| CITIZENS HOLDING CO /MS/ ITEM 1A RISK FACTORS In addition to the other information contained in or incorporated by reference into this Annual Report on Form 10-K and the exhibits hereto, the following risk factors should be considered carefully in evaluating our business |
| The risks disclosed below, either alone or in combination, could materially adversely affect the business, financial condition or results of operations of the Company |
| Additional risks not presently known to us, or that we currently deem immaterial, may also adversely affect our business, financial condition or results of operations |
| Risks Related To Our Business and Industry We are subject to interest rate risk |
| Our earnings and cash flows are largely dependent upon the net interest income of the Company |
| Net interest income is the difference between interest earned on assets, such as loans and securities, and the cost of interest-bearing liabilities, such as deposits and borrowed funds |
| Interest rates are highly sensitive to many factors that are beyond our control, including general economic conditions and policies of various governmental and regulatory agencies and, in particular, the FRB Changes in monetary policy, including changes in interest rates, could influence not only the interest we receive on loans and securities and the amount of interest we pay on deposits and borrowings, but such changes could also affect (i) our ability to originate loans and obtain deposits, which could reduce the amount of fee income generated, (ii) the fair value of our financial assets and liabilities, and (iii) the average duration of our mortgage-backed securities portfolio |
| If the interest rates paid on deposits and other borrowings increase at a faster rate than the interest rates received on loans and other investments, our net interest income could be adversely affected, which in turn could negatively affect our earnings |
| Earnings could also be adversely affected if the interest rates received on loans and other investments fall more quickly than the interest rates paid on deposits and other borrowings |
| Although management believes it has implemented effective asset and liability management strategies to reduce the potential effects of changes in interest rates on the results of operations of the Company, any substantial, unexpected, prolonged change in market interest rates could have a material adverse effect on our financial condition and results of operations |
| Volatility in interest rates may also result in disintermediation, which is the flow of funds away from financial 9 ______________________________________________________________________ [37]Table of Contents institutions into direct investments, such as US Government and Agency securities and other investment vehicles, including mutual funds, which generally pay higher rates of return than financial institutions because of the absence of federal insurance premiums and reserve requirements |
| Disintermediation could also result in material adverse effects on our financial condition and results of operations |
| A discussion of the policies and procedures used to identify, assess and manage certain interest rate risk is set forth in Item 7A, “Qualitative and Quantitative Disclosures about Market Risk |
| ” We are subject to lending risk |
| There are inherent risks associated with our lending activities |
| These risks include, among other things, the impact of changes in interest rates and changes in the economic conditions in the markets where we operate as well as those across the United States |
| Increases in interest rates and/or weakening economic conditions could adversely impact the ability of borrowers to repay outstanding loans or the value of the collateral securing these loans |
| As of December 31, 2005, approximately 82prca of our loan portfolio consisted of commercial, construction and commercial real estate loans |
| These types of loans are generally viewed as having more risk of default than residential real estate loans or consumer loans due primarily to the large amounts loaned to individual borrowers |
| Because the loan portfolio contains a significant number of commercial, construction and commercial real estate loans with relatively large balances, the deterioration of one or a few of these loans could cause a significant increase in non-performing loans |
| An increase in non-performing loans could result in a net loss of earnings from these loans, an increase in the provision for possible loan losses and an increase in loan charge-offs, all of which could have a material adverse effect on our financial condition and results of operations |
| The allowance for possible loan losses may be insufficient |
| Although we try to maintain diversification within our loan portfolio in order to minimize the effect of economic conditions within a particular industry, management also maintains an allowance for loan losses, which is a reserve established through a provision for loan losses charged to expense, to absorb probable credit losses inherent in the entire loan portfolio |
| The appropriate level of the allowance is based on management’s quarterly analysis of the loan portfolio and represents an amount that management deems adequate to provide for inherent losses, including collective impairment |
| Among other considerations in establishing the allowance for loan losses, management considers economic conditions reflected within industry segments, the unemployment rate in our markets, loan segmentation, and historical losses that are inherent in the loan portfolio |
| The determination of the appropriate level of the allowance for loan losses inherently involves a high degree of subjectivity and requires management to make significant estimates of current credit risks and future trends, all of which may undergo material changes |
| Changes in economic conditions affecting borrowers, new information regarding existing loans, identification of additional problem loans and other factors, both within and outside of the our control, may require an increase in the allowance for loan losses |
| 10 ______________________________________________________________________ [38]Table of Contents In addition, bank regulatory agencies periodically review the allowance for loan losses and may require an increase in the provision for loan losses or the recognition of further loan charge-offs, based on judgments different than those of management |
| In addition, if charge-offs in future periods exceed the allowance for loan losses, we will need additional provisions to increase the allowance for loan losses |
| Any increases in the allowance for loan losses will result in a decrease in net income and, possibly, capital, and may have a material adverse effect on our financial condition and results of operations |
| A discussion of the policies and procedures related to management’s process for determining the appropriate level of the allowance for loan losses is set forth in Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations |
| ” Bank holding companies depend on the accuracy and completeness of information about customers and counterparties |
| In deciding whether to extend credit or enter into other transactions, we often rely on information furnished by or on behalf of customers and counterparties, including financial statements, credit reports and other financial information |
| We may also rely on representations of those customers, counterparties or other third parties, such as independent auditors, as to the accuracy and completeness of that information |
| Reliance on inaccurate or misleading financial statements, credit reports or other financial information could have a material adverse impact on our business and, in turn, our financial condition and results of operations |
| We are subject to environmental liability risk associated with lending activities |
| A significant portion of the loan portfolio is secured by real property |
| In doing so, there is a risk that hazardous or toxic substances could be found on these properties |
| If hazardous or toxic substances are found, we may be liable for remediation costs, as well as for personal injury and property damage |
| Environmental laws may require us to incur substantial expenses and may materially reduce the affected property’s value or limit the ability of the Company to use or sell the affected property |
| In addition, future laws or more stringent interpretations or enforcement policies with respect to existing laws may increase our exposure to environmental liability |
| Although management has policies and procedures to perform an environmental review during the loan application process and also before initiating any foreclosure action on real property, these reviews may not be sufficient to detect all potential environmental hazards |
| The remediation costs and any other financial liabilities associated with an environmental hazard could have a material adverse effect on our financial condition and results of operations |
| The profitability of the Company depends significantly on economic conditions in the State of Mississippi |
| Our success depends primarily on the general economic conditions of the State of Mississippi and the specific local markets in which we operate |
| Unlike larger national or other regional banks that are more geographically diversified, we provide banking and financial services to customers primarily in East Central Mississippi |
| The local economic conditions in this area have a significant impact on the demand for our products and services as well as the ability of our customers to repay loans, the value of the collateral securing loans and the stability of our deposit funding sources |
| 11 ______________________________________________________________________ [39]Table of Contents The earnings of bank holding companies are significantly affected by general business and economic conditions |
| In addition to the risks associated with the general economic conditions in the markets in which we operate, our operations and profitability are also impacted by general business and economic conditions in the United States and abroad |
| These conditions include short-term and long-term interest rates, inflation, money supply, political issues, legislative and regulatory changes, fluctuations in both debt and equity capital markets, broad trends in industry and finance, and the strength of the US economy and the local economies in which we operate, all of which are beyond our control |
| A deterioration in economic conditions could result in an increase in loan delinquencies and non-performing assets, decreases in loan collateral values and a decrease in demand for our products and services, among other things, any of which could have a material adverse impact on our financial condition and results of operations |
| We operate in a highly competitive industry and market area |
| We face substantial competition in all areas of our operations from a variety of different competitors, many of which are larger and may have more financial resources |
| Such competitors primarily include national, regional and community banks within the various markets in which we operate |
| We also face competition from many other types of financial institutions, including savings and loans, credit unions, finance companies, brokerage firms, insurance companies, factoring companies and other financial intermediaries |
| The information under the heading “Competition” in Item 1, “Business,” provides more information regarding the competitive conditions in our markets |
| Our industry could become even more competitive as a result of legislative, regulatory and technological changes and continued consolidation |
| Banks, securities firms and insurance companies can merge under the umbrella of a financial holding company, which can offer virtually any type of financial service, including banking, securities underwriting, insurance (both agency and underwriting) and merchant banking |
| Also, technology has lowered barriers to entry and made it possible for non-banks to offer products and services traditionally provided by banks, such as automatic transfer and automatic payment systems |
| Many of our competitors have fewer regulatory constraints and may have lower cost structures |
| Additionally, many of our competitors have substantially greater resources than us, including higher total assets and capitalization, greater access to capital markets and a broader offering of financial services |
| Our ability to compete successfully depends on a number of factors, including, among other things: • The ability to develop, maintain and build upon long-term customer relationships based on top quality service, high ethical standards and safe, sound assets |
| • The ability to expand the Company’s market position |
| • The scope, relevance and pricing of products and services offered to meet customer needs and demands |
| • The rate at which we introduce new products and services relative to our competitors |
| • Customer satisfaction with our level of service |
| • Industry and general economic trends |
| 12 ______________________________________________________________________ [40]Table of Contents Failure to perform in any of these areas could significantly weaken our competitive position, which could adversely affect our growth and profitability, which, in turn, could have a material adverse effect on our financial condition and results of operations |
| We are subject to extensive government regulation and supervision |
| The Company and the Bank are subject to extensive federal and state regulation and supervision |
| Banking regulations are primarily intended to protect depositors’ funds, federal deposit insurance funds and the banking system as a whole, not the economic or other interests of shareholders |
| These regulations affect our lending practices, capital structure, investment practices, dividend policy and growth, among other things |
| Changes to statutes, regulations or regulatory policies, including changes in interpretation or implementation of the foregoing, could affect the Company and/or the Bank in substantial and unpredictable ways |
| Such changes could subject us to additional costs, limit the types of financial services and products we may offer and/or increase the ability of non-banks to offer competing financial services and products, among other things |
| Under regulatory capital adequacy guidelines and other regulatory requirements, the Company and the Bank must meet guidelines that include quantitative measures of assets, liabilities and certain off-balance sheet items, subject to qualitative judgments by regulators about components, risk weightings and other factors |
| If we fail to meet these minimum capital guidelines and other regulatory requirements, our financial condition would be materially and adversely affected |
| Our failure to maintain the status of “well capitalized” under our regulatory framework could affect the confidence of our customers in us, thus compromising our competitive position |
| In addition, failure to maintain the status of “well capitalized” under our regulatory framework or “well managed” under regulatory examination procedures could compromise our status as a bank holding company and related eligibility for a streamlined review process for acquisition proposals |
| We are also subject to laws, regulations and standards relating to corporate governance and public disclosure, including the Sarbanes Act and new SEC regulations |
| These laws, regulations and standards are subject to varying interpretations in many cases, and as a result, their application in practice may evolve over time as new guidance is provided by regulatory and governing bodies, which could result in continuing uncertainty regarding compliance matters and higher costs necessitated by ongoing revisions to disclosure and governance practices |
| We are committed to maintaining high standards of corporate governance and public disclosure |
| As a result, our efforts to comply with evolving laws, regulations and standards have resulted in, and are likely to continue to result in, increased expenses and a diversion of management time and attention |
| Failure to comply with laws, regulations or policies could also result in sanctions by regulatory agencies and/or civil money penalties, which could have a material adverse effect on our business, financial condition and results of operations |
| While we have policies and procedures designed to prevent any such violations, there can be no assurance that such violations will not occur |
| The information under the heading “Supervision and Regulation” in Item 1, “Business,” and Note 14, “Regulatory Matters” to the Consolidated Financial Statements of the Company in Item 8, “Financial Statements and Supplementary Data,” provides more information regarding the regulatory environment in which we and our Bank operate |
| 13 ______________________________________________________________________ [41]Table of Contents Our controls and procedures may fail or be circumvented |
| Management regularly reviews and updates our internal control over financial reporting, disclosure controls and procedures and corporate governance policies and procedures |
| Any system of controls, however well designed and operated, has inherent limitations, including the possibility that a control can be circumvented or overridden, and misstatements due to error or fraud may occur and not be detected |
| Also, because of changes in conditions, internal control effectiveness may vary over time |
| Accordingly, even an effective system of internal control will provide only reasonable assurance with respect to our adherence to financial reporting, disclosure and corporate governance policies and procedures |
| Slower than anticipated growth in new branches and new product and service offerings could result in reduced income |
| We have placed a strategic emphasis on expanding our branch network and product offerings |
| Executing this strategy carries risks of slower than anticipated growth both in new branches and new products |
| New branches and products require a significant investment of both financial and personnel resources |
| Lower than expected loan and deposit growth in new investments can decrease anticipated revenues and net income generated by those investments, and opening new branches and introducing new products could result in more additional expenses than anticipated and divert resources from current core operations |
| We are substantially dependent on dividends from the Bank for our revenues |
| The Company is a separate and distinct legal entity from the Bank, and it receives substantially all of its revenue from dividends from the Bank |
| These dividends are the principal source of funds to pay dividends on our common stock and interest and principal on debt |
| Various federal and/or state laws and regulations limit the amount of dividends that the Bank may pay to the Company |
| In the event the Bank is unable to pay dividends to us, we may not be able to service debt, pay obligations or pay dividends on our common stock |
| The inability to receive dividends from the Bank could have a material adverse effect on our business, financial condition and results of operations |
| The information under the heading “Supervision and Regulation” in Item 1, “Business,” provides a discussion about the restrictions governing the Bank’s ability to transfer funds to us |
| Potential acquisitions may disrupt the our business and dilute shareholder value |
| We seek merger or acquisition partners that are culturally similar and have experienced management and possess either significant market presence or have potential for improved profitability through financial management, economies of scale or expanded services |
| Acquiring other banks, businesses or branches involves various risks commonly associated with acquisitions, including, among other things: • Potential exposure to unknown or contingent liabilities of the target company |
| • Exposure to potential asset quality issues of the target company |
| • Difficulty and expense of integrating the operations and personnel of the target company |
| 14 ______________________________________________________________________ [42]Table of Contents • Potential disruption to our business |
| • Potential diversion of management’s time and attention |
| • The possible loss of key employees and customers of the target company |
| • Difficulty in estimating the value of the target company |
| • Potential changes in banking or tax laws or regulations that may affect the target company |
| We regularly evaluate merger and acquisition opportunities and conduct due diligence activities related to possible transactions with other financial institutions |
| As a result, merger or acquisition discussions and, in some cases, negotiations may take place and future mergers or acquisitions involving cash, debt or equity securities may occur at any time |
| Acquisitions typically involve the payment of a premium over book and market values, and, therefore, some dilution of our tangible book value and net income per common share may occur in connection with any future transaction |
| Furthermore, failure to realize the expected revenue increases, cost savings, increases in geographic or product presence, and/or other projected benefits from an acquisition could have a material adverse effect on our financial condition and results of operations |
| Our success depends in part on our ability to retain key executives and to attract and retain additional qualified personnel who have experience both in sophisticated banking matters and in operating a bank of our size |
| Competition for such personnel is strong in the banking industry, and we may not be successful in attracting or retaining the personnel we require |
| The unexpected loss of one or more of our key personnel could have a material adverse impact on our business because of their skills, knowledge of our markets, years of industry experience and the difficulty of promptly finding qualified replacements |
| We expect to effectively compete in this area by offering financial packages that are competitive within the industry |
| Our information systems may experience an interruption or breach in security |
| We rely heavily on communications and information systems to conduct our business |
| Any failure, interruption or breach in security of these systems could result in failures or disruptions in our customer relationship management, general ledger, deposit, loan and other systems |
| While we have policies and procedures designed to prevent or limit the effect of the failure, interruption or security breach of our information systems, there can be no assurance that any such failures, interruptions or security breaches will not occur or, if they do occur, that they will be adequately addressed |
| The occurrence of any failures, interruptions or security breaches of our information systems could damage our reputation, result in a loss of customer business, subject us to additional regulatory scrutiny, or expose us to civil litigation and possible financial liability, any of which could have a material adverse effect on the financial condition and results of operations of the Company |
| We continually encounter technological change |
| Our industry is continually undergoing rapid technological change with frequent introductions of new technology-driven products and services |
| The effective use of technology increases efficiency and enables financial institutions to better serve customers and reduce costs |
| 15 ______________________________________________________________________ [43]Table of Contents Our future success depends, in part, upon our ability to address the needs of our customers by using technology to provide products and services that will satisfy customer demands, as well as to create additional efficiencies in our operations |
| Many of our competitors have substantially greater resources to invest in technological improvements |
| We may not be able to effectively implement new technology-driven products and services or be successful in marketing these products and services to our customers |
| Failure to successfully keep pace with technological change affecting our industry could have a material adverse impact on our business and, in turn, our financial condition and results of operations |
| Consumers may decide not to use banks to complete their financial transactions |
| While we continually attempt to use technology to offer new products and services, at the same time, technology and other changes are allowing parties to complete financial transactions that historically have involved banks through alternative methods |
| For example, consumers can now maintain funds in brokerage accounts or mutual funds that would have historically been held as bank deposits |
| Consumers can also complete transactions such as paying bills and/or transferring funds directly without the assistance of banks |
| The process of eliminating banks as intermediaries, known as disintermediation, could result in the loss of fee income, as well as the loss of customer deposits and the related income generated from those deposits |
| The loss of these revenue streams and the lower cost deposits as a source of funds could have a material adverse effect on our financial condition and results of operations |
| Severe weather, natural disasters, acts of war or terrorism and other external events could significantly impact our business |
| Severe weather, natural disasters, acts of war or terrorism and other adverse external events could have a significant impact on the ability of the Company to conduct business |
| Such events could affect the stability of our deposit base, impair the ability of borrowers to repay outstanding loans, impair the value of collateral securing loans, cause significant property damage, result in loss of revenue and/or cause us to incur additional expenses |
| For example, during 2005, Hurricanes Katrina and Rita made landfall and subsequently caused extensive flooding and destruction along the coastal areas of the Gulf of Mexico |
| Although our operations were not disrupted by these hurricanes or their aftermath, other severe weather or natural disasters, acts of war or terrorism or other adverse external events may occur in the future |
| Although management has established disaster recovery policies and procedures, the occurrence of any such event could have a material adverse effect on our business, which, in turn, could have a material adverse effect on our financial condition and results of operations |
| Stock price volatility may make it more difficult for you to resell your common stock when you want and at prices you find attractive |
| Our stock price can fluctuate significantly in response to a variety of factors including, among other things: • Actual or anticipated variations in quarterly results of operations |
| 16 ______________________________________________________________________ [44]Table of Contents • Recommendations by securities analysts |
| • Operating and stock price performance of other companies that investors deem comparable to the Company |
| • News reports relating to trends, concerns and other issues in the banking and financial services industry |
| • Perceptions in the marketplace regarding us and/or our competitors |
| • New technology used, or services offered, by competitors |
| • Significant acquisitions or business combinations, strategic partnerships, joint ventures or capital commitments by or involving us or our competitors |
| • Failure to integrate acquisitions or realize anticipated benefits from acquisitions |
| • Changes in government regulations |
| • Geopolitical conditions such as acts or threats of terrorism or military conflicts |
| General market fluctuations, industry factors and general economic and political conditions and events, such as economic slowdowns or recessions, interest rate changes or credit loss trends, could also cause our stock price to decrease regardless of operating results |
| The trading volume in our common stock is less than that of other larger bank holding companies |
| Our common stock is listed for trading on the American Stock Exchange; the average daily trading volume in our common stock is low, generally less than that of many of the our competitors and other larger bank holding companies |
| A public trading market having the desired characteristics of depth, liquidity and orderliness depends on the presence in the marketplace of willing buyers and sellers of our common stock at any given time |
| This presence depends on the individual decisions of investors and general economic and market conditions over which we have no control |
| Given the lower trading volume of our common stock, significant sales of our common stock, or the expectation of these sales, could cause volatility in the price of our common stock |
| An investment in our common stock is not an insured deposit |
| Our common stock is not a bank deposit and, therefore, is not insured against loss by the FDIC, any deposit insurance fund or by any other public or private entity |
| Investment in our common stock is inherently risky for the reasons described in this “Risk Factors” section and elsewhere in this report and is subject to the same market forces that affect the price of common stock in any company |
| As a result, if you acquire our common stock, you may lose some or all of your investment |
| Our Articles of Incorporation and Bylaws, as well as certain banking laws, may have an anti-takeover effect |
| Provisions of our Articles of Incorporation and Bylaws, which are exhibits to this Annual Report on Form 10-K, and federal banking laws, including regulatory approval requirements, could make it more difficult for a third party to acquire the Company, even if doing so would be perceived to be beneficial to our shareholders |
| The combination of these provisions impedes a non-negotiated merger or other business combination, which, in turn, could adversely affect the market price of our common stock |