securities.

Securities Available-for-Sale

Securities available-for-sale are reported at fair value with unrealized gains and losses reported as a separate component of stockholders’ equity. Securities that are held for indefinite periods of time or used as part of the Company’s asset/liability management strategy and that may be sold in response to interest rate changes, changes in prepayment risk, the need to increase regulatory capital, and other similar factors are classified as available-for-sale.

Realized gains or losses, determined on the basis of the cost of specific securities sold, are included in earnings. The amortization of premiums and accretion of discounts are recognized in interest income.

 

12


CITIZENS HOLDING COMPANY AND SUBSIDIARY

Years Ended December 31, 2005, 2004 and 2003

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 1. Continued

Loans and Allowance for Loan Losses

Loans receivable that management has the intent and ability to hold for the foreseeable future or until maturity or payoff are reported at the principal amount outstanding, net of unearned discounts and unearned finance charges. The Company has no loans held-for-sale.

Loan origination and commitment fees and direct loan origination costs attributable to loans held with a maturity of more than one year are not significant and are, therefore, recognized as income or expense, as applicable in the period received or incurred.

Unearned discounts on installment loans are recognized as income over the terms of the loans by a method that approximates the interest method. Unearned finance charges and interest on commercial loans are recognized based on the principal amount outstanding. For all other loans, interest is accrued daily on the outstanding balances. For impaired loans, interest is discontinued on a loan when management believes, after considering collection efforts and other factors, that the borrower’s financial condition is such that collection of interest is doubtful. Cash collections on impaired loans are credited to the loan receivable balance, and no interest income is recognized on those loans until the principal balance has been collected. The Company generally discontinues the accrual of interest income when a loan becomes 90 days past due as to principal or interest; however, management may elect to continue the accrual when the estimated net realizable value of collateral is sufficient to cover the principal balance and the accrued interest. Interest income on other nonaccrual loans is recognized only to the extent of interest payments. Upon discontinuance of the accrual of interest on a loan, any previously accrued but unpaid interest is reversed against interest income.

A loan is impaired when management determines that it is probable the Company will be unable to collect all contractual principal and interest payments due in accordance with the terms of the loan agreement. Impaired loans are measured based on the present value of expected future cash flows discounted at the loan’s effective interest rate or, as a practical expedient, at the loan’s observable market price or the fair value of the collateral if the loan is collateral dependent. The amount of impairment, if any, and any subsequent changes are included in the allowance for loan losses.

 

13


CITIZENS HOLDING COMPANY AND SUBSIDIARY

Years Ended December 31, 2005, 2004 and 2003

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 1. Continued

The allowance for loan losses is established through a provision for loan losses charged against net income. Loans determined to be uncollectible are charged against the allowance for loan losses, and subsequent recoveries, if any, are credited to the allowance. The allowance represents an amount, which in management’s judgment, will be adequate to absorb estimated probable losses on existing loans that may become uncollectible. Management’s judgment in determining the adequacy of the allowance is based on evaluations of the collectibility of loans and prior loss experience. These evaluations take into consideration such factors as changes in the nature and volume of the loan portfolio, review of specific problem loans, the Company’s past loan loss experience, adverse situations that may affect the borrowers’ ability to pay, the estimated value of any underlying collateral, current economic conditions, and other relevant factors.

The allowance consists of specific, general and unallocated components. The specific component relates to loans that are classified as either doubtful, substandard or special mention as well as loans considered impaired. For such loans that are also classified as impaired, a specific allowance is established when the discounted cash flows (or collateral value or observable market price) of the impaired loan is lower than the carrying value of that loan. The general component covers non-classified loans and is based on historical loss experience adjusted for qualitative and other factors. An unallocated component is maintained to cover uncertainties that could affect management’s estimate of probable losses. The unallocated component of the allowance reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating specific and general losses in the portfolio.

Large groups of small-balance homogenous loans are collectively evaluated for impairment. Accordingly, the Company does not separately identify individual consumer and residential loans for impairment disclosures.

 

14


CITIZENS HOLDING COMPANY AND SUBSIDIARY

Years Ended December 31, 2005, 2004 and 2003

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 1. Continued

Bank Premises, Furniture, Fixtures and Equipment

The Company’s premises, furniture, fixtures and equipment are stated at cost less accumulated depreciation computed primarily by straight-line methods over the estimated useful lives of the assets. Costs of major additions and improvements are capitalized. Expenditures for maintenance and repairs are charged to expense as incurred.

Real Estate Acquired by Foreclosure

Real estate acquired by foreclosure consists of properties repossessed by the Company on foreclosed loans. These assets are stated at the lower of the outstanding loan amount (including accrued interest, if any) or fair value at the date acquired less estimated costs to sell. Losses arising from the acquisition of such property are charged against the allowance for loan losses. Declines in value resulting from subsequent revaluation of the property or losses resulting from disposition of such property are expensed. Revenue and expenses from operations of other real estate owned are reflected as other income (expense).

Cash Value of Life Insurance

The Company has purchased life insurance contracts on certain employees and directors. Certain of such policies were acquired pursuant to “split-dollar” arrangements with employees. During 2004 and 2003, several of these policies were converted to bank owned policies and the remainder of each policy was surrendered for cash. The cash surrender value of the remaining “split-dollar” policies as well as other Company owned policies is carried at the actual cash surrender value of the policy at the balance sheet date.

Intangible Assets

Intangible assets include core deposits purchased and goodwill. Core deposits intangibles are amortized on a straight-line basis over their estimated economic lives ranging from 5 to 10 years. Prior to 2002, goodwill was amortized over 40 years. Goodwill and other intangible assets with indefinite lives are not amortized, but are tested at least annually for impairment. Fair values are determined based on market valuation multiples for the Company and comparable businesses based on the assets and cash flow of the Bank, the Company’s only reportable segment. If impairment has occurred, the goodwill or other intangible asset is reduced to its estimated fair value through a charge to expense.

 

15


CITIZENS HOLDING COMPANY AND SUBSIDIARY

Years Ended December 31, 2005, 2004 and 2003

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 1. Continued

Investment – Insurance Company

The Company accounts for its investment in New South Life Insurance Company (“New South”), a 33 percent owned affiliate, by the equity method of accounting. The Company’s share of the net income of New South is recognized as income in the Company’s income statement and added to the investment account, and dividends received from New South would be treated as a reduction of the investment account. New South has not paid dividends.

The fiscal year of New South ends on November 30, and the Company follows the practice of recognizing the net income of New South on that basis.

The investment in New South, which is included in other assets, totaled $1,898,643 and $1,766,979 at December 31, 2005 and 2004, respectively. Income from the investment for the years ended December 31, 2005, 2004, and 2003 included in other income totaled $131,664, $188,911 and $78,389, respectively.

Trust Assets

Assets held by the Trust Department of the Company in fiduciary or agency capacities are not assets of the Company and are not included in the consolidated financial statements.

Income Taxes

Provisions for income taxes are based on taxes payable or refundable for the current year and deferred taxes on temporary differences between the tax bases of assets and liabilities and their reported amounts in the consolidated financial statements. Deferred tax assets and liabilities are included in the financial statements at currently enacted income tax rates applicable to the period in which the deferred tax assets and liabilities are expected to be realized or settled as described in SFAS No. 109, “Accounting for Income Taxes.” As changes in tax laws or rates are enacted, deferred tax assets and liabilities are adjusted through the provision for income taxes. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or all of the deferred tax assets will not be realized.

 

16


CITIZENS HOLDING COMPANY AND SUBSIDIARY

Years Ended December 31, 2005, 2004 and 2003

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 1. Continued

Comprehensive Income

Comprehensive income includes net earnings reported in the statements of income and changes in unrealized gain (loss) on securities available-for-sale reported as a component of stockholders’ equity. Unrealized gain (loss) on securities available-for-sale, net of related income taxes, is the only component of accumulated other comprehensive income for the Company.

Net Income Per Share

Basic net income per share is computed by dividing net income by the weighted average number of common shares outstanding during the year. Diluted net income per share is based on the weighted average number of shares of common stock outstanding for the periods, including the dilutive effect of the Company’s outstanding stock options. The effect of the dilutive shares for the years 2005, 2004 and 2003 is illustrated in the following table.

 

     2005    2004    2003

Basic weighted average shares outstanding

     5,006,493      4,992,792      4,974,910

Dilutive effect of stock options

     59,672      63,845      44,849
                    

Dilutive weighted average shares outstanding

     5,066,165      5,056,637      5,019,759
                    

Net income

   $ 7,966,132    $ 7,546,085    $ 6,970,929
                    

Net income per share-basic

   $ 1.59    $ 1.51    $ 1.40

Net income per share-diluted

   $ 1.57    $ 1.49    $ 1.39

Stock Based Compensation

Stock option grants are accounted for in accordance with Accounting Principles Board (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees.” Accordingly, no compensation expense is recognized for stock options granted if the option price is not less than the fair market value of the underlying stock at the grant date. For each of the years ended December 31, 2005, 2004 and 2003, no stock based compensation expense was included in the determination of net income as all options granted during the years had an exercise price equal to the market value of the stock on the date of grant.

 

17


CITIZENS HOLDING COMPANY AND SUBSIDIARY

Years Ended December 31, 2005, 2004 and 2003

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 1. Continued

Had compensation expense been determined on the basis of fair value pursuant to SFAS No. 123, “Accounting for Stock-Based Compensation,” net income and earnings per share would have been reduced as follows:

 

     2005     2004     2003  

Net income

      

As reported

   $ 7,966,132     $ 7,546,085     $ 6,970,929  

Stock based employee compensation expense included in reported net income

     —         —         —    

Less stock based compensation expense determined under fair value method for all stock options, net of related income tax benefit

     (55,340 )     (201,610 )     (143,654 )
                        

Pro forma net income

   $ 7,910,792     $ 7,344,475     $ 6,827,275  
                        
     2005     2004     2003  

Basic earnings per share

      

As reported

   $ 1.59     $ 1.51     $ 1.40  

Pro forma

   $ 1.58     $ 1.47     $ 1.37  

Diluted earnings per share

      

As reported

   $ 1.57     $ 1.49     $ 1.39  

Pro forma

   $ 1.56     $ 1.45     $ 1.36  

The fair value of each option is estimated on the grant date using the Black-Scholes option pricing model. The following weighted average assumptions were made in estimating fair values in 2005, 2004 and 2003:

 

Assumption

   2005     2004     2003  

Dividend yield

   3.0 %   3.0 %   1.5 %

Risk-free interest rate

   4.0 %   4.0 %   4.0 %

Expected life

   7 years     7 years     7 years  

Expected volatility

   5.36 %   20.40 %   15.00 %

 

18


CITIZENS HOLDING COMPANY AND SUBSIDIARY

Years Ended December 31, 2005, 2004 and 2003

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 1. Continued

Advertising Costs

Advertising costs are charged to expense when incurred. Advertising expense was $495,579, $440,538 and $379,319 for the years ended December 31, 2005, 2004 and 2003, respectively.

Fair Value of Financial Instruments

SFAS No. 107, “Disclosures about Fair Value of Financial Instruments,” requires disclosure of financial instruments’ fair values, as well as the methodology and significant assumptions used in estimating fair values. These requirements have been incorporated in Note 15. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. In that regard, the derived fair value estimates cannot be substantiated by comparison to independent markets and, in many cases, could not be realized in immediate settlement of the instrument. SFAS No. 107 excludes certain financial instruments from its disclosure requirements. Accordingly, the aggregate fair value amounts presented do not represent the underlying value of the Company and may not be indicative of amounts that might ultimately be realized upon disposition or settlement of those assets and liabilities.

Recent Accounting Pronouncements

In December 2004, the Financial Accounting Standards Board issued SFAS No. 123(R), “Share Based Payment,” or SFAS No. 123(R). SFAS No. 123(R) is effective for public companies at the beginning of the first interim or annual period after December 15, 2005. This statement prohibits the use of the intrinsic value-based method under APB Opinion No. 25, “Accounting for Stock Issued to Employees,” in accounting for share-based compensation. SFAS No. 123(R) requires the Company to calculate equity-based compensation expense for stock options and employee stock purchase plan rights granted to employees based on the fair value of the equity instrument at the time of grant. Currently, the Company discloses the pro forma net income (loss) and the related pro forma income (loss) per share information in accordance with SFAS No. 123 and SFAS No. 148, “Accounting for Stock-Based Compensation Costs-Transition and Disclosure.” The Company will record compensation expense for stock options granted to employees after January 1, 2006 as all outstanding options of the Company at December 31, 2005 are fully vested. SFAS No. 123(R) is not expected to have a material impact on the Company’s results of operations or financial condition. Additionally, on March 29, 2005, the Securities and Exchange Commission (the “SEC”) issued Staff Accounting Bulletin (“SAB”) No. 107, “Share-Based Payment”. SAB No. 107 provides companies implementation guidance for the adoption of SFAS No. 123(R), including valuation methodologies to determine the fair value of stock based grants.

 

19


CITIZENS HOLDING COMPANY AND SUBSIDIARY

Years Ended December 31, 2005, 2004 and 2003

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 1. Continued

FASB Staff Position No. FAS 115-1 and FAS 124-1, “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments” the (“FSP”), was issued in November 2005 and addresses the determination of when an investment is considered impaired; whether the impairment is other than temporary; and to measure an impairment loss. The FSP also addresses accounting considerations subsequent to the recognition of an other-than-temporary impairment on a debt security, and requires certain disclosures about unrealized losses that have not been recognized as other-than-temporary impairments. The FSP replaces the impairment guidance in Emerging Issues Task Force Issue No. 03-1 with references to existing authoritative literature concerning other-than-temporary determinations (principally SFAS No. 115 and SEC Staff Accounting Bulletin 59). Under the FSP, impairment losses must be recognized in earnings in an amount equal to the entire difference between the security’s cost and its fair value at the financial statement date, without considering partial recoveries subsequent to that date. The FSP also requires that an investor recognize an other-than-temporary impairment loss when a decision to sell a security has been made and the investor does not expect the fair value of the security to fully recover prior to the expected time of sale. The FSP is effective for reporting periods beginning after December 15, 2005. The Company does not expect that the adoption of the FSP will have a material impact on its financial condition, results of operations or financial statement disclosures.

In May 2005, the FASB issued SFAS No. 154, “Accounting Changes and Error Corrections,” or SFAS No. 154, which replaces APB Opinion No. 20, “Accounting Changes” or APB No. 20, and SFAS No. 3, “Reporting Account Changes in Interim Financial Statements,” and changes the requirements for the accounting for and reporting of a change in accounting principle. SFAS No. 154 applies to all voluntary changes in accounting principle and to changes required by an accounting pronouncement when the pronouncement does not include specific transition provisions. SFAS No. 154 requires retrospective application of changes in accounting principle to prior periods’ financial statements unless it is impracticable to determine either the period-specific effects or the cumulative effect of the change. APB No. 20 previously required that most voluntary changes in accounting principles be recognized by including the cumulative effect of the change in net income for the period of the change in accounting principle. SFAS No. 154 carries forward without change the guidance contained in APB No. 20 for reporting the correction of an error in previously issued financial statements and a change in accounting estimate. SFAS No. 154 also carries forward the guidance in APB No. 20 requiring justification of a change in accounting principle on the basis of preferability. SFAS No. 154 is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005, with early adoption permitted. The adoption of this statement is not expected to have an impact on the Company’s financial conditions or results of operations.

 

20


CITIZENS HOLDING COMPANY AND SUBSIDIARY

Years Ended December 31, 2005, 2004 and 2003

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 1. Continued

In December 2003, the Accounting Standards Executive Committee issued Statement of Position (“SOP”) 03-3, “Accounting for Certain Loans or Debt Securities Acquired in a Transfer.” The SOP is effective for loans acquired in fiscal years beginning after December 15, 2004. The SOP addresses accounting for differences between contractual cash flows and cash flows expected to be collected from an investor’s initial investment in loans or debt securities (loans) acquired in a transfer if those differences are attributable, at least in part, to credit quality. The SOP applies to loans acquired in business combinations but does not apply to loans originated by the Company. Management does not believe the provisions of this standard will have a material impact on the Company’s results of operations or financial condition.

On March 9, 2004, the SEC issued Staff Accounting Bulletin (“SAB”) No. 105, Application of Accounting Principles to Loan Commitments. SAB No. 105 requires that when a company is recognizing and valuing a loan commitment at fair value, only differences between the guaranteed interest rate in the loan commitment and a market interest rate should be included. Any expected future cash flows related to the customer relationships or loan servicing should be excluded from the fair value measurement. The expected future cash flows that are excluded from the fair-value determination include anticipated fees for servicing the funded loan, late-payment charges, other ancillary fees, or other cash flows form the servicing rights. The guidance in SAB No. 105 is effective for mortgage-loan commitments that are accounted for as derivatives and are entered into after March 31, 2004. The adoption of the provisions of this standard did not have any impact on the Company’s results of operations or financial condition.

Reclassifications

Certain information for 2004 and 2003 have been reclassified to conform to the financial presentation for 2005. Such reclassifications are not considered material and had no effect on net income or stockholders’ equity.

 

21


CITIZENS HOLDING COMPANY AND SUBSIDIARY

Years Ended December 31, 2005, 2004 and 2003

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 2. Intangible Assets

In 2002, the Company acquired CB&T Capital Corporation, a one-bank holding company, whose wholly-owned subsidiary was Citizens Bank & Trust Company in Louisville, Mississippi. In addition to the intangible assets related to the purchase of CB&T Capital Corporation, the Company recorded intangible assets from the purchase of branches located in Kosciusko, Scooba, Forest and Decatur, Mississippi along with the purchase of Three D Mortgage Company. The following table details the goodwill associated with each purchase which is no longer being amortized.

 

Purchase

   Total    Life to Date
Amortization
   Unamortized

Kosciusko Branch

   $ 605,122    $ 309,285    $ 295,837

Scooba Branch

     400,000      180,000      220,000

Three D Mortgage Company

     76,408      10,188      66,220

CB&T Capital Corporation

     2,567,600      —        2,567,600
                    

Total goodwill

   $ 3,649,130    $ 499,473    $ 3,149,657
                    

The Company has also allocated intangible assets to be recognized as core deposit intangibles on the acquisition of the Forest and Decatur branches and the CB&T Capital Corporation acquisition. These transactions are detailed in the following table.

 

Purchase

   Total    Current
Amortization
Per Year
   Life to Date
Amortization
   Unamortized

Decatur and Forest branches

   $ 2,487,574    $ 352,812    $ 1,532,255    $ 955,319

CB&T Capital Corporation

     1,846,909      184,691      661,809      1,185,100
                           

Total core deposit intangible

   $ 4,334,483    $ 537,503    $ 2,194,064    $ 2,140,419
                           

Total amortization expense related to all intangible assets for the years ended December 31, 2005, 2004 and 2003 was $537,503, $537,503 and $537,503, respectively. Estimated amortization expense attributable to core deposit intangible assets for the next five years is detailed in the table below.

 

Year Ending December 31,

   Amount

2006

   $ 537,503

2007

     537,503

2008

     434,386

2009

     184,691

2010

     184,691

 

22


CITIZENS HOLDING COMPANY AND SUBSIDIARY

Years Ended December 31, 2005, 2004 and 2003

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 3. Investment Securities

The amortized cost and fair value of investment securities at December 31, 2005 is as follows:

 

    

Amortized

Cost

   Gross
Unrealized
Gains
   Gross
Unrealized
Losses
   Fair Value

Securities available-for-sale Obligations of U.S.

           

Government agencies

   $ 12,200,149    $ 27,462    $ 255,547    $ 11,972,064

U.S. Treasuries

     2,000,836      1,664      —        2,002,500

Mortgage-backed securities

     58,096,368      122,317      948,220      57,270,465

Other investments

     91,480,979      1,054,497      1,577,388      90,958,088
                           

Total

   $ 163,778,332    $ 1,205,940    $ 2,781,155    $ 162,203,117
                           

The following table shows the gross unrealized losses and fair value of the Company’s investments with unrealized losses that are not deemed to be other-than-temporarily impaired (in thousands), aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, at December 31, 2005.

 

     Less than 12 months    12 months or more    Total

Description of Securities

   Fair
Value
   Unrealized
Losses
   Fair
Value
   Unrealized
Losses
  

Fair

Value

   Unrealized
Losses

Obligations of U. S. Government agencies

   $ 10,806    $ 256    $ —      $ —      $ 10,806    $ 256

U. S. Treasuries

     —        —        —        —        —        —  

Mortgage-backed securities

     25,877      507      25,420      441      51,297      948

Other investments

     24,260      822      20,499      755      44,759      1,577
                                         

Total

   $ 60,943    $ 1,585    $ 45,919    $ 1,196    $ 106,862    $ 2,781
                                         

Mortgage-backed Securities. The unrealized losses on the Company’s investment in mortgage-backed securities were caused by interest rate increases. The contractual cash flows of these investments are guaranteed either by the full faith and credit of the United States or by an agency of the United States Government and it is not expected that the securities would be settled at a price less than the amortized cost of the Company’s investment. Because the decline in fair value is attributable to changes in interest rates and not credit quality and because the Company

 

23


CITIZENS HOLDING COMPANY AND SUBSIDIARY

Years Ended December 31, 2005, 2004 and 2003

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 3. Continued

has the ability and intent to hold these investments until a recovery of fair value, which may be maturity, the Company does not consider these investments to be other-than-temporarily impaired at December 31, 2005.

Other investments. The Company’s unrealized loss on other investments relates to state, county and municipal bonds that have seen a decline in value due to changes in interest rates. It is not expected that these securities would be settled at a price less than amortized cost of the Company’s investment. Because the decline in fair value is attributable to changes in interest rates and not credit quality and because the Company has the ability and intent to hold these investments until a recovery of fair value, which may be maturity, the Company does not consider these investments to be other-than-temporarily impaired at December 31, 2005.

The amortized cost and fair value of investment securities at December 31, 2004 is as follows:

 

    

Amortized

Cost

   Gross
Unrealized
Gains
   Gross
Unrealized
Losses
   Fair Value

Securities available-for-sale Obligations of U.S.

           

Government agencies

   $ 17,981,545    $ 120,640    $ —      $ 18,102,185

U.S. Treasuries

     4,031,294      71,826      —        4,103,120

Mortgage-backed securities

     49,420,029      299,317      315,176      49,404,170

Other investments

     79,662,381      1,345,248      901,021      80,106,608
                           

Total

   $ 151,095,249    $ 1,837,031    $ 1,216,197    $ 151,716,083
                           

The following table shows the gross unrealized losses and fair value of the Company’s investments with unrealized losses that are not deemed to be other-than-temporarily impaired (in thousands), aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, at December 31, 2004.

 

24


CITIZENS HOLDING COMPANY AND SUBSIDIARY

Years Ended December 31, 2005, 2004 and 2003

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 3. Continued

 

     Less than 12 months    12 months or more    Total

Description of Securities

   Fair
Value
   Unrealized
Losses
   Fair
Value
   Unrealized
Losses
   Fair
Value
   Unrealized
Losses

Obligations of U. S. Government Agencies

   $ —      $ —      $ —      $ —      $ —      $ —  

U. S. Treasuries

     —        —        —        —        —        —  

Mortgage-backed securities

     36,000      315      —        —        36,000      315

Other Investments

     33,680      850      661      51      34,341      901
                                         

Total

   $ 69,680    $ 1,165    $ 661    $ 51    $ 70,341    $ 1,216
                                         

The Company, as a member of the Federal Home Loan Bank of Dallas (“FHLB”) system, owns stock in such organization. No ready market exists for the stock, and it has no quoted market value. The Company’s investment in the FHLB is carried at cost of $3,497,400 and $3,227,300 at December 31, 2005 and 2004, respectively, and is included in other investments.

The amortized cost and estimated fair value of securities at December 31, 2005, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.

 

    

Amortized

Cost

   Fair Value

Securities available-for-sale

     

Due in one year or less

   $ 7,258,741    $ 7,261,706

Due after one year through five years

     8,915,058      8,958,974

Due after five years through ten years

     20,149,428      20,318,487

Due after ten years

     127,455,105      125,663,950
             

Total

   $ 163,778,332    $ 162,203,117
             

 

25


CITIZENS HOLDING COMPANY AND SUBSIDIARY

Years Ended December 31, 2005, 2004 and 2003

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 3. Continued

Investment securities with carrying values of $98,540,046 and $74,620,615 at December 31, 2005 and 2004, respectively, were pledged as collateral for public deposits.

Gross realized gains and losses are included in other income. Total gross realized gains and gross realized losses from the sale of investment securities for each of the years ended December 31 were:

 

     2005    2004     2003  

Gross realized gains

   $ —      $ 10,141     $ 780,705  

Gross realized losses

     —        (3,121 )     (313,495 )
                       
   $ —      $ 7,020     $ 467,210  
                       

Note 4. Loans

The composition of net loans at December 31, 2005 and 2004 is as follows:

 

     2005     2004  
     (In Thousands)  

Commercial, financial and agricultural loans

   $ 213,444     $ 201,424  

Real estate – construction loans

     8,779       10,706  

Real estate – mortgage loans

     90,952       92,503  

Consumer loans

     67,712       66,666  
                
     380,887       371,299  

Unearned discount

     (1,361 )     (1,710 )

Allowance for loan losses

     (4,562 )     (4,721 )
                

Loans, net

   $ 374,964     $ 364,868  
                

Loans are made principally to customers in the Company’s trade area. The Company’s lending policy provides that loans collateralized by real estate are normally made with loan-to-loan value ratios of 80 percent or less. Commercial loans are typically collateralized by property, equipment, inventories and/or receivables with loan-to-value ratios from 50 percent to 80 percent. Real estate mortgage loans are collateralized by personal residences with loan-to-value ratios of 80 percent or less. Consumer loans are typically collateralized by real estate, vehicles and other consumer durable goods. Approximately $87,198,406 and $87,127,000 of the loans outstanding at December 31, 2005 and 2004, respectively, were variable rate loans.

 

26


CITIZENS HOLDING COMPANY AND SUBSIDIARY

Years Ended December 31, 2005, 2004 and 2003

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 4. Continued

Changes in the allowance for loan losses at December 31, 2005, 2004 and 2003 are as follows:

 

     2005     2004     2003  

Balance, beginning

   $ 4,720,875     $ 5,126,735     $ 4,222,341  

Provision for loan losses

     1,084,326       1,067,443       2,002,570  

Loans charged off

     (1,567,186 )     (1,799,687 )     (1,399,947 )

Recoveries of loans previously charged off

     323,802       326,384       301,771  
                        

Balance, end of year

   $ 4,561,817     $ 4,720,875     $ 5,126,735  
                        

Loans on nonaccrual (impaired) status were $4,346,512, $3,146,041 and $1,502,971 at December 31, 2005, 2004 and 2003, respectively. Allowance for loan losses attributable to the entire balance of nonaccrual (impaired) loans totaled $883,041 and $1,451,357 at December 31, 2005 and 2004, respectively. Interest income forgone on loans classified as nonaccrual (impaired) during the years ended December 31, 2005, 2004 and 2003 was $348,804, $229,286 and $169,135, respectively.

Note 5. Bank Premises, Furniture, Fixtures and Equipment

Bank premises, furniture, fixtures and equipment consist of the following at December 31, 2005 and 2004:

 

     2005    2004

Land and buildings

   $ 11,357,801    $ 10,545,802

Furniture, fixtures and equipment

     8,901,348      8,626,549
             
     20,259,149      19,172,351

Less accumulated depreciation

     10,364,934      9,400,138
             

Total

   $ 9,894,215    $ 9,772,213
             

Depreciation expense for the years ended December 31, 2005, 2004 and 2003 was $1,024,320, $1,056,647 and $1,020,645, respectively.

 

27


CITIZENS HOLDING COMPANY AND SUBSIDIARY

Years Ended December 31, 2005, 2004 and 2003

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 6. Deposits

The composition of deposits is as follows:

 

     2005    2004

Non-interest bearing

   $ 87,333,891    $ 78,070,820

NOW and money market accounts

     148,434,618      148,617,480

Savings deposits

     35,579,157      38,151,914

Time certificates, $100,000 or more

     79,393,146      82,016,625

Other time certificates

     123,071,422      127,606,905
             

Total

   $ 473,812,234    $ 474,463,744
             

The scheduled maturities of certificates of deposit at December 31, 2005 are as follows:

 

Year Ending December 31,

   Amount

2006

   $ 157,037,228

2007

     36,987,203

2008

     8,080,136

2009

     165,258

2010

     194,743
      
   $ 202,464,568
      

Interest expense for certificates of deposit over $100,000 was approximately $2,074,000, $1,691,000 and $1,997,000 for the years ended December 31, 2005, 2004 and 2003, respectively.

 

28


CITIZENS HOLDING COMPANY AND SUBSIDIARY

Years Ended December 31, 2005, 2004 and 2003

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 7. Federal Home Loan Bank Advances

Pursuant to collateral agreements with the FHLB, advances are collateralized by all the Company’s stock, FHLB securities ($3,497,400 included in securities available-for-sale at December 31, 2005) and qualifying first mortgage and other loans. As of December 31, 2005, the balance in qualifying first mortgage loans was $88,653,972. At December 31, 2005, advances from the FHLB, along with their rate and maturity date, consist of the following:

 

Advance Amount at December 31,   

Interest

Rate

  

Final Maturity

2005      2004      
$ 10,000,000      $ 10,000,000    3.76    May 24, 2006
  648,818        1,718,566    4.94    July 3, 2006
  5,000,000        5,000,000    5.46    February 26, 2008
  5,000,000        5,000,000    5.66    April 28, 2008
  15,000,000        —      4.50    June 23, 2008
  3,000,000        3,000,000    5.24    April 20, 2009
  2,000,000        2,000,000    5.29    April 20, 2009
  2,000,000        2,000,000    4.47    September 7, 2010
  2,000,000        2,000,000    4.88    August 22, 2011
  1,000,000        1,000,000    4.76    August 29, 2011
  900,000        900,000    4.43    September 19, 2011
  10,000,000        10,000,000    3.66    June 17, 2013
  3,500,000        3,500,000    4.67    December 16, 2014
                  
$ 60,048,818      $ 46,118,566      
                  

The scheduled payments for the next five years are as follows:

 

Year Due

   Payment

2006

   $ 10,648,818

2007

     —  

2008

     25,000,000

2009

     5,000,000

2010

     2,000,000

Thereafter

     17,400,000
      
   $ 60,048,818
      

 

29


CITIZENS HOLDING COMPANY AND SUBSIDIARY

Years Ended December 31, 2005, 2004 and 2003

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 8. Other Income and Other Expense

The following is a detail of the major income classifications that are included in Other Income under Non-Interest income on the income statement.

 

Other Income

   2005    2004    2003

BOLI Insurance

   $ 485,890    $ 410,436    $ —  

Mortgage Loan Origination Fees

     380,049      328,295      324,791

Other Income

     728,872      767,110      400,922
                    

Total Other Income

   $ 1,594,811    $ 1,505,841    $ 725,713
                    

The following is a detail of the major expense classifications that make up the Other Expense line item in the income statement.

 

Other Expense

   2005    2004    2003

Intangible Amortization

   $ 537,503    $ 537,503    $ 537,503

Advertising

     495,579      440,538      379,319

Office Supplies

     559,442      535,628      581,673

Legal and Audit Fees

     404,183      454,131      231,675

Telephone Expense

     398,435      394,270      343,165

Other Expenses

     2,496,554      2,616,640      2,130,379
                    

Total Other Expense

   $ 4,891,696    $ 4,978,710    $ 4,203,714
                    

Note 9. Income Taxes

The consolidated provision for income taxes consists of the following:

 

     2005     2004    2003  

Currently payable

       

Federal

   $ 2,250,896     $ 2,297,257    $ 2,939,498  

State

     425,520       374,200      377,892  
                       
     2,676,416       2,671,457      3,317,390  

Deferred tax expense (benefit)

     (310,432 )     11,432      (472,691 )
                       

Income tax expense

   $ 2,365,984     $ 2,682,889    $ 2,844,699  
                       

 

30


CITIZENS HOLDING COMPANY AND SUBSIDIARY

Years Ended December 31, 2005, 2004 and 2003

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 9. Continued

The differences between income taxes calculated at the federal statutory rate and income tax expense were as follows:

 

     2005     2004     2003  

Federal taxes based on statutory rate

   $ 3,512,919     $ 3,477,851     $ 3,337,314  

State income taxes, net of federal benefit

     280,843       246,972       249,409  

Tax-exempt investment interest

     (1,067,853 )     (922,520 )     (714,510 )

Other, net

     (359,925 )     (119,414 )     (27,514 )
                        

Income tax expense

   $ 2,365,984     $ 2,682,889     $ 2,844,699  
                        

At December 31, 2005 and 2004, net deferred tax assets consist of the following:

 

     2005    2004

Deferred tax assets

     

Allowance for loan losses

   $ 1,511,038    $ 1,427,477

Deferred compensation liability

     882,739      804,577

Unrealized loss on available-for-sale securities

     587,555      —  

Other

     86,123      102,271
             

Total

     3,067,455      2,334,325

Deferred tax liabilities

     

Unrealized gain on available-for-sale securities

     —        211,084

Premises and equipment

     553,955      650,656

Intangible assets

     151,712      280,238

Other

     400,354      339,984
             

Total

     1,106,021      1,478,242
             

Net deferred tax asset

   $ 1,961,434    $ 852,363
             

The net deferred tax asset of $1,961,434 and $852,363 at December 31, 2005 and 2004, respectively, is included in other assets. The Company has evaluated the need for a valuation allowance related to the above deferred tax assets and, based on the weight of the available evidence, has determined that it is more likely than not that all deferred tax assets will be realized.

 

31


CITIZENS HOLDING COMPANY AND SUBSIDIARY

Years Ended December 31, 2005, 2004 and 2003

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 10. Summarized Financial Information of Citizens Holding Company

Summarized financial information of Citizens Holding Company, parent company only, at December 31, 2005 and 2004, and for the years ended December 31, 2005, 2004 and 2003, is as follows:

Balance Sheets

December 31, 2005 and 2004

 

     2005    2004

Assets

     

Cash (a)

   $ 1,514,327    $ 1,110,270

Securities available-for-sale, at fair value

     —        510,940

Investment in bank subsidiary (a)

     62,144,841      58,584,644

Other assets (a)

     117,338      25,091
             

Total assets

   $ 63,776,506    $ 60,230,945
             

Liabilities

     

Other liabilities

   $ 2,401    $ 39,720

Stockholders’ equity

     63,774,105      60,191,225
             

Total liabilities and stockholders’ equity

   $ 63,776,506    $ 60,230,945
             

(a) Eliminates in consolidation.

 

32


CITIZENS HOLDING COMPANY AND SUBSIDIARY

Years Ended December 31, 2005, 2004 and 2003

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 10. Continued

Income Statements

Years Ended December 31, 2005, 2004 and 2003

 

     2005     2004     2003  

Interest income

   $ 30,359     $ 38,994     $ 38,706  
                        

Other income

      

Other

     —         —         14,426  

Dividends from bank subsidiary (a)

     3,265,783       3,017,969       2,918,280  

Equity in undistributed earnings of bank subsidiary (a)

     4,717,327       4,540,676       4,066,482  
                        

Total other income

     7,983,110       7,558,645       6,999,188  
                        

Other expense

     58,468       60,605       76,771  
                        

Income before income taxes

     7,955,001       7,537,034       6,961,123  

Income tax expense (benefit)

     (11,131 )     (9,051 )     (9,806 )
                        

Net income

   $ 7,966,132     $ 7,546,085     $ 6,970,929  
                        

Statements of Cash Flows

Years Ended December 31, 2005, 2004 and 2003

 

     2005     2004     2003  

Cash flows from operating activities

      

Net income

   $ 7,966,132     $ 7,546,085     $ 6,970,929  

Adjustments to reconcile net income to net cash provided by operating activities

      

Equity in undistributed earnings of Bank

     (4,717,327 )     (4,540,676 )     (4,066,482 )

(Increase) decrease in other assets

     13,961       (9,051 )     —    

Increase (decrease) in other liabilities

     (36,603 )     (10,075 )     851  
                        

Net cash provided by operating activities

     3,226,163       2,986,283       2,905,298  
                        

Cash flows from investing activities

      

Other

     300,890       4,259       (115,378 )
                        

Net cash provided by (used by) investing activities

     300,890       4,259       (115,378 )
                        

 

33


CITIZENS HOLDING COMPANY AND SUBSIDIARY

Years Ended December 31, 2005, 2004 and 2003

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 10. Continued

 

     2005     2004     2003  

Cash flows from financing activities

      

Dividends paid to stockholders

   $ (3,254,591 )   $ (2,996,881 )   $ (2,835,769 )

Proceeds from exercise of stock options

     131,595       210,062       45,993  
                        

Net cash used by financing activities

     (3,122,996 )     (2,786,819 )     (2,789,776 )
                        

Net increase in cash

     404,057       203,723       144  
                        

Cash, beginning of year

     1,110,270       906,547       906,403  
                        

Cash, end of year

   $ 1,514,327     $ 1,110,270     $ 906,547  
                        

The Bank is required to obtain approval from state regulators before paying dividends. The Bank paid dividends of $3,265,783, $3,017,969 and $2,918,280 to the Citizens Holding Company during the years ended December 31, 2005, 2004 and 2003, respectively.

Note 11. Related Party Transactions

The Company has had, and may be expected to have in the future, banking transactions in the ordinary course of business with directors, significant stockholders, principal officers, their immediate families, and affiliated companies in which they are principal stockholders (commonly referred to as related parties). In management’s opinion, such loans are made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with unrelated parties, and do not involve more than the normal risk of collectibility at the time of the transaction.

The balance of loans made to related parties at December 31, 2005 and 2004 was $355,698 and $1,133,660, respectively. Advances to related parties during the year ended December 31, 2005 totaled $2,342,859. Payments received from related parties during the year ended December 31, 2005 totaled $2,562,619.

Deposits from related parties at December 31, 2005 and 2004 approximated $2,469,000 and $3,026,000, respectively.

 

34


CITIZENS HOLDING COMPANY AND SUBSIDIARY

Years Ended December 31, 2005, 2004 and 2003

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 12. Off-Balance Sheet Financial Instruments, Commitments and Contingencies and Concentrations of Risks

Commitments to Extend Credit

In the ordinary course of business, the Company makes various commitments and incurs certain contingent liabilities to fulfill the financing needs of its customers. These commitments and contingent liabilities include commitments to extend credit and issue standby letters of credit. They involve, to varying degrees, elements of credit risk in excess of the amount recognized in the balance sheets. The Company’s exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit and standby letters of credit is represented by the contractual amount of those instruments. At December 31, 2005 and 2004, commitments related to unused lines of credit were $21,477,893 and $19,832,752 and standby letters of credit were $1,261,236 and $4,250,996, respectively. The fair value of such commitments is not material. As some of these commitments are expected to expire without being drawn upon, the total commitment amount does not necessarily represent future cash requirements. The Company applies the same credit policies and standards as it does in the lending process when making these commitments. The collateral obtained is based upon the assessed credit worthiness of the borrower. Collateral held varies, but may include accounts receivable, crops, livestock, inventory, property and equipment, residential real estate and income-producing commercial properties.

Interest Rate Risk

The Company is principally engaged in providing short-term and medium-term installment, commercial and agricultural loans with interest rates that are fixed or fluctuate with the prime lending rate. These assets are primarily funded through short-term demand deposits and long-term certificates of deposit with variable and fixed rates. Accordingly, the Company is exposed to interest rate risk because, in changing interest rate environments, interest rate adjustments on assets and liabilities may not occur at the same time or in the same amount. The Company manages the overall rate sensitivity and mix of its asset and liability portfolio and attempts to minimize the effects that interest rate fluctuations will have on its net interest margin.

Legal Proceedings

The Company is party to lawsuits and other claims that arise in the ordinary course of business. The lawsuits assert claims related to the general business activities of the Company. The cases are being vigorously contested. In the regular course of business, management evaluates estimated losses or costs related to litigation, and provision is made for anticipated losses whenever management believes that such losses are probable and can be reasonably estimated. While management believes that the final resolution of pending legal proceedings will not have a material impact on the Company’s financial position or results of operations, the final resolution of such proceedings could have such a material adverse effect.

 

35


CITIZENS HOLDING COMPANY AND SUBSIDIARY

Years Ended December 31, 2005, 2004 and 2003

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 12. Continued

Concentration of Risk

The Company makes agricultural, agribusiness, commercial, residential and consumer loans primarily in the eastern region of Mississippi. A substantial portion of the Company’s customers’ abilities to honor their contracts is dependent on the business and agricultural economy in that area.

Although the Company’s loan portfolio is diversified, there is a relationship in this region between the agricultural economy and the economic performance of loans made to nonagricultural customers. The Company’s lending policies for agricultural and nonagricultural customers require loans to be well-collateralized and supported by cash flows. Collateral for agricultural loans includes equipment, crops, livestock, and land. Credit losses from loans related to the agricultural economy are consistent with credit losses experienced in the portfolio as a whole. The concentration of credit in the regional agricultural economy is taken into consideration by management in determining the allowance for loan losses.

See Note 4 for a summary of loans by type.

The nature of the Company’s business requires that it maintain amounts due from banks, which at times may exceed federally insured limits. The Company has not experienced any losses in such accounts.

Note 13. Lease Commitment and Total Rental Expense

The Company has operating leases under noncancellable operating lease agreements for banking facilities and equipment. Future minimum rental payments due under the leases are as follows:

 

Years Ending December 31,

   Amounts

2006

   $ 84,048

2007

     80,335

2008

     60,534

2009

     58,531

2010

     58,531
      
   $ 341,979
      

The total rental expense included in the income statements for the years ended December 31, 2005, 2004 and 2003 is $63,398, $58,847, and $59,330, respectively.

 

36


CITIZENS HOLDING COMPANY AND SUBSIDIARY

Years Ended December 31, 2005, 2004 and 2003

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 14. Benefit Plans

The Company provides its employees with a profit sharing and savings plan, which allows employees to direct a percentage of their compensation into a tax deferred retirement account, subject to statutory limitations. To encourage participation, the Company provides a 100 percent matching contribution for up to 6 percent of each participant’s compensation, plus discretionary non-matching contributions. Employees are eligible after one year of service. For 2005, 2004 and 2003, the Company’s contributions were $516,555, $448,334 and $407,577, respectively.

Deferred Compensation Plans

The Company provides a deferred compensation plan covering its directors. Participants in the deferred compensation plan can defer a portion of their compensation for payment after attaining age 70. Life insurance contracts have been purchased which may be used to fund payments under the plan. Net expenses related to this plan were $144,158, $131,120 and $137,364 for the plan years ended December 31, 2005, 2004 and 2003, respectively.

The Company has also entered into deferred compensation arrangements with certain officers that provide for payments to such officers or their survivors after retirement. Life insurance policies have been purchased which may be used to fund payments under these arrangements. The obligations of the Company under both the directors and officers deferred compensation arrangements are on a systematic basis over the remaining expected service period of the individual directors and officers.

During 2004 and 2003, the Company surrendered certain life insurance policies that were acquired pursuant to “split-dollar” arrangements with employees and settled the Company’s obligations to such employees under such arrangements. The impact of such transactions on the Company’s financial statements was not significant.

Also during 2003, one of the Company’s directors died and the Company received life insurance proceeds of approximately $600,000 in excess of the carrying amount of the related policy. In addition, as a result of the death, the Company’s liability for amounts due under the deferred compensation agreement increased by approximately the same amount. Accordingly, the Company did not realize a significant gain or loss. The Company did, however, realize an income tax benefit as the proceeds received from the life insurance policy was not subject to income taxes.

Note 15. Regulatory Matters

The Company (on a consolidated basis) and the Bank are subject to various regulatory capital requirements administered by federal banking agencies. Failure to meet the minimum regulatory capital requirements can initiate certain mandatory, and possible additional discretionary actions by regulators that, if undertaken, could have a direct material affect on the Company.

 

37


CITIZENS HOLDING COMPANY AND SUBSIDIARY

Years Ended December 31, 2005, 2004 and 2003

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 15. Continued

Under the regulatory capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company must meet specific capital guidelines involving quantitative measures of the Company’s assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting practices. The Company’s capital amounts and classification under the prompt corrective action guidelines are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. Quantitative measures established by regulation to ensure capital adequacy require the Company to maintain minimum amounts and ratios of total capital and Tier I capital to risk-weighted assets (as defined in the regulations) and Tier I capital to average assets (as defined in the regulations). Management believes, as of December 31, 2005, that the Company and the Bank meet all capital adequacy requirements to which they are subject.

As of December 31, 2005 and 2004, the most recent regulatory notification categorized the Bank as well capitalized. There have been no conditions or events that would cause changes to the capital structure of the Company since this notification. To continue to be categorized as well capitalized under the regulatory framework for prompt corrective action, the Company would have to maintain minimum total risk-based, Tier I risk-based, and Tier I leverage ratios as disclosed below, in comparison with actual capital amounts and ratios:

 

     Actual    

For Capital

Adequacy Purposes

    To Be Well
Capitalized under Prompt
Corrective Action Provisions
 
     Amount    Ratio     Amount    Ratio     Amount    Ratio  

As of December 31, 2005

               

Total Capital

               

(to Risk-Weighted Assets)

               

Citizens Holding Company

   $ 65,370,218    16.20 %   $ 32,279,732    8 %   $ N/A    —    

Citizens Bank

     63,762,072    15.80       32,279,732    8     40,349,665    10 %

Tier I Capital

               

(to Risk-Weighted Assets)

               

Citizens Holding Company

     60,808,401    15.07       16,139,866    4     N/A    —    

Citizens Bank

     59,200,255    14.67       16,139,866    4     24,209,799    6  

Tier I Capital

               

(to Average Assets)

               

Citizens Holding Company

     60,808,401    10.11       24,064,264    4     N/A    —    

Citizens Bank

     59,200,255    9.84       24,066,894    4     30,083,618    5  

 

38


CITIZENS HOLDING COMPANY AND SUBSIDIARY

Years Ended December 31, 2005, 2004 and 2003

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 15. Continued

 

     Actual    

For Capital

Adequacy Purposes

    To Be Well
Capitalized under Prompt
Corrective Action Provisions
 
     Amount    Ratio     Amount    Ratio     Amount    Ratio  

As of December 31, 2004

               

Total Capital

               

(to Risk-Weighted Assets)

               

Citizens Holding Company

   $ 60,327,088    15.39 %   $ 31,354,423    8 %   $ N/A    —    

Citizens Bank

     58,716,354    14.99       31,344,415    8     39,180,519    10 %

Tier I Capital

               

(to Risk-Weighted Assets)

               

Citizens Holding Company

     55,430,160    14.14       15,677,212    4     N/A    —    

Citizens Bank

     53,820,971    13.74       15,672,207    4     23,508,311    6  

Tier I Capital

               

(to Average Assets)

               

Citizens Holding Company

     55,430,160    9.72       22,813,669    4     N/A    —    

Citizens Bank

     53,820,971    9.46       22,745,381    4     28,431,727    5  

Note 16. Fair Values of Financial Instruments

The following represents the carrying value and estimated fair value of the Company’s financial instruments at December 31, 2005 and 2004:

 

     2005    2004
     Carrying
Amount
  

Fair

Value

   Carrying
Amount
  

Fair

Value

Financial assets

           

Cash and due from banks

   $ 26,743,200    $ 26,743,200    $ 16,837,433    $ 16,837,433

Interest bearing deposits with banks

     312,825      312,825      818,716      818,716

Federal funds sold

     —        —        11,000,000      11,000,000

Securities available-for-sale

     162,203,117      162,203,117      151,716,083      151,716,083

Net loans

     374,964,316      372,219,005      364,868,117      363,276,796

Accrued interest receivable

     4,695,147      4,695,147      4,385,892      4,385,892

Financial liabilities

           

Deposits

   $ 473,812,234    $ 473,587,831    $ 474,463,744    $ 474,627,262

Federal Home Loan Bank advances

     60,048,818      59,344,446      46,118,566      46,711,095

Accrued interest payable

     798,667      798,667      620,590      620,590

Federal funds purchased

     1,600,000      1,600,000      —        —  

The fair value estimates, methods and assumptions used by the Company in estimating its fair value disclosures for financial instruments were:

 

39


CITIZENS HOLDING COMPANY AND SUBSIDIARY

Years Ended December 31, 2005, 2004 and 2003

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 16. Continued

Cash and Due from Banks and Interest Bearing Deposits with Banks

The carrying amounts reported in the balance sheet for these instruments approximate those assets’ fair values because of their immediate and shorter-term maturities.

Securities Available-for-Sale

Fair values for investment securities are based on quoted market prices, where available. If quoted market prices are not available, fair values are based on quoted market prices of comparable instruments.

Net Loans

For variable-rate loans that reprice frequently and with no significant change in credit risk, fair values are based on carrying values. The fair values for other loans (i.e., commercial real estate and rental property mortgage loans, commercial and industrial loans, financial institution loans, and agricultural loans) are estimated using discounted cash flow analyses, using interest rates currently being offered for loans with similar terms to borrowers of similar credit quality. The carrying amount of accrued interest receivable approximates its fair value.

Federal Funds Sold and Purchased

Due to the short term nature of these instruments, the carrying amount is equal to the fair value.

Deposits

The fair values for demand deposits, NOW and money market accounts and savings accounts are, by definition, equal to the amount payable on demand at the reporting date (i.e., their carrying amounts). The carrying amounts for variable-rate, fixed-term money market accounts and time deposits approximate their fair values at the reporting date. Fair values for fixed-rate time deposits are estimated using a discounted cash flow calculation that applies interest rates currently being offered on certificates to a schedule of aggregated expected monthly maturities on time deposits. The carrying amount of accrued interest payable approximates its fair value.

Federal Home Loan Bank Borrowings

The fair value of the portion of FHLB advances that matures within 90 days approximates its fair value. For longer term maturities, the fair value is based on discounted cash flow analysis.

Off-Balance Sheet Instruments

The fair value of commitments to extend credit and letters of credit are estimated using fees currently charged to enter into similar agreements. The fees associated with these financial instruments are not material.

 

40


CITIZENS HOLDING COMPANY AND SUBSIDIARY

Years Ended December 31, 2005, 2004 and 2003

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 17. Stock Options

The Company has a directors’ stock compensation plan and employees’ long-term incentive plan. Under the directors’ plan, the Company may grant options for up to 210,000 shares of common stock. The price of each option is equal to the market price determined as of the option grant date. Options granted are exercisable after 6 months and expire after 10 years. Under the employees’ incentive plan the Company may grant options for up to 7 percent of the total number of shares of common stock, which may be issued and outstanding. Incentive options must be granted within 10 years of the adoption of the plan and expire no later than 10 years from the grant date. The exercise price is equal to the market price of the Company’s stock on the date of grant.

Following is a summary of the status of the plans for the years ending December 31, 2005, 2004 and 2003:

 

     Directors’ Plan    Employees’ Plan
     Number
of
Shares
    Weighted
Average
Exercise
Price
  

Number
of

Shares

    Weighted
Average
Exercise
Price

Outstanding at January 1, 2003

   70,800     $ 10.37    53,900     $ 13.33

Granted

   16,500       16.40    41,500       14.57

Exercised

   (3,300 )     7.15    (1,750 )     12.80

Forfeited

   —         —      —         —  
                         

Outstanding at December 31, 2003

   84,000     $ 11.68    93,650     $ 13.89

Granted

   13,500       22.25    43,500       21.85

Exercised

   (19,650 )     9.94    (1,000 )     14.65

Forfeited

   —         —      —         —  
                         

Outstanding at December 31, 2004

   77,850     $ 13.95    136,150     $ 16.43

Granted

   12,000       20.00    43,500       21.05

Exercised

   (6,000 )     14.66    (3,000 )     14.55

Forfeited

   —         —      (4,450 )     17.24
                         

Outstanding at December 31, 2005

   83,850     $ 14.77    172,200     $ 17.60
                         

Options exercisable at:

         

December 31, 2005

   83,850     $ 14.77    172,200     $ 17.60
                         

Weighted average fair value of Options granted during years ended

         

December 31, 2003

     $ 4.21      $ 3.74
                 

December 31, 2004

     $ 5.69      $ 5.59
                 

December 31, 2005

     $ 1.48      $ 1.56
                 

 

41


CITIZENS HOLDING COMPANY AND SUBSIDIARY

Years Ended December 31, 2005, 2004 and 2003

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 17. Continued

The following table presents the outstanding stock options granted in relation to the option price and the weighted average maturity.

 

Range of Exercise Prices

   Options
Outstanding
   Weighted
Average Price
   Weighted Average
Life Remaining

$7.15 to $10.00

   14,850    $ 7.27    3 years, 2 months

$10.01 to $15.00

   117,200      13.46    6 years, 1 month

$15.01 to $20.00

   25,500      18.09    8 years, 3 months

$20.01 and above

   98,500      21.56    8 years, 8 months
                

Total

   256,050    $ 16.68    7 years, 1 month
                

 

42


Management’s Discussion and Analysis of Financial Condition and Results of Operations as of December 31, 2005, 2004 and 2003

OVERVIEW

The following information discusses the financial condition and results of operations of Citizens Holding Company (the “Company”) as of December 31, 2005, 2004 and 2003. In this discussion, all references to the activities, operations or financial performance of the Company reflect the Company’s activities, operations and financial performance through its majority-owned subsidiary, The Citizens Bank of Philadelphia, Mississippi (the “Bank”), unless otherwise specifically noted.

Over the past three years, the Company has experienced growth in asset size and earnings as management has capitalized on opportunities for natural economic growth within our market area. Growth in 2004 and 2003 is attributable to steady loan demand fueled by continued low interest rates. Much of the loan growth in 2003 was funded by low interest rate borrowings from the Federal Home Loan Bank, while the loan growth in 2004 was funded in part by an increase in demand deposit accounts. In 2005, both an increase in demand deposits and an increase in Federal Home Loan Bank borrowings funded the growth in loans despite a decrease in certificate of deposit balances. Earnings have increased steadily over the three-year period as management utilized low cost funds to increase net interest income. At the same time, management believes it has made appropriate provisions for loan losses.

In 2005, the Company continued to grow although the growth rate was less than the two previous years. The Company’s assets grew to $607,709,136, or 3.5% from 2004, loans increased to $374,964,316, or 2.8% and deposits decreased $651,511, or .1%. The decrease in savings accounts and certificates of deposit were the primary reason for the decrease in deposits as they ended 2005 at $9,731,729, or 3.9% lower than 2004. Demand, NOW and money market accounts grew $9,080,209, or 4.0% to $235,768,509, at December 31, 2005.

In 2004, the Company grew through the expansion of its existing customer base within the Company’s market area. Total assets for the year increased 6.6% from 2003 to $587,238,991, and net loans increased 3.7% from 2003 to $364,868,117. The loan growth in 2004 was funded in part by an increase in demand deposit accounts. Deposits grew 8.2% in 2004 to $474,463,744 even though certificates of deposits declined by $12,135,472, or 5.5%.

In 2003, the Company experienced normal growth in assets without any acquisitions, relying on the continued growth of the Company’s market area. Total assets for the year increased 6.2% from 2002 to $550,761,143, and net loans increased 15.8% from 2002 to $351,937,005. Deposit growth for the year was 1.4% to $438,697,298.

The Company’s net income after taxes for 2005 increased 5.6% to $7,966,132 over 2004. Interest rates continued to rise in 2005 resulting in a higher cost of investible funds for the Company. This increase was offset by a corresponding increase in interest rates on loans and investments. Net income for 2005 produced, on a fully diluted basis, earnings per share of $1.57 compared to $1.49 in 2004 and $1.39 for 2003.


Net income after taxes of the Company for 2004 increased 8.3% over 2003 to $7,546,085. Net income after taxes of the Company for 2003 increased by 10.7% over 2002 to $6,970,929. Net income was positively affected in both 2004 and 2003 by a decrease in interest paid on deposits and other borrowed money.

The Company’s Return on Average Assets (ROA) was 1.35% in 2005, compared to 1.33% in 2004 and 1.27% in 2003. Its Return on Average Equity (ROE) was 12.63% in 2005, 12.84% in 2004 and 12.42% in 2003. During these periods, leverage capital ratios (the ratio of equity to average total assets) increased from 9.11% in 2003 to 9.72% in 2004 and to 10.11% in 2005. The increase in ROE indicates that the Company has been successful in using its capital to support growth in both assets and earnings. This growth has enabled the Company to increase the annual dividend payout rate to approximately 40.9% of 2005 earnings per share. Even though the dividend payout ratio has increased, the leverage capital ratio increased to 10.11% in 2005, which is well above the regulatory requirement of 5% to be considered “well capitalized” under applicable Federal Deposit Insurance Corporation (the “FDIC”) guidelines for the Bank.

CRITICAL ACCOUNTING POLICIES

The allowance for loan losses is established through a provision for loan losses charged against net income. The allowance represents an amount, which in management’s judgment will be adequate to absorb estimated probable losses within the existing loan portfolio. Loans that management determines to be uncollectible are charged against the allowance for loan losses, and subsequent recoveries, if any, are credited to the allowance. Management’s judgment in determining the adequacy of the allowance is based on evaluations of the collectibility of specific loans and prior loss experience. Other factors considered by management include specific economic events, general economic conditions and trends, and loan portfolio mix and growth. The allowance for loan losses is subject to close regulatory review from the FDIC and the Mississippi Department of Banking and Consumer Finance and is also a factor in their determination of capital adequacy. The estimation of losses in our loan portfolio is susceptible to changes resulting from changes in the financial condition of individual borrowers and economic conditions in the Company’s market area.

Prior to the adoption of Statement of Financial Accounting Standards No. 123 (revised 2004), “Share Based Payment” (“SFAS No. 123(R),” effective January 1, 2006), the Company accounted for stock options in accordance with Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB No. 25”). APB No. 25 did not require the Company to recognize compensation expense for stock options granted to employees if the option price was not less than the fair market value of the underlying stock at the grant date. Accordingly, the Company did not recognize compensation expense for the 55,500, 57,000 and 58,000 options granted to employees and directors for 2005, 2004 and 2003, respectively. If the Company had applied the provisions of SFAS No. 123(R) for the options granted, the Company would have reported compensation expense of $55,340, $201,610 and $143,654 for 2005, 2004, and 2003, respectively.

Generally, all options granted to employees and directors have become fully vested at the date of grant rather than a vesting period. Since all options outstanding at December 31, 2005 are fully vested, no future compensation expense will be required upon the adoption of SFAS No. 123(R). Furthermore, no cumulative effect of the adoption will be recorded by the Company for options granted prior to December 31, 2005. The Company has not changed the amount or terms of any outstanding option arrangements in anticipation of the adoption of SFAS No. 123(R).


In future periods, the Company will be required to expense the fair value of options granted; the Company intends to use the Black-Scholes valuation model to determine the fair value. The Black-Scholes model requires the use of certain assumptions, including the volatility of the Company’s stock price (the Company has used the historical volatility in prior periods to determine the estimated compensation expense), the expected life of the option, the expected dividend rate and the discount rate. The Company does not expect to change the methods in determining the assumptions underlying the valuation of future stock option grants.

Accordingly, the Company does not expect the adoption of SFAS No. 123(R) to have a material impact on the Company’s income or financial position. For more information on the Company’s stock options, please refer to Notes 1 and 17 to the Company’s Consolidated Financial Statements included in this Annual Report.

Please refer to Note 1, “Summary of Significant Accounting Policies,” to the Consolidated Financial Statements of the Company included in this Annual Report for a detailed discussion of recent account pronouncements affecting the Company.

DISCLOSURE REGARDING FORWARD-LOOKING STATEMENTS

In addition to historical information, this report contains statements which constitute forward-looking statements and information which are based on management’s beliefs, plans, expectations, assumptions and on information currently available to management. The words “may,” “should,” “expect,” “anticipate,” “intend,” “plan,” “continue,” “believe,” “seek,” “estimate,” and similar expressions used in this report that do not relate to historical facts are intended to identify forward-looking statements. These statements appear in a number of places in this report, including, but not limited to, statements found in Item 1, “Business,” and in Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” The Company notes that a variety of factors could cause the actual results or experience to differ materially from the anticipated results or other expectations described or implied by such forward-looking statements. The risks and uncertainties that may affect the operation, performance, development and results of the business of the Company and the Bank, include, but are not limited to, the following:

 

    the risk of adverse changes in business conditions in the banking industry generally and in the specific markets in which the Company operates;

 

    changes in the legislative and regulatory environment that negatively impact the Company and the Bank through increased operating expenses;

 

    increased competition from other financial institutions;

 

    the impact of technological advances;

 

    expectations about the movement of interest rates, including actions that may be taken by the Federal Reserve Board in response to changing economic conditions;

 

    changes in asset quality and loan demand;

 

    expectations about overall economic strength and the performance of the economy in the Company’s market area; and

 

    other risks detailed from time to time in the Company’s filings with the Securities and Exchange Commission.


The Company does not undertake any obligation to update or revise any forward-looking statements subsequent to the date on which they are made.

SELECTED FINANCIAL DATA

The following selected financial data has been taken from the Company’s Consolidated Financial Statements and related notes included in this Annual Report and should be read in conjunction with such consolidated financial statements and related notes. Dollar references in all of the following tables are in thousands except for per share data. All per share data has been adjusted to give effect to the three-for-two stock split effected January 2, 2002.

The major components of the Company’s operating results for the past five years are summarized in Table 1—Five Year Financial Summary of Consolidated Statements and Related Statistics.

TABLE 1 - FIVE YEAR SUMMARY OF CONSOLIDATED STATEMENTS AND RELATED STATISTICS

(in 000’s except for per share data)

 

     2005    2004    2003    2002    2001
Summary of Earnings               

Total interest income

   $ 33,043    $ 29,972    $ 29,725    $ 30,197    $ 29,119

Total interest expense

     9,847      7,537      8,188      9,746      13,399

Provision for loan losses

     1,084      1,067      2,003      1,758      1,123

Non-interest income

     5,737      5,574      5,324      4,435      3,980

Non-interest expense

     17,517      16,713      15,042      13,865      10,308

Income tax expense

     2,366      2,683      2,845      2,965      2,558

Net income

     7,966      7,546      6,971      6,298      5,711
Per Share Data               

Earnings-basic

   $ 1.59    $ 1.51    $ 1.40    $ 1.27    $ 1.15

Earnings-diluted

     1.57      1.49      1.39      1.26      1.15

Cash dividends

     0.65      0.60      0.57      0.52      0.38

Book value at year end

     12.73      12.04      11.35      10.81      9.51
Selected Year End Actual Balances               

Loans, net of unearned income

   $ 379,526    $ 369,589    $ 357,064    $ 308,175    $ 264,278

Allowance for loan losses

     4,562      4,721      5,127      4,222      3,375

Securities available for sale

     162,203      151,716      143,181      162,276      122,567


Earning assets

     535,322       525,155       493,209       468,592       394,315  

Total assets

     607,709       587,239       550,761       518,450       427,213  

Deposits

     473,812       474,464       438,697       432,768       359,309  

Long term borrowings

     60,049       46,119       47,637       24,606       14,629  

Shareholders’ equity

     63,774       60,191       56,502       53,783       47,182  
Selected Year End Average Balances           

Loans, net of unearned income

   $ 371,925     $ 364,922     $ 337,763     $ 289,407     $ 255,185  

Allowance for loan losses

     4,646       5,532       4,495       3,905       3,335  

Securities available for sale

     156,333       142,994       164,371       153,726       106,632  

Earning assets

     528,562       506,898       499,726       450,174       372,923  

Total assets

     591,872       565,892       549,520       491,833       403,881  

Deposits

     464,629       457,510       447,188       414,135       327,536  

Long term borrowings

     54,823       41,607       35,314       19,301       14,815  

Shareholders’ equity

     63,068       58,750       56,121       51,304       47,664  
Selected Ratios           

Return on average assets

     1.35 %     1.33 %     1.27 %     1.28 %     1.41 %

Return on average equity

     12.63 %     12.84 %     12.42 %     12.28 %     11.98 %

Dividend payout ratio

     40.86 %     39.71 %     40.71 %     40.98 %     33.31 %

Equity to year end assets

     10.49 %     10.25 %     10.26 %     10.37 %     11.04 %

Total risk-based capital to risk-adjusted assets

     16.20 %     15.35 %     14.94 %     15.57 %     18.40 %

Leverage capital ratio

     10.11 %     9.72 %     9.11 %     8.83 %     10.51 %

Efficiency ratio

     58.14 %     57.65 %     54.45 %     54.51 %     51.32 %

The year-end and average balances for 2002 reflect the increase in loans, assets and deposits that resulted from the May 2002 acquisition of CB&T Capital Corporation and its bank subsidiary, Citizens Bank and Trust Company of Louisville. Similarly, the balances in 2001 increased in part by the acquisition of two Union Planters branches located in Forest and Decatur, Mississippi in July 2001.

NET INTEREST INCOME

Net interest income is the most significant component of the Company’s earnings. Net interest income is the difference between interest and fees realized on earning assets, primarily loans and securities, and interest paid on deposits and other borrowed funds. The net interest margin is this difference expressed as a percentage of average earning assets. Net interest income is affected by several factors, including the volume of earning assets and liabilities, the mix of earning assets and liabilities, and interest rates. The discussion below is presented on a tax equivalent basis which management believes to be the best way to analyze net interest income.


Net interest income on a tax equivalent basis was $24,373,000, $23,435,000 and $22,317,000 for the years 2005, 2004 and 2003, respectively. Net interest margin was 4.61%, 4.61% and 4.49% for the same periods. During 2005, the rates on interest earning assets and interest bearing liabilities both rose to the extent that the net interest margin in 2005 was unchanged from 2004. Both volume and rates increased on both interest bearing assets and liabilities.

The increase in net interest income in 2004 was due to the increases in the volume and yield of interest-bearing assets exceeding the increases in the volume of and rates paid on deposits. For the year ended December 31, 2004, the average yield on earnings assets decreased 4 basis points to 6.09% from 2003 and the average rate paid on interest-bearing liabilities decreased 18 basis points to 1.76% from 2003. The volume of earning assets increased 2.1% while the volume of interest-bearing liabilities increased 1.7% in 2004.

In 2003, the increase in the volume of interest-bearing assets, partially offset by the slightly larger decrease in the interest rate charged on loans than the decrease in the interest rate paid on deposits, caused the rise in net interest income in 2003. The average yield on earnings assets in 2003 decreased to 6.13% from 6.83% in 2002, while the average rate on interest-bearing liabilities decreased to 1.94% from 2.59% in 2002. Earning assets volume increased 10.6% while interest-bearing liabilities volume increased 12.0% in 2003.

During this three-year period, loan demand has remained strong and has allowed the Company to continue to invest its available funds in loans. Loans generally provide the Company with yields that are greater than the yields on typical investment securities.

During 2003, the Company purchased $11.4 million of additional bank-owned life insurance, increasing the Company’s investment in such insurance to $14.9 million at December 31, 2003. The income received by the Company on these policies increased the Company’s total investment from $14.9 million at December 31, 2003 to approximately $15.5 million at December 31, 2004 and $16.0 million at December 31, 2005. The additional purchases were made to provide a future funding source for certain of the Company’s deferred compensation arrangements. Such insurance also offers more attractive yields than other investment securities.

Table 2 – Average Balance Sheets and Interest Rates sets forth average balance sheet data, including all major categories of interest-earning assets and interest-bearing liabilities, together with the interest earned or interest paid and the average yield or average rate paid on each such category for the fiscal years ended December 31, 2005, 2004 and 2003.


TABLE 2 - AVERAGE BALANCE SHEETS AND INTEREST RATES

 

     Average Balance    Income/Expense    Average Yield/Rate  
     2005    2004    2003    2005    2004    2003    2005     2004     2003  

Loans:

                        

Loans, net of unearned

   $ 370,982    $ 363,405    $ 336,275    $ 25,435    $ 24,162    $ 23,697    7.13 %   6.65 %   7.05 %

Investment Securities

                        

Taxable

     71,916      72,023      108,695      3,023      2,847      3,761    4.20 %   3.95 %   3.39 %

Tax-exempt

     80,728      66,542      49,183      4,564      3,863      2,998    5.65 %   5.80 %   6.10 %
                                                            

Total Investment Securities

     152,644      138,565      157,878      7,587      6,710      6,759    4.97 %   4.84 %   4.28 %

Federal Funds Sold and Other

     5,891      6,031      3,575      180      83      34    3.06 %   1.38 %   0.95 %
                                                            

Total Interest Earning Assets

     529,517      508,001      497,728      34,202      30,955      30,490    6.46 %   6.09 %   6.13 %
                                                            

Non-Earning Assets

     62,355      57,891      51,792                
                                    

Total Assets

   $ 591,872    $ 565,892    $ 549,520                
                                    

Deposits:

                        

Interest-bearing Demand Deposits

   $ 144,134    $ 127,902    $ 123,338    $ 2,098    $ 1,372    $ 1,212    1.46 %   1.07 %   0.98 %

Savings

     35,494      37,591      34,696      301      319      354    0.89 %   0.85 %   1.02 %

Time

     204,265      219,150      222,695      5,014      4,065      5,024    2.45 %   1.85 %   2.26 %
                                                            

Total Deposits

     383,893      384,643      380,729      7,413      5,756      6,590    1.93 %   1.50 %   1.73 %

Borrowed Funds

                        

Short-term Borrowings

     2,344      1,113      4,065      84      18      56    3.58 %   1.62 %   1.37 %

Long-term Borrowings

     54,823      41,607      35,314      2,332      1,746      1,527    4.25 %   4.20 %   4.32 %
                                                            

Total Borrowed Funds

     57,167      42,720      39,379      2,416      1,764      1,583    4.23 %   3.70 %   4.02 %
                                                            

Total Interest-Bearing Liabilities

     441,060      427,363      420,108      9,829      7,520      8,173    2.22 %   1.76 %   1.94 %

Non-Interest Bearing Liabilities

                        

Demand Deposits

     80,737      72,867      65,985                

Other Liabilities

     7,007      6,912      7,306                

Shareholders’ Equity

     63,068      58,750      56,121                
                                    

Total Liabilities and Shareholders’ Equity

   $ 591,872    $ 565,892    $ 549,520                
                                    

Interest Rate Spread

                     4.24 %   4.33 %   4.19 %
                                    

Net Interest Margin

            $ 24,373    $ 23,435    $ 22,317    4.61 %   4.61 %   4.49 %
                                                

Less

                        

Tax Equivalent Adjustment

              1,177      1,000      781       
                                    

Reported Net Interest Income

            $ 23,196    $ 22,435    $ 21,536       
                                    


Table 3 - Net Average Interest Earning Assets illustrates net interest earning assets and liabilities for 2005, 2004, and 2003.

TABLE 3 - NET AVERAGE INTEREST EARNING ASSETS

 

     2005    2004    2003

Average interest earning assets

   $ 529,517    $ 508,001    $ 497,728

Average interest bearing liabilities

     441,614      427,363      420,108
                    

Net average interest earning assets

   $ 87,903    $ 80,638    $ 77,620
                    

Table 4 – Volume/Rate Analysis depicts the dollar effect on interest income and interest expense of changes in volume and changes in rate from 2003 through 2005. Variances which were attributable to both volume and rate are allocated proportionately between rate and volume using the absolute values of each for a basis for the allocation. Non-accruing loans are included in the average loan balances used in determining the yields. Interest income on tax-exempt securities and loans has been adjusted to a tax equivalent basis using a federal income tax rate of 34%.

TABLE 4 - VOLUME/RATE ANALYSIS

 

     2005 Change from 2004     2004 Change from 2003  
     Volume     Rate     Total     Volume     Rate     Total  

INTEREST INCOME

            

Loans

   $ 540     $ 1,733     $ 2,273     $ 1,804     $ (1,339 )   $ 465  

Taxable Securities

     (4 )     180       176       (1,449 )     536       (913 )

Non-Taxable Securities

     801       (100 )     701       1,007       (143 )     864  

Federal Funds Sold and Other

     (4 )     101       97       34       15       49  
                                                

TOTAL INTEREST INCOME

   $ 1,333     $ 1,914     $ 3,247     $ 626     $ (161 )   $ 465  
                                                

INTEREST EXPENSE

            

Interest-bearing demand deposits

   $ 237     $ 489       726     $ 49     $ 111     $ 160  

Savings Deposits

     (18 )     —         (18 )     25       (60 )     (35 )

Time Deposits

     (365 )     1,314       949       (66 )     (893 )     (959 )

Short-term borrowings

     44       22       66       (48 )     10       (38 )

Long-term borrowings

     562       24       586       264       (45 )     219  
                                                

TOTAL INTEREST EXPENSE

   $ 460     $ 1,849       2,309     $ 224     $ (877 )   $ (653 )
                                                

NET INTEREST INCOME

   $ 873     $ 65     $ 938     $ 402     $ 716     $ 1,118  
                                                


LOANS

The loan portfolio constitutes the major earning asset of the Company and, in the opinion of management, offers the best alternative for maximizing interest spread above the cost of funds. The Company’s loan personnel have the authority to extend credit under guidelines established and approved by the Board of Directors. Any aggregate credit that exceeds the authority of the loan officer is forwarded to the Board’s loan committee for approval. The loan committee is composed of various directors, including the Chairman. All aggregate credits which exceed the loan committee’s lending authority are presented to the full Board of Directors for ultimate approval or denial. The loan committee not only acts as an approval body to ensure consistent application of the Company’s loan policy but also provides valuable insight through communication and pooling of knowledge, judgment, and experience of its members.

The Company has stated in its Loan Policy the following objectives for its loan portfolio:

 

    to make loans on sound and thorough credit analysis;

 

    to properly document all loans;

 

    to eliminate loans from the portfolio that are under-priced, high risk or difficult and costly to administer;

 

    to seek good relationships with the customer;

 

    to avoid undue concentrations of loans; and

 

    to keep non-accrual loans to a minimum by aggressive collection policies.

Loan demand has remained strong in the Company’s market area over the past three years. In general, the loan growth experienced in 2005, 2004 and 2003 was due to a continuation of the overall growth in the market area served by the Company. The impact on housing caused by the opening of a casino on the nearby Choctaw Indian Reservation in 1995 is beginning to show less of an impact on the housing market in the area. Real estate mortgage loans originated by the Company declined by 1.7%, or $1,550,809, in 2005, after having increased by .5%, or $500,699, in 2004 and 3.3%, or $2,959,217, in 2003.

Commercial and agricultural loans showed significant growth during this period. These loans grew $12,019,676, or 6.0%, in 2005, $14,317,978, or 7.7%, in 2004 and $37,188,745, or 24.8%, in 2003. This increase was caused by the influence of the casino in the area and by an increase in the number of loans originated during these years to poultry producers. Commercial and agricultural loans are the largest segment of the loan portfolio and, by nature, bear a higher degree of risk. Management believes the lending practices, policies, and procedures surrounding this loan category are adequate to manage any risk represented by the growth of the loans in this category.

Consumer loans have shown moderate growth during the period. This category increased $1,046,248, or 1.6%, in 2005, $1,919,155, or 3.2%, in 2004 and $4,649,580, or 7.8%, in 2003. The Company believes that changes in consumer purchasing habits and the increase in loan sources have affected the growth of this segment of loans. Sustained low unemployment may also have lessened the dependence on consumer loans for some purchases.


Table 5 - Loans Outstanding reflects outstanding balances by loan type for the past five years. Additional loan information is presented in Note 4 to the Company’s Consolidated Financial Statements included in this Annual Report.

TABLE 5 - LOANS OUTSTANDING

 

     AT DECEMBER 31,
     2005    2004