Flag Financial First Quarter 10-Q
 
 

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended March 31, 2005

OR

[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Transition Period from _____ to ______

Commission file number 0-24532
 
 
 
FLAG FINANCIAL CORPORATION
(Exact name of registrant as specified in its charter)


 Georgia
58-2094179 
(State of incorporation)
(I.R.S. Employer Identification No.)
 


3475 Piedmont Road N.E. Suite 550
Atlanta, Georgia 30305
(Address of principal executive offices)

(404) 760-7700
(Registrant’s Telephone Number)

_______________
 
Indicate by check mark whether the registrant has (1) 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 o

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


Common stock, par value $1 per share: 8,531,086 shares outstanding as of May 6, 2005





Flag Financial Corporation and Subsidiary
   
Table of Contents
 
 
Page
 
   
 
   
 
December 31, 2004 (audited) and March 31, 2004 (unaudited)
3
   
 
Quarters Ended March 31, 2005 and 2004 (unaudited)
4
   
 
Quarters Ended March 31, 2005 and 2004 (unaudited)
5
   
 
Quarters Ended March 31, 2005 and 2004 (unaudited)
6
   
7
   
 
and Results of Operations
10
   
19
 
19
   
 
 
   
20
   
 
   
20
   
20
   
20
   
20
   




Part I.   Financial Information
 
Item 1.   Financial Statements

FLAG FINANCIAL CORPORATION AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
 
 
   
March 31,  
   
December 31,
   
March 31,
 
     
2005
   
2004
   
2004
 
   
(Unaudited) 
   
(Audited)
 
 
(Unaudited)
 
                     
Assets
                     
Cash and due from banks
 
$
17,748
 
$
13,345
 
$
14,519
 
Federal funds sold
   
27,990
   
13,574
   
-
 
Other interest-bearing deposits in banks
   
13,564
   
13,397
   
12,329
 
Total cash and cash equivalents
   
59,302
   
40,316
   
26,848
 
Other interest-bearing deposits in banks
   
5,386
   
5,473
   
2,576
 
Investment securities available-for-sale
   
98,027
   
111,390
   
120,815
 
Other investments
   
13,403
   
13,161
   
14,694
 
Mortgage loans held-for-sale
   
7,271
   
10,688
   
4,998
 
Loans, net
   
606,253
   
596,101
   
470,986
 
Premises and equipment, net
   
13,657
   
14,458
   
14,477
 
Other assets
   
37,116
   
36,750
   
29,429
 
Total assets
 
$
840,415
 
$
828,337
 
$
684,823
 
     
         
 
Liabilities and Stockholders’ Equity
                     
Deposits:
                   
Noninterest-bearing deposits
 
$
53,122
 
$
48,812
 
$
42,499
 
Interest-bearing demand deposits
   
331,261
   
347,940
   
280,079
 
Savings
   
22,132
   
20,940
   
22,371
 
Time
   
306,845
   
289,155
   
203,518
 
Total deposits
   
713,360
   
706,847
   
548,467
 
Advances from Federal Home Loan Bank
   
25,000
   
25,000
   
53,000
 
Federal funds purchased and repurchase agreements
   
2,166
   
2,295
   
9,362
 
Other borrowings
   
4,500
   
4,300
   
1,600
 
Junior subordinated debentures
   
14,433
   
14,433
   
-
 
Other liabilities
   
10,659
   
6,260
   
5,771
 
Total liabilities
   
770,118
   
759,135
   
618,200
 
                     
Preferred stock (10,000,000 shares authorized, none
                   
issued and outstanding)
   
-
   
-
   
-
 
Common stock ($1 par value, 20,000,000 shares authorized,
                   
10,079,647, 10,053,572 and 9,775,099 shares issued at
                   
March 31, 2005, December 31, 2004 and
                   
March 31, 2004, respectively)
   
10,080
   
10,054
   
9,775
 
Additional paid-in capital
   
28,152
   
27,954
   
24,557
 
Retained earnings
   
45,958
   
44,642
   
40,878
 
Accumulated other comprehensive (loss) income
   
(389
)
 
56
   
990
 
Less: Treasury stock at cost; 1,551,186 shares at March 31, 2005 and
December 31, 2004 and 1,246,961 shares at March 31, 2004
   
(13,504
)
 
(13,504
)
 
(9,577
)
Total stockholders' equity
   
70,297
   
69,202
   
66,623
 
Total liabilities and stockholders’ equity
 
$
840,415
 
$
828,337
 
$
684,823
 
 
See accompanying notes to consolidated financial statements


 
FLAG FINANCIAL CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF EARNINGS
(in thousands, except per share data)
       
   
Three Months Ended
 
   
March 31,
 
   
2005
 
2004
 
   
(Unaudited)
 
Interest income:
             
Interest and fees on loans
 
$
11,411
 
$
8,119
 
Interest on investment securities
   
1,075
   
1,455
 
Interest on federal funds sold and other interest-bearing deposits
   
301
   
100
 
Total interest income
   
12,787
   
9,674
 
Interest expense:
             
Interest on deposits:
             
Demand
   
1,662
   
1,050
 
Savings
   
31
   
34
 
Time
   
2,131
   
1,238
 
Interest on other borrowings
   
384
   
219
 
Total interest expense
   
4,208
   
2,541
 
Net interest income before provision for loan losses
   
8,579
   
7,133
 
Provision for loan losses
   
375
   
720
 
Net interest income after provision for loan losses
   
8,204
   
6,413
 
Noninterest income:
             
Service charges on deposit accounts
   
749
   
892
 
Mortgage banking activities
   
580
   
530
 
Insurance commissions and brokerage fees
   
74
   
113
 
Gain on sale of branch
   
-
   
3,000
 
Gain on sales of investment securities available-for-sale
   
123
   
7
 
Gain (loss) on sales of other real estate owned
   
91
   
(3
)
Other
   
985
   
153
 
Total noninterest income
   
2,602
   
4,692
 
Noninterest expense:
             
Salaries and employee benefits
   
4,993
   
4,790
 
Occupancy
   
956
   
910
 
Professional fees
   
549
   
300
 
Postage, printing and supplies
   
246
   
235
 
Communications
   
513
   
584
 
Other
   
860
   
1,169
 
Total noninterest expense
   
8,117
   
7,988
 
               
Earnings before provision for income taxes
   
2,689
   
3,117
 
Provision for income taxes
   
862
   
1,021
 
Net earnings
 
$
1,827
 
$
2,096
 
               
Basic earnings per share
 
$
0.21
 
$
0.25
 
               
Diluted earnings per share
 
$
0.20
 
$
0.23
 
 
See accompanying notes to consolidated financial statements
 

 
FLAG FINANCIAL CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(in thousands)
       
   
Three Months Ended
 
     March 31,  
   
2005
 
2004
 
   
(Unaudited)
 
           
Net earnings
 
$
1,827
 
$
2,096
 
Other comprehensive loss, net of tax:
             
Unrealized losses on investment
             
securities available-for-sale:
             
Unrealized losses arising during the period,
             
net of tax of $225 and $133, respectively
   
(369
)
 
(217
)
Less: Reclassification adjustment for gains included in
             
net earnings, net of tax of $47 and $2, respectively
   
(76
)
 
(5
)
               
Other comprehensive loss
   
(445
)
 
(222
)
               
Comprehensive income
 
$
1,382
 
$
1,874
 
               
 
See accompanying notes to consolidated financial statements 


 

 
FLAG FINANCIAL CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASHFLOW
(in thousands)
       
   
Three Months Ended
 
   
March 31,
 
   
2005
 
2004
 
   
(Unaudited)
 
       
Cash flows from operating activities:
             
Net earnings
 
$
1,827
 
$
2,096
 
Adjustment to reconcile net earnings to net
             
cash provided by operating activities:
             
Depreciation, amortization and accretion
   
594
   
864
 
Provision for loan losses
   
375
   
720
 
Gain on sale of branch office
   
-
   
(3,000
)
Gain on sales of investment securities available-for-sale
   
(123
)
 
(7
)
Gain on sales of loans
   
(362
)
 
(336
)
(Gain) loss on disposals of premises and equipment
   
(25
)
 
25
 
(Gain) loss on sales of other real estate owned
   
(91
)
 
3
 
Change in:
             
Mortgage loans held-for-sale
   
3,779
   
(427
)
Other assets and liabilities
   
4,166
   
521
 
Net cash provided by operating activities
   
10,140
   
459
 
               
Cash flows from investing activities (net of effect of branch sale):
             
    Cash paid in branch sale
   
-
   
(14,141
)
Net change in other interest-bearing deposits
   
87
   
99
 
Proceeds from sales, calls and maturities of investment
             
securities available-for-sale
   
63,195
   
18,346
 
Purchases of investment securities available-for-sale
   
(50,586
)
 
(17,306
)
Purchases of other investments
   
(242
)
 
-
 
    Proceeds from sale of other investments
   
-
   
250
 
Net change in loans
   
(10,527
)
 
(11,301
)
Proceeds from sales of other real estate owned
   
265
   
11
 
Proceeds from sales of premises and equipment
   
881
   
1
 
Purchases of premises and equipment
   
(466
)
 
(175
)
Purchases of cash surrender value life insurance
   
(50
)
 
(37
)
Net cash provided by (used in) investing activities
   
2,557
   
(24,253
)
               
Cash flows from financing activities:
             
Net change in deposits
   
6,513
   
13,652
 
Change in federal funds purchased and repurchase agreements
   
(129
)
 
5,264
 
Change in other borrowings
   
200
   
500
 
Payments of FHLB advances
   
-
   
(5,000
)
Proceeds from exercise of stock options
   
223
   
-
 
Cash dividends paid
   
(518
)
 
(512
)
Net cash provided by financing activities
   
6,289
   
13,904
 
               
Net change in cash and cash equivalents
   
18,986
   
(9,890
)
Cash and cash equivalents at beginning of period
   
40,316
   
36,738
 
               
Cash and cash equivalents at end of period
 
$
59,302
 
$
26,848
 
 
See accompanying notes to consolidated financial statements

 


Flag Financial Corporation and Subsidiary
Notes to Consolidated Financial Statements

      The accompanying consolidated financial statements have not been audited. The results of operations are not necessarily indicative of the results of operations for the full year or any other interim periods.

Note 1.    Basis of Presentation
 
        The consolidated financial statements include the accounts of Flag Financial Corporation (“Flag” or the “Company”) and its wholly owned subsidiary, Flag Bank (the “Bank”). All significant intercompany accounts and transactions have been eliminated in consolidation.

The consolidated financial information furnished herein represents all adjustments that are, in the opinion of management, necessary to present a fair statement of the results of operations, and financial position for the periods covered herein and are normal and recurring in nature. For further information, refer to the consolidated financial statements and related notes included in Flag’s annual report on Form 10-K for the year ended December 31, 2004.

Note 2.    Recent Accounting Pronouncements

As permitted by SFAS No. 123, Accounting for Stock-Based Compensation, Flag currently accounts for share-based payments to employees using APB opinion No. 25’s intrinsic value method and, as such, generally recognizes no compensation expense for employee stock options. The impact of adoption of SFAS No. 123(R) cannot be predicted at this time because it will depend on levels of share-based payments granted in the future. However, had we adopted SFAS No.123(R) in prior periods, the impact of that standard would have approximated the impact of SFAS No. 123 as described in the disclosure of pro forma net income earnings per share in Note 4 to our consolidated financial statements. SFAS No. 123(R) also requires the benefits of tax deductions in excess of recognized compensation cost to be reported as a financing cash flow, rather than as an operating cash flow as required under current literature. This requirement will reduce net operating cash flows and increase net financing cash flows in the periods after adoption. While the company cannot estimate what those amounts will be in the future (because they depend on, among other things, when employees exercise stock options), the amount of operating cash flows recognized in prior periods for such excess tax deductions were insignificant. SFAS No. 123(R) is effective as of the beginning of the first interim or annual reporting period that begins after June 15, 2005. On April 14, 2005, the Securities and Exchange Commission (the “SEC”) announced a new rule that amends the compliance dates for SFAS No. 123(R). The SEC’s new rule allows companies to implement SFAS No. 123(R) at the beginning of their next fiscal year, instead of the next reporting period, that begins after June 15, 2005. Flag will adopt the standard in the first quarter of 2006.

Note 3.    Net Earnings Per Common Share

Net earnings per common share are based on the weighted average number of common shares outstanding during each period. The calculation of basic and diluted earnings per share is as follows (in thousands, except per share amounts):

   
Three Months Ended
March 31,
 
   
2005
 
2004
 
           
Basic earnings per share:
         
           
    Net earnings
 
$
1,827
 
$
2,096
 
               
    Weighted average common shares outstanding
   
8,515
   
8,528
 
               
    Basic earnings per share
 
$
0.21
 
$
0.25
 
               
Diluted earnings per share:
             
               
    Net earnings
 
$
1,827
 
$
2,096
 
               
    Effect of dilutive stock options and warrants
   
753
   
566
 
               
    Diluted earnings per share
 
$
0.20
 
$
0.23
 


 


Flag Financial Corporation and Subsidiary
Notes to Consolidated Financial Statements
 
Note 4.    Stock-based Compensation

Flag currently accounts for stock-based compensation to employees and non-employee members of the Board under the recognition and measurement principles of APB Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations. No stock-based employee compensation cost is reflected in net earnings, as all options granted under those plans had an exercise price equal to the market value of the underlying common stock on the date of grant.

The following table illustrates the effect on net earnings and earnings per share if Flag had applied the fair value recognition provisions of SFAS No. 123, Accounting for Stock-Based Compensation, to stock-based employee compensation (in thousands, except per share amounts):
 
   
Three Months Ended
 
   
March 31,
 
   
2005
 
2004
 
Net earnings as reported
 
$
1,827
 
$
2,096
 
Deduct: Total stock-based employee compensation
    expense determined under fair-value based method
    for all awards, net of tax
   
(44
)
 
(28
)
Pro forma net earnings
 
$
1,783
 
$
2,068
 
               
Basic earnings per share:
             
    As reported
 
$
0.21
 
$
0.25
 
    Pro forma
   
0.21
   
0.24
 
               
Diluted earnings per share:
             
    As reported
 
$
0.20
 
$
0.23
 
    Pro forma
   
0.19
   
0.23
 

During the first three months of 2005, Flag issued 70,000 options with a weighted average grant date fair value of $3.92 each. The fair value of each option was estimated on the date of grant using the Black-Scholes options-pricing model with the following weighted average assumptions: dividend yield of 1.80%, volatility of 0.2225, risk free interest rate of 4.24% and an expected life of 7 years.

Note 5.     Loans

Flag engages in a full complement of lending activities, including permanent residential mortgage loans, permanent residential construction loans, commercial mortgage loans, commercial business loans, financial loans and consumer installment loans. Flag generally concentrates lending efforts on real estate related loans. As of March 31, 2005, Flag’s loan portfolio consisted of 58.7% real estate mortgage loans, including 1-4 family residential loans, multi-family loans and commercial real estate loans, 29.1% real estate construction loans, 9.6% commercial and financial loans, and 2.6% consumer installment loans. While risk of loss is primarily tied to the credit quality of the various borrowers, risk of loss may also increase due to factors beyond Flag’s control, such as local, regional and/or national economic downturns. General conditions in the real estate market may also impact the relative risk in the real estate portfolio. Of the target areas of lending activities, commercial and financial loans are generally considered to have a greater risk of loss than real estate loans or consumer installment loans.

 


Flag Financial Corporation and Subsidiary
Notes to Consolidated Financial Statements
 
Note 5.     Loans (continued)

Loans are reported at outstanding unpaid balances and unamortized premiums or discounts on purchased loans. Balances within the major loans receivable categories are represented in the following table (in thousands):


 
March 31,
% of
December 31,
% of
March 31,
% of
 
2005
Total Loans
2004
Total Loans
2004
Total Loans
             
Commercial/financial/agricultural
$ 59,183
9.6%
$ 57,231
9.5%
$ 50,900
10.7%
Real estate - construction
178,892
29.1%
176,111
29.1%
121,051
25.3%
Real estate - mortgage
360,939
58.7%
355,575
58.8%
291,211
60.9%
Installment loans to individuals
16,083
2.6%
15,644
2.6%
14,582
3.1%
Lease financings
18
-
142
-
294
-
Total loans
615,115
100.0%
604,703
100.0%
478,038
100.0%
 
Less: Allowance for loan losses
8,862
 
8,602
 
7,052
 
Total net loans
$606,253
 
$596,101
 
$470,986
 

Note 6.     Stock Repurchase Program

In March 2004, Flag’s Board of Directors authorized a stock repurchase program covering an amount equal to 10% of the outstanding shares of Flag’s common stock. As of March 31, 2005, the Company has repurchased approximately 304,000 shares of the approximately 853,000 shares authorized to be purchased, at an average price of $12.91. See Item 2. “Changes in Securities” for additional information about Flag’s share repurchases.



 

 
 
Flag Financial Corporation and Subsidiary
Item 2.   Management's Discussion and Analysis of Financial Condition
        
       The Company’s net income for the quarter ended March 31, 2005, was $1.8 million, or $0.20 per diluted share, compared with net income of $2.1 million, or $0.23 per diluted share, for the same quarter last year. Net interest income grew 20.3% to $8.6 million during the first quarter of 2005 compared to $7.1 million in the first quarter of 2004. This improvement in net interest income over the first quarter of 2004 resulted from a 24.3% growth in average loans outstanding as well as an increase in Flag’s yield on loans of 95 basis points to 7.67% from 6.72%. Growth in loans outstanding comes as Flag continues to develop a stronger presence in metro Atlanta and through its Atlanta based lending lines of business.

Nonperforming assets were 0.80% percent of total assets at March 31, 2005, compared to 0.99% at March 31, 2004. Net charge-offs were 0.08% of average loans outstanding for the quarter ended March 31, 2005, compared to 0.29% for the quarter ended March 31, 2004. The allowance for loan losses at March 31, 2005 was 1.44% of total loans outstanding, compared to 1.42% at December 31, 2004 and 1.48% at March 31, 2004.

During the first quarter of 2004, Flag sold its Thomaston, Georgia, branch to another Georgia based bank. Flag recorded an after-tax gain of approximately $1.47 million, which included $635,000 in expenses related directly to the sale of the branch. Included in the sale was approximately $1.7 million of premises and equipment, $16.7 million in loans and $35.8 million in deposits.

Forward-Looking Statements
     
      The following discussion and comments contain "forward-looking statements" relating to, without limitation, future economic performance, plans and objectives of management for future operations, and projections of revenues and other financial items that are based on the beliefs of our management, as well as assumptions made by and information currently available to our management. The words “expect”, “estimate”, “anticipate”, and “believe”, as well as similar expressions, are intended to identify forward-looking statements. Our actual results may differ materially from the results discussed in the forward-looking statements, and our operating performance each quarter is subject to various risks and uncertainties. Factors that could cause actual results to differ from those discussed in the forward-looking statements include, but are not limited to, (i) the strength of the U.S. economy as well as the strength of the local economies in which operations are conducted; (ii) the effects of changing interest rates which could lower margins; (iii) inflation, interest rate, market and monetary fluctuations; (iv) unanticipated regulatory proceedings or legal actions, or changes in accounting policies and practices as adopted by the Financial Accounting Standards Board; (v) issues involved in the integration of acquisitions; and (vi) the timely development of products and services that position Flag to succeed in an increasingly competitive industry. If we are unsuccessful in managing the risks relating to these factors, together with other risks incident to the operation of our business, our financial condition, results of operations and cash flows could be adversely affected. Forward-looking statements speak only as of the date on which they are made. We undertake no obligation to update any forward-looking statement to reflect events or circumstances after the date on which the statement is made to reflect the occurrence of unanticipated events.

Critical Accounting Policies

The accounting principles we follow and our methods of applying these principles conform with accounting principles generally accepted in the United States and with general practices within the banking industry. In connection with the application of those principles, we have made judgments, estimates and assumptions which, in the case of the determining our allowance for loan losses (ALL), have been critical to the determination of our financial position and results of operations. Management assesses the adequacy of the ALL regularly during the year, and formally prior to the end of each calendar quarter. This assessment includes procedures to estimate the allowance and test the adequacy and appropriateness of the resulting balance.

This estimation process can affect our estimated loan loss expense for a given period. Generally, the allowance for loan losses increases as the outstanding balance of loans or the level of classified or impaired loans increases. Loans or portions of loans that are deemed uncollectible are charged against and reduce the allowance. The allowance is replenished by means of a provision for loan losses that is charged as an expense. As a result, our estimate of the allowance for loan losses affects our earnings directly.

 

 
Flag Financial Corporation and Subsidiary
Management's Discussion and Analysis of Financial Condition
 
The ALL consists of two portions (1) allocated amounts representing the potential exposures on specifically identified credits and other exposures readily predictable by historical or comparative experience; and (2) an unallocated amount representative of inherent loss which is not readily identifiable. Even though the ALL is composed of two components, the entire ALL is available to absorb any credit losses. Allocated amounts are used on loans where management has determined that there is an increased probability or severity of loss than on the loan portfolio as a whole. We base the allocation for these unique loans primarily on risk rating grades assigned to each of these loans as a result of our loan management and review processes. We then assign each risk-rating grade a loss ratio, which is determined based on the experience of management, discussions with banking regulators and our independent loan review process. We estimate losses on impaired loans based on estimated cash flows discounted at the loan's original effective interest rate or based on the underlying collateral value. To the extent that management does not believe that a certain loan's risk is appropriately represented by the risk rating grades, a specific review of the credit is performed which would result in a specific allocation for that particular loan.

Unallocated amounts are particularly subjective and do not lend themselves to exact mathematical calculation. The unallocated amount represents estimated inherent credit losses which may exist, but have not yet been identified, as of the balance sheet date. In estimating the unallocated amount, we consider such matters as changes in the local or national economy, the depth or experience in the lending staff, any concentrations of credit in any particular industry group, and new banking laws or regulations. After we assess applicable factors, we evaluate the aggregate unallocated amount based on our management's experience. We then test the resulting ALL balance by comparing the balance in the ALL to historical trends and peer information. Our management then evaluates the result of the procedures performed, including the result of our testing, and concludes on the appropriateness of the balance of the ALL in its entirety.

The audit committee of our board of directors reviews the assessment prior to the filing of quarterly and annual financial information. In assessing the adequacy of the ALL, we also rely on an ongoing independent loan review process. We undertake this process both to ascertain whether there are loans in the portfolio whose credit quality has weakened over time and to assist in our overall evaluation of the risk characteristics of the entire loan portfolio. Our loan review process includes the judgment of management, input from our independent loan reviewer, and reviews that may have been conducted by bank regulatory agencies as part of their usual examination process.

See "Provision and Allowance for Loan Losses" for additional information.


 

 
Flag Financial Corporation and Subsidiary
Management's Discussion and Analysis of Financial Condition
 
Summary Financial Data

The following table presents summary financial data for the previous five quarters (in thousands, except per share data):
 
   
          2005
 
2004
 
(unaudited)
 
First Quarter
 
Fourth Quarter
 
Third Quarter
 
Second Quarter
 
First Quarter
 
INCOME SUMMARY
                     
Interest income
 
$
12,787
 
$
12,063
 
$
10,813
 
$
10,071
 
$
9,674
 
Interest expense
   
4,208
   
3,639
   
3,165
   
2,712
   
2,541
 
Net interest income
   
8,579
   
8,424
   
7,648
   
7,359
   
7,133
 
Provision for loan losses
   
375
   
375
   
375
   
375
   
720
 
Noninterest income
   
2,602
   
1,931
   
2,254
   
2,591
   
4,692
 
Noninterest expense
   
8,117
   
7,490
   
7,297
   
6,734
   
7,988
 
Earnings before taxes
   
2,689
   
2,490
   
2,230
   
2,841
   
3,117
 
Income taxes
   
862
   
798
   
571
   
920
   
1,021
 
Net earnings
   $
1,827
   $
1,692
   $
1,659
   $
1,921
   $
2,096
 
                                 
PERFORMANCE RATIOS 
               
         
 
Earnings per common share:
                               
    Basic
 
$
0.21
 
$
0.20
 
$
0.20
 
$
0.23
 
$
0.25
 
    Diluted 
   
0.20
   
0.19
   
0.19
   
0.21
   
0.23
 
Cash dividends declared
   
0.06
   
0.06
   
0.06
   
0.06
   
0.06
 
Return on average equity
   
10.49
%
 
10.25
%
 
10.21
%
 
11.59
%
 
12.68
%
Return on average assets
   
0.88
%
 
0.86
%
 
0.87
%
 
1.07
%
 
1.19
%
Net interest margin
   
4.50
%
 
4.57
%
 
4.28
%
 
4.46
%
 
4.40
%
Yield on earning assets
   
6.71
%
 
6.54
%
 
6.05
%
 
6.11
%
 
5.96
%
Cost of funds
   
2.26
%
 
2.02
%
 
1.98
%
 
1.73
%
 
1.59
%
Efficiency ratio
   
71.83
%
 
72.66
%
 
74.00
%
 
67.39
%
 
67.33
%
Net overhead ratio
   
2.66
%
 
2.83
%
 
2.64
%
 
2.32
%
 
1.87
%
Dividend payout ratio 
   
27.97
%
 
30.14
%
 
29.90
%
 
26.63
%
 
24.42
%
                                 
ASSET QUALITY
                               
Allowance for loan losses
 
$
8,862
 
$
8,602
 
$
8,328
 
$
7,489
 
$
7,052
 
Nonperforming assets
   
6,740
   
5,310
   
5,907
   
5,853
   
6,786
 
Allowance for loan losses to loans
   
1.44
%
 
1.42
%
 
1.41
%
 
1.41
%
 
1.48
%
Nonperforming assets to total assets
   
0.80
%
 
0.64
%
 
0.74
%
 
0.78
%
 
0.99
%
Net charge-offs to average loans
   
0.08
%
 
0.07
%
 
(0.04
)%
 
(0.05
)%
 
0.29
%
                                 
AVERAGE BALANCES
                               
  Loans
 
$
603,412
 
$
590,355
 
$
566,691
 
$
503,045
 
$
485,528
 
  Earning assets
   
772,409
   
733,709
   
710,765
   
663,258
   
652,312
 
  Total assets
   
830,013
   
786,976
   
762,679
   
715,212
   
706,763
 
  Deposits
   
707,934
   
670,725
   
629,221
   
572,871
   
577,212
 
  Stockholders’ equity
   
69,657
   
66,016
   
65,003
   
66,311
   
66,093
 
  Common shares outstanding:
                               
    Basic
   
8,515
   
8,337
   
8,263
   
8,457
   
8,528
 
    Diluted
   
9,268
   
8,993
   
8,856
   
8,991
   
9,094
 
                                 
AT PERIOD END
                               
  Loans
 
$
615,115
 
$
604,703
 
$
590,374
 
$
530,338
 
$
478,038
 
  Earning assets
   
780,756
   
772,387
   
741,162
   
693,613
   
633,450
 
  Total assets
   
840,415
   
828,337
   
793,038
   
749,371
   
684,823
 
  Deposits
   
713,360
   
706,847
   
663,317
   
610,636
   
548,467
 
  Stockholders’ equity
   
70,297
   
69,202
   
65,038
   
64,392
   
66,623
 
  Common shares outstanding
   
8,528
   
8,503
   
8,260
   
8,333
   
8,528
 


 

 
Flag Financial Corporation and Subsidiary
Management’s Discussion and Analysis of Financial Condition
 
Overview of Financial Condition

Total assets were $840.4 million at March 31, 2005, an increase of $12.1 million or 1.5%, from $828.3 million at December 31, 2004. Earning assets (consisting of loans, investment securities and short-term investments) totaled $780.8 million or 92.9% of total assets at March 31, 2005, compared to $772.4 million or 93.2% of total assets at December 31, 2004. During the same period, stockholders’ equity increased $1.1 million or 1.6% to $70.3 million at March 31, 2005.

Loans

Gross loans outstanding at March 31, 2005, totaled $615.1 million, an increase of $10.4 million or 1.7%, from $604.7 million at December 31, 2004. Mortgage loans held-for-sale decreased to $7.3 million at March 31, 2005 from $10.7 million at December 31, 2004. Loans outstanding, including mortgage loans held-for-sale, comprised 79.7% of earning assets at March 31, 2005 and December 31, 2004. Flag concentrates its lending activities in several areas that management believes provides adequate diversification with acceptable yield and risk levels. These areas include, but are not limited to construction, commercial real estate, agricultural and correspondent lending (lending services to other community banks). For more information see Note 5 to the Notes to Consolidated Financial Statements and Management’s Discussion and Analysis of Financial Condition and Results of Operations - Provision and Allowance for Loan Losses.
 
Investment Securities

Investment securities at March 31, 2005, totaled $111.4 million, a decrease of $13.1 million or 10.5%, from $124.5 million at December 31, 2004. Investment securities comprised 14.3% and 16.1% of earning assets at March 31, 2005 and December 31, 2004, respectively.

Federal Funds Sold and Other Interest-Bearing Deposits

Short-term investments (federal funds sold and other interest-bearing deposits) totaled $41.6 million at March 31, 2005, an increase of $14.6 million or 54.1%, from the December 31, 2004 level of $27.0 million. Historically, Flag has maintained lower levels of short-term investments, choosing instead to invest more heavily in loans and investment securities. Short-term investments amounted to 5.3% of earning assets at March 31, 2005 and 3.5% of earning assets at December 31, 2004.

Premises and Equipment

Premises and equipment at March 31, 2005, totaled $13.7 million, a decrease of $801,000 or 5.5%, from $14.5 million at December 31, 2004. During the first quarter of 2005, Flag sold one of its banking centers with a net book value of $828,000 and recognized a pre-tax gain of $36,000. Flag maintains a branch location in the center under a lease agreement with the buyer.

Deposits and Other Funding

Total deposits at March 31, 2005, were $713.3 million, an increase of $6.5 million or 0.9%, from $706.8 million at December 31, 2004. Core deposits offer the Bank a lower cost source of funds. Core deposits (noninterest-bearing demand deposits, interest-bearing demand deposits, and savings) were $406.5 million at March 31, 2005, compared to $417.7 million at December 31, 2004. Core deposits comprise 57.0% of the total deposit base at March 31, 2005 versus 59.1% at December 31, 2004. Total time deposits amounted to $306.8 million at March 31, 2005, compared to $289.2 million at December 31, 2004. Customer deposits represented 93.9% of total funding at March 31, 2005 and December 31, 2004.

Federal funds purchased and other borrowings of $6.7 million at March 31, 2005 remained steady compared to $6.6 million at December 31, 2004.

Advances from the Federal Home Loan Bank
 
       Advances from the Federal Home Loan Bank (“FHLB”) remained unchanged at $25.0 million at March 31, 2005 and December 31, 2004. Borrowings from the FHLB decreased during the last year as a result of Flag’s successful implementation of its deposit sales program.

 

 
Flag Financial Corporation and Subsidiary
Management’s Discussion and Analysis of Financial Condition
 
Liquidity

Liquidity management involves Flag’s ability to maintain adequate short-term assets to meet the cash flow expectations of depositors and other lending institutions, and to provide funds for the growth in earning assets. Liquidity is managed daily by understanding the cash flow expectations of depositors and other lending institutions and maintaining enough liquid assets to meet these expectations. As of March 31, 2005, Flag had $384.4 million of deposits due on demand, $22.1 million in savings deposits and $209.9 million of time deposits and other borrowings due within one year. Potential liquidity needs of these liabilities are met with liquid assets (assets that can be easily converted to cash). Liquid assets at March 31, 2005, totaled $108.3 million and included cash and due from banks, federal funds sold and other interest-bearing deposits, unpledged investment securities available-for-sale and mortgage loans held-for-sale. In addition to using liquid assets to meet potential liquidity needs, Flag maintains available lines of credit with other financial institutions. These include federal funds and other lines of credit totaling $46 million and a line of credit with the FHLB totaling $95 million. Flag also maintains a line of credit with the Federal Reserve Bank of Atlanta totaling $125 million. At March 31, 2005, $29.5 million of the available $266 million in total lines was advanced to Flag.

Off Balance Sheet Arrangements

Flag is a party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments consist of commitments to extend credit and standby letters of credit. Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Standby letters of credit are written conditional commitments issued by the Bank to guarantee the performance of a customer to a third party. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. A commitment involves, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the balance sheets. Flag’s exposure to credit loss in the event of non-performance by the other party to the instrument is represented by the contractual notional amount of the instrument.
 
       Since certain commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. Flag uses the same credit policies in making commitments to extend credit as they do for on-balance-sheet instruments. Collateral held for commitments to extend credit varies but may include accounts receivable, inventory, property, plant, equipment, and income-producing commercial properties.
 
       The following table summarizes Flag’s off-balance-sheet financial instruments whose contract amounts represent credit risk as of March 31, 2005 and December 31, 2004 (in thousands):
 
 
2005
2004
Commitments to extend credit
$176,465
$142,036
Standby letters of credit
$ 3,242
$ 3,650

Market Risk Sensitivity 
 
        Market rate sensitivity is the tendency for changes in the interest rate environment to be reflected in Flag’s net interest income and results of operations. Flag, through its asset and liability management program, seeks to balance maturities and rates on earning assets and the corresponding funding such that interest rate fluctuations have a minimal impact on earnings and the value of Flag’s equity.

Historically, the average term to maturity or repricing (rate changes) of assets (primarily loans and investment securities) has exceeded the average repricing period of liabilities (primarily deposits and borrowings). Flag’s primary source of funding has been demand deposits (interest-bearing and noninterest-bearing) instead of time deposits and wholesale borrowings with longer maturities. This method of funding earning assets has issues concerning interest rate risk, liquidity and profitability, all of which were contemplated and measured by the Company. Flag concluded that this strategy is the most profitable method of funding growth in earning assets of the Company for the foreseeable future and has committed significant sales, marketing and training resources at being successful in this effort. Where interest rate risk is concerned, Flag considered factors such as account size, relationship strength and historical rate levels needed to remain competitive. Generally speaking, it is the opinion of management that these deposits are less sensitive to rate movements than the earning assets they are funding. Flag uses an interest rate simulation model that uses management assumptions and theories regarding rate movements and the impact each movement will have on individual components of the balance sheet. As of March 31, 2005, Flag’s simulation model shows that Flag’ balance sheet is, in fact, asset-sensitive, meaning a rising rate environment would have a positive impact on Flag’s net interest income.

 

 
Flag Financial Corporation and Subsidiary
Management’s Discussion and Analysis of Financial Condition
 
       Management carefully measures and monitors market rate sensitivity and believes that its operating strategies offer protection against interest rate risk. As required by various regulatory authorities, Flag’s Board of Directors established an interest rate risk policy, which sets specific limits on interest rate risk exposure. Adherence to this policy is reviewed by Flag's executive committee and presented at least annually to the Board of Directors.

Flag’s management from time to time uses certain derivative instruments in an effort to add stability to the Company’s net interest income and manage exposure to changing interest rates. Guidance for using these instruments is found in SFAS No. 149, Amendment of Statement 133 on Derivative Instruments and Hedging Activities. Under the terms of this statement, all derivatives are classified as either fair value hedges (those designed to hedge the fair market value of asset or liabilities affected by changing interest rates) or cash flow hedges (those designed to mitigate exposure to variability in expected future cash flows due to changing interest rates).

At March 31, 2005, the Company had three derivative instruments designated as cash flow hedges. No fair value hedges were outstanding. The following table summarizes the outstanding derivative instruments (in thousands).

Type
Transaction
Date
Term
Date
Notional
Receive
Rate
Pay
Rate
Current
Spread
Fair
Value
Receive Fixed, Pay LIBOR Swap
June 2004
Dec 2005
$ 5,000
2.68%
2.86%
(0.18)%
$ (35)
Receive Fixed, Pay LIBOR Swap
June 2004
June 2006
15,000
3.00%
2.86%
0.14%
(168)
Receive Fixed, Pay LIBOR Swap
June 2004
Dec 2006
5,000
3.27%
2.86%
0.41%
(72)
Total Received Fixed Swaps
   
$25,000
2.99%
2.86%
0.13%
$(275)

For the first quarter of March 31, 2005, there was no material amount recognized which represented the ineffective portion of cash flow hedges. All components of each derivative’s gain or loss are included in the assessment of hedge effectiveness, unless otherwise noted.

Capital

At March 31, 2005, the capital ratios of Flag and the Bank were adequate compared to the minimum regulatory capital requirements. Minimum regulatory capital levels for banks and holding companies require Tier 1 capital (core capital accounts less intangible assets) to risk-weighted assets of at least 4%, total capital (Tier 1 capital plus a portion of the allowance for loan losses) to risk-weighted assets of 8%, and Tier 1 capital to average assets of at least 4%.

On April 15, 2004, the Company closed a private offering of 14,000 floating rate Capital Securities offered and sold by Flag Financial Corporation Statutory Trust (the “Trust”) having a liquidation amount of $1,000 each. The proceeds from such issuances, together with the proceeds of the related issuance of common securities of the Trust purchased by the Company in the amount of $433,000, were invested in floating rate Junior Subordinated Debentures (the “Debentures”) of the Company totaling $14.4 million. The sole assets of the Trust are the Debentures. The Debentures are unsecured and rank junior to all senior debt of the Company. The Company owns all of the common securities of the Trust. For the quarter ended March 31, 2005, the floating rate securities had a 5.31% interest rate, which will reset quarterly at the three-month LIBOR rate plus 2.75%.

 


Flag Financial Corporation and Subsidiary
Management’s Discussion and Analysis of Financial Condition
 
In March 2004, Flag’s Board of Directors authorized a stock repurchase program covering an amount equal to 10% of the outstanding shares of Flag’s common stock. As of March 31, 2005, the Company has repurchased approximately 304,000 shares of the approximately 853,000 shares authorized to be purchased, at an average price of $12.91. See Item 2. “Changes in Securities” for additional information about Flag’s share repurchases.

The following table reflects Flag’s capital position with respect to the regulatory minimums as of March 31, 2005:
 

 
Actual
   
Required
   
Excess
 
 
Amount
%
 
Amount
%
 
Amount
%
                 
Total Capital (to Risk Weighted Assets)
$70,297
11.46%
 
$55,520
8.00%
 
$ 14,777
3.46%
Tier 1 Capital (to Risk Weighted Assets)
63,695
10.20%
 
27,760
4.00%
 
35,935
6.20%
Tier 1 Capital (to Average Assets)
63,695
7.87%
 
21,355
4.00%
 
42,340
3.87%
 
Provision and Allowance for Loan Losses

The allowance for loan losses is established through provisions for loan losses charged to expense. Loans are charged against the allowance for loan losses when management believes that the collection of the principal is unlikely. The allowance is an amount which, in management's judgment, will be adequate to absorb losses on existing loans that may become uncollectible. The allowance is established through consideration of such factors, including, but not limited to, historical loss experience, changes in the nature and volume of the portfolio, adequacy of collateral, delinquency trends, loan concentrations, specific problem loans, and economic conditions that may affect the borrower's ability to pay.

        Management believes that the allowance for loan losses is adequate. While management uses available information to recognize losses on loans, future additions to the allowance may be necessary based on changes in economic conditions. In addition, various regulatory agencies, as an integral part of their examination process, periodically review Flag's allowance for loan losses. Such agencies may require Flag to recognize additions to the allowance based on their judgments about information available to them at the time of their examination.
 
       The following table presents an analysis of the allowance for loan losses for the three month periods ended March 31, 2005 and 2004 (in thousands):
 
   
Three Months Ended
 
   
March 31,
 
   
2005
 
2004
 
           
Balance of allowance for loan losses at beginning of period
 
$
8,602
 
$
6,685
 
Provision charged to operating expense
   
375
   
720
 
Charge offs:
             
    Commercial
   
252
   
-
 
Real estate - mortgage
   
4
   
6
 
Real estate - construction
   
-
   
364
 
Installment loans to individuals
   
11
   
81
 
Total charge-offs
   
267
   
451
 
Recoveries:
             
Commercial
   
58
   
47
 
Real estate - mortgage
   
59
   
4
 
Real estate - construction
   
18
   
22
 
Installment loans to individuals
   
17
   
25
 
Total recoveries
   
152
   
98
 
Net charge-offs
   
115
   
353
 
Balance of allowance for loan losses at end of period
 
$
8,862
 
$
7,052
 


 


Flag Financial Corporation and Subsidiary
Management’s Discussion and Analysis of Financial Condition

See “Critical Accounting Policies” for an explanation of our methodology for determining the appropriate level for the allowance and its effect on our results of operations.

Nonperforming Assets

Nonperforming assets (nonaccrual loans, loans over 90 days past due and still accruing, other real estate owned and repossessions) totaled $6.7 million at March 31, 2005, compared to $5.3 million at December 31, 2004. Nonperforming assets as a percentage of total assets represented 0.80% and 0.64%, respectively.

Flag has a loan review function that continually monitors selected accruing loans for which general economic conditions or changes within a particular industry could cause the borrowers financial difficulties. The loan review function also identifies loans with high degrees of credit or other risks. The focus of loan review is to maintain a low level of nonperforming assets and to return current nonperforming assets to earning status.

Flag’s credit quality has improved significantly over the past few years. This is due to several factors including a stricter credit culture that focuses more heavily on the quality of the borrower’s financial condition and collateral values. In addition, Flag’s expansion into lending in metro Atlanta presents more credit opportunities than in the Company’s past, allowing the Company to be more selective in the credit approval process without hindering or slowing the growth in loans outstanding. The following table summarizes the nonperforming assets for the three month periods presented (in thousands):

   
March 31,
 
December 31,
 
March 31,
 
   
2005
 
2004
 
2004
 
Loans on nonaccrual
 
$
5,822
 
$
4,224
 
$
3,973
 
Loans past due 90 days and still accruing
   
-
   
74
   
143
 
Other real estate owned and repossessions
   
918
   
1,012
   
2,670
 
Total nonperforming assets
 
$
6,740
 
$
5,310
 
$
6,786
 
Total nonperforming assets as a percentage of
                   
total assets
   
0.80
%
 
0.64
%
 
0.99
%
 
Results of Operations for the Three Month Periods Ended March 31, 2005 and 2004

Net income - Net income for the quarter ended March 31, 2005, was $1.8 million or $0.20 per diluted share, compared to $2.1 million or $0.23 per diluted share for the quarter ended March 31, 2004. Included in the 2004 earnings is an after-tax gain on the sale of its Thomaston, Georgia branch of approximately $1.47 million. In addition to the one-time gain, Flag had other charges to earnings of 2004, including credit related charges of approximately $376,000 after-tax and a charge relating to its benefit plans of approximately $234,000 after-tax. Excluding the effects of the one-time gain and other charges, earnings for the first quarter of 2004 were approximately $1.2 million.

Net interest income - Net interest income for the quarter ended March 31, 2005, was $8.6 million, an increase of $1.5 million or 20.3%, from $7.1 million for the quarter ended March 31, 2004. Flag’s net interest margin (net interest income divided by average earning assets) increased to 4.50% from 4.40% on average earning assets of $772.4 million and $652.3 million for the first quarter of 2005 and 2004, respectively. In 2004, in anticipation of rising interest rates, Flag began to reposition its balance sheet to a more asset-sensitive position. A balance sheet is considered asset sensitive when its assets (loans and securities) reprice faster or to a greater extent than liabilities (deposits and borrowings). An asset-sensitive balance sheet will produce more net interest income when interest rates rise and less net interest income when interest rates decline. The Federal Reserve has increased the federal funds rate seven times since June 2004, increasing the rate from 1.0% to 2.75%. See “Market Risk Sensitivity” for more information on Flag’s asset and liability management program.

Interest income - Interest income for the quarter ended March 31, 2005, was $12.8 million, an increase of $3.1 million or 32.2%, from $9.7 million for the same quarter of 2004. The increase is primarily due to higher levels of average interest-earning assets coupled with increases in the yield on loans. The yield on interest-earning assets increased 75 basis points to 6.71% during the quarter ended March 31, 2005, compared to 5.96% for the first quarter of 2004.

 


Flag Financial Corporation and Subsidiary
Management’s Discussion and Analysis of Financial Condition
 
Interest income and fees on loans in the current quarter increased $3.3 million or 40.5% to $11.4 million, compared to $8.1 million in the same quarter of 2004. Average loans outstanding during the first quarter of 2005 were $603.4 million compared to $485.5 million for 2004. The yield on loans during the first quarter of 2005 was 7.67% an increase from 6.72% in the first quarter of 2004.

Interest on investment securities decreased $380,000 or 26.1% to $1.1 million for the first quarter of 2005 from $1.5 million in the first quarter of 2004. This decrease in interest income was driven primarily by the declining average balance of investment securities in the first quarter of 2005. In the first quarter of 2005, average investment securities decreased to $114.7 million, compared to $133.3 million in the first quarter of 2004. The decrease in the average balance is primarily due to calls of investments securities and accelerated prepayments of mortgage-backed securities. Instead of reinvesting in investment securities, Flag chose to invest the proceeds in short-term investments that could be liquidated and used to fund projected loan growth.

Interest on federal funds sold and other interest-bearing deposits increased $201,000 or 201.0% to $301,000 during the first quarter of 2005 from $100,000 in the same quarter last year. Interest on federal funds sold and other interest-bearing deposits increased as a result of an increase in the average balance of federal funds sold, resulting from the liquidation of investments, and an increase in the yield. The yield on federal funds sold and other interest-bearing deposits increased to 2.57% from 1.30% during the first quarter of 2005 compared to 2004.
 
Interest expense - Interest expense for the first quarter of 2005 was $4.2 million, an increase of $1.7 million or 65.6%, from $2.5 million in the same quarter of 2004. The increase is due to higher levels of average funding coupled with a rising interest rate environment. In the first quarter of 2005, average funding increased $116.7 million or 18.3% to $754.2 million from $637.5 million in the first quarter of 2004. Flag’s total cost of funds increased 67 basis points to 2.26% from 1.59% over the same period.

Interest expense on deposits increased $1.5 million or 64.7% to $3.8 million in the current quarter from $2.3 million in the first quarter of 2004. Average demand deposits (interest-bearing and noninterest-bearing) during the first quarter of 2005 were $386.4 million, an increase of $56.4 million or 17.1%, from $330.0 million in the first quarter of 2004. Average time deposits in the first quarter of 2005 were $299.8 million, an increase of $77.2 million or 34.7% from $222.6 million in the first quarter of 2004. The weighted average interest rate for interest-bearing demand deposits was 2.00% and 1.48% in the first quarter of 2005 and 2004, respectively. The weighted average interest rate for time deposits was 2.88% and 2.24% in the first quarter of 2005 and 2004, respectively.

Interest expense on other borrowings for the first quarter of 2005 was $384,000, an increase of $165,000 or 75.3%, from $219,000 for the same quarter of 2004. Average other borrowings in the first quarter of 2005 were $44.9 million, a decrease of $14.1 million or 23.9%, from $59.0 million in the same quarter of 2004. An increase in the weighted average rate offset the decrease in average borrowings in the first quarter of 2005, increasing to 3.47% compared to 1.49% in the first quarter of 2004. Included in interest expense on other borrowings in the first quarter of 2005, is interest expense of $192,000 related to the Company’s junior subordinated debentures that were issued in the second quarter of 2004.

Noninterest income - Noninterest income for the first quarter of 2005 totaled $2.6 million, a decrease of $2.1 million or 44.5%, compared to $4.7 million in the same quarter last year. In the first quarter of 2004, noninterest income includes a $3.0 million pre-tax gain on the sale of Flag’s Thomaston, Georgia branch.

Traditionally service charges on deposit accounts and revenues from mortgage banking activities have been the largest components of noninterest income. Service charges on deposit accounts decreased to $749,000 for the first quarter of 2005, a decrease of $143,000 or 16.0%, from $892,000 in the first quarter of 2004. While Flag maintained strong growth in deposits during the past year, most of the growth came from higher-balance money market and interest-bearing checking balances where customers carry balances sufficient to qualify for reduced or eliminated fees. Mortgage banking activities includes origination fees, service release premiums and the gain on the sales of mortgage loans held-for-sale. Mortgage banking activities totaled $580,000, an increase of $50,000 or 9.4%, compared to $530,000 in the first quarter of 2004.

In the first quarter of 2005, gain on sales of securities was $123,000, an increase of $116,000, compared to $7,000 in the same quarter last year. Gain (loss) on sale of other real estate owned increased $94,000 to a gain of $91,000 from a loss of $3,000 in the first quarter of 2004.

 


Flag Financial Corporation and Subsidiary
Management’s Discussion and Analysis of Financial Condition
 
Other income increased $832,000 or 543.8% to $985,000 in the first quarter of 2005, compared to $153,000 in the same quarter last year. Payroll Solutions contributed $581,000 to other income in the first quarter of 2005. During the fourth quarter of 2004, Flag acquired Payroll Solutions a leading provider of payroll services. Other fees on loans, which are included in other income, increased $100,000 or 300.0% to $150,000 in the first quarter of 2005, compared to $50,000 in the first quarter of 2004. The rise in other loan fees is primarily due to increased loan production.

Noninterest expense - Noninterest expense for the first quarter of 2005 totaled $8.1 million, an increase of $129,000 or 1.6%, compared to $8.0 million in the same quarter of 2004.

Salaries and employee benefits totaled $5.0 million, an increase of $203,000 or 4.2%, from $4.8 million in the first quarter of 2004. Salaries and commissions increased $511,000 in the first quarter of 2005. This increase is primarily attributable to an increase in commissions on loan originations and the addition of Payroll Solutions personnel totaling $185,000. In the first quarter of 2004, salaries and employee benefits included a $376,000 charge related to a recent accounting interpretation on expenses of deferred compensation plans.

Occupancy expense for the first quarter of 2005 totaled $956,000, an increase of $46,000 or 5.1% from $910,000 in the first quarter of 2004. The decrease in occupancy expense related to the sale of the Thomaston, Georgia, branch in the first quarter of 2004 was offset by increases in rent expense related to the purchase of mortgage and construction offices during the third quarter of 2004 and the addition of the Payroll Solutions offices.

Professional fees were $549,000, an increase of $249,000 or 83.0%, compared to $300,000 in the same quarter of 2004. This increase is in part due to additional expenses related to compliance with the Sarbanes-Oxley Act.

Other noninterest expense totaled $860,000 for the first quarter of 2005, a decrease of $309,000 or 26.4%, compared to $1.2 million in the same quarter of 2004. Included in other noninterest expense in 2004, were real estate write-downs totaling $262,000, compared to $32,000 in the first quarter of 2005, a decrease of $230,000 or 87.8%. Other outside service fees decreased in the first quarter of 2005, to $111,000, a decrease of $115,000 or 50.9%, from $226,000 in the same quarter of 2004. In the first quarter of 2004, other outside services included $145,000 charge related to the sale of the Thomaston branch. Marketing expense totaled $137,000, an increase of $83,000 or 53.7%, from $54,000 in the first quarter of 2004. The increase in marketing expense is primarily attributable to advertising costs associated with building Flag’s metro Atlanta franchise. 

Income taxes - Income tax expense for the quarter ended March 31, 2005, totaled $862,000 compared to $1.0 million for the same quarter of 2004. Flag’s effective tax rate decreased to 32.1% in the first quarter of 2005 compared to 32.8% in the same quarter of 2004. Flag’s lower effective tax rate relates to certain state income tax credits taken during the first quarter of 2005.

Item 3.   Quantitative and Qualitative Disclosures about Market Risk

As of March 31, 2005, there were no substantial changes in the composition of Flag’s market-sensitive assets and liabilities or their related market values from that reported as of December 31, 2004. The foregoing disclosures related to the market risk of Flag should be read in conjunction with Flag’s audited consolidated financial statements, related notes and management’s discussion and analysis of financial condition and results of operations for the year ended December 31, 2004, included in Flag’s 2004 Annual Report on Form 10-K.

Item 4.   Controls and Procedures

As of the end of the period covered by this report, Flag carried out an evaluation, under the supervision and with the participation of Flag’s management, including Flag’s Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of Flag’s disclosure controls and procedures pursuant to Exchange Act Rule 13a-15. Based upon that evaluation, Flag’s Chief Executive Officer and Chief Financial Officer concluded that Flag’s disclosure controls and procedures are effective in timely alerting them to material information relating to Flag (including its consolidated subsidiary) that is required to be included in Flag’s periodic filings with the Securities and Exchange Commission. There have been no significant changes in Flag’s internal controls or, to Flag’s knowledge, in other factors that could significantly affect those internal controls subsequent to the date Flag carried out its evaluation, and there have been no corrective actions with respect to significant deficiencies or material weaknesses.


 


Flag Financial Corporation and Subsidiary
Part II.   Other Information

Item 1.   Legal Proceedings - None

Item 2.   Changes in Securities

The following table sets forth information regarding the Company’s purchases of its common stock on a monthly basis during the quarter ended March 31, 2005 (in thousands):
         
     
Total Number of
Maximum
     
Shares Purchased as
Number Of Shares
     
Part Of Publicly
that May Yet Be
 
Total of Number
Average Price
Announced Plans
Purchased Under the
Period
Shares Purchased
Paid Per Share
or Programs (1)
Plans or Programs
         
January 1 through
       
January 31, 2005
$                                                 -
-
1,551
549
         
February 1 through
       
February 28, 2005
-
-
1,551
549
         
March 1 through
       
March 31, 2005
-
-
1,551
549
         
Total
$                                                 -
-
1,551
549

(1) On March 19, 2004, Flag Financial Corporation announced a stock repurchase plan. The Company’s board of directors authorized the repurchase of up to 10% of the Company’s outstanding shares of common stock. No expiration date was specified, and no shares were repurchased under or outside of the plan during the first quarter of 2005. As of March 31, 2005, the Company has repurchased 304,000 shares at an aggregate cost of $3.9 million.

Item 3.   Defaults upon Senior Securities - None

Item 4.   Submission of Matters to a Vote of Security Holders - None

Item 5.   Other Information
 
        Pursuant to Rule 14a-14(c)(1) promulgated under the Securities Exchange Act of 1934, as amended, shareholders desiring to present a proposal for consideration at the Company’s 2006 Annual Meeting of Shareholders must notify the Company in writing to the Secretary of the Company, at 3475 Piedmont Road, N.E., Suite 550, Atlanta, Georgia, 30305, of the contents of such proposal no later than November 10, 2005, to be included in the 2006 Proxy Materials. Under the Company’s bylaws, a shareholder must also notify the Company before November 10, 2005 of a proposal for the 2006 Annual Meeting that the shareholder intends to present other than by inclusion in the Company’s proxy material. If the Company does not receive such notice prior to November 10, 2005, proxies solicited by the management of the Company will confer discretionary authority upon the management of the Company to vote upon any such matter.

During the first quarter of 2005, the Compensation Committee established the Company’s 2005 bonus plan for executive officers and determined executive officer base salaries for the year. This information was previously filed as Exhibit 10.29 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2004.

Item 6.   Exhibits

 
(a)
Exhibits
     
 
31.1
Section 302 Certification by Chief Executive Officer
 
31.2
Section 302 Certification by Chief Financial Officer
     
 
32.1
Section 906 Certification by Chief Executive Officer and Chief Financial Officer



 



 

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.


 
Flag Financial Corporation
   
   
 
/s/ Joseph W Evans
 
Joseph W. Evans
 
Chief Executive Officer
   
 
May 10, 2005



 
/s/ J. Daniel Speight.
 
J. Daniel Speight
 
Chief Financial Officer
   
 
May 10, 2005