CITIZENS HOLDING CO /MS/ - Quarter Report: 2003 September (Form 10-Q)

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SECURITIES AND EXCHANGE COMMISSION

Washington, D. C. 20549

FORM 10-Q

For the quarterly period ended September 30, 2003

OR

For the transition period from                      to                     

Commission file number: 000-25221

CITIZENS HOLDING COMPANY

(exact name of registrant as specified in its charter)

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

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    x  Yes    ¨  No

Indicate by check whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).    x  Yes    ¨  No

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date, November 10, 2003.

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CITIZENS HOLDING COMPANY

THIRD QUARTER 2003 INTERIM FINANCIAL STATEMENTS

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PART I. FINANCIAL INFORMATION

ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS

CITIZENS HOLDING COMPANY AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF CONDITION

See notes to consolidated financial statements.

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CITIZENS HOLDING COMPANY AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF INCOME

See notes to consolidated financial statements.

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CITIZENS HOLDING COMPANY AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

See notes to consolidated financial statements.

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CITIZENS HOLDING COMPANY AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF CASH FLOWS

See notes to consolidated financial statements.

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CITIZENS HOLDING COMPANY AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

For the nine months ended September 30, 2003

The interim consolidated financial statements of Citizens Holding Company include the accounts of its 97.52% owned subsidiary, The Citizens Bank of Philadelphia (collectively referred to as “the Corporation”). All significant intercompany transactions have been eliminated in consolidation.

Investment Securities - The Corporation classifies all of its securities as available-for-sale and carries them at fair value with unrealized gains or losses reported as a separate component of capital, net of any applicable income taxes. Realized gains or losses on the sale of securities available-for-sale, if any, are determined on an identification basis. The Corporation does not have any securities classified as held for trading or held to maturity.

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The follow is a summary of the assets and liabilities acquired:

The Corporation has completed its evaluation of the assets and liabilities acquired and has allocated $1,846,909 of the $4,414,509 total intangible asset to core deposit intangibles and the remaining $2,567,600 to goodwill. The core deposit intangible is to be amortized at the rate of $15,391 per month until fully amortized, representing an estimated economic life of 10 years. The amount of core deposit amortization expense related to this acquisition was $138,518 year to date at September 30, 2003. The operations of CB&T Capital Corporation are included in the consolidated financial statements since the acquisition date.

Total amortization expense related to the core deposit intangible assets for the nine months ended September 30, 2003 and 2002 was $403,128 and $326,173, respectively.

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In November 2002, FASB Interpretation (“FIN”) No. 45, “Guarantors Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others,” was issued. FIN No. 45 elaborates on the disclosures to be made by a guarantor in its interim and annual financial statements regarding its obligations under certain guarantees that it has issued. FIN No. 45 also clarifies the requirement of the guarantor to recognize, at the inception of a guarantee, a liability for the fair value of the obligation undertaken in issuing the guarantee. The initial recognition and initial measurement provisions of this interpretation were adopted by the Corporation effective January 1, 2003. The adoption of FIN No. 45 did not have any material impact on the financial statements of the Corporation.

In January 2003, FIN No. 46, “Consolidation of Variable Interest Entities,” was issued. FIN No. 46 sets forth the criteria used in determining whether an investment in a variable interest entity (“VIE”) should be consolidated. FIN No. 46 was effective upon issuance for interest in VIE’s created or obtained after January 31, 2003. For variable interests in VIE’s created before February 1, 2003, the provisions of FIN No. 46 must be applied in the first fiscal year or interim

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period beginning after June 15, 2003. The adoption of FIN No. 46 by the Corporation is not expected to have a material impact on the financial position or results of operations of the Corporation.

In April 2003, SFAS No. 149, “Amendment of Statement 133 on Derivative Instruments and Hedging Activities,” was issued. SFAS No. 149 amends and clarifies financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts (collectively referred to as derivatives) and for hedging activities under SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities.” SFAS No. 149 was adopted by the Corporation effective June 30, 2003 and is expected to have no material impact on the financial position or results of operations of the Corporation.

SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity,” was issued in May 2003. SFAS No. 150 establishes standards for an issuer’s classification and measurement of certain financial instruments with characteristics of both liabilities and equity. SFAS No. 150 was adopted by the Corporation effective May 31, 2003 and is expected to have no material impact on the financial position or results of operations of the Corporation.

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CITIZENS HOLDING COMPANY AND SUBSIDIARY

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL

CONDITION AND RESULTS OF OPERATIONS

Management’s discussion and analysis is written to provide greater insight into the results of operations and the financial condition of Citizens Holding Company and its 97.52% owned subsidiary, The Citizens Bank of Philadelphia (collectively, the “Corporation”).

LIQUIDITY

The Corporation has an asset and liability management program that assists management in maintaining net interest margins during times of both rising and falling interest rates and in maintaining sufficient liquidity. Liquidity of the Corporation at September 30, 2003 was 62.28%, at December 31, 2002 was 75.24% and at September 30, 2002 was 79.34%. Liquidity is the ratio of net deposits and short-term liabilities divided by net cash, short-term investments and marketable assets. Management believes it maintains adequate liquidity for the Corporation’s current needs.

When the Corporation has more funds than it needs for its reserve requirements or short-term liquidity needs, the Corporation increases its security investments or sells federal funds. It is management’s policy to maintain an adequate portion of its portfolio of assets and liabilities on a short-term basis to insure rate flexibility and to meet loan funding and liquidity needs. The Corporation has secured and unsecured federal funds lines with correspondent banks in the amount of $35,000,000. In addition, the Corporation has the ability to draw on its line of credit with the Federal Home Loan Bank in excess of $144,959,475 at September 30, 2003. At September 30, 2003, the Corporation had unused and available $35,000,000 of its federal funds line of credit and $96,075,807 of its line of credit with the Federal Home Loan Bank.

CAPITAL RESOURCES

The Corporation’s equity capital was $55,104,293 at September 30, 2003. The main source of capital for the Corporation has been the retention of net income.

On January 2, 2002, the Corporation issued a three-for-two (3:2) split to the shareholders of the Corporation. This split increased the number of outstanding shares to 4,963,028 and increased the authorized shares from 15,000,000 to 22,500,000. In December 2002, certain employees exercised stock options for 11,550 shares that brought the number of outstanding shares to 4,974,578. Cash dividends in the amount of $2,089,323 or $0.42 per share were paid during the period January 1, 2003 to September 30, 2003.

Quantitative measures established by regulation to ensure capital adequacy require the Corporation to maintain minimum amounts and ratios of Total and Tier 1 capital (primarily common stock and retained earnings, less goodwill) to risk weighted assets, and of Tier 1 capital to average assets. Management believes that as of September 30, 2003, the Corporation meets all capital adequacy requirements to which it is subject.

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RESULTS OF OPERATIONS

The following table sets forth for the periods indicated, certain items in the consolidated statements of income of the Corporation and the related changes between those periods:

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Net Income Per Share - Basic is calculated using weighted average number of shares outstanding for the period. Net Income Per Share - Diluted is calculated using the weighted average number of shares outstanding for the period, plus the net dilutive effect of granted stock options determined using the treasury stock method.

Annualized return on average equity (ROE) was 13.37% and 12.37% for the three and nine months ended September 30, 2003, and 12.45% and 12.93% for the three and nine months ended September 30, 2002.

The book value per share increased to $11.08 at September 30, 2003 compared to $10.81 at December 31, 2002. This increase is due to earnings exceeding dividends paid during this period. Average assets for the nine months ended September 30, 2003, were $547,435,590 compared to $491,832,644 for the year ended December 31, 2002, and average equity increased to $56,100,776 for the nine months ended September 30, 2003, from $51,303,506 for the year ended December 31, 2002. The increase in average assets is due to the expansion of the Corporation’s business as a result of the acquisition of CB&T Capital Corporation in May 2002.

NET INTEREST INCOME/NET INTEREST MARGIN

One component of the Corporation’s earnings is net interest income, which is the difference between the interest and fees earned on loans and investments and the interest paid for deposits and borrowed funds. The net interest margin is net interest income expressed as a percentage of average earning assets.

The annualized net interest margin was 4.42% and 4.44% for the three and nine months ended September 30, 2003, compared to an annualized net interest margin of 4.69% for the three and nine months ended September 30, 2002. This slight decline in net interest margin can be attributed to continued declines in market interest rates and the ongoing re-pricing of investments, loans and deposits. Earning assets averaged $499,707,879 for the nine months ended September 30, 2003. This represented an increase of $57,663,711, or 13.0%, over average earning assets of $442,044,168 for the nine months ended September 30, 2002. The increase in average earning assets results from the May 2002 CB&T Capital Corporation acquisition and normal bank growth.

Net interest income was $5,483,345 and $15,979,039 for the three and nine month periods in 2003, an increase of $95,343 and $835,799 respectively over the same periods in 2002. An increase in loan volume in the first nine months of 2003 was the primary contributor to this increase. A lower cost of deposits and other borrowed funds during 2003 over the same period in 2002 also contributed to the increase in Net Interest Income. While investment volume increased slightly during the first nine months of 2003, interest income from investment securities decreased as a result of market conditions requiring the proceeds from the maturity or call of higher yielding securities to be invested in lower yield instruments.

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Other interest income decreased in the three and nine month periods ended September 30, 2003 compared to the same period in 2002 due to a decrease in the interest rates on Federal Funds Sold.

The following table shows the interest and fees and corresponding yields for loans only.

The decrease in rates in the three and nine month periods ended September 30, 2003 when compared to the three and nine months of 2002, reflects the decrease in all loan rates for both new and refinanced loans.

CREDIT LOSS EXPERIENCE

As a natural corollary to the Corporation’s lending activities, some loan losses are to be expected. The risk of loss varies with the type of loan being made and the creditworthiness of the borrower over the term of the loan. The degree of perceived risk is taken into account in establishing the structure of, and interest rates and security for, specific loans and for various types of loans. The Corporation attempts to minimize its credit risk exposure by use of thorough loan application and approval procedures.

The Corporation maintains a program of systematic review of its existing loans. Loans are graded for their overall quality. Those loans which the Corporation’s management determines require further monitoring and supervision are segregated and reviewed on a periodic basis. Significant problem loans are reviewed on a monthly basis by the Corporation’s Board of Directors.

The Corporation charges off that portion of any loan which management considers to represent a loss. A loan is generally considered by management to represent a loss in whole or in part when an exposure beyond the collateral value is apparent, servicing of the unsecured portion has been discontinued or collection is not anticipated based on the borrower’s financial condition and general economic conditions in the borrower’s industry. The principal amount of any loan which is declared a loss is charged against the Corporation’s allowance for loan losses.

The Corporation’s allowance for loan losses is designed to provide for loan losses which can be reasonably anticipated. The allowance for loan losses is established through

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charges to operating expenses in the form of provisions for loan losses. Actual loan losses or recoveries are charged or credited to the allowance for loan losses. The amount of the allowance is determined by management of the Corporation. Among the factors considered in determining the allowance for loan losses are the current financial condition of the Corporation’s borrowers and the value of security, if any, for their loans. Estimates of future economic conditions and their impact on various industries and individual borrowers are also taken into consideration, as are the Corporation’s historical loan loss experience and reports of banking regulatory authorities. Because these estimates, factors and evaluations are primarily judgmental, no assurance can be given as to whether or not the Corporation will sustain loan losses in excess or below its allowance or that subsequent evaluation of the loan portfolio may not require material increases or decreases in such allowance.

The following table summarizes the Corporation’s allowance for loan losses for the dates indicated:

The provision for loan losses for the three months ended September 30, 2003 was $717,400, an increase of $380,609 or 113.0% when compared to the $336,791 for the same period in 2002. The provision for the nine months ended September 30, 2003 was $1,467,400, an increase of $460,795 or 45.8% over the $1,006,605 for the nine months ended September 30, 2002. The increase in the provision for the three and nine month periods ended September 30, 2003 were made to bring the allowance back to the desired levels after the net charge-offs for these periods and to cover the volume increases in the loan portfolio.

For the three months ended September 30, 2003, net loan losses charged to allowance for loan losses totaled $367,434, an increase of $30,643 over the same period in 2002. For the nine months ended September 30, 2003, net loan losses charged to the allowance for loan losses totaled $821,444, a decrease of $185,161 over the same period in 2002. Non-accrual loans increased in the third quarter of 2003 to $1,839,039 due mainly to the placing on non-accrual status of two credits that were in the process of foreclosure at September 30, 2003. It is management’s belief that these credits are sufficiently collateralized and the Corporation’s loss, if any, will not be material.

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Management of the Corporation reviews with the Board of Directors the adequacy of the allowance for possible loan losses on a quarterly basis. The loan loss provision is adjusted when specific items reflect a need for such an adjustment. Management believes that there were no material loan losses during the last three months that have not been charged off. Management also believes that the Corporation’s allowance will be adequate to absorb probable losses inherent in the Corporation’s loan portfolio. However, in light of overall economic conditions in the Corporation’s geographic area and the nation as a whole, it is possible that additional provisions for loan loss may be required.

OTHER INCOME

Other operating income includes service charges on deposit accounts, wire transfer fees, safe deposit box rentals and other revenue not derived from interest on earning assets.

Other operating income for the three months ended September 30, 2003 increased $520,985 or 45.2% over the same period in 2002 and for the nine months ended September 30, 2003, increased $929,799 or 29.0% over the same period in 2002. The increase in both periods was the result of increased overdraft, returned check income and other service charges and mortgage loan origination income. Net gains on the sale of securities during the three and nine months ended September 30, 2003 totaled $271,018 and $471,167, respectively, compared to $0 and $22,780 for the three and nine month periods ended September 30, 2002. These securities were sold as a strategy to increase the yields on the security portfolio and to provide additional liquidity for loan growth.

OTHER EXPENSE

Other expenses include salaries and employee benefits, occupancy and equipment, and other operating expenses. Other expenses for the three and nine months ended September 30, 2003 were $3,821,859 and $11,207,172 compared to the $3,721,183 and $10,128,377 for the three and nine months ended September 30, 2002 for an increase of $100,676 and $1,078,795 respectively. Salaries and benefits increased to $2,016,484 and $5,907,636 for the three and nine month periods in 2003 from $1,903,613 and $5,380,510 for the same periods in 2002, an increase of $112,871 or 5.9% and $527,126 or 9.8% respectively. Both the increase in Other Expenses as a whole, and salaries and benefits specifically, are the result of the growth of the Corporation, both from the acquisition of CB&T Capital Corporation in May 2002 and internal growth of the deposit base. The Corporation’s efficiency ratio for the three and nine month periods ended September 30, 2003 was 51.88% and 54.26% compared to 55.69% and 54.08% for the same periods in 2002. The efficiency ratio improved in the third quarter of 2003 when compared to the same period in 2002 due to the growth in Noninterest Income exceeding the growth in Noninterest Expenses. The improvement was attributable in part to improved efficiency of operations of the CB&T Capital Corporation subsequent to its acquisition by the Corporation.

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PROVISION FOR INCOME TAXES

The provision for income taxes for the three months and nine months ended September 30, 2003, decreased for the same periods of 2002, in both absolute dollar amount and as a percentage of income before income taxes, primarily as a result of the nontaxable life insurance proceeds due the Corporation because of the death of one of members of the Board of Directors.

BALANCE SHEET ANALYSIS

CASH AND CASH EQUIVALENTS

Cash and cash equivalents are made up of cash, balances at correspondent banks and items in process of collection. The balance as of September 30, 2003 decreased $262,244 or 1.24% from December 31, 2002.

INVESTMENT SECURITIES

The investment securities are made up of U. S. Treasury Notes, U. S. Agency debentures, mortgage-backed securities, obligations of states, counties and municipal governments and Federal Home Loan Bank Stock. Investments increased $9,244,254 or 5.7% as of September 30, 2003 compared to December 31, 2002.

LOANS

Loan demand in the Corporation’s service area began to strengthen as net loans increased by $36,806,308 or 12.1% during the nine month period ended September 30, 2003. Residential housing loans continue to be in demand along with commercial and industrial loans. No special loan programs were initiated during this period.

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DEPOSITS

The following shows the balance and percentage change in the various deposits:

The increase is the result of normal deposit growth. The Corporation does not have any brokered deposits. There were no special deposit programs or incentives in place during this period.

FORWARD LOOKING STATEMENTS

In addition to historical information, this report contains statements which constitute forward-looking statements and information within the meaning of the Private Securities Litigation Reform Act of 1995 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 “Notes to Consolidated Financial Statements” and in Item 2 “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” The Corporation 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 Corporation’s business include, but are not limited to, the following: (a) the risk of adverse changes in business conditions in the banking industry generally and in the specific markets in which the Corporation operates; (b) changes in the legislative and regulatory environment that negatively impact the Corporation through increased operating expenses; (c) increased competition from other financial institutions; (d) the impact of technological advances; (e) expectations

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about the movement of interest rates, including actions that may be taken by the Federal Reserve Board in response to changing economic conditions; (f) changes in asset quality and loan demand; (g) expectations about overall economic strength and the performance of the economics in the Corporation’s market area and (h) other risks detailed from time to time in the Corporation’s filings with the Securities and Exchange Commission. The Corporation does not undertake any obligation to update or revise any forward-looking statements subsequent to the date on which they are made.

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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES

ABOUT MARKET RISK

Overview

The definition of market risk is the possibility of loss that could result from adverse changes in market prices and rates. The Corporation has taken steps to assess the amount of risk that is associated with its asset and liability structure. The Corporation measures the potential risk on a regular basis and makes changes to its strategies to manage these risks. The Corporation does not participate in some of the financial instruments that are inherently subject to substantial market risk.

Market/Interest Rate Risk Management

The primary purpose in managing interest rate risk is to effectively invest capital and preserve the value created by the core banking business. The Corporation utilizes an investment portfolio to manage the interest rate risk naturally created through its business activities. The quarterly interest rate risk report is used to evaluate exposure to interest rate risk, project earnings and manage the composition of the balance sheet and its growth.

Static gap analysis is also used in measuring interest rate risk. An analysis of the Corporation’s repricing opportunities indicates a negative gap position over the next three- and twelve–month periods, which indicates that the Corporation would benefit somewhat from a decrease in market interest rates. Interest rates remained stable during the quarter ended September 30, 2003. The Corporation’s interest bearing deposit liabilities have been substantially repriced to reflect the current interest rate environment.

There has been no material change in the Corporation’s disclosure of quantitative and qualitative disclosures about market risk as of September 30, 2003 from that presented in the Corporation’s annual report on Form 10-K for the fiscal year ended December 31, 2002. For additional information concerning the Corporation’s quantitative and qualitative disclosures about market risk, see our annual report on Form 10-K for the fiscal year ended December 31, 2002.

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ITEM 4. CONTROLS AND PROCEDURES

As of the end of the period covered by this quarterly report on Form 10-Q, the Corporation carried out an evaluation, under the supervision and with the participation of our principal executive officer and principal financial officer, of the effectiveness of the design and operation of our disclosure controls and procedures as defined in Rule 13a-15(e) and Rule 15d-15(e) under the Securities Exchange Act of 1934, as amended. Based on this evaluation, our principal executive officer and principal financial officer concluded that our disclosure controls and procedures are effective in timely alerting them to material information required to be included in our periodic SEC reports. There has been no change in the Corporation’s internal control over financial reporting during the fiscal quarter covered by this quarterly report that has materially affected, or is reasonably likely to materially affect, the Corporation’s internal control over financial reporting.

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PART II. - OTHER INFORMATION

The following report on form 8-K was filed by the Corporation during the quarterly period covered by this Form 10-Q:

On July 23, 2003, the Corporation furnished on Form 8-K under Item 7(a), Item 9 and Item 12 a press release announcing the financial results of the Corporation for the quarter ended June 30, 2003.

On September 3, 2003, the Corporation furnished on Form 8-K under Item 7(c) and Item 9 a press release announcing the payment of a $.14 per share dividend of the Corporation for the third quarter of 2003.

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SIGNATURES

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

CITIZENS HOLDING COMPANY