10-K 1 r10k1231.txt SECURITIES AND EXCHANGE COMMISSION Washington, D. C. 20549 FORM 10-K Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the fiscal year ended December 31, 2001 Commission file number 2-71249 SOUTH BANKING COMPANY (Exact name of registrant as specified in its charter Georgia 58-1418696 (State or other jurisdiction of (I.R.S. Employer Identification incorporation or organization) Number) 104 North Dixon Street, Alma, Georgia 31510 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (912) 632-8631 Securities registered pursuant to Section 12(b) of the Act: None Securities registered pursuant to Section 12(g) of the Act: None Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation 5-K is not contained herein and will not be contained to the best of registrant's knowledge in definitive proxy on information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. (X) State the aggregate market value of the voting stock held by nonaffiliates of the registrant: There is no established market for the outstanding common stock of the registrant. Indicate the number of shares outstanding of each of the registrant's classes of common stock, as of the most recent practicable date. Class Outstanding at February 28, 2002 Common stock $1.00 par value per 399,500 share DOCUMENTS INCORPORATED BY REFERENCE List hereunder the following documents if incorporated by reference and the part of the Form 10-K into which the documents are incorporated: (1) any annual reports to security holders; (2) any prospectus filed pursuant to Rule 424(b) or (c) under the Securities Act of 1933. None PART 1. SPECIAL CAUTIONARY NOTICE REGARDING FORWARD LOOKING INFORMATION Statements and financial discussion and analysis contained in this Annual Report on Form 10-K that are not historical facts are forward- looking statements made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Forward-looking statements describe the Company's future plans, strategies and expectations, are based on assumptions and involve a number of risks and uncertainties, many of which are beyond the Company's control. The important factors that could cause actual results to differ materially from the forward-looking statements include, without limitation: o changes in interest rates and market prices, which could reduce the Company's net interest margins, asset valuations and expense expectations; o changes in the levels of loan prepayments and the resulting effects on the value of the Company's loan portfolio; o changes in local economic and business conditions which adversely affect the Company's customers and their ability to transact profitable business with the Company, including the ability of its borrowers to repay their loans according to their terms or a change in the value of the related collateral; o increased competition for deposits and loans adversely affecting rates and terms; o the timing, impact and other uncertainties of the Company's potential future acquisitions, including the Company's ability to identify suitable future acquisition candidates, the success or failure in the integration of their operations, and the Company's ability to enter new markets successfully and capitalize on growth opportunities; o increased credit risk in the Company's assets and increased operating risk caused by a material change in commercial, consumer and/or real estate loans as a percentage of the total loan portfolio; o the failure of assumptions underlying the establishment of and provisions made to the allowance for loan losses; o changes in the availability of funds resulting in increased costs or reduced liquidity; o changes in the Company's ability to pay dividends on its Common Stock; o increased asset levels and changes in the composition of assets and the resulting impact on the Company's capital levels and regulatory capital ratios; 1 o the Company's ability to acquire, operate and maintain cost effective and efficient systems without incurring unexpectedly difficult or expensive but necessary technological changes; o the loss of senior management or operating personnel and the potential inability to hire qualified personnel at reasonable compensation levels; o changes in statutes and government regulations or their interpretations applicable to bank holding companies and the Company's present and future banking and other subsidiaries, including changes in tax requirements and tax rates; o all written or oral forward-looking statements attributable to the Company are expressly qualified in their entirety by these cautionary statements. Item 1. Business South Banking Company (the "Registrant") is a business corporation organized at the direction of Alma Exchange Bank & Trust ("Alma Bank") and Citizens State Bank ("Citizens Bank") (collectively, the "Banks") in 1980 under the Georgia Business Corporation Code. It was formed to obtain all the issued and outstanding shares of Common Stock of the Banks. Pursuant to the terms and provisions of a Plan of Reorganization and Agreement of Merger, dated as of January 13, 1981 and approved by the shareholders of the Banks on June 24, 1981, the Banks were reorganized into a holding company structure by merging the Banks with wholly-owned subsidiaries of the Registrant, which transaction was consummated on July 28, 1981. In connection with those mergers, the outstanding shares of Common Stock of the Banks were converted into shares of the Registrant at specified ratios and the Banks became wholly- owned subsidiaries of the Registrant. Pursuant to the terms and provision of an agreement of merger dated June 12, 1989 between South Banking and Georgia Peoples Bankshares, Inc. and approved by shareholders of Georgia Peoples on February 26, 1990, Georgia Peoples Bankshares and its subsidiary, Peoples State Bank, were merged into South Banking Company. In connection with the merger, the outstanding shares of Georgia Peoples Bankshares were converted into shares of the Registrant at specified ratios. During 1993, South Banking Company formed Banker's Data Services, Inc. ("Banker's Data") for the purpose of handling all the computer functions of the Banks. Operations began in April, 1994. South Banking entered into an agreement in October of 1995 to acquire all the stock of Pineland State Bank ("Pineland Bank") in Metter, Georgia. On January 11, 1996, the transaction was completed. On August 1, 2000, Pineland Bank acquired branches from Flag Inc. in Metter, Georgia, Cobbtown, Georgia, and Statesboro, Georgia. During 1998, Alma Bank formed South Financial Products, Inc. (SFP) as a vehicle to enter the financial services market and provide service to its customers. South Financial Products, Inc. offers a complete array of investment options including stocks, bonds, mutual funds, financial and retirement planning, tax advantaged investments and asset allocations. SFP offers securities through Unvest, a North Carolina based independent clearing firm. SFP is licensed and regulated through the National Association of Securities Dealers, the Securities and Exchange Commission and various state and federal banking authorities. 2 The maturing of the baby boomer generation is creating a market for asset management services. The Company expects growth in this department and anticipates that resulting fees will provide a stable stream of income. The Banks The Banks operate full service banking business in Bacon, Appling, Candler, Tattnall, Bulloch, and Camden Counties, Georgia, providing such customary banking services as checking and savings accounts, various other types of time deposits, safe deposit facilities and money transfers. The Banks also finance commercial and agricultural transactions, make secured and unsecured loans, and provide other financial services to its customers. The Banks do not conduct trust activities. On December 31, 2000, Alma Bank and Peoples Bank ranked, on the basis of total deposits, as the 202nd and 272nd largest banks among 338 banks in Georgia. Citizens Bank, one of five banking operations in Camden County, ranked the 303rd largest bank among 338 banks in Georgia; and Pineland Bank, one of two banking operations in Metter, Georgia, ranked the 220th largest bank among 338 banks in Georgia, Sheshunoff's Banks of Georgia (2001 edition). The Banks make and service both secured and unsecured loans to individuals, firms, and corporations. Commercial lending operations include various types of credit for the Banks' customers. The Banks' installment loan departments make direct loans to individuals and, to a limited extent, purchase installment obligations from retailers both with and without recourse. The Banks make a variety of residential, industrial, commercial, and agricultural loans secured by real estate, including interim construction financing. Each bank has established desired mixes of real estate, commercial, agricultural, and consumer lending depending upon activities within the local area. The ratios are established in accordance with risk diversification goals. All banks are located in small rural areas with low to moderate income levels. The banks primarily look to real estate lending as a major portion of portfolio. Real estate values have remained fairly stable over the past few years to give stability to lending activities. Loan to value ratios are maintained in the 60% to 80% level for various real estate lending. Loan to value ratio of non real estate loans vary from 50% for the inventory or receivables to 90% for vehicles and other consumer lending. The economy of the area remains fairly constant without great fluctuation. The national economy will effect the area primarily in the timber and other agricultural products; however, the movement is not as wide locally as national movement indicates. Citizens Bank, Pineland Bank and Peoples Bank act as agents for another bank in offering "Master Card" and "VISA" credit cards to its customers and does not assume the credit risk on these transactions. Alma Bank offers "Master Card" credit cards to its customers. At December 31, 2001, the Banks had correspondent relationships with 6 other commercial banks. These correspondent banks provide certain services to the banks such as processing checks and other items, buying and selling federal funds, handling money transfers and exchanges, shipping coins and currency, providing security and safekeeping of funds or other valuable items and furnishing limited management information and advice. As compensation for the services, the Banks maintain certain balances with its correspondents in non- interest bearing accounts. 3 Employees On December 31, 2001, the Registrant and its subsidiaries had 94 full-time and 20 part-time employees. The Registrant is not a party to any collective bargaining agreement and employee relations are deemed to be good. Competition The Banking business is highly competitive. The Banks compete primarily with other commercial banks operating in Bacon, Camden, Appling, Tattnall, Bulloch, and Candler Counties. In addition, the Banks compete with other financial institutions, including savings and loan associations, credit unions and finance companies and, to a lesser extent, insurance companies and certain governmental agencies. The banking industry is also experiencing increased competition for deposits from less traditional sources such as money-market mutual funds. Customers The majority of the Banks' customers are individuals and small to medium-sized businesses headquartered within its service area. The Banks are not dependent upon a single or a very few customers, the loss of which would have a material adverse effect on the Banks. No customer accounts for more than 5% of the Banks' total deposits at any time. Management does not believe that the Banks' loan portfolio is dependent on a single customer or group of customers concentrated in a particular industry whose loss or insolvency would have a material adverse effect on the Banks. Monetary Policies The results of operations of the Banks, and therefore of the Registrant, are affected by credit policies of monetary authorities, particularly the Board of Governors of the Federal Reserve System (the "Board of Governors"), even though the Banks are not members of the Federal Reserve. The instruments of monetary policy employed by the Federal Reserve include open market operations in U. S. Government securities and changes in the discount rate on member bank borrowing changes in reserve requirements against member bank deposits. In view of changing conditions in the national economy and in the money markets, as well as the effect of action by monetary and fiscal authorities, including the Federal Reserve System, no prediction can be made as to possible future changes in interest rates, deposit levels, loan demand or the business and earnings of the Banks. Supervision and Regulations The Registrant is a bank holding company within the meaning of the Bank Holding Company Act of 1956, as amended (the "Act"), and is required to register as such with the Board of Governors. The Registrant is required to file with the Board of Governors an annual report and such other information as may be required to keep the Board of Governors 4 informed with respect to the Registrant's compliance with the provisions of the Act. The Board of Governors may also make examinations of the Registrant and its subsidiaries from time to time. The Act requires every bank holding company to obtain the prior approval of the Board of Governors before it may acquire substantially all the assets of any bank or ownership or control of any voting shares of any bank, if, after such acquisition, it would own or control, directly or indirectly, more than five percent of the voting shares of such bank. In no case, however, may the Board of Governors approve the acquisition by the Registrant of the voting shares of any bank located outside Georgia, unless such acquisition is specifically authorized by the laws of the state in which the bank to be acquired is located. In addition, a bank holding company is generally prohibited from engaging in or acquiring direct or indirect control of voting shares of any company engaged in nonbanking activities. One of the principal exceptions to this prohibition is for activities found by the Board of Governors, by order or regulation, to be so closely related to banking, managing or controlling banks as to be a proper incident thereto. Some of the activities that the Board of Governors has determined by regulation to be closely related to banking are: making or servicing loans and certain types of leases; performing certain data processing services; acting as fiduciary, investment or financial advisor; making investments in corporations or projects designed primarily to promote community welfare. In January, 1989, the Board of Governors issued final regulations which implement risk-based rules for assessing bank and bank holding company capital adequacy. The regulations revise the definition of capital and establish minimum capital standards in relation to assets and off-balance sheet exposures, as adjusted for credit risk. Payment of Dividends and Other Restrictions South is a legal entity separate and distinct from its subsidiaries. There are various legal and regulatory limitations under federal and state law on the extent to which South's subsidiaries can pay dividends or otherwise supply funds to South. The principal source of South's cash revenues is dividends from its subsidiaries. The prior approval of the FRB or the Georgia Department of Bankers, as the case may be, is required if the total of all dividends declared by any state member bank of the Federal Reserve System in any calendar year exceeds the Bank's net profits (as defined) for that year combined with its retained net profits for the preceding two calendar years, less any required transfers to surplus or a fund for the retirement of any preferred stock. The relevant federal and state regulatory agencies also have authority to prohibit a state member bank or bank holding company, which would include South and the Subsidiary Banks from engaging in what, in the opinion of such regulatory body, constitutes an unsafe or unsound practice in conducting its business. The payment of dividends could, depending upon the financial condition of the subsidiary, be deemed to constitute such an unsafe or unsound practice. 5 Under Georgia law, the prior approval of the DBF is required before any cash dividends may be paid by a state bank if: (i) total classified assets at the most recent examination of such bank exceed 80% of the equity capital (as defined, which includes the reserve for loan losses) of such bank; (ii) the aggregate amount of dividends declared or anticipated to be declared in the calendar year exceeds 50% of the net profits (as defined) for the previous calendar year; or (iii) the ratio of equity capital to adjusted total assets is less than 6%. In addition, the Banks are subject to limitations under Section 23A of the Federal Reserve Act with respect to extensions of credit to, investments in, and certain other transactions with South. Furthermore, loans and extensions of credit are also subject to various collateral requirements. Capital Adequacy The FRB has adopted risk-based capital guidelines for bank holding companies. The minimum ratio of total capital ("Total Capital") to risk- weighted assets (including certain off-balance sheet items, such as standby letters of credit) is 8%. At least half of the Total Capital is to be composed of common stock, minority interests in the equity accounts of consolidated subsidiaries, noncumulative perpetual preferred stock and a limited amount of perpetual preferred stock, less goodwill ("Tier I Capital"). The remainder may consist of subordinated debt, other preferred stock and a limited amount of loan loss reserves. In addition, the FRB has established minimum leverage ratio guidelines for bank holding companies. These guidelines provide for a minimum ratio of Tier I Capital to total assets, less goodwill (the "Leverage Ratio") of 3% for bank holding companies that meet certain specified criteria, including those having the highest regulatory rating. All other bank holding companies generally are required to maintain a Leverage Ratio of at least 3% plus an additional cushion of 100 to 200 basis points. The guidelines also provide that bank holding companies experiencing internal growth or making acquisitions will be expected to maintain strong capital positions substantially above the minimum supervisory levels without significant reliance on intangible assets. Furthermore, the FRB has indicated that it will consider a "tangible Tier I capital leverage ratio" (deducting all intangibles) and other indications of capital strength in evaluating proposals for expansion or new activities. Effective December 19, 1992, a new Section 38 to the Federal Deposit Insurance Act implemented the prompt corrective action provisions that Congress enacted as a part of the Federal Deposit Insurance Corporation Improvement Act of 1991 (the "1991 Act"). The "prompt corrective action" provisions set forth five regulatory zones in which all banks are placed largely based on their capital positions. Regulators are permitted to take increasingly harsh action as a Bank's financial condition declines. Regulators are also empowered to place in receivership or require the sale of a bank to another depository institution when a bank's capital leverage ratio reaches two percent. Better capitalized institutions are generally subject to less onerous regulation and supervision than banks with less amounts of capital. 6 The FDIC has adopted regulations implementing the prompt corrective action provisions of the 1991 Act, which place financial institutions in the following five categories based upon capitalization ratios: (i) a "well capitalized" institution has a total risk-based capital ratio of at least 10%, a Tier I risk-based ratio of at least 6% and a leverage ratio of at least 5%; (ii) an "adequately capitalized" institution has a total risk-based capital ratio of at least 8%, a Tier I risk-based ratio of at least 4% and a leverage ratio of at least 4%, (iii) an "undercapitalized" institution has a total risk-based capital ratio of under 8%, a Tier I risk-based ratio of under 4% or a leverage ratio of under 4%; (iv) a "significantly undercapitalized" institution has a total risk-based capital ratio of under 6%, a Tier I risk-based ratio of under 3% or a leverage ratio of under 3%; and (v) a "critically undercapitalized" institution has a leverage ratio of 2% or less. Institutions in any of the three undercapitalized categories would be prohibited from declaring dividends or making capital distributions. The FDIC regulations also establish procedures for "downgrading" an institution to a lower capital category based on supervisory factors other than capital. The downgrading of an institution's category is automatic in two situations: (i) whenever an otherwise well-capitalized institution is subject to any written capital order or directive; and (ii) where an undercapitalized institution fails to submit or implement a capital restoration plan or has its plan disapproved. The Federal banking agencies may treat institutions in the well-capitalized, adequately capitalized and undercapitalized categories as if they were in the next lower level based on safety and soundness considerations relating to factors other than capital levels. All insured institutions regardless of their level of capitalization are prohibited by the Federal Deposit Insurance Corporation Improvement Act of 1991 (the "FDIC Act") from paying any dividend or making any other kind of capital distribution or paying any management fee to any controlling person if following the payment or distribution the institution would be undercapitalized. While the prompt corrective action provisions of the FDIC Act contain no requirements or restrictions aimed specifically at adequately capitalized institutions, other provisions of the FDIC Act and the agencies' regulations relating to deposit insurance assessments, brokered deposits and interbank liabilities treat adequately capitalized institutions less favorably than those that are well-capitalized. Under the FDIC's regulations, all of the Subsidiary Banks are "well capitalized" institutions. The written policies of the Georgia Department of Banking and Finance (the "DBF") require that state banks in Georgia generally maintain a minimum ratio of primary capital to total assets of 6.0%. At December 31, 2001, the Banks were in compliance with these requirements. In addition, the DBF is likely to compute capital obligations in accordance with the risk-based capital rules while continuing to require a minimum absolute level of capital. 7 It is not anticipated that such minimum capital requirements will affect the business operations of the Banks. However, the Board, in connection with granting approval for bank holding companies to acquire other banks and bank holding companies or to engage in non- banking activities, requires bank holding companies to maintain tangible capital ratios at approximate peer group levels. This requirement can result in a bank holding company maintaining more capital than it would otherwise maintain. At the present time, South Banking Company's tangible primary capital ratios are equal or above their peer group level. The laws of Georgia require annual registration with the DBF by all Georgia bank holding companies. Such registration includes information with respect to the financial condition, operations and management of intercompany relationships of the bank holding company and its subsidiaries and related matters. The DBF may also require such other information as is necessary to keep informed as to whether the provisions of Georgia law and the regulations and orders issued thereunder by the DBF have been in compliance with and the DBF may make examinations of the bank holding company and each bank subsidiary thereof. The banks are also subject to examination by the DBF and the FDIC. The DBF regulates and monitors all areas of the operations of the banks, including reserves, loans, mortgages, issuances of securities, payment of dividends, interest rates, and establishment of branches. Interest and certain other charges collected or contracted for by the Banks are also subject to state usury laws and certain federal laws concerning interest rates. The Banks' deposits are insured by the FDIC up to the maximum permitted by law. Legislation has passed that would allow banks to branch statewide subject to certain restrictions. This law became effective July 1, 1996. Georgia banking laws permit bank holding companies to own more than one bank, subject to the prior approval of the Georgia Department of Banking and Finance; thereby, in effect, permitting statewide banking organizations. Such banks may be acquired as subsidiaries of the Registrant or merged into its existing bank subsidiaries. Support of Subsidiary Banks Under the FRB policy, South is expected to act as a source of financial strength to, and to commit resources to support, each of the Subsidiary Banks. This support may be required at times when, absent such FRB policy, South may not be inclined to provide it. In the event of a bank holding company's bankruptcy, any commitment by the bank holding company to a Federal bank regulatory agency to maintain the capital of a subsidiary bank will be assumed by the bankruptcy trustee and entitled to a priority of payment. As a result of the enactment of Section 206 of the Financial Institutions Reform, Recovery and Enforcement Act ("FIRREA") on August 9, 1989, a depository institution insured by the FDIC can be held liable for any loss incurred by, or reasonably expected to be incurred by, the FDIC after August 9, 1989 in connection with (i) the default of a commonly controlled FDIC-insured depository institution or (ii) any assistance provided by the FDIC to any commonly controlled FDIC- insured depository 8 institution "in danger of default" is defined generally as the existence of certain conditions indicating that a default is likely to occur in the absence of regulator assistance. FDIC Insurance Assessments The Subsidiary Banks are subject to FDIC deposit insurance assessments for the Bank Insurance Fund (the "BIF"). Since 1989, the annual FDIC deposit insurance assessments increased from $.083 per $100 of deposits to a minimum level of $.23 per $100, an increase of 177 percent. The FDIC implemented a risk-based assessment system whereby banks are assessed on a sliding scale depending on their placement in nine separate supervisory categories, from $.23 per $100 of deposits for the healthiest banks (those with the highest capital, best management and best overall condition) to as much as $.31 per $100 of deposits for the less-healthy institutions, for an average of $.259 per $100 of deposits. On August 8, 1995, the FDIC lowered the BIF premium for "healthy" banks 83% from $.23 per $100 in deposits to $.04 per $100 in deposits, while retaining the $.31 level for the riskiest banks. The average assessment rate was therefore reduced from $.232 to $.044 per $100 of deposits. The new rate took effect on September 29, 1995. On November 14, 1995, the FDIC again lowered the BIF premium for "healthy" banks from $.04 per $100 of deposits to zero for the highest rated institutions (92% of the industry). All of the Subsidiary Banks are insured under the BIF fund and it is expected that they will be required to pay only the legally required annual minimum payments during 2002. Recent Legislative and Regulatory Action On April 19, 1995, the four Federal bank regulatory agencies adopted revisions to the regulations promulgated pursuant to the Community Reinvestment Act (the "CRA"), which are intended to set distinct assessment standards for financial institutions. The revised regulations contain three evaluation tests: (i) a lending test which will compare the institution's market share of loans in low- and moderate-income areas to its market share of loans in its entire service area and the percentage of a bank's outstanding loans to low- and moderate-income areas or individuals; (ii) a services test which will evaluate the provisions of services that promote the availability of credit to low- and moderate-income areas; and (iii) an investment test, which will evaluate an institution's record of investments in organizations designed to foster community development, small- and minority-owned businesses, and affordable housing lending, including state and local government housing or revenue bonds. The regulation is designed to reduce some paperwork requirements of the current regulations and provide regulators, institutions, and community groups with a more objective and predictable manner with which to evaluate the CRA performance of financial institutions. The rule became effective on January 1, 1996, at which time evaluation under streamlined procedures were scheduled to begin for institutions with assets of less than $250 million. These regulations have had little or no effect on South and the Subsidiary Banks. Congress and various Federal agencies (including Housing and Urban Development, the Federal Trade Commission and the Department of Justice)(collectively, the "Federal Agencies") responsible for implementing 9 the nation's fair lending laws have been increasingly concerned that prospective home buyers and other borrowers are experiencing discrimination in their efforts to obtain loans. In recent years, the Department of Justice has filed suit against financial institutions, which it determined had discriminated, seeking fines and restitution for borrowers who allegedly suffered from discriminatory practices. Most, if not all, of these suits have been settled (some for substantial sums) without a full adjudication on the merits. On March 8, 1994, the Federal Agencies, in an effort to clarify what constitutes lending discrimination and specify the factors the agencies will consider in determining if lending discrimination exists, announced a joint policy statement detailing specific discriminatory practices prohibited under the Equal Opportunity Act and the Fair Housing Act. In the policy statement, three methods of proving lending discrimination were identified: (i) over evidence of discrimination, when a lender blatantly discriminates on a prohibited basis; (ii) evidence of disparate treatment, when a lender treats applicants differently based on a prohibited factor even where there is no showing that the treatment was motivated by prejudice or a conscious intention to discriminate against a person; and (iii) evidence of disparate impact, when a lender applies a practice uniformly to all applicants, but the practice has a discriminatory effect, even where such practices are neutral on their face and are applied equally, unless the practice can be justified on the basis of business necessity. On September 23, 1994, President Clinton signed the Reigle Community Development and Regulatory Improvement Act of 1994 (the "Regulatory Improvement Act"). The Regulatory Improvement Act contains funding for community development projects through banks and community development financial institutions and also numerous regulatory relief provisions designed to eliminate certain duplicative regulations and paperwork requirements. On September 29, 1994, President Clinton signed the Reigle-Neal Interstate Banking and Branching Efficiency Act of 1994 (the "Federal Interstate Bill") which amended Federal law to permit bank holding companies to acquire existing banks in any state effective September 29, 1995, and to permit any interstate bank holding company to merge its various bank subsidiaries into a single bank with interstate branches after May 31, 1997. States have the authority to authorize interstate branching prior to June 1, 1997, or, alternatively, to opt out of interstate branching prior to that date. The Georgia Financial Institutions Code was amended in 1994 to permit the acquisition of a Georgia bank or bank holding company by out-of-state bank holding companies beginning July 1, 1995. On September 29, 1995, the interstate banking provisions of the Georgia Financial Institutions Code were superseded by the Federal Interstate Bill. On November 12, 1999, the Gramm-Leach-Bliley Act ("the Act"), formerly known as the Financial Modernization Act was enacted. The new statute is the most sweeping financial services legislation enacted in decades. It repeals depression-era laws and eliminates the barriers preventing affiliations among banks, insurance companies, and securities firms. Key provisions to the Act are summarized in the following paragraphs. Repeal of the Glass-Stegall Act - At its core, the Act repeals, effective 120 days after enactment, the anti-affiliation provisions in sections 20 and 32 of the Banking Act of 1933 (also known as the Glass- 10 Stegall Act) and amends provisions in the Bank Holding Company Act of 1956 to permit financial companies to offer a broad array of banking, insurance, securities, and other financial products, either through financial holding companies ("FHCs") or through operating subsidiaries qualifying under the Act. In general, Congress decided to preserve the Federal Reserve's role as the umbrella supervisor for holding companies. The Board will work, however, within a system of functional regulation designed to take advantage of the traditional strengths of the federal and state financial supervisors. In addition, the legislation establishes a mechanism for coordination between the Federal Reserve and Treasury regarding the approval of new financial activities for both holding companies and national bank financial subsidiaries. Banking organizations are prohibited under the Act from participating in new financial affiliations unless their depository institution subsidiaries are well capitalized and well managed. Regulators are required to address any failure to maintain safety and soundness standards in a prompt manner. In addition, regulators must prohibit holding companies from participating in new financial affiliations if, at the time of certification, any insured depository affiliate had received a less- than-satisfactory Community Reinvestment Act ("CRA") rating at its most recent examination. Affiliation Authority - The Act amends section 4 of the Bank Holding Company Act ("BHCA") to provide a new framework for engaging in new financial activities. Those bank holding companies ("BHCs") that qualify to engage in the new financial activities are designated as financial holding companies ("FHCs"). New provisions of the BHCA permit BHCs that qualify as FHCs to engage in activities, and acquire companies engaged in activities that are financial in nature or incidental to such financial activities. FHCs are also permitted to engage in activities that are complementary to financial activities if the Board of Governors of the Federal Reserve Bank ("FRB Board") determines that the activity does not pose a substantial risk to the safety or soundness of the institution or the financial system in general. The FRB Board may act by either regulation or order in determining what activities are financial in nature, incidental to financial in nature, or complementary. In doing so, the FRB must notify the Treasury of requests to engage in new financial activities and may not determine that an activity is financial or incidental to a financial activity if Treasury objects. Furthermore, Treasury may propose that the Board find a particular activity financial in nature or incidental to a financial activity. The Act establishes a similar procedure with regard to the Treasury's (acting through the Office of the Comptroller of the Currency ("OCC") determination of financial activities and activities that are incidental to financial activities for subsidiaries of national banks. Congress intends for the Federal Reserve and Treasury to establish a consultative process that will negate the need for either agency to veto a proposal of the other agency. 11 Federal Home Loan Bank Reform - The Act reforms the Federal Home Loan Bank System, including greatly expanding the collateral that a community bank can pledge against FHLB System advances, thus giving smaller banks access to a substantial new liquidity source. FHLB members under $500 million in assets can now pledge small business and agricultural loans (or securities representing a whole interest in such loans) as collateral for advances. Privacy - The Act imposes a number of new restrictions on the ability of financial institutions - read as any entity offering financial products, including banks, insurance companies, securities houses, and credit unions - to share nonpublic personal information with nonaffiliated third parties. Specifically, the bill: o requires financial institutions to establish privacy policies and disclose them annually to all their customers, setting forth how the institutions share nonpublic personal financial information with affiliates and third parties o directs regulators to establish regulatory standards that ensure the security and confidentiality of customer information o permits customers to prohibit (opt-out-of permitting) such institutions from disclosing personal financial information to nonaffiliated third parties o prohibits transfer of credit card or other account numbers to third- party marketers o prohibits pretext calling (that is, makes it illegal for information brokers to call banks to obtain customer information with the intent to defraud the bank or customer) o protects stronger state privacy laws, as well as those not "inconsistent" with these Federal rules o requires the Treasury and other Federal regulators to study the appropriateness of sharing information with affiliates, including considering both negative and positive aspects of such sharing for consumers. The bill also imposes an affirmative obligation on banks to respect their customers' privacy interests. Language protects a community bank's ability to share information with third parties selling financial products (for example, insurance or securities) to bank customers. Community banks can thus continue such sales practices without being subject to the opt-out provisions contained elsewhere in the legislation. Bankruptcy Legislation - Although proposed bankruptcy legislation is not finalized and signed into law, it appears that the final legislation may assist in reducing the number of voluntary liquidation bankruptcies. This legislation may be of long-term benefit to financial institutions and other creditors. 12 Various legislation, including proposals to substantially change the financial institution regulatory system and to expand or contract the powers of banking institutions and bank holding companies, is from time to time introduced in Congress. This legislation may change banking statutes and the operating environment of the combined company and its subsidiaries in substantial and unpredictable ways. If enacted, such legislation could increase or decrease the cost of doing business, limit or expand permissible activities or affect the competitive balance among banks, savings associations, credit unions, and other financial institutions. The Registrant cannot accurately predict whether any of this potential legislation will ultimately be enacted, and, if enacted, the ultimate effect that it, or implementing regulations, would have upon the financial condition or results of operations of itself or any of its subsidiaries. Omnibus Budget Reconciliation Act of 1993 The Omnibus Budget Reconciliation Act of 1993 (the "Tax Act") continues the recent legislation affecting banks and financial institutions. The Tax Act was designed as a deficit reduction with similarities to the 1990 Act which was also designed to slice $500 billion from the deficit. Generally the Tax Act affects all corporations as to a new 35% tax rate for income in excess of $10 million and the maximum corporate capital gains rate was increased to 35%. The Registrant currently will not be affected by the change due to the income level of the Registrant. Various other provisions would restrict certain deductions and/or change the treatment of certain transactions. Provisions that especially affect financial institutions included market to market Accounting for Securities. The Tax Act requires that securities that are inventory in the hands of a dealer be inventoried at fair market value (market to market). For the purposes of these rules, "securities" and a "dealer" are defined more broadly than under prior law. A "dealer" is any person who either regularly purchases securities from or sells securities to customers in the ordinary course of business or regularly offers to enter into, assume, offset, assign or otherwise terminate positions in securities with customers in the ordinary course of a trade or business. Banks have been determined to qualify as a dealer under the new definitions. Unless securities are properly identified as held for investment, all inventory will be required to be market to market. A second item affecting financial institutions is the treatment of tax-free FSLIC Assistance that was credited on or after March 4, 1991 in connection with the disposition of "covered" assets. Financial institutions are required to treat that assistance as compensation for any losses claimed on dispositions or charge-offs of these assets, effectively denying them any tax loss for those assets. This provision should not have any effect on the Registrant. The third item affecting financial institutions is the amortization of intangible assets effective for purchase after the enactment (August 10, 1993). Taxpayers are required to amortize most intangibles (including goodwill, core deposits, going concern value and covenant not to compete) used in a trade or business over a 15 year period. Exception to this rule 13 includes mortgage service rights. The provision will have significant impact on any future purchases the holding company may decide to undertake. Some of the other provisions such as eliminating deductions for lobbying expense and club dues will impact the taxes payable by the Registrant. Recent and Proposed Changes in Accounting Rules In June, 1997, the FASB issued SFAS No. 130, Reporting Comprehensive Income. The statement is effective for annual and quarterly financial statements for fiscal years beginning after December 15, 1997, with earlier application permitted. For the Company, the statement became effective in the first quarter of 1998 and required reclassification of earlier financial statements for comparative purposes. SFAS No. 130 requires that changes in the amounts of comprehensive income items be shown in a primary financial statement. Comprehensive income is defined by the statement as "the change in equity (net assets) of a business enterprise during a period from transactions and other events and circumstances from nonowner sources. It includes all changes in equity during a period except those resulting from investments by owners and distributions to owners." While the adoption of this statement changed the look of the Company's financial statements, it did not have a material effect on the Company. Also, in June 1997, the FASB issued SFAS No. 131, Disclosures about Segments of an Enterprise and Related Information. The statement is effective for financial statements for fiscal years beginning after December 15, 1997, with earlier application permitted. SFAS No. 131 changes the way public companies report information about segments of their business in their annual financial statements and requires them to report selected segment information in their quarterly reports issued to shareholders. A company is required to report on operating segments based on the management approach. An operating segment is defined as any component of an enterprise that engages in business activities from which it may earn revenues and incur expenses. The management approach is based on the way that management organizes the segments within the enterprise for making operating decisions and assessing performance. The adoption of this standard did not have a material effect on the Company. In February 1998, the FASB issued SFAS No. 132, Employers' Disclosures about Pensions and Other Postretirement Benefits. The statement is effective for fiscal years beginning after December 15, 1997. SFAS No. 132 provides additional information to facilitate financial analysis and eliminates certain disclosures which are no longer useful. To the extent practical, the statement also standardizes disclosures for retiree benefits. The adoption of this standard did not have a material effect on the Company. In June 1998, the Financial Accounting Standards Board ("FASB") issued SFAS No. 133 "Accounting for Derivative Instruments and Hedging Activities." This Statement establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities. It requires that 14 an entity recognize all derivatives as either assets or liabilities in the statement of financial position and measure those instruments at fair value. The accounting for changes in the fair value of a derivative depends on the intended use of the derivative and the resulting designation. In June of 1999, the FASB issued SFAS No. 137, "Accounting for Derivative Instruments and Hedging Activities - Deferral of the Effective Date of FASB Statement No. 133." This statement deferred the effective date of SFAS No. 133 to fiscal years beginning after June 15, 2000, with early application encouraged. South is in the process of determining the impact, if any, the implementation of SFAS No. 133 and SFAS No. 137 will have on its results of operations. In October 1998, the FASB issued SFAS No. 134, Accounting for Mortgage-Backed Securities Retained after the Securitization of Mortgage Loans Held for Sale by Mortgage Banking Enterprise, an amendment to SFAS No. 65. This statement is effective for the first fiscal quarter beginning after December 15, 1998, (or January 1, 1999 for the Company). The statement requires that after the securitization of mortgage loans held for sale, any retained mortgage-backed securities be classified in accordance with SFAS No. 115, based on the entity's ability and intent to sell or hold those investments. Prior to this statement, mortgage banking entities were required to classify these securities as trading only. The adoption of this standard did not have a material effect on the Company. In September 2000, the FASB issued Statement of Financial Accounting Standards No. 140, "Accounting for transfers and Servicing of Financial Assets and Extinguishments of Liabilities - a Replacement of FASB Statement No. 125" ("SFAS 140"). SFAS 140 revises the criteria for accounting for securitizations and other transfers of financial assets and collateral. In addition, SFAS 140 requires certain additional disclosures. Except for the new disclosure provisions, which were effective for the year ended December 31, 2000, SFAS 140 was effective for the transfer of financial assets occurring after March 31, 2001. The provisions of SFAS 140 did not have a significant effect on the company. In July 2001, the FASB issued Statements of Financial Accounting Standards No. 141, "Business Combinations" ("FAS 141") and No. 142, "Goodwill and Other Intangible Assets"("FAS 142"). These standards change the accounting for business combinations by, among other things, prohibiting the prospective use of pooling-of-interests accounting and requiring companies to stop amortizing goodwill and certain intangible assets with an indefinite useful life created by business combinations accounted for using the purchase method of accounting. Instead, goodwill and intangible assets deemed to have an indefinite useful life will be subject to an annual review for impairment. The new standards generally will be effective in the first quarter of 2002. The provisions of these statements did not have an effect on the company. Industry Developments Certain recently-enacted and proposed legislation could have an effect on both the costs of doing business and the competitive factors facing the financial institution's industry. Because of the uncertainty of the final terms and likelihood of passage of the proposed legislation, the Company is unable to assess the impact of any proposed legislation on its financial condition or operations at this time. 15 Selected Statistical Information The tables and schedules on the following pages set forth certain significant statistical data with respect to: (i) the distribution of assets, liabilities and shareholders' equity and the interest rates and interest differentials experienced by, the Registrant and its subsidiaries; (ii) the investment portfolio of the Registrant and its subsidiaries; (iii) the loan portfolio of the Registrant and its subsidiaries, including types of loans, maturities and sensitivity to changes in interest rates and information on nonperforming loans; (iv) summary of the loan loss experience and reserves for loan losses of the Registrant and its subsidiaries; (v) types of deposits of the Registrant and its subsidiaries; and (vi) the return on assets and equity for the Registrant and its subsidiaries. I. DISTRIBUTION OF ASSETS, LIABILITIES AND SHAREHOLDERS' EQUITY; INTEREST RATES AND INTEREST DIFFERENTIALS A. The condensed average balance sheets for the periods indicated are presented below. Year Ended Year Ended Year Ended December 31, December 31, December 31, 2001 2000 1999 ASSETS (In Thousands) Cash and due from banks $ 6,705 $ 6,283 $ 7,836 Cash in bank - interest bearing 957 822 1,355 Taxable investment securities 16,518 16,884 15,905 Nontaxable investment securities 1,326 1,613 1,825 Ohers 1,343 1,487 1,435 Federal funds sold and securities purchased under agreements to resell 18,028 9,945 8,757 Loans - net 166,639 148,195 121,166 Other assets 14,555 10,762 8,031 Total Assets $ 226,071 $ 195,991 $ 166,310 LIABILITIES AND SHAREHOLDERS' EQUITY Deposits: Demand - non-interest bearing $ 24,903 $ 22,444 $ 20,341 Demand - interest bearing 30,600 24,959 23,777 Savings 11,809 11,122 10,674 Time 131,154 114,026 92,406 Total Deposits $ 198,466 $ 172,551 $ 147,198 Federal funds purchased 23 114 55 Other borrowed funds 6,065 4,518 3,087 Other liabilities 2,453 1,768 962 Total Liabilities $ 207,007 $ 178,951 $ 151,302 Shareholders' equity 19,064 17,040 15,008 Total Liabilities and Shareholders' Equity $ 226,071 $ 195,991 $ 166,310 B. Interest Rates. The tables below show for the periods indicated the average amount outstanding for major categories of interest earning assets and interest bearing liabilities; the average interest rates earned or paid; the interest income and expense earned or paid thereon; net interest earnings and the net yield on interest-earning assets. 16 Year Ended December 31, 2001 Average Yield/ Balance Interest Rate ASSETS (In Thousands) Cash in banks - interest bearing $ 957 $ 54 5.64% Loans 166,639 16,737 10.04% Taxable investments 16,518 947 5.73% Non-taxable investments 1,326 66 4.97% Other 1,343 60 4.47% Federal funds sold and securities purchased under agreements to resell 18,028 741 4.11% Total Interest-Bearing Assets $ 204,811 $ 18,605 9.08% LIABILITIES Demand - interest bearing $ 30,600 $ 694 2.27% Savings deposits 11,809 314 2.65% Other time deposits 131,154 7,897 6.02% Other borrowing 6,065 429 7.07% Federal funds purchased 23 1 4.34% Total Interest-Bearing Liabilities $ 179,651 $ 9,335 5.20% Net interest earnings $ 9,270 Net yield on interest earning assets 3.88% Year Ended December 31, 2000 Average Yield/ Balance Interest Rate ASSETS (In Thousands) Cash in banks - interest bearing $ 822 $ 53 6.44% Loans 148,195 16,604 11.20% Taxable investments 16,884 1,021 6.05% Non-taxable investments 1,613 79 4.90% Other 1,487 73 4.91% Federal funds sold and securities purchased under agreements to resell 9,945 623 6.26% Total Interest-Bearing Assets $ 178,946 $ 18,453 10.31% LIABILITIES Demand - interest bearing $ 24,959 $ 648 2.59% Savings deposits 11,122 359 3.23% Other time deposits 114,026 7,115 6.24% Other borrowing 4,518 448 9.91% Federal funds purchased 114 8 7.02% Total Interest-Bearing Liabilities $ 154,739 $ 8,578 5.54% Net interest earnings $ 9,875 Net yield on interest earning assets 4.77% 17 Year Ended December 31, 1999 Average Yield/ Balance Interest Rate ASSETS (In Thousands) Cash in banks - interest bearing $ 1,355 $ 78 5.75% Loans 121,166 12,859 10.61% Taxable investments 15,905 936 5.88% Non-taxable investments 1,825 87 4.77% Other 1,435 96 6.68% Federal funds sold and securities purchased under agreements to resell 8,757 462 5.28% Total Interest-Bearing Assets $ 150,443 $ 14,518 9.65% LIABILITIES Demand - interest bearing $ 23,777 $ 633 2.66% Savings deposits 10,674 352 3.30% Other time deposits 92,406 5,037 5.45% Other borrowing 3,087 236 7.65% Federal funds purchased 55 3 5.45% Total Interest-Bearing Liabilities $ 129,999 $ 6,261 4.82% Net interest earnings $ 8,257 Net yield on interest earning assets 4.83% (1) Note: Loan fees are included for rate calculation purposes. Loan fees included in interest amounted to approximately $1,208,871 in 2001, $999,520 in 2000 and $892,522 in 1999. Non accrual loans have been included in the average balances. C. Interest Differentials. The following tables set forth for the periods indicated a summary of the changes in interest earned and interest paid resulting from changes in volume and changes in rates. 2001 Compared to 2000 Increase (Decrease) Due to (1) Volume Rate Change Interest earned on: (In Thousands) Cash in banks - interest bearing $ 9 $( 8) $ 1 Loans 2,066 ( 1,933) 133 Taxable investments ( 22) ( 52) ( 74) Nontaxable investments ( 14) 1 ( 13) Other ( 7) ( 6) ( 13) Federal funds sold and securities purchased under agreement to resell 505 ( 387) 118 Total Interest-Earning Assets $ 2,537 $( 2,385) $ 152 18 2001 Compared to 2000 (Con't) Increase (Decrease) Due to (1) Volume Rate Change (In Thousands) Interest paid on: NOW deposits $ 144 $( 98) $ 46 Savings deposits 22 ( 67) ( 45) Other time deposits 1,070 ( 288) 782 Other borrowing 153 ( 172) ( 19) Federal funds purchased ( 6) ( 1) ( 7) Total Interest-Bearing Liabilities $ 1,383 $( 626) $ 757 Net Interest Earnings $ 1,154 $( 1,759) $( 605) (1) The change in interest due to volume has been determined by applying the rate from the earlier year to the change in average balances outstanding from one year to the next. The change in interest due to rate has been determined by applying the change in rate from one year to the next to average balances outstanding in the later year. 2000 Compared to 1999 Increase (Decrease) Due to (1) Volume Rate Change Interest earned on: (In Thousands) Cash in banks - interest bearing $( 31) $ 6 $( 25) Loans 2,867 878 3,745 Taxable investments 57 28 85 Nontaxable investments ( 10) 2 ( 8) Other 3 ( 26) ( 23) Federal funds sold and securities purchased under agreement to resell 63 98 161 Total Interest-Earning Assets$ 2,949 $ 986 $ 3,935 Interest paid on: NOW deposits $ 31 $( 16) $ 15 Savings deposits 14 ( 7) 7 Other time deposits 1,178 900 2,078 Other borrowing 109 103 212 Federal funds purchased 3 2 5 Total Interest-Bearing Liabilities $ 1,335 $ 982 $ 2,317 Net Interest Earnings $ 1,614 $ 4 $ 1,618 (1) The change in interest due to volume has been determined by applying the rate from the earlier year to the change in average balances outstanding from one year to the next. The change in interest due to rate has been determined by applying the change in rate from one year to the next to average balances outstanding in the later year. 19 1999 compared to 1998 Increase (Decrease) Due to (1) Volume Rate Change Interest earned on (In Thousands) Cash in banks - interest bearing $( 3) $( 1) $( 4) Loans 1,084 ( 377) 707 Taxable investments ( 38) 38 - Nontaxable investments ( 7) 2 ( 5) Other 24 14 38 Federal funds sold and securities purchased under agreement to resell ( 137) ( 2) ( 139) Total Interest-Earning Assets $ 923 $( 326) $ 597 Interest paid on: NOW deposits $ 31 $( 76) $( 45) Savings deposits 52 12 64 Other time deposits 372 ( 499) ( 127) Other borrowing ( 23) ( 3) ( 26) Federal funds purchased 3 - 3 Total Interest-Bearing Liabilities $ 435 $( 566) $( 131) Net Interest Earnings $ 488 $ 240 $ 728 (1) The change in interest due to volume has been determined by applying the rate from the earlier year to the change in average balances outstanding from one year to the next. The change in interest due to rate has been determined by applying the change in rate from one year to the next to average balances outstanding in the later year. II. INVESTMENT PORTFOLIO A. Types of Investments The carrying amounts of investment securities at the dates indicated are summarized as follows: Year Ended Year Ended Year Ended December 31, December 31, December 31, 2001 2000 1999 (In Thousands) U. S. Treasury and other U. S. government agencies and corporations $ 15,691 $ 18,449 $ 16,292 State and political subdivisions (domestic) 1,131 1,529 1,714 Mortgage backed securities 236 399 502 Equities 262 465 545 Totals $ 17,320 $ 20,842 $ 19,053 20 B. Maturities The amounts of investment securities in each category as of December 31, 2001 are shown in the following table according to maturity classifications (1) one year or less, (2) after one year through five years, (3) after five years through ten years, (4) after ten years. U. S. Treasury and Other U. S. Government State Agencies and and Political Mortgage Backed Corporations Subdivisions Securities Average Average Yield Yield Average Amount (1) Amount (1)(2) Amount Yield (In Thousands) Maturity: One year or less $ 1,962 4.46% $ 359 8.14%$ - - After one year through five years 10,815 5.00 309 7.35 - - After five years through ten years 2,914 4.92 103 7.33 - - After ten years - - 360 9.14 236 7.27 Totals $ 15,691 4.92% $ 1,131 8.17% $ 236 7.27% (1) Yields were computed using coupon interest, adding discount accretion or subtracting premium amortization, as appropriate, on a ratable basis over the life of each security. The weighted average yield for each maturity range was computed using the acquisition price of each security in that range. (2) Yields on securities of state and political subdivisions are stated on a tax equivalent basis, using a tax rate of 34%. III. Loan Portfolio A. Types of Loans The amount of loans outstanding at the indicated dates are shown in the following table according to type of loan. Year Ended Year Ended Year Ended December 31, December 31, December 31, 2001 2000 1999 (In Thousands) Commercial, financial and agricultural $ 49,558 $ 42,973 $ 34,607 Real estate - mortgage 85,876 81,314 62,829 Real estate - construction 9,015 7,646 13,413 Installments 27,929 31,294 21,433 $ 172,378 $ 163,227 $ 132,282 Less - Unearned income 289 253 216 Reserve for possible losses 2,756 2,728 2,169 Total Loans $ 169,333 $ 160,246 129,897 21 B. Maturities and Sensitivity to Changes in Interest Rates The amount of total loans by category outstanding as of December 31, 2001 which, based on remaining repayments of principal, are due in (1) one year or less, (2) more than one year but less than five and (3) more than five years are shown in the following table. The amounts due after one year are classified according to the sensitivity to changes in interest rates. Maturity Classification Over One One Year Through Over or Less Five Years Five Years Total Types of Loans (In Thousands) Commercial, financial and agricultural $ 21,309 $ 13,789 $ 14,460 $ 49,558 Real estate mortgage 37,159 29,669 19,048 85,876 Real estate construction 4,178 1,331 3,506 9,015 Installment 8,736 13,320 5,873 27,929 Total loans due after one year with: Predetermined interest rate 50,484 Floating interest rate 48,512 C. Nonperforming Loans The following table presents, at the dates indicated, the aggregate amounts of nonperforming loans for the categories indicated. Year Ended Year Ended Year Ended December 31, December 31, December 31, 2001 2000 1999 (In Thousands) Loans accounted for on a non-accrual basis $ 1,002 $ 876 $ 422 Loans contractually past due ninety days or more as to interest or principal payments 1,028 734 419 Loans, the terms of which have been renegotiated to provide a reduction or deferral of interest or principal because of a deterioration in the financial position of the borrower 4 8 29 22 C. Nonperforming Loans - (con't) Year Ended Year Ended Year Ended December 31, December 31, December 31, 2001 2000 1999 (In Thousands) Loans now current about which there are serious doubts as to the ability of the borrower to comply with present loan repayment terms - - - Loans are placed on non-accrual basis when loans are past due ninety days or more. Management can elect not to place loans on non- accrual status if net realizable value of collateral is sufficient to cover the balance and accrued interest. D. Commitments and Lines of Credit The banks provide commitments and lines of credit to their most worthy customers only. Commitments are for short terms, usually not exceeding 30 days, and are provided for a fee of 1% of the amount committed. Lines of credit are for periods extending up to one year. No fee is usually charged with respect to the unused portion of a line of credit. Interest rates on loans made pursuant to commitments or under lines of credit are determined at the time that the commitment is made or line is established. 23 E. Rate Sensitivity Analysis SOUTH BANKING COMPANY DECEMBER 31, 2001 INTEREST RATE RISK Note: Dollar amounts in columns are cumulative amounts Total assets on this date equaled $224,791 Interest Rate Risk 0 - 3 0 - 12 0 to 3 0 to 5 0 - 15 Months Months Years Years Years Rate sensitive assets: Securities (fixed rates)$ - $ 4,483 $7,837 $ 15,711 $ 16,823 Securities (floating rates) 236 236 236 236 236 Mutual funds @ UVEST 57 45 57 57 57 CD's at banks 797 1,174 1,273 1,273 1,273 Loans (fixed rates) 19,975 44,265 73,030 83,519 93,379 Loans (floating rates) 74,473 75,893 75,893 75,893 75,893 Federal funds sold 10,252 10,252 10,252 10,252 10,252 Total rate sensitive assets $105,790 $136,348 $168,578 $ 186,941 $ 197,913 Rate sensitive liabilities: CD/IRA's under $100M $ 30,333 $ 83,714 $ 90,930 $ 91,426 $ 91,426 CD/IRA's => $100M 8,589 30,200 31,760 31,760 31,760 Regular savings/Christmas11,510 11,510 11,510 11,510 11,510 Now/Super Now 23,382 23,382 23,382 23,382 23,382 Money market deposit 7,923 7,923 7,923 7,923 7,923 Treasury, tax & loan note 35 35 35 35 35 Federal funds purchased 0 0 0 0 0 Note payable-Ford Motor 3 7 7 7 7 Note payable-Banker's Bank 0 325 1,125 2,125 4,725 Note payable-Waycross Bank & Trust 0 0 0 0 0 Note payable-Banker's Bank (BDS) 51 204 612 849 849 Note payable-FHLB 1,500 1,500 1,500 1,500 1,500 Total rate sensitive liabilities $ 83,326 $158,800 $168,784 $ 170,517 $ 173,117 Rate sensitive assets less Rate sensitive liabilities $ 22,464 $(22,452) $( 206)$ 16,424 $ 24,796 Rate sensitive assets less Rate sensitive liabilities/Total assets 9.99% (9.99%) ( 0.09%) 7.31% 11.03% Rate sensitive assets/ Rate sensitive liabilities 126.96% 85.86% 99.88% 109.63% 114.32% 24 E. Rate Sensitivity Analysis SOUTH BANKING COMPANY DECEMBER 31, 2001 The rate sensitivity analysis table is designed to demonstrate South's sensitivity to changes in interest rates by setting forth in comparative form the repricing maturities of South's assets and liabilities for the period shown. A ratio of greater than 1.0 times interest earnings assets to interest bearing liabilities indicates that an increase in interest rates will generally result in an increase in net income for South and a decrease in interest rates will result in a decrease in net income. A ratio of less than 1.0 times earnings assets to interest-bearing liabilities indicates that a decrease in interest rates will generally result in an increase in net income for South and an increase in interest rates will result in a decrease in net income. 24 IV. Summary of Loan Loss Experience The following table summarizes loan balances at the end of each period and average balances during the year for each category; changes in the reverse for possible loan losses arising from loans charged off and recoveries on loans previously charged off; additions to the reserve which have been charged to operating expense; and the ratio of net charge-offs during the period to average loans. Year Ended Year Ended Year Ended December 31, December 31, December 31, 2001 2000 1999 (In Thousands) A. Average amount of loans outstanding $ 166,639 $ 148,195 $ 121,166 B. Balance of reserve for possible loan losses at beginning of period $ 2,728 $ 2,169 $ 1,971 C. Loans charged off: Commercial, financial and agricultural $ 398 $ 274 $ 149 Real estate - mortgage 225 127 67 Installments 379 263 217 $ 1,002 $ 664 $ 433 D. Recoveries of loans previously charged off: Commercial, financial and agricultural $ 4 $ 83 $ 2 Real estate 49 29 31 Installment 85 99 95 $ 138 $ 211 $ 128 E. Net loans charged off during period $ 864 $ 453 $ 305 Additions to reserve charged to operating expense during period (1)$ 893 $ 424 $ 503 Addition from bank acquisition - 588 - $ 893 $ 1,012 $ 503 F. Balance of reserve for possible loan losses at end of period $ 2,757 $ 2,728 $ 2,169 G. Ratio of net loans charged off during the period to average loans outstanding .52 .31 .25 25 (1) Although the provisions exceeded the minimum provision required by regulatory authorities, the Board of Directors believe that the provision has not been in excess of the amount required to maintain the reserve at a sufficient level to cover potential losses. The amount charged to operations and the related balance in the reserve for loan losses is based upon periodic evaluations by management of the loan portfolio. These evaluations consider several factors including, but not limited to, general economic conditions, loan portfolio composition, prior loan loss experience and management's estimation of future potential losses. (2) Management's review of the loan portfolio did not allocate reserves by category due to the portfolio's small size. The reserves were allocated on the basis of a review of the entire portfolio. The portfolio does not contain excessive concentrations in any industry or loan category that might expose South to significant risk. V. Deposits A. Average deposits, classified as demand deposits, savings deposits and time certificates of deposit for the periods indicated are presented below: Year Ended Year Ended Year Ended December 31, December 31, December 31, 2001 2000 1999 (In Thousands) Demand deposits $ 24,903 $ 22,444 $ 20,341 NOW deposits 30,600 24,959 23,777 Savings deposits 11,809 11,122 10,674 Time certificates of deposits 131,154 114,026 92,406 Total Deposits $ 198,466 $ 172,551 $ 147,198 B. The amounts of time certificates of deposit issued in amounts of $100,000 or more as of December 31, 2001 are shown below by category, which is based on time remaining until maturity of (1) three months or less, (2) over three through six months, (3) over six through twelve months and (4) over twelve months. Three months or less $ 8,741 Over three through twelve months 21,505 Over twelve months 1,560 Total $ 31,806 26 VI. Return on Assets and Shareholders' Equity The following rate of return information for the periods indicated is presented below: Year Ended Year Ended Year Ended December 31, December 31, December 31, 2001 2000 1999 Return on assets (1) .74% 1.35% 1.28% Return on equity (2) 8.83% 15.53% 14.18% Dividend payout ratio (3) 16.63% 10.57% 12.20% Equity to assets ratio (4) 8.43% 8.69% 9.02% (1) Net income divided by average total assets. (2) Net income divided by average equity. (3) Dividends declared per share divided by net income per share. (4) Average equity divided by average total assets. Item 2. Properties Alma Bank's main banking office and the Registrant's principal executive offices are located at 104 North Dixon Street, Alma, Georgia 31510. The building, containing approximately 13,040 square feet of usable office and banking space, and the land, approximately 1.2 acres, are owned by Alma Bank. Alma Bank also has a separate drive-in banking facility located at 505 South Pierce Street, Alma, Georgia. The building, containing 510 square feet, in which the branch is located and the land, approximately .4 acres, on which it is located are owned by Alma Bank. Citizens Bank's main banking office is located at 205 East King Street, Kingsland, Georgia 31548. The building, containing approximately 6,600 square feet of usable office and banking space, and the land, approximately 2 acres, are owned by Citizens Bank. Peoples Bank's main banking office is located at Comas and E. Parker Streets, Baxley, Georgia 31513. The building, containing approximately 7,800 square feet of usable office and banking space, and the land, approximately 2.5 acres, are owned by the Peoples Bank. The Bank does not have branches. Pineland Bank's main banking office is located at 257 North Broad Street, Metter, Georgia 30439. The building, containing approximately 10,000 square feet of usable office and banking space, and the land, approximately 1 acre, are owned by the Pineland Bank. Pineland Bank also has three branches. The branch in Metter, Georgia is a limited service drive-in facility containing approximately 500 square feet and is situated on land covered by a long term lease. 27 A building acquired in the Flag acquisition houses the branch in Cobbtown, Georgia. This facility consists of a 3,396 square foot building on a 90 x 120 ft. lot. A building in Statesboro, Georgia is leased to accommodate a small branch. This lease is renewed on an annual basis. Item 3. Legal Proceedings Neither the Registrant or its subsidiaries are parties to, nor is any of their property the subject of, any material pending legal proceedings, other than ordinary routine proceedings incidental to the business of the Banks, nor to the knowledge of the management of the Registrant are any such proceedings contemplated or threatened against it or its subsidiaries. Item 4. Submission of Matters to a vote of Security Holders None applicable. Part II. Item 5. Market for the Registrant's Common Stock and Related Security Holder Matters There is no public market for the common stock of South or the Banks. The last known selling price of South's common stock, based on information available to South's management, was $12.00 per share on September 13, 2001. As of March 1, 2002, the Company had 469 shareholders with 399,500 shares outstanding. For the years ended December 31, 2001, 2000 and 1999, South paid cash dividends of $279,628 or $.70 per share, $279,628 or $.70 per share, and $259,675 or $.65 per share, respectively. These dollars equate to dividend payout ratios (dividends declared divided by net income) of 16.63%, 10.57% and 12.20% in 2001, 2000 and 1999, respectively. Certain other information concerning dividends and historical trading prices is set forth below: QUARTERLY COMMON STOCK DATA Set forth below is information concerning high and low sales prices by quarter for each of the last two fiscal years and dividend information for the last two fiscal years. The Company's common stock is not traded on any established pubic trading market. The Company acts as its own transfer agent, and the information concerning sales prices set forth below is derived from the Company's stock transfer records. As of December 31, 2001, there were 469 shareholders of record. SALES PRICES BY QUARTER High Low Fiscal Year 2001 First Quarter $ - $ - Second Quarter - - Third Quarter 12.00 12.00 Fourth Quarter - - 28 SALES PRICES BY QUARTER High Low Fiscal Year 2000 First Quarter $12.00 $12.00 Second Quarter - - Third Quarter 12.00 12.00 Fourth Quarter - - DIVIDENDS PAID PER SHARE Fiscal Year 2001 2000 March 31 $ .00 .00 June 30 .00 .00 September 30 .00 .00 December 31 .70 .70 Item 6. Selected Financial Data Years Ended December 31, 2001 2000 1999 1998 1997 (In Thousands) Total Assets $ 224,791 $ 220,450 $ 173,807 $164,890 $149,895 Operations: Interest income $ 18,605 $ 18,454 $ 14,518 $ 13,920 $12,328 Interest expense 9,335 8,578 6,261 6,392 5,387 Net interest income $ 9,270 $ 9,876 $ 8,257 $ 7,528 $ 6,941 Provision for loan losses 893 424 503 286 179 Net interest income after provision for loan losses $ 8,377 $ 9,452 $ 7,754 $ 7,242 $ 6,762 Other income $ 3,125 $ 2,718 $ 2,298 $ 1,905 $ 1,569 Other expenses $ 9,085 $ 8,302 $ 6,906 $ 6,387 $ 6,017 Income before income taxes $ 2,417 $ 3,868 $ 3,146 $ 2,760 $ 2,314 Federal income taxes 733 1,222 1,017 831 768 Net income before extraordinary items $ 1,684 $ 2,646 $ 2,129 $ 1,929 $ 1,546 Extraordinary items $ - $ - $ - $ - $ - Net income $ 1,684 $ 2,646 $ 2,129 $ 1,929 $ 1,546 Per Share Data: Income after extraordinary items $ 4.21 $ 6.62 $ 5.33 $ 4.83 $ 3.86 Net income $ 4.21 $ 6.62 $ 5.33 $ 4.83 $ 3.86 Dividends declared $ .70 $ .70 $ .65 $ .65 $ .60 Book value $ 49.71 $ 45.73 $ 39.57 $ 35.56 $ 31.28 29 Item 6. Selected Financial Data (con't) Years Ended December 31, 2001 2000 1999 1998 1997 (In Thousands) Profitability Ratios Net income to average total assets .74% 1.35% 1.28% 1.23% 1.13% Net income to average stockholders' equity 8.83% 15.52% 14.18% 14.45% 13.06% Net interest Margin 3.88% 4.77% 4.83% 4.52% 5.18% Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations The purpose of this discussion is to focus on information about South Banking Company's financial condition and results of operations which is not otherwise apparent from the consolidated financial statement included in this report. Reference should be made to those statements, selected statistical information and the selected financial data presented elsewhere in this report for an understanding of the following discussion and analysis. Financial Condition and Liquidity Financial Condition South functions as a financial institution and as such its financial condition should be examined in terms of trends in its sources and uses of funds. A comparison of daily average balances indicate how South has managed its sources and uses of funds. Included in the selected statistical information, the comparison of daily average balance in the business portion of the filing indicated how South has managed its sources and uses of funds. South used its funds primarily to support its lending activities. South's total assets increased to $224,790,523 at year end 2001 from $220,450,038 at year end 2000. This increase of $4,340,485 represents a 1.9% increase in 2001 compared to 14.7% increase in 2000. This increase is attributable to normal growth within the banking area with limited entry into competitive situations for large deposits. Due to the increased competition in certain markets, the net interest margins have declined. The net interest margin is not anticipated to change much in 2002 as the effect of the new competition and rate reductions have leveled off. However, continued decreases in the prime rate could impact the margins. The interest rate sensitivity analysis, which is a part of this report, gives some indication of the repricing opportunities of South. The gap ratios for the first twelve months are outside the limits established by the Bank as ideal, however, the current interest rates are not favorable to customers purchasing certificates in excess of twelve 30 months. Loan demand continues to be strong with loans increasing $9,151,132 in 2001. The banks continue to look for good quality loans as loans represent the highest yielding asset on the Bank's books. The rural economy of the Banks' market area has been stable prior to 1998. The Banks have noticed some decline beginning in 1999, 2000 and 2001 in the overall economy, and especially in the agricultural and timber industries. While the Banks are not heavy into these industries, the decline in these areas have impacted the overall economy. Classified loans for regulatory purposes remain at low levels and, despite the problem in the local economies, do not represent any trend or uncertainties which management reasonably expects will materially impact future operating results, liquidity of capital resources, or represents material credits about which management is aware that causes management to have serious doubts as to the ability of such borrowers to comply with the loan payment terms. South's investment portfolio, including certificates of deposits in other banks, decreased to $18,593,836 from $21,667,660. The decrease of $3,073,824 from operations is an indication of the loan demand of the banks and the desire of the banks to utilize the assets of South in the highest yielding manner available to the banks without creating liquidity problems. South has maintained adequate federal funds sold and investments available for sale to sufficiently maintain adequate liquidity. South's securities are primarily short term of three years or less in maturity, enabling South to better monitor the rate sensitivity of these assets. Unrealized gain and losses on this portfolio is not material to the statement as South maintains a slight unrealized gain of $158,707. As the primary source of funds, aggregate deposits increased by $3,321,388 in 2001 compared to $21,505,401 in 2000. This represents a 1.72% increase for the year compared to a 14.07% increase in 2000. This illustrates the efforts of the banks to maintain good core deposits. Most of the growth was from the demand accounts which have lower interest rates as time certificate rates have dropped to levels customers do not wish to lock-in rates for extended periods. Liquidity The primary function of asset/liability management is to assure adequate liquidity and maintain an appropriate balance between interest sensitive earning assets and interest bearing liabilities. Liquidity management involves the ability to meet the cash flow requirements of customers who may be either depositors desiring to withdraw funds or borrowers requiring assurance that sufficient funds will be available to meet their credit needs. Interest rate sensitivity management seeks to avoid fluctuating net interest margins and to enhance consistent growth of net interest income through periods of changing interest rates. 31 Interest rate sensitivity varies with different types of interest- earning assets and interest bearing liabilities. Overnight federal funds on which rates change daily and loans which are tied to prime differ considerably from long-term investment and fixed rate loans. Similarly, time deposits over $100,000 and money market accounts are much more interest sensitive than passbook savings and long-term capital notes. The shorter-term interest rate sensitivities are key to measuring the interest sensitivity gap, or excess interest-sensitive earning assets over interest-bearing liabilities. An interest rate sensitivity table is included elsewhere in this document, and it shows the interest sensitivity gaps for different time intervals as of December 31, 2001. The first 30 days there is an excess of interest- bearing assets over interest-bearing liabilities. South becomes more sensitive to interest rate fluctuations on a short time period. While the cumulative gap declines with each time interval, South remains within a manageable position. Marketable investment securities, particularly those of shorter maturities, and federal funds sold are the principal sources of asset liquidity. Securities maturing in one year or less amounted to $2,062,259 and federal funds sold net of federal funds purchased with daily maturities amounted to $10,252,000 at year end 2001, a decrease from prior years as loan demand exceeded deposit growth. Maturing loans and certificates of deposits in other banks are other sources of liquidity. The overall liquidity of South has been enhanced by a significant aggregate amount of core deposits. These core deposits have remained constant during this period. South has utilized less stable short-term funding sources to enhance liquidity such as large denomination time deposits and money market certificates within its current customer base, but has not attempted to acquire these type of accounts from non- core deposit customers. South has utilized its core deposit base to help insure it maintains adequate liquidity. Historically, the trend in cash flows as represented in the statement of cash flows shows a steady increase in cash generated by operations from the last three years. This is a result of increasing net income for each year until 2001. While income is not predictable, it is anticipated that liquidity will continue to be enhanced by the operations of the bank. Operations activity, however, generate only a small portion of the cash flow activities of the bank. Primary cash flow comes from investing activities such as sales and/or maturity of investment securities and in the financing activity through an increase in deposits. The primary use of cash flow includes the purchase of securities and making new loans as investing activities. The history of the bank's cash flow indicates a nonrepeating source such as proceeds from borrowings utilized as sources of cash for the purpose of acquisition or expansion. South's overall cash flows indicate the relative stability and manageable growth of the bank's assets. South utilized deposit growth as its primary source of funds to handle growth. South's liquidity is maintained at levels determined by management to be sufficient to handle the cash needs that might arise at 32 any given date. Outside sources are maintained, but South looks to these sources only on a very short term basis. South's long term liquidity plans include utilizing internally generated deposits as its primary source of cash flows and utilizing the shifting of the make up of assets to handle short term demands on cash. Capital Resources In January 1989, the Federal Reserve Board released new standards for measuring capital adequacy for U. S. banking organizations. These standards are based on the original risk-based capital requirements first proposed in early 1986 by U. S. bank regulators and then developed jointly by authorities from the twelve leading industrial countries. As a result, the standards are designed to not only provide more risk-responsive capital guidelines for financial institutions in the U. S., but also incorporate a consistent framework for use by financial institutions operating in the major international financial markets. In general, the standards require banks and bank holding companies to maintain capital based on "risk-adjusted" assets so that categories of assets with potentially higher credit risk will require more capital backing than assets with lower risk. In addition, banks and bank holding companies are required to maintain capital to support, on a risk-adjusted basis, certain off-balance sheet activities such as loan commitments and interest rate swaps. The Federal Reserve Board standards classify capital into two tiers, referred to as Tier 1 and Tier 2. Tier 1 capital consists of common shareholders' equity, noncumulative and cumulative (BHCs only) perpetual preferred stock and minority interest less goodwill. Tier 2 capital consists of allowance for loan and lease losses, perpetual preferred stock (not included in Tier 1), hybrid capital instruments, term subordinated debt and intermediate-term preferred stock. By December 31, 1992, all banks were required to meet a minimum ratio of 8% of qualifying total capital to risk-adjusted total assets with at least 4% Tier 1 capital. Capital that qualifies as Tier 2 capital is limited to 100% of Tier 1 capital. Loans and Asset Quality Management of the Company believes that the loan portfolio is adequately diversified. Commercial loans are spread through numerous types of businesses with no particular industry concentrations. Loans to individuals are made primarily to finance consumer goods purchased. At December 31, 2001, total loans, net of unearned discounts, were 85% of total earning assets. Loans secured by real estate accounted for 55% of total loans as of December 31, 2001. Most of the loans classified as real estate-mortgage are commercial loans where real estate provides additional collateral. The Banks do not participate in the secondary loan market. 33 Nonperforming assets include nonaccrual loans, accruing loans past due 90 days or more and other real estate, which includes foreclosures, deeds in lieu of foreclosure and in-substance foreclosures. A loan is generally classified as nonaccrual when full collectibility of principal or interest is doubtful or a loan becomes 90 days past due as to principal or interest, unless management determines that the estimated net realizable value of the collateral is sufficient to cover the principal balance and accrued interest. When interest accruals are discontinued, unpaid interest credited to income in the current year is reversed and unpaid interest accrued in prior years is charged to the allowance for loan losses. Nonperforming loans are returned to performing status when the loan is brought current and has performed in accordance with contract terms for a period of time. A summary of South's loan loss experience is included elsewhere in this report. Distribution of Nonperforming Assets 2001 2000 1999 (In Thousands) Nonaccrual loans $ 1,002 $ 876 $ 442 Past due 90 days still accruing 1,028 734 419 Other real estate (ORE) 1,265 725 168 $ 3,295 $ 2,335 $ 1,029 Nonperforming loans to year end loans 1.18% .99% .65% Nonperforming assets to year end loan and ORE 1.91% 1.42% .78% The ratio of nonperforming assets has increased each year from 1994 to 1997. However in 1998 and 1999, a slight decrease occurred as 90 days past dues declined. During 2000 and 2001, the economy in the banks' market area declined with certain loans deteriorating to nonperforming status. Management continues to work on nonperforming assets to reduce this ratio. Asset-Liability Management and Market Risk Sensitivity Market risk is the risk of loss from adverse changes in market prices and rates. The Company's market risk arises principally from interest rate risk inherent in its lending, deposit and borrowing activities. Management actively monitors and manages its inherent rate risk exposure. Although the Company manages other risks, as in credit quality and liquidity risk, in the normal course of business, management considers interest rate risk to be its most significant market risk and could potentially have the largest material effect on the Company's financial condition and results of operations. Other types of market risks, such as foreign currency exchange rate risk and commodity price risk, do not arise in the normal course of the Company's business activities. 34 The Company's profitability is affected by fluctuations in interest rates. Management's goal is to maintain a reasonable balance between exposure to interest rate fluctuations and earnings. A sudden and substantial increase in interest rates may adversely impact the Company's earnings to the extent that the interest rates on interest- earning assets and interest-bearing liabilities do not change at the same speed, to the same extent or on the same basis. The Company monitors the impact of changes in interest rates on its net interest income using several tools. The Banks' goal is to minimize interest rate risk between interest bearing assets and liabilities at various maturities through its Asset- Liability Management (ALM). ALM involves managing the mix and pricing of assets and liabilities in the face of uncertain interest rates and an uncertain economic outlook. It seeks to achieve steady growth of net interest income with an acceptable amount of interest rate risk and sufficient liquidity. The process provides a framework for determining, in conjunction with the profit planning process, which elements of the Company's profitability factors can be controlled by management. Understanding the current position and implications of past decisions is necessary in providing direction for the future financial management of the Company. The Company uses an asset-liability model to determine the appropriate strategy for current conditions. Interest sensitivity management is part of the asset-liability management process. Interest sensitivity gap (GAP) is the difference between total rate sensitive assets and rate sensitive liabilities in a given time period. The Company's rate sensitive assets are those repricing within one year and those maturing within one year. Rate sensitive liabilities include insured money market accounts, savings accounts, interest-bearing transaction accounts, time deposits and borrowings. The profitability of the Company is influenced significantly by management's ability to manage the relationship between rate sensitive assets and liabilities. At December 31, 2001, approximately 69% of the Company's earnings assets could be repriced within one year compared to approximately 92% of its interest-bearing liabilities. This compares to 58% and 92% in 2000. The Company's current GAP analysis reflects that in periods of increasing interest rates, rate sensitive assets will reprice slower than rate sensitive liabilities. The Company's GAP analysis also shows that at the interest repricing of one year, the Company's net interest margin would be adversely impacted. This analysis, however, does not take into account the dynamics of the marketplace. GAP is a static measurement that assumes if the prime rate increases by 100 basis points, all assets and liabilities that are due to reprice will increase by 100 basis points at the next opportunity. However, the Company is actually able to experience a benefit from rising rates in the short term because deposit rates do not follow the national money market. They are controlled by the local market. Loans do follow the money market; so when rates increase they reprice immediately, but the Company is able to manage the deposit side. The Company generally does not raise deposit rates as fast or as much. The Company also has the ability to manage its funding costs by choosing alternative sources of funds. 35 The Company's current GAP position would also be interpreted to mean that in periods of declining interest rates, the Company's net interest margin would benefit. However, competitive pressures in the local market may not allow the Company to lower rates on deposits, but force the Company to lower rates on loans. Computation of prospective effects of hypothetical interest rate changes are based on numerous assumptions including relative levels of market interest rates, loan prepayments and deposit decay rates, and should not be relied upon as indicative of actual results. Further, the computations do not contemplate any actions the Company could undertake in response to changes in interest rates. The rate sensitivity analysis as presented in the selected statistical information shows the Company's financial instruments that are sensitive to changes in interest rates, categorized by expected maturity. Market risk sensitive instruments are generally defined as on and off balance sheet derivatives and other financial instruments. Notes to Market Risk Sensitivity Table: n Expected maturities are contractual maturities adjusted for prepayments of principal when possible. The Company uses certain assumptions to estimate expected maturities. n For loans, the Company has used contractual maturities due to the fact that the Company has no historical information on prepayment speeds. Since most of these loans are consumer and commercial loans, and since the Company's customer base is community-based, the Company feels its prepayment rates are insignificant. n For mortgage-backed securities, expected maturities are based upon contractual maturity, projected repayments and prepayment of principal. The prepayment experience herein is based on industry averages as provided by the Company's investment trustee. n Loans receivable includes non-performing loans. n Interest-bearing liabilities are included in the period in which the balances are expected to be withdrawn as a result of contractual maturities. For accounts with no stated maturities, the balances are included in the 0 to 90 day category. n The interest rate sensitivity gap represents the difference between total interest-earning assets and total interest-bearing liabilities. An important aspect of achieving satisfactory net interest income is the composition and maturities of rate sensitive assets and liabilities. The table generally reflects that in periods of rising interest rates, rate sensitive liabilities will reprice faster than rate sensitive assets, thus having a negative effect on net interest income. It must be understood, however, that such an analysis is only a snapshot picture and 36 does not reflect the dynamics of the market place. Therefore, management reviews simulated earnings statements on a monthly basis to more accurately anticipate its sensitivity to changes in interest rates. Results of Operations 2001 Compared to 2000 Net interest income remains an effective measurement of how well management has balanced South's interest rate sensitive assets and liabilities. Net interest income decreased by $605,669. The decrease of 6.1%, which included a full year of the 2000 branch acquisitions, compared to a 25.8% increase in 2000 when the branch acquisitions were included after August. The primary determinants of the decrease were loans and time deposits. Loan demand increased slightly and funds were channeled into loans as they represent the highest yielding asset. Management continued its policy of limited solicitation of high interest deposits. The drastic reduction in rates by the Federal Reserve system resulted in repricing of most of interest rate sensitive assets and deposits. As the tables presented earlier demonstrate the assets rates decreased faster than deposits therefore, the margins were squeezed resulting in the decrease in net interest income. The yield on interest earning assets decreased to 9.08% from 10.31% while interest bearing deposits yield decreased to 5.20% from 5.54%. The net yield decreased to 3.88% from 4.77%. With the rate reduction not anticipated to continue this trend should correct itself during 2002; however, with the low rates currently in the market, this margin will remain low. Interest and fees on loans increased only $133,211 or .8% in 2001 from 2000 due to rate decreases of 123 basis points and loan growth of 5.6% in 2001. Interest on investment securities decreased $131,101 or 11.1% in 2001 from 2000 due to a slight decrease in the yield in investments as rates have decreased. Interest income on federal funds sold increased $117,989 or 18.9% due to higher average balances invested and lower rates. Total interest expense increased 8.8% or $756,847 from 2000 to 2001. The largest component of total interest expense is interest expense on deposits, which increased $783,123 or 9.6% from 2000 to 2001 due to a growth in deposits. The average rate paid on deposits was 5.13%, 5.54% and 4.82% in 2001, 2000 and 1999, respectively. The allowance for possible loan losses is established through charges to expense in the form of a provision for loan losses. The provision for loan losses was $893,000 and $424,000, respectively, for the years ended December 31, 2001 and 2000. The provision in 2001 reflects replenishing the allowance for loan losses to cover net charge- offs of $864,439, plus providing for the increase in total loans outstanding. The allowance for loan losses to total loans outstanding is 1.60% at December 31, 2001. Net charge-offs to average loans are .52% for 2001 as compared to 0.31% for 2000. The allowance for loan losses is based on an in-depth analysis of the loan portfolio. Specifically included in that analysis are the following types of loans: loans determined to be of a material amount, loans commented on by regulatory authorities, loans commented on by internal and external auditors, loans past due more than 60 days, and 37 loans on a nonaccrual status. The allowance for loan losses is not allocated to specific credit risk, but rather to the overall loan portfolio as the individual banks are relatively small and can be looked at as a whole. The overall loan portfolio remains of good quality, however, some deterioration has been noted in the economy which reflects on the loan portfolio. The Banks have made provisions where necessary to reflect the overall quality of loans. Non-Interest Income Non-interest income for 2001 increased by $407,219 or 15.0% over 2000, as compared to an increase in 2000 of $420,249 or 15.5% over 1999. These increases generally resulted from increased activity in data processing, financial services and service charges on deposits. A significant contributor to non-interest income is service charges on deposit accounts which increased 13.4%. Management views deposit fee income as critical influence on profitability. Periodic monitoring of competitive fee schedules and examination of alternative opportunities ensure that the Company realizes the maximum contribution to profits from this area. The addition of the branch acquisition contributed to the increase in fees. Non-Interest Expense Non-interest expenses totaled $9,084,778 in 2001 as compared to $8,301,997 in 2000. This represented a 9.4% increase from 2000 to 2001, and a 20.2% increase from 1999 to 2000. The overall increases during the year were attributable to growth in all geographic markets, and includes operations of branches acquired during 2000. Salaries and other personnel expenses, which comprised 54% of total non-interest expenses for 2001, were up $694,299 or 16.4% over 2000 due to normal salary increases, benefit cost increases, and increased personnel due to two new branches. During 2000 and 1999, salaries and other personnel expenses accounted for 52% and 54% of total other operating expenses, respectively. Combined net occupancy and furniture and equipment expenses decreased $130,966, or 8.8% from 2000 to 2001, as compared to an increase of $298,051, or 25.4% in 2000. Income Taxes Income tax expense totaled $733,859 in 2001 as compared to $1,221,738 in 2000. The changes in net income tax expense for the years were due to changes in taxable income for each respective year. Taxable income is affected by net income, income on tax exempt investment securities and loans, and the provision for loan losses. For tax purposes, the Bank can only recognize actual loan losses. The Company works actively with outside tax consultants to minimize tax expenses. 38 2000 Compared to 1999 Net interest income remains an effective measurement of how well management has balanced South's interest rate sensitive assets and liabilities. Net interest income increased by $1,619,133. The increase of 25.8%, which included the results of the branch acquisitions, compared to a 9.68% increase in 1999. The primary determinants of the increase were loans and time deposits. As loan demand increases, funds are channeled into higher yielding loans. Management continues its policy of not soliciting high interest deposits and was able to maintain stable cost of funds. The growth of assets and liabilities was primarily the reason for the increase as net interest yield decreased slightly to 4.77% from 4.83%. With the low interest rate currently in the market and South's current rate gap, South will continue its efforts to channel funds into higher yielding assets. Due to the rate sensitivity gap, South will attempt to improve its current position with a controlled attempt to lengthen its maturity of interest rate sensitive liabilities although this remains difficult without rate adjustments upward. Interest and fees on loans increased $3,744,981 or 29.13% in 2000 from 1999 due to rate increases of 59 basis points and loan growth of 23.8% in 2000. Interest on investment securities increased $53,083 or 4.8% in 2000 from 1999 due to a slight increase in the yield in investments as rates have increased slightly. Interest income on federal funds sold increased $160,488 or 34.7% due to higher average balances invested and higher rates. Total interest expense increased 37% or $2,316,587 from 1999 to 2000. The largest component of total interest expense is interest expense on deposits, which increased $2,109,540 or 35.1% from 1999 to 2000 due to a rate increase and growth in deposits. The average rate paid on deposits was 5.54%, 4.82% and 5.27% in 2000, 1999 and 1998, respectively. The allowance for possible loan losses is established through charges to expense in the form of a provision for loan losses. The provision for loan losses was $424,000 and $503,000, respectively, for the years ended December 31, 2000 and 1999. The provision in 2000 reflects replenishing the allowance for loan losses to cover net charge- offs of $452,964, plus providing for the increase in total loans outstanding. The allowance for loan losses to total loans outstanding is 1.67% at December 31, 2000. Net charge-offs to average loans are .31% for 2000 as compared to 0.25% for 1999. The allowance for loan losses is based on an in-depth analysis of the loan portfolio. Specifically included in that analysis are the following types of loans: loans determined to be of a material amount, loans commented on by regulatory authorities, loans commented on by internal and external auditors, loans past due more than 60 days, and loans on a nonaccrual status. The allowance for loan losses is not allocated to specific credit risk, but rather to the overall loan portfolio as the individual banks are relatively small and can be looked at as a whole. The overall loan portfolio remains of good quality, however, some deterioration has been noted in the economy which reflects on the loan portfolio. The Banks have made provisions where necessary to reflect the overall quality of loans. 39 Non-Interest Income Non-interest income for 2000 increased by $420,249 or 15.5% over 1999, as compared to an increase in 1999 of $392,788 or 20.6% over 1998. These increases generally resulted from increased activity in data processing, financial services and service charges on deposits. A significant contributor to non-interest income is service charges on deposit accounts which increased 24.2%. Management views deposit fee income as critical influence on profitability. Periodic monitoring of competitive fee schedules and examination of alternative opportunities ensure that the Company realizes the maximum contribution to profits from this area. The addition of the branch acquisition contributed to the increase in fees. Non-Interest Expense Non-interest expenses totaled $8,301,997 in 2000 as compared to $6,905,856 in 1999. This represented an 20.2% increase from 1999 to 2000, and a 8% increase from 1998 to 1999. The overall increases during the year were attributable to growth in all geographic markets, and includes operations of branches acquired during the year. Salaries and other personnel expenses, which comprised 51% of total non-interest expenses for 2000, were up $535,840 or 14.5% over 1999 due to normal salary increases, benefit cost increases, and increased personnel due to two new branches. During 1999 and 1998, salaries and other personnel expenses accounted for 54% and 51% of total other operating expenses, respectively. Combined net occupancy and furniture and equipment expenses increased $298,051, or 25.4% from 1999 to 2000, as compared to an increase of $26,489, or 2.3% in 1999. Income Taxes Income tax expense totaled $1,221,738 in 2000 as compared to $1,017,056 in 1999. The changes in net income tax expense for the years were due to changes in taxable income for each respective year. Taxable income is affected by net income, income on tax exempt investment securities and loans, and the provision for loan losses. For tax purposes, the Bank can only recognize actual loan losses. The Company works actively with outside tax consultants to minimize tax expenses. 40 Results of Operations 1999 Compared to 1998 Net interest income remains an effective measurement of how well management has balanced South's interest rate sensitive assets and liabilities. Net interest income increased by $728,607. The increase of 9.68% compared to a 8.45% increase in 1998. The primary determinants of the increase were loans and time deposits. As loan demand increased, funds were channeled into higher yielding loans. Management continues its policy of not soliciting high interest deposits and was able to maintain stable cost of funds. The growth of assets and liabilities was only part of the reason for the increase as net interest yield increased to 4.83% from 4.52%. With the low interest rates in the market and South's interest rate gap, South continued its efforts to channel funds into higher yielding assets. Due to the rate sensitivity gap, South attempted to improve its current position with a controlled attempt to lengthen its maturity of interest rate sensitive liabilities although this is difficult without rate adjustments upward. Interest and fees on loans increased $706,985 or 5.82% from 1998 to 1999 due to loan growth of 15.1% in 1999. Interest on investment securities decreased $29,504 or 2.5% from 1998 to 1999 due to a reduction in the yield in investments as rates have increased slightly. Interest income on federal funds sold decreased $113,905 or 18.9% due to higher average balances invested. Total interest expense decreased 20% or $131,134 from 1998 to 1999. The largest component of total interest expense is interest expense on deposits, which decreased $117,482 or 1.9% from 1998 to 1999 due to a rate decrease that offset growth in deposits. The average rate paid on deposits was 4.82%, 5.27% and 5.10% in 1999, 1998 and 1997, respectively. The allowance for possible loan losses is established through charges to expense in the form of a provision for loan losses. The provision for loan losses was $503,000 and $286,000, respectively, for the years ended December 31, 1999 and 1998. The provision in 1999 reflects replenishing the allowance for loan losses to cover net charge- offs of $432,472, plus providing for the 15.10% increase in total loans outstanding. The allowance for loan losses to total loans outstanding is 1.64% at December 31, 1999. Net charge-offs to average loans are .25% for 1999 as compared to 0.12% for 1998. The allowance for loan losses is based on an in-depth analysis of the loan portfolio. Specifically included in that analysis are the following types of loans: loans determined to be of a material amount, loans commented on by regulatory authorities, loans commented on by internal and external auditors, loans past due more than 60 days, and loans on a nonaccrual status. The allowance for loan losses is not allocated to specific credit risk, but rather to the overall loan portfolio as the individual banks are relatively small and can be looked at as a whole. The overall loan portfolio remains of good quality, however, some deterioration was noted in the economy which reflects on the loan portfolio. The Banks have made provisions where necessary to reflect the overall quality of loans. 41 Non-Interest Income Non-interest income for 1999 increased by $392,788 or 20.6% over 1998, as compared to an increase in 1998 of $335,546 or 21.4% over 1997. These increases generally resulted from increased activity in data processing, financial services and service charges on deposits. A significant contributor to non-interest income is service charges on deposit accounts which increased 24.2%. Management views deposit fee income as critical influence on profitability. Periodic monitoring of competitive fee schedules and examination of alternative opportunities ensure that the Company realizes the maximum contribution to profits from this area. Non-Interest Expense Non-interest expenses totaled $6,905,856 in 1999 as compared to $6,386,678 in 1998. This represented an 8% increase from 1998 to 1999, and a 6% increase from 1997 to 1998. The overall increases during the year were due to growth in all geographic markets, which is evidenced by the growth in deposits of 4.7% from 1998 to 1999 and 11% from 1997 to 1998. Salaries and other personnel expenses, which comprised 54% of total non-interest expenses for 1999, were up $410,409 or 12.5% over 1998 due to normal salary increases, benefit cost increases, and increased personnel due to the one new branch. During 1998 and 1997, salaries and other personnel expenses accounted for 51% and 50% of total other operating expenses, respectively. Combined net occupancy and furniture and equipment expenses increased $26,489, or 2.3% from 1998 to 1999, as compared to an increase of $102,423, or 9.8%, in 1998. Income Taxes Income tax expense totaled $1,017,056 in 1999 as compared to $830,744 in 1998. The changes in net income tax expense for the years were due to changes in taxable income for each respective year. Taxable income is affected by net income, income on tax exempt investment securities and loans, and the provision for loan losses. For tax purposes, the Bank can only recognize actual loan losses. The Company works actively with outside tax consultants to minimize tax expenses. Regulatory Matters During the year 2001, federal and state regulatory agencies completed asset quality examinations at South's subsidiary banks. South's level and classification of identified potential problem loans was not revised significantly as a result of this regulatory examination process. However, one bank has seen some increase in classified loans as a result of branch acquisitions in the year 2000. Examination procedures require individual judgments about a borrower's ability to repay loans, sufficiency of collateral values and the effects of changing economic circumstances. These procedures are similar to those employed by South in determining the adequacy of the allowance for loan losses and in classifying loans. Judgments made by regulatory examiners may differ from those made by management. 42 Management and the boards of directors of South and affiliates evaluate existing practices and procedures on an ongoing basis. In addition, regulators often make recommendations during the course of their examinations that relate to the operations of South and its affiliates. As a matter of practice, management and the boards of directors of South and its subsidiaries consider such recommendations promptly. Impact of Inflation and Changing Prices The majority of assets and liability of a financial institution are monetary in nature; therefore, differ greatly from most commercial and industrial companies that have significant investments in fixed assets or inventories. However, inflation does have an important impact on the growth of total assets in the banking industry and the resulting need to increase equity capital at higher than normal rates in order to maintain an appropriate equity-to-assets ratio. An important effect of this has been the reduction of asset growth to maintain appropriate levels. Another significant effect of inflation is on other expenses, which tend to rise during periods of general inflation. Management believes the most significant impact on financial results is South's ability to react to changes in interest rates. As discussed previously, management is attempting to maintain an essentially balanced position between interest sensitive assets and liabilities in order to protect against wide interest rate fluctuations. Item 8. Financial Statements and Supplementary Data The following consolidated financial statements of the Registrant and its subsidiaries are included on pages F1 through F47 of this Annual report on Form 10-K. Consolidated Balance Sheets - December 31, 2001 and 2000 Consolidated Statements of Income and Other Comprehensive Income - Years ended December 31, 2001, 2000 and 1999 Consolidated Statements of Changes in Stockholders' Equity - Years ended December 31, 2001, 2000 and 1999 Consolidated Statements of Cash Flow - Years ended December 31, 2001, 2000 and 1999 Notes to Consolidated Financial Statements Item 9. Disagreement on Accounting and Financial Disclosures Not applicable. 43 Part III. Item 10. Directors and Executive Officers of the Registrant The Directors and Executive Officers of the Registrant and their respective ages, positions with the Registrant, principal occupation and Common Stock of the Registrant beneficially owned as of March 1, 2001 are as follows: Director (Officer) of # of shares Position with Registrator Owned Registrant of one of Beneficiary & Principal the Banks (Percent of Name (Age) Occupation Since Class) Paul T. Bennett (46) President, 1978(1)(2) 19,000 Treasurer and (3) ( 4.75%) Director; Vice (4) Chairman and Director, Citizens Bank; Vice Chairman and Director, Peoples State Bank & Trust, Baxley, Georgia; President Peoples Bank, Lyons, Georgia; Director and President Banker's Data Services; Director, Alma Exchange Bank and Trust; Director, Chairman and President Pineland State Bank Olivia Bennett (82) Executive Vice 1969(1)(2) 189,307 President, Secretary (3) ( 47.39%) and Director; Chairman and Director, Alma Bank; Director, Banker's Data Services; Chairman of Board, President, Citizens Bank; Director, Peoples Bank Lawrence Bennett (54) President and 1987(1)(2) 12,498 Director, Alma (4) ( 3.13%) Bank; Director, Banker's Data Services; Director, Peoples Bank, Baxley; Director Peoples Bank, Lyons Director, Pineland State Bank 44 Item 10. Directors and Executive Officers of the Registrant (Con't) Director (Officer) of # of shares Position with Registrator Owned Registrant of one of Beneficiary & Principal the Banks (Percent of Name (Age) Occupation Since Class) Charles Stuckey (54) Director; Executive 1990(3) 992 Vice President, ( .2%) Peoples Bank; Director, Banker's Data Services James W. Whiddon (57) Director; Executive 1989(2) 279 Vice President and ( .1%) Director, Citizens Bank; Director, Banker's Data Services Kenneth F. Wade (59) Director; Executive 1980(1) 4,934 Vice President, Director ( 1.23%) and Cashier, Alma Bank; Director, Banker's Data Services (1) Director of Alma Bank (2) Director of Citizens Bank (3) Director of Peoples Bank (4) Director of Pineland State Bank Included in shares owned by Olivia Bennett are 166,085 shares owned by Estate of Valene Bennett of which she is the Executrix and 22,983 shares owned by Bennett Family Limited Partnership of which she is the general partner. None of the directors are a director of a publicly-held corporation which is required to file reports with the Securities and Exchange Commission. Each of the Directors and Executive Officers have been engaged in his or her present principal occupation for at least five years. Olivia Bennett is the mother of Paul T. Bennett and Lawrence Bennett. There are no other family relationships between any other Director or Executive Officer. Directors serve until the next annual meeting of shareholders or until their successors are elected and qualified. Officers serve at the pleasure of the Board of Directors. 45 Item 11. Management Renumeration and Transactions The following information is given as to the cash and cash equivalent forms of renumeration received by South's CEO. Long-Term Compensation Annual Compensation Awards Payouts (A) (B) (C) (D) (E) (F) (G) (H) (I) Other All Name and Annual Restricted Other Principal Compen- Stock Options/ LTIP Compen- Position Year Salary Bonus sation (2) Award SARS # Payouts sation Paul T. Bennett 2001 196,700 - 32,090 - - - - CEO 2000 182,848 - 31,440 - - - - CEO 1999 164,348 - 28,910 - - - - CEO 1998 140,956 - 26,200 - - - - 1997 125,138 - 20,235 - - - - Olivia Bennett Secretary2001 202,618 - 20,875 - - - - 2000 215,099 - 20,915 - - - - 1999 205,366 - 20,345 - - - - 1998 195,935 - 22,010 - - - - 1997 182,936 - 15,135 - - - - (1) Does not include fees and dues for clubs and fraternal and civic organizations paid by the Banks to certain officers for business related purposes. Also, does not include any amounts for use of an automobile. (2) Other compensation consists of director fees from registrant and subsidiary banks. Transactions with Management Item 12. Security Ownership of Certain Beneficial Owners and Management The following table sets forth, as of March 1, 2002, the beneficial ownership of Common Stock of Registrant by the Only "person" (as that term is defined by the Securities and Exchange Commission), who owns of record or is known by the Registrant to own beneficially 5% or more of the outstanding shares of Common Stock of the Registrant and by all Executive Officers and Directors of the Registrant as a group. 46 Number of Percent of Shares Owned Outstanding Name Beneficially Shares Estate of Valene Bennett Route 4 Alma, Georgia 31510 166,085 41.57% Olivia Bennett Route 4 Alma, Georgia 31510 23,222 5.81% ll Executive Officers and Directors as a group (7 persons) 227,248 56.9% Item 13. Certain Relationships and Related Transactions The Banks have had, and expect to have in the future, banking transactions in the ordinary course of business with Directors and Officers of the Banks and their associates, including corporations, partnerships and other organizations in which such Directors and Officers have an interest, on substantially the same terms (including interest rates and collateral) as those prevailing at the time for comparable transactions with unrelated parties. Such transactions have not involved more than the normal risk of collectibility or presented other unfavorable features. Item 14. Exhibits, Financial Statement Schedule and Reports on Form 8-K Item 14(a) 1. and 3. and Item 14(d) (a) The following documents are filed as part of this report: 1. Financial Statements (a) South Banking Company and Subsidiaries: (i) Consolidated Balance Sheets - December 31, 2001 and 2000 (ii) Consolidated Statements of Income and Other Comprehensive Income - Years ended December 31, 2001, 2000 and 1999 (iii)Consolidated Statements of Stockholders' Equity - Years ended December 31, 2001, 2000 and 1999 (iv) Consolidated Statements of Cash Flow - Years ended December 31, 2001, 2000 and 1999 (b) South Banking Company (Parent Corporation Only): (i) Balance Sheets - December 31, 2001 and 2000 (ii)Statements of Income and Other Comprehensive Income - Periods ended December 31, 2001, 2000 and 1999 (iii)Statements of Stockholders' Equity - Periods ended December 31, 2001, 2000 and 1999 (iv) Statements of Cash Flow - Years ended December 31, 2001, 2000, and 1999 47 Item 14. Exhibits, Financial Statement Schedule and Reports on Form 8-K (Con't) 3. Exhibits required by Item 7 of regulation S-K: (3) Articles of Incorporation and By-Laws (included as Exhibits 3(a) and (b), respectively, to Appendix II to Registrant's Registration Statement on Form S-14, File No. 2- 71249, previously filed with the Commission and incorporated herein by reference). (13) 2002 Annual Report to Shareholders of South Banking Company (not deemed filed except to the extent that sections thereof are specifically incorporated into this report on Form 10-K by reference). (22) List of the Registrant's subsidiaries: (1) Alma Exchange Bank & Trust (2) Citizens State Bank (3) Peoples State Bank & Trust (4) Bankers' Data Services, Inc. (5) Pineland State Bank (6) South Financial Products, Inc. All of the Registrant's subsidiaries were incorporated under the laws of the State of Georgia and are doing business in Georgia under the above names. (b) The registrant has not filed a Form 8-K during the last quarter of the period. (c) The response to this Item 14(c) is included in item 14(a). (d) Financial Statements Schedules - None. 48 POWER OF ATTORNEY Know all men by these present, that each person whose signature appears below constitutes and appoints Paul T. Bennett, his attorney- in-fact, to sign any amendments to this Report, and to file the same, with exhibits thereto, and other documents in connection therewith. The Securities and Exchange Commission hereby ratifying and confirming all that said attorney-in-fact, or his substitute or substitutes, may do or cause to be done by virtue hereof. Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated. Date: March 29, 2002 Paul T. Bennett Principal Executive, Financial and Accounting Officer and Director Date: March 29, 2002 Olivia Bennett Executive Vice President And Director Date: March 29, 2002 Charles Stuckey Director Date: March 29, 2002 James W. Whiddon Director Date: March 29, 2002 Kenneth F. Wade Director Date: March 29, 2002 Lawrence Bennett Director 49 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. SOUTH BANKING COMPANY Date: March 29, 2002 By: Paul T. Bennett President, Treasurer and Director 50 SUPPLEMENTAL INFORMATION The following supplemental information has not been sent to the Registrant's shareholders, but will be sent subsequent to the filing of this Annual Report on Form 10-K: (1) 2001 annual report to shareholders. (2) Proxy statement for 2001 annual meeting of shareholders. The foregoing materials will be furnished to the Commission when they are sent to the shareholders since the Registrant does not have securities registered pursuant to Section 12 of the Securities Exchange Act of 1934. The foregoing materials shall not be deemed to be "filed" with the Commission or otherwise subject to the liabilities of Section 18 of that Act. 51 SOUTH BANKING COMPANY ALMA, GEORGIA FINANCIAL STATEMENTS DECEMBER 31, 2001 F1 REPORT OF INDEPENDENT ACCOUNTANTS Board of Directors South Banking Company Alma, Georgia 31510 We have audited the accompanying consolidated balance sheets of South Banking Company and Subsidiaries as of December 31, 2001 and 2000 and the related consolidated statements of income, stockholders' equity, and cash flows for each of the three years in the period ended December 31, 2001. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audit in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of South Banking Company and Subsidiaries at December 31, 2001 and 2000 and the consolidated results of its operations, stockholders' equity, and cash flows for each of the three years in the period ended December 31, 2001, in conformity with accounting principles generally accepted in the United States. Respectfully submitted, H. H. BURNET & COMPANY, P.C. Waycross, Georgia February 6, 2002 F2 SOUTH BANKING COMPANY ALMA, GEORGIA CONSOLIDATED BALANCE SHEETS December 31, December 31, 2001 2000 ASSETS Cash and due from banks $ 11,140,462 $ 8,911,914 Deposits in other banks - interest bearing $ 1,273,000 $ 825,279 Investment securities Available for sale $ 17,173,350 $ 20,695,055 Held to maturity - market value of $152,583 in 2001 and $151,512 in 2000 $ 147,536 $ 147,326 Georgia Bankers stock $ 547,283 $ 547,283 Federal Home Loan Bank stock $ 426,100 $ 426,100 Federal funds sold $ 10,252,000 $ 14,693,000 Loans $ 172,378,811 $ 163,227,679 Less: Unearned discount ( 288,968) ( 253,273) Reserve for loan losses ( 2,756,780) ( 2,728,219) $ 169,333,063 $ 160,246,187 Bank premises and equipment $ 6,715,813 $ 6,111,361 Intangible assets $ 1,680,572 $ 1,916,358 Other assets $ 6,101,344 $ 5,930,175 Total Assets $ 224,790,523 $ 220,450,038 The accompanying notes are an integral part of these financial statements. F3 SOUTH BANKING COMPANY ALMA, GEORGIA CONSOLIDATED BALANCE SHEETS (Con't) December 31, December 31, 2001 2000 LIABILITIES AND STOCKHOLDERS' EQUITY Liabilities Deposits: Demand - non-interest bearing $ 29,999,788 $ 24,298,756 Demand - interest bearing 32,764,586 27,404,525 Savings 10,537,057 11,326,824 Time 122,699,172 129,649,110 $ 196,000,603 $ 192,679,215 Borrowing 5,581,251 6,223,363 Accrued expenses and other liabilities 1,850,430 2,236,900 Federal funds purchased - - N/P - Federal Home Loan Bank 1,500,000 1,040,000 Total Liabilities $ 204,932,284 $ 202,179,478 Stockholders' Equity Common stock $1 par value; shares authorized - 1,000,000, shares issued and outstanding - 2001 and 2000 - 399,500 and 399,500, respectively $ 399,500 $ 399,500 Surplus 3,070,831 3,070,831 Undivided profits 16,291,126 14,887,046 Accumulated other comprehensive income 96,782 ( 86,817) Total Stockholders' Equity $ 19,858,239 $ 18,270,560 Total Liabilities and Stockholders' Equity $ 224,790,523 $ 220,450,038 The accompanying notes are an integral part of these financial statements. F4 SOUTH BANKING COMPANY ALMA, GEORGIA CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME Year Ended Year Ended Year Ended December 31, December 31, December 31, 2001 2000 1999 Interest Income Interest and other fees on loans $ 16,737,159 $ 16,603,948 $ 12,858,967 Interest on deposits - interest bearing 54,303 53,224 78,124 Interest on federal funds sold 740,769 622,780 462,292 Interest on investment securities: U. S. Treasury 31,021 77,571 144,635 U. S. Government agencies 898,919 910,190 753,245 Mortgage backed securities 16,360 33,411 37,875 State and municipal subdivisions 66,100 79,343 86,777 Other securities 60,031 73,017 95,849 Total Interest Income $ 18,604,662 $ 18,453,484 $ 14,517,764 Interest Expense Interest on deposits $ 8,904,780 $ 8,121,657 $ 6,012,117 Interest - other borrowing 429,874 456,150 249,103 Total Interest Expense $ 9,334,654 $ 8,577,807 $ 6,261,220 Net interest income $ 9,270,008 $ 9,875,677 $ 8,256,544 Provision for loan losses 893,000 424,000 503,000 Net interest income after provision for loan losses$ 8,377,008 $ 9,451,677 $ 7,753,544 Other Operating Income Service charge on deposits$ 1,787,500 $ 1,576,094 $ 1,446,630 Commission on insurance 81,052 89,036 68,614 Other income 528,323 429,101 399,993 Securities gains (losses) ( 3,684) 7 236 Data processing fees 537,212 459,036 382,396 Gain (Loss) on sale of fixed assets 60,333 2,019 - Financial service income 134,601 162,825 - Total Other Operating Income $ 3,125,337 $ 2,718,118 $ 2,297,869 The accompanying notes are an integral part of these financial statements. F5 SOUTH BANKING COMPANY ALMA, GEORGIA CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME (Con't) Year Ended Year Ended Year Ended December 31, December 31, December 31, 2001 2000 1999 Other Operating Expenses Salaries $ 3,676,504 $ 3,354,689 $ 2,866,950 Profit sharing and other personnel expenses 1,247,944 875,460 827,359 Occupancy expense of bank premises 514,595 475,452 408,211 Furniture and equipment expense 826,664 996,773 756,963 Stationery and supplies 199,901 254,881 167,909 Data processing 295,852 310,141 240,633 Director fees 182,760 174,260 170,260 Other real estate expenses 92,080 13,006 21,112 Other expenses 2,048,478 1,847,335 1,437,459 Total Other Operating Expenses $ 9,084,778 $ 8,301,997 $ 6,905,856 Income before income taxes$ 2,417,567 $ 3,867,798 $ 3,145,557 Applicable income taxes 733,859 1,221,738 1,017,056 Net Income $ 1,683,708 $ 2,646,060 $ 2,128,501 Other comprehensive income before tax Unrealized gain on securities $ 291,307 $ 151,160 $( 402,268) Other comprehensive income before tax $ 291,307 $ 151,160 $( 402,268) Income tax expenses related to items of other comprehensive income 107,708 57,048 ( 136,771) Other comprehensive income, net of tax $ 183,599 $ 94,112 $( 265,497) Comprehensive Income $ 1,867,307 $ 2,740,172 $ 1,863,004 Per share data based on weighted outstanding shares: Weighted average outstanding 399,500 399,500 399,500 Net Income $ 4.21 $ 6.62 $ 5.33 The accompanying notes are an integral part of these financial statements. F6 SOUTH BANKING COMPANY ALMA, GEORGIA CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY Accumulated Other Total Common Undivided Comprehensive Stockholders' Stock Surplus Profits Income Equity Balance, December 31, 1998 $399,500 $3,070,831 $10,651,788 $ 84,568 $14,206,687 Net income - - 2,128,501 - 2,128,501 Cash dividends - - ( 259,675) - ( 259,675) Unrealized gain (loss) on securities available for sale - - - ( 265,497) ( 265,497) Balance, December 31, 1999 $399,500 $3,070,831 $12,520,614 $( 180,929) $ 15,810,016 Net income - - 2,646,060 - 2,646,060 Cash dividends - - ( 279,628) - ( 279,628) Unrealized gain (loss) on securities available for sale - - - 94,112 ( 94,112) Redemption of shares - - - - - Balance, December 31, 2000 $399,500 $3,070,831 $14,887,046 $( 86,817) $ 18,270,560 Net income - - 1,683,708 - 1,683,708 Cash dividends - - ( 279,628) - ( 279,628) Unrealized gain (loss) on securities available for sale - - - 183,599 183,599 Redemption of shares - - - - - Balance, December 31, 2001 $399,500 $3,070,831 $16,291,126 $ 96,782 $ 19,858,239 The accompanying notes are an integral part of these financial statements. F7 SOUTH BANKING COMPANY ALMA, GEORGIA CONSOLIDATED STATEMENTS OF CASH FLOWS Year Ended Year Ended Year Ended December 31, December 31, December 31, 2001 2000 1999 Cash Flows From Operating Activities: Net income $ 1,683,708 $ 2,646,060 $ 2,128,501 Add expenses not requiring cash: Provision for depreciation and amortization 1,080,954 930,972 668,207 Provision for loan losses 893,000 424,000 503,000 Provision for loss on ORE 52,000 3,408 5,000 Bond portfolio losses (gains) 3,685 - ( 202) (Gain) loss on sale of premises & equipment ( 60,070) ( 2,019) ( 6,080) (Gain) loss on sale of other real estate owned 20,625 23,040 34,444 Increase (decrease) in taxes payable 136,792 ( 236,230) 290,973 Increase (decrease) in interest payable ( 403,513) 568,654 ( 39,109) Increase (decrease) in other liabilities ( 119,749) 324,957 (348,857) (Increase) decrease in interest receivable 341,390 ( 460,066) 167,420 (Increase) decrease in prepaid expenses ( 175,310) ( 80,167) 17,824 (Increase) decrease in other assets 260,171 ( 284,686) ( 101,191) Recognition of unearned loan income 60,094 - 61,852 Net Cash Provided By Operating Activities $ 3,773,777 $ 3,857,923 $ 3,381,782 Cash Flows From Investing Activities: Proceeds from maturities of securities held to maturity $ - $ 600,000 $ - Purchase of securities held to maturity - - - The accompanying notes are an integral part of these financial statements. F8 SOUTH BANKING COMPANY ALMA, GEORGIA CONSOLIDATED STATEMENTS OF CASH FLOWS (Con't) Year Ended Year Ended Year Ended December 31, December 31, December 31, 2001 2000 1999 Cash Flows From Investing Activities: (con't) Proceeds from maturity of securities available for sale $ 25,668,030 2,101,866 6,371,028 Net loans to customers ( 11,476,813) ( 13,197,595) (17,816,584) Proceeds from sale of securities available for sale 295,094 - - Purchase of securities available for sale ( 22,139,058) $( 4,339,254) $( 7,849,323) Purchase of premises and equipment ( 2,044,019) ( 1,645,225) ( 696,558) Proceeds from sale of premises and equipment 639,520 29,970 11,538 Proceeds from sale of other real estate owned 659,090 885,084 163,262 Purchase of Bank stock - - ( 250,000) Purchase of FHLB stock - - ( 29,900) Purchase of Bank Branches - ( 4,193,634) - Net Cash Provided By Investing Activities $( 8,398,156) $( 19,758,788) $(20,096,537) Cash Flows From Financing Activities: Net increase (decrease) in demand deposits, NOW and money markets $ 11,061,093 $ 1,686,060 $( 3,360,349) Net increase in savings and time deposits ( 7,739,705) 19,819,341 10,170,379 Proceeds from borrowing 1,523,810 4,756,750 38,812 Payments on borrowing ( 1,705,922) ( 256,463) ( 578,499) Dividends paid ( 279,628) ( 279,628) ( 259,675) Payments to retire stock - - - Increase in federal funds purchased - ( 1,140,000) 1,140,000 The accompanying notes are an integral part of these financial statements. F9 SOUTH BANKING COMPANY ALMA, GEORGIA NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2001 Year Ended Year Ended Year Ended December 31, December 31, December 31, 2001 2000 1999 Cash Flows From Financing Activities: (con't) Net Cash Provided By Financing Activities $ 2,859,648 $ 24,586,060 $ 7,150,668 Net increase (decrease) in Cash and Cash Equivalents $( 1,764,731) $ 8,685,195 $( 9,564,087) Cash and Cash Equivalents at Beginning of Year 24,430,193 15,744,998 25,309,085 Cash and Cash Equivalents at End of Year $ 22,665,462 $ 24,430,193 $ 15,744,998 Note 1. Significant Accounting Policies The accounting and reporting policies of South Banking Company, Inc. and its subsidiaries conform with generally accepted accounting principles and with practices within the banking industry. (a) Basis of Presentation During 1996, Pineland State Bank was acquired by South Banking Company. The transaction was accounted for using the purchase method. During 2000, Pineland State Bank acquired, in its immediate vicinity, three branches of Flag, Inc. The transaction was accounted for using the purchase method. (b) Principles of Consolidation The consolidated financial statements include the accounts of South Banking Company, Alma, Georgia (The Bank) and its wholly owned bank subsidiaries, Alma Exchange Bank, Alma, Georgia; Peoples State Bank, Baxley, Georgia; Citizens State Bank, Kingsland, Georgia; Pineland State Bank, Metter, Georgia; and its wholly owned computer center, Bankers' Data Services, Inc., Alma, Georgia. All significant intercompany transactions and balances have been eliminated in consolidation. F10 SOUTH BANKING COMPANY ALMA, GEORGIA NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2001 Note 1. Significant Accounting Policies (Con't) (c) Nature of Operations: The Banks provide a variety of banking services to individuals and businesses through its offices in Alma, Georgia; Kingsland, Georgia; Baxley, Georgia; Metter, Georgia; Cobbtown, Georgia; and Statesboro, Georgia. Its primary source of revenue is loans to customers who are primarily low to middle income individuals and small to mid size businesses. (d) Use of Estimates: The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant change relate to the determination of the allowance for losses on loans and the valuation of fore-closed real estate. In connection with the determination of the estimated losses on loans and foreclosed real estate, management obtains independent appraisals for significant properties. While management uses available information to recognize losses on loans and foreclosed real estate, further reductions in the carrying amounts of loans and foreclosed assets may be necessary based on changes in local economic conditions. In addition, regulatory agencies, as an integral part of their examination process, periodically review the estimated losses on loans and foreclosed real estate. Such agencies may require the Bank to recognize additional losses based on their F11 SOUTH BANKING COMPANY ALMA, GEORGIA NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2001 Note 1. Significant Accounting Policies (Con't) (d) Use of Estimates: (Con't) judgments about information available to them at the time of their examination. Because of these factors, it is reasonably possible that the estimated losses on loans and foreclosed real estate may change materially in the near term. However, the amount of the change that is reasonably possible cannot be estimated. (e) Securities: The Bank's investments in securities are classified in two categories and accounted for as follows. Securities to be Held to Maturity. Bonds, notes and debentures for which the Bank has the positive intent and ability to hold to maturity are reported at cost, adjusted for amortization of premiums and accretion of discounts which are recognized in interest income using the interest method over the period to maturity. Securities Available for Sale. Securities available for sale consist of bonds, notes, debentures, and certain equity securities not classified as trading securities or as securities to be held to maturity. Declines in fair value of individual held-to-maturity and available-for-sale securities below their cost that are other than temporary have resulted in write-downs of the individual securities to their fair value. The related write-downs have been included in earnings as realized losses. F12 SOUTH BANKING COMPANY ALMA, GEORGIA NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2001 Note 1. Significant Accounting Policies (Con't) (e) Securities: (Con't) Unrealized holding gains and losses, net of tax, on securities available for sale are reported as a net amount in a separate component of shareholders' equity until realized. Gains and losses on the sale of securities available- for-sale are determined using the specific-identification method. Federal Home Loan Bank Stock Individual banks within the holding company have joined the Federal Home Loan Bank ("FHLB") of Atlanta to increase the Bank's available liquidity. As a FHLB member, the Banks are required to acquire and retain shares of capital stock in FHLB of Atlanta in an amount equal to the greater of (1) 1.0% of the aggregate outstanding principal amount of the residential mortgage loans, home purchase contracts, and similar obligations, or (2) 0.3% of total assets at the beginning of each year. The Bank is in compliance with this requirement with an investment in FHLB stock of $426,100 and $426,100 at December 31, 2001 and 2000, respectively. No ready market exists for this stock and it has no quoted market value. However, redemption of this stock has historically been at par value. (f) Loans Receivable: Loans and Interest Income Loans are carried at principal amounts outstanding reduced by unearned discounts. Interest income on all loans is recorded on an accrual basis. The accrual of interest is generally discontinued on loans which become 90 days past due as to principal or interest. The accrual of interest on some loans, however, may continue even though they are 90 days past due, if the loans are well secured, in the process of collection, and management deems inappropriate. If non-accrual loans decrease their past due status to 60 days or less, they are reviewed individually by management to determine if they should be returned to accrual status. F13 SOUTH BANKING COMPANY ALMA, GEORGIA NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2001 Note 1. Significant Accounting Policies (Con't) Impaired Loans The Bank accounts for its impaired loans in accordance with SFAS No. 114, Accounting by Creditors for Impairment of a Loan, which requires that all creditors value all specifically reviewed nonhomogeneous loans for which it is probable that the creditor will be unable to collect all amounts due according to the terms of the loan agreement at the loan's fair value. Fair value may be determined based upon the present value of expected cash flows, market price of the loan, if available, or value of the underlying collateral. Expected cash flows are required to be discounted at the loan's effective interest rate. SFAS No. 114 was amended by SFAS No. 118 to allow a creditor to use existing methods for recognizing interest income on impaired loans and by requiring additional disclosures about how a creditor recognizes interest income related to impaired loans. The Bank determines which loans are impaired through a loan review process. When the ultimate collectibility of an impaired loan's principal is in doubt, wholly or partially, all cash receipts are applied to principal. When this doubt no longer exists, cash receipts are applied under the contractual terms of the loan agreement first to principal and then to interest income. Once the recorded principal balance has been reduced to zero, future cash receipts are applied to interest income, to the extent that any interest has been foregone. Further cash receipts are recorded as recoveries or any amounts previously charged off. SFAS No. 114 specifically states that it need not be applied to "large groups of smaller-balance homogeneous loans that are collectively evaluated for impairment". Thus, the Company determined that the statement does not apply to its consumer loan, credit card, or residential mortgage loan portfolios, except that it may choose to apply it to certain specific larger loans determined by management. In effect, these portfolios are covered adequately in the Company's normal formula for determining loan loss reserves. F14 SOUTH BANKING COMPANY ALMA, GEORGIA NOTES TO FINANCIAL STATEMENTS DECEMBER 31, 2001 Note 1. Significant Accounting Policies (Con't) Loan Fees and Costs Nonrefundable fees and certain direct costs associated with originating or acquiring loans are recognized as yield adjustment over the contractual life of the related loans, or if the related loan is held for resale, until the loan is sold. Recognition of deferred fees and costs is discontinued on non-accrual loans until they return to accrual status or are charged-off. Commitment fees associated with lending are deferred and if the commitment is exercised, the fee is recognized over the life of the related loan as a yield adjustment. If the commitment expires unexercised, the amount is recognized upon expiration of the commitment. (g) Allowances for Loan Losses: The allowance for loan losses is maintained at a level which, in management's judgment, is adequate to absorb credit losses inherent in the loan portfolio. The amount of the allowance is based on management's evaluation of the collectibility of the loan portfolio, including the nature of the portfolio, credit concentrations, trends in historical loss experience, specific impaired loans, economic conditions, and other risks inherent in the portfolio. Allowances for impaired loans are generally determined based on collateral values or the present value of estimated cash flows. Although management uses available information to recognize losses on loans, because of uncertainties associated with local economic conditions, collateral values, and future cash flows on impaired loans, it is reasonably possible that a material change could occur in the allowance for loan losses in the near term. However, the amount of the change that is reasonably possible cannot be estimated. The allowance is increased by a provision for loan losses, which is charged to expense and reduced by charge-offs, net of recoveries. Changes in the allowance relating to impaired loans are charged or credited to the provision for loan losses. F15 SOUTH BANKING COMPANY ALMA, GEORGIA NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2001 Note 1. Significant Accounting Policies (Con't) (h) Premises and Equipment: Land is carried at cost. Other premises and equipment are carried at cost net of accumulated depreciation. Depreciation is computed using the straight-line and the declining balance methods based principally on the estimated useful lives of the assets. Maintenance and repairs are expensed as incurred while major additions and improvements are capitalized. Gains and losses on dispositions are included in current operations. (i) Other Real Estate (ORE) Real estate acquired in satisfaction of a loan and in- substance foreclosures are reported in other assets. In- substance foreclosures are properties in which a borrower with little or no equity in the collateral, effectively abandons control of the property or has no economic interest to continue involvement in the property. The borrower's ability to rebuild equity based on current financial condition also is considered doubtful. Properties acquired by foreclosure or deed in lieu of foreclosure and properties classified as in-substance foreclosures are transferred to ORE and recorded at the lower of cost or fair market value based on appraised value at the date actually or constructively received. Loan losses arising from the acquisition of such property are charged against the allowance for loan losses. Losses on ORE due to subsequent valuation adjustments are recorded on a specific property basis. (j) Income Taxes Income taxes are provided for the tax effects of the transactions reported in the financial statements and consist of taxes currently due plus deferred taxes related primarily to differences between the basis of the allowance for loan losses and accumulated depreciation. The deferred tax assets and liabilities represent the future tax return consequences of those differences, which will either be taxable or deductible when the assets and liabilities are recovered or settled. Deferred tax assets and liabilities are reflected at income tax rates applicable to the period in which the deferred tax assets or liabilities are expected to be realized or settled. As F16 SOUTH BANKING COMPANY ALMA, GEORGIA NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31,2001 Note 1. Significant Accounting Policies (Con't) (j) Income Taxes (Con't) changes in tax laws or rates are enacted, deferred tax assets and liabilities are adjusted through the provision for income taxes. The Bank files a consolidated federal income tax return with its subsidiaries. Each subsidiary provides for income taxes on a separate return basis and remits to the parent company amounts determined to be currently payable. (k) Intangibles The intangibles (Goodwill and Core Deposits) recorded by the Company in the acquisition of Pineland State Bank and subsequent branches are being amortized on a straight line basis over eight to ten years. (l) Earnings Per Share Earnings per share are based on the weighted average number of shares outstanding. (m) Comprehensive Income Comprehensive income includes net income and all other changes in equity during a period except those resulting from investments by owners and distributions to owners. Other comprehensive income includes revenues, expenses, gains, and losses that under generally accepted accounting principles are included in comprehensive income but excluded from net income. Comprehensive income and accumulated other comprehensive income are reported net of related income taxes. Accumulated other comprehensive income for the Bank consists solely of unrealized holding gains or losses on available-for-sale securities. In accordance with SFAS No. 130, the Company elected to disclose changes in comprehensive income in its Consolidated Statements of Income and Comprehensive Income. F17 SOUTH BANKING COMPANY ALMA, GEORGIA NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31,2001 Note 1. Significant Accounting Policies (Con't) (n) Cash Flow Information For purposes of the statements of cash flows, the Company considers cash, federal funds sold and due from banks as cash and cash equivalents. Cash paid during the years ended December 31, 2001, 2000 and 1999 for interest was $9,738,167, $8,117,741, and $6,300,329, respectively. Total income tax payments during 2001, 2000 and 1999 were $844,223, $1,552,939, and $1,025,000, respectively. (o) Recent Pronouncements and Accounting Changes The Financial Accounting Standards Board (FASB) issued Statement of Financial Standards (SFAS) No. 141, Business Combinations, and SFAS No. 142, Goodwill and Other Intangible Assets, on July 20, 2001. SFAS No. 141 provides that all business combinations shall be accounted for using the purchase method of accounting; the use of the pooling-of-interests method is now prohibited. The provisions of SFAS No. 141 apply to all business combinations initiated after June 30, 2001 or to all business combinations accounted for by the purchase method that are completed after June 30, 2001. The Company has not been involved in any recent business combination discussions. SFAS No. 142 provides that goodwill shall not be amortized but should be tested for impairment on an annual basis, using criteria prescribed in the statement. If the carrying amount of goodwill exceeds its implied fair value, as recalculated, an impairment loss equal to the excess shall be recognized. Recognized intangible assets other than goodwill should be amortized over their useful lives and reviewed for impairment in accordance with SFAS No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of (superseded by SFAS No. 144, see discussion which follows). SFAS No. 142 will be effective for fiscal years beginning after December 15, 2001. F18 SOUTH BANKING COMPANY ALMA, GEORGIA NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31,2001 Note 1. Significant Accounting Policies (Con't) (o) Recent Pronouncements and Accounting Changes (Con't) The Company's intangible assets at December 31, 2001 are classified as intangible assets other than goodwill. Approximately $1.576 million of the intangibles recorded on the balance sheet at December 31, 2001 represents the remaining unamortized intangible related to the Company's 2000 acquisition of three branch offices from another bank. The balance of $104 thousand is the remaining intangibles from the original purchase of the bank in 1996. The intangible are being amortized over eight to ten years in accordance with SFAS No. 72, Accounting for Certain Acquisitions of Banking or Thrift Institutions, which was not superseded by SFAS No. 142. During December 2001, the FASB announced it will undertake a limited-scope project to reconsider part of the guidance in SFAS No. 72. Issuance of a final statement is not expected until the fourth quarter of 2002. SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of, was issued by the FASB on October 3, 2001 and is effective for fiscal years beginning after December 15, 2001. This statement effectively supersedes SFAS No. 121 and Accounting Principles Board (APB) Opinion No. 30 and requires that long-lived assets, including discontinued operations, that are to be disposed of by sale be measured at the lower of carrying amount or fair value less cost to sell. The statement also resolves certain implementation issues regarding SFAS No. 121. This statement is not expected to have a material impact on the Company's statements of financial condition or results of operations. F19 SOUTH BANKING COMPANY ALMA, GEORGIA NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31,2001 Note 2. Investment Securities The amortized cost and estimated market values of investments in debt securities are as follows: Gross Gross Amortized Unrealized Unrealized Fair Cost Gains Losses Value Securities available for sale - December 31, 2001: U.S. Government and agency securities $15,583,819 $ 165,042 $57,519 $ 15,691,342 State and municipal securities 948,774 34,883 - 983,657 Mortgage backed securities 227,844 8,207 - 236,051 Equity securities 259,253 3,047 - 262,300 Totals $17,019,690 $ 211,179 $57,519 $ 17,173,350 December 31, 2000: U.S. Government and agency securities $18,538,619 $ 13,424 $102,839 $ 18,449,204 State and municipal securities 1,349,710 31,796 - 1,381,506 Mortgage backed securities 394,373 5,187 975 398,585 Equity securities 550,000 - 84,240 465,760 Totals $20,832,702 $ 50,407 $188,054 $ 20,695,055 F20 SOUTH BANKING COMPANY ALMA, GEORGIA NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2001 Note 2. Investment Securities (Con't) Gross Gross Amortized Unrealized Unrealized Fair Cost Gains Losses Value Securities to be Held to Maturity - December 31, 2001: U.S. Government and agency securities $ - $ - $ - $ - State and municipal securities 147,536 5,047 - 152,583 Mortgage backed securities - - - - Totals $ 147,536 $ 5,047 $ - $ 152,583 December 31, 2000 U.S. Government and agency securities $ - $ - $ - $ - State and municipal securities 147,326 4,186 - 151,512 Mortgage backed securities - - - - Totals $ 147,326 $ 4,186 $ - $ 151,512 Gross realized gains and loses on sales of available- for-sale securities were $-0- and $(3,685) in 2001, respectively and $-0- and $-0-, respectively for 2000 and $- 0- and $-0-, respectively in 1999. During the year ended December 31, 2001, investment securities available for sale, with a fair value at the date of sale of $295,094, were sold. In the years 2000 and 1999, no securities were sold. Assets, principally securities carried at approximately $11,615,367 at December 31, 2001 and $12,406,833 at December 31, 2000, were pledged to secure public deposits and for other purposes required or permitted by law. F21 SOUTH BANKING COMPANY ALMA, GEORGIA NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2001 Note 2. Investment Securities (Con't) The scheduled contractual maturities of securities to be held to maturity and securities available for sale at December 31, 2001 were as follows: Securities Securities To Be Held Available To Maturity for Sale Amortized Amortized Cost Fair Value Cost Fair Value Due in one year or less $ 100,000 $ 100,836 $ 1,931,605 $ 1,962,259 Due from one year to five years - - 11,103,871 11,227,555 Due from five years to ten years - - 3,198,257 3,173,119 Due after ten years 47,536 51,747 526,704 548,117 $ 147,536 $ 152,583 $16,760,437 $16,911,050 The market value of State and Other Political Subdivision Obligations is established with the assistance of an outside bond department and is based on available market data which often reflects transactions of relatively small size and is not necessarily indicative of prices at which large amounts of particular issues could readily be sold or purchased. Expected maturities will differ from contractual maturities because issuers may have the right to call on prepay obligations with or without call on prepayment penalties. F22 SOUTH BANKING COMPANY ALMA, GEORGIA NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2001 Note 3. Loans The composition of the bank's portfolio was as follows: 2001 2000 (In Thousands) Commercial, financial and agricultural $ 49,558 $ 42,973 Real estate - mortgage 85,876 81,314 Real estate - construction 9,015 7,646 Installment and consumer 27,929 31,294 Total Loans $ 172,378 $ 163,227 Less: Unearned discount ( 289) ( 253) Reserve for loan losses ( 2,756) ( 2,728) Loans, net $ 169,333 $ 160,246 Non-accrual loans (principally collateralized by real estate) amounted to approximately $1,002,000, $876,000 and $442,000 at December 31, 2001, 2000, and 1999, respectively. Impaired loans were $-0- and $-0- at December 31, 2001 and 2000. The Company and its subsidiaries have granted loans to the officers and directors of the Company, its subsidiaries, and to their associates. Related party loans are made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with unrelated persons and do not involve more than normal risk of collectibility. The aggregate dollar amount of these loans was $520,150 and $633,116 at December 31, 2001 and 2000. During 2001, $358,381 of new loans were made, and repayments totaled $471,347. F23 SOUTH BANKING COMPANY ALMA, GEORGIA NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2001 Note 4. Reserve for Loan Losses Transactions in the reserve for loan losses are summarized as follows: Year Ended Year Ended Year Ended December 31, December 31, December 31, 2001 2000 1999 Balance at beginning of period $ 2,728,219 $ 2,168,877 $ 1,970,620 Additions: Provision charged to operating expenses $ 893,000 $ 424,000 $ 503,000 Balance from bank acquisition - 588,306 - $ 893,000 $ 1,012,306 $ 503,000 Deductions: Loans charged off $ 1,002,886 $ 664,298 $ 432,472 Less: recoveries 138,447 211,334 127,729 $ 864,439 $ 452,964 $ 304,743 Balance at end of period $ 2,756,780 $ 2,728,219 $ 2,168,877 Additions to the reserve for loan losses are based on management's evaluation of the loan portfolio under current economic conditions, past loan loss experience and such other factors which, in management's judgment, deserve recognition in estimating loan losses. Loans are charged off when, in the opinion of management, such loans are deemed to be uncollectible. Recognized losses are charged to the reserve and subsequent recoveries added. Loans having carrying values of $1,436,843 and $833,029 were transferred to foreclosed real estate in 2001 and 2000, respectively. The bank is not committed to lend additional funds to debtors whose loans have been modified. F24 SOUTH BANKING COMPANY ALMA, GEORGIA NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2001 Note 5. Deposits The aggregate amount of short-term jumbo CDs, each with a minimum denomination of $100,000, was approximately $31,805,741 in 2001 and $37,569,711 in 2000. At December 31, 2001, the scheduled maturities of CDs are as follows: (In Thousands) 2002 $ 113,427 2003 and 2004 8,777 2005 and thereafter 495 $ 122,699 Note 6. Premises and Equipment A summary of the account: Year Ended Year Ended December 31, December 31, 2001 2000 Land $ 640,582 $ 526,763 Buildings 5,971,572 4,936,869 Furniture and equipment 5,697,359 5,470,568 $12,309,513 $10,934,200 Less: Accumulated depreciation 5,593,700 4,822,839 $ 6,715,813 $ 6,111,361 Depreciation expense was $860,117 in 2001, $803,318 in 2000 and $614,430 in 1999. F25 SOUTH BANKING COMPANY ALMA, GEORGIA NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2001 Note 7. Borrowings Data relating to borrowing is as follows: Year Ended Year ended December 31, December 31, Parent Company - 2001 2000 Note payable in 10 annual payments with interest payable quarterly and accrues at prime rate minus 50 basis points. Subsidiary bank stock is pledged to secure loan. $ 4,725,000 $ 5,000,000 Note payable due June 30, 2001. Interest payable quarterly and accrues at prime rate and is secured by bank stock - 200,000 Subsidiary - Bankers Data Services, Inc. Note payable due January 27, 2002 monthly principal amount of $10,833.33 plus interest. Interest accrues at prime minus 1%. Computer equipment is pledged as collateral for loan. 824,419 987,847 Note payable in 36 monthly payments of $434.02. Interest accrues at 1.9% rate and is secured by vehicle. 433 5,580 Note payable in 24 monthly payments of $664.13. Interest accrues at 5.9% rate and is secured by vehicle. 6,465 13,816 Note payable in 24 monthly payments of $791.66. Interest accrues at 0% and is secured by auto. 17,416 - Subsidiary - Alma Exchange Bank Note payable in 36 monthly payments of $696.98. Interest accrues at 3.9% rate and is secured by vehicle. 7,517 16,120 F26 SOUTH BANKING COMPANY ALMA, GEORGIA NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2001 Note 7. Borrowings (Con't) Year Ended Year ended December 31, December 31, 2001 2000 Note payable in 3 annual payments of $7,937. Interest accrues at 0% and is secured by auto. 23,811 - Following are maturities of long term debt for each of the next five years. 2002 $ 486,851 2003 520,853 2004 562,937 2005 605,000 2006 655,000 Note 8. Income Taxes Income tax expense (benefit) was $733,859 for 2001, (an effective rate of 30.4%), $1,221,738 for 2000 (an effective rate of 31.6%) and $1,017,056 for 1999 (an effective rate of 32.3%). The actual expense for 2001, 2000 and 1999 differs from the "expected" tax expense for those years (computed by applying the federal corporate rate of 34%) as follows: 2001 2000 1999 Computed "expected" tax expenses 34.0% 34.0% 34.0% Alternative minimum tax - - - Effect of State Income Tax ( .1%) 1.1% 2.4% Tax exempt interest on securities and loans ( 4.6%) ( 3.6%) ( 2.9%) Other, net 1.1% .1% ( 1.2%) 30.4% 31.6% 32.3% F27 SOUTH BANKING COMPANY ALMA, GEORGIA NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2001 Note 8. Income Taxes (Con't) The current and deferred amounts of these tax provisions were as follows: 2001 2000 1999 Current - Federal $ 725,566 $1,178,493 $1,140,833 - State - 83,299 104,994 Deferred - Federal 7,123 ( 24,534) ( 146,891) - State 1,170 ( 15,520) ( 81,880) $ 733,859 $1,221,738 $1,017,056 The tax effects of each type of income and expense item that gave rise to deferred taxes are: December 31, December 31, 2001 2000 Net unrealized appreciation on securities available for sale $( 55,726) $ 50,833 Depreciation ( 219,899) ( 190,400) Deferred loan fees 101,281 85,229 Allowance for credit losses 788,595 806,587 Other 32,728 9,626 Purchase accounting treatment ( 65,820) ( 65,820) Net deferred tax asset (liability) $ 581,159 $ 696,055 F28 SOUTH BANKING COMPANY ALMA, GEORGIA NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2001 Note 9. Employee Benefit Plans The Company maintains a 401K deferred compensation plan for all subsidiaries effective January 1, 1993. The Company elected to match 75% of employee contributions for 2001, 2000 and 1999. The expense to the Company for 2001, 2000 and 1999 was $140,000, $134,297, and $115,297, respectively. Note 10. Leases The Pineland State Bank leases 5.35 acres of land in Candler County under an operating lease expiring December 31, 2054 with an option to lease the land for an additional 75 years. Minimum future rental payments under non-cancelable operating lease having remaining term in excess of 1 year as of December 31, 2001 for each of the next 5 years and in the aggregate is: Year Ended 2002 $ 4,000 2003 4,000 2004 4,000 2005 4,000 2006 4,000 Subsequent to 2007 192,000 Total minimum future rental payments $ 212,000 In June, 1997, the parties amended the lease to allow Pineland State Bank to sublet part of the property and in consideration, the landlord will receive 50% of gross rental under the sublease in addition to the minimum amount above. F29 SOUTH BANKING COMPANY ALMA, GEORGIA NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2001 Note 11. Liabilities Standby Letters of Credit. These transactions are used by the Company's customers as a means of improving their credit standing in their dealings with others. Under these agreements, the Company agrees to honor certain financial commitments in the event that its customers are unable to do so. As of December 31, 2001 and 2000, the Company had $911,779 and $450,240 in outstanding standby letters of credit. Loan Commitments. As of December 31, 2001 and 2000, the Company had commitments outstanding to extend credit totaling $15,710,009 and $28,328,739, respectively. These commitments generally require the customers to maintain certain credit standards. Management does not anticipate any material losses as a result of these commitments. Note 12. Financial Instruments The Bank 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 and to reduce its own exposure to fluctuations in interest rates. These financial instruments include commitments to extend credit, and standby letters of credit, and financial guarantees. Those instruments involve, to varying degrees, elements of credit and interest-rate risk in excess of the amount recognized in the consolidated statements of financial condition. The contract or notional amounts of those instruments reflect the extent of the Bank's involvement in particular classes of financial instruments. The Bank's exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit, standby letters of credit, and financial guarantees written is represented by the contractual notional amount of those instruments. The Bank uses the same credit policies in making commitments and conditional obligations as it does for on-balance-sheet instruments. F30 SOUTH BANKING COMPANY ALMA, GEORGIA NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2001 Note 12. Financial Instruments (Con't) Commitments to Extend Credit and Financial Guarantees. 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. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Bank evaluates each customer's credit worthiness on a case-by-case basis. The amount of collateral obtained, if it is deemed necessary by the Bank upon extension of credit, is based on management's credit evaluation of the counterparty. Collateral held varies; but, may include accounts receivable; inventory, property, plant and equipment; and income-producing commercial properties. Standby letters of credit and financial guarantees written are conditional commitments issued by the Bank to guarantee the performance of a customer to a third party. Those guarantees are primarily issued to support private borrowing arrangements, including commercial paper and similar transactions. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. The Bank holds various assets as collateral supporting those commitments for which collateral is deemed necessary. The Bank has not been required to perform on any financial guarantees during the past two years. The Bank has not incurred any losses on its commitments in 2001, 2000 or 1999. F31 SOUTH BANKING COMPANY ALMA, GEORGIA NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2001 Note 13. Restrictions on Subsidiary Dividends, Loans or Advances Dividends are paid by the Company from its assets which are mainly provided by dividends from the Banks. However, certain restrictions exist regarding the ability of the Banks to transfer funds to the Company in the form of cash dividends, loans or advances. The approval of the Georgia Department of Banking is required to pay dividends in excess of 50% of the Bank's net profits for the prior year. Note 14. Restrictions on Cash and Due from Banks Under Federal Reserve regulation, the Bank also is limited as to the amount it may loan to its affiliates, including the Company, unless such loans are collateralized by specified obligations. At December 31, 2001, the maximum amount available for transfer from the Bank to the Company in the form of loans approximated 20% of consolidated net equity. The bank is required to maintain reserve balances with the Federal Reserve Bank. The average amount of those reserve balances for the year ended December 31, 2001 was approximately $-0-. Note 15. Related Party Transactions The Company has entered into a split dollar life insurance arrangement with a director and substantial shareholder. The Company and director's trust each contribute toward the payment of premium for life insurance policy. The Company records its contribution at the present value of anticipated future return or total cash surrender value of policy, whichever is higher; however, the carrying amount cannot exceed the amount of premiums paid by the Company. The Company will receive all reimbursement from anticipated withdrawal of cash surrender value or from the proceeds of policy in the event of the death of the director. All cash surrender value of the policy accrues to the benefit of the Company until such time as the cash surrender value exceeds advances made by the Company. As of December 31, 2001, $962,596 is carried in other assets related to this arrangement. F32 SOUTH BANKING COMPANY ALMA, GEORGIA NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2001 Note 16. Fair Value of Financial Instruments The following table shows the estimated fair value and the related carrying values of South Banking Company's financial instruments at December 31, 2001 and 2000. Items which are not financial instruments are not included. 2001 Carrying Estimated Cash and due from financial Amount Fair Value institutions $ 11,140,462 $11,140,462 Interest earning balances with financial institutions 1,273,000 1,273,000 Federal funds sold 10,252,000 10,252,000 Securities available for sale 17,173,350 17,173,350 Securities held to maturity 147,536 152,583 Federal Home Loan Bank stock 426,100 426,100 Georgia Bankers Bank - stock 547,283 770,240 Loans - net of allowances 169,333,063 161,938,092 Demand and savings deposits 73,301,431 73,301,431 Time deposits 122,699,172 123,606,169 Federal funds purchased - - 2000 Cash and due from financial institutions 8,911,914 $ 8,911,914 Interest earning balances with financial institutions 825,279 825,279 Federal funds sold 14,693,000 14,693,000 Securities available for sale 20,695,055 20,695,055 Securities held to maturity 147,326 151,512 Federal Home Loan Bank stock 426,100 426,100 Georgia Bankers Bank - stock 547,283 784,085 Loans - net of allowances 160,246,187 158,371,357 Demand and savings deposits 63,030,105 63,030,105 Time deposits 129,649,110 132,081,000 Federal funds purchased - - F33 SOUTH BANKING COMPANY ALMA, GEORGIA NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2001 Note 16. Fair Value of Financial Instruments (Con't) For purposes of the above disclosures of estimated fair value, the following assumptions were used as of December 31, 2001 and 2000. The estimated fair value for cash and due from financial institutions and federal funds sold are considered to approximate cost. The estimated fair value for interest- earning balances with financial institutions, securities available-for-sale, securities held-to-maturity, and Georgia Bankers Bank stock are based on quoted market values for the individual securities or for equivalent securities. The estimated fair value for commercial loans is based on estimates of the difference in interest rates the Company would charge the borrowers for similar such loans with similar maturities made at December 31, 2001 and 2000, applied for an estimated time period until the loan is assumed to reprice or be paid. The estimated fair value for other loans is based on estimates of the rate the Company would charge for similar such loans at December 31, 2001 and 2000 applied for the time period until estimated repayment. The estimated fair value for individual retirement account deposits and time deposits is based on estimates of the rate the Company would pay on such deposits or borrowings at December 31, 2001 and 2000, applied for the time period until maturity. The estimated fair value for other financial instruments and off-balance- sheet loan commitments are considered to approximate cost at December 31, 2001 and 2000. While these estimates of fair value are based on management's judgment of the most appropriate factors, there is no assurance that were the Company to have disposed of such items at December 31, 2001 and 2000, the estimated fair values would necessarily have been achieved at that date, since market values may differ depending on various circumstances. The estimated fair values at December 31, 2001 and 2000 should not necessarily be considered to apply at subsequent dates. In addition, other assets and liabilities of the Company that are not defined as financial instruments are not included in the above disclosures, such as property and equipment. Also, non-financial instruments typically not recognized in the financial statements, nevertheless, may have value but are not included in the above disclosures. These include, among other items, the estimated earnings power of core deposit accounts, the earnings potential of loan servicing rights, the trained work force, customer goodwill, and similar items. F34 SOUTH BANKING COMPANY ALMA, GEORGIA NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2001 Note 17. Regulatory Matters The Company and its subsidiaries are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory - and possibly additional discretionary - actions by regulators that, if undertaken, could have a direct material effect on the Company's financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company must meet specific capital guidelines that involve quantitative measures of the Company's assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. The Company's capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings and other factors. Quantitative measures established by regulation to ensure capital adequacy require the Company to maintain minimum amounts and ratios of total and Tier I capital (as defined in the regulations) to risk-weighted assets (as defined) and of Tier I capital (as defined) to average assets (as defined). Management believes, as of December 31, 2001, that the Company and its subsidiaries meet all capital adequacy requirements to which it is subject. As of December 31, 2001, the most recent notification from the FDIC categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized, the Bank must maintain minimum total risk-based, Tier I risk-based, and Tier I leverage ratios as set forth in the table. There are no conditions or events since that notification that, management believes, have changed the institution's category. F35 SOUTH BANKING COMPANY ALMA, GEORGIA NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2001 Note 17. Regulatory Matters (Con't) The Company and its subsidiaries' actual capital amounts and ratios are also presented in the table. To Be Well Capitalized Under For Capital Prompt Corrective Actual Adequacy Purposes Action Provisions: Amount Ratio Amount Ratio Amount Ratio As of December 31, 2001: Total Capital (to Risk Weighted Assets) Consolidated$ 20,435 10.9% >$ 15,041 > 8.0% >$ 18,801 > 10.0% Subsidiary - Alma 7,775 11.5% > 5,384 > 8.0% > 6,730 > 10.0% Subsidiary - Baxley 6,737 15.9% > 3,381 > 8.0% > 4,227 > 10.0% Subsidiary - Kingsland 3,192 12.4% > 2,065 > 8.0% > 2,581 > 10.0% Subsidiary - Metter 5,410 10.4% > 4,159 > 8.0% > 5,199 > 10.0% As of December 31, 2001: Tier I Capital (to Risk Weighted Assets) Consolidated $ 18,080 9.6% >$ 7,520 > 4.0% >$ 11,280 > 6.0% Subsidiary - Alma 6,924 10.3% > 2,692 > 4.0% > 4,038 > 6.0% Subsidiary - Baxley 6,207 14.7% > 1,691 > 4.0% > 2,536 > 6.0% Subsidiary - Kingsland 2,868 11.1% > 1,032 > 4.0% > 1,549 > 6.0% Subsidiary - Metter 4,769 9.2% > 2,080 > 4.0% > 3,120 > 6.0% F36 SOUTH BANKING COMPANY ALMA, GEORGIA NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2001 To Be Well Capitalized Under For Capital Prompt Corrective Actual Adequacy Purposes Action Provisions: Amount Ratio Amount Ratio Amount Ratio As of December 31, 2001: Tier I Capital (to Average Assets) Consolidated $ 18,080 8.1% >$ 8,924 > 4.0% >$ 11,155 > 5.0% Subsidiary - Alma 6,924 8.9% > 3,104 > 4.0% > 3,881 > 5.0% Subsidiary - Baxley 6,207 12.1% > 2,052 > 4.0% > 2,565 > 5.0% Subsidiary - Kingsland 2,868 9.1% > 1,266 > 4.0% > 1,583 > 5.0% Subsidiary - Metter 4,769 7.8% > 2,435 > 4.0% > 3,043 > 5.0% As of December 31, 2000: Total Capital (to Risk Weighted Assets) Consolidated $ 18,647 10.7% > $13,933 8.0% > $17,407 > 10.0% Subsidiary - Alma 7,463 12.9% > 4,597 8.0% > 5,746 > 10.0% Subsidiary - Baxley 6,444 16.1% > 3,324 8.0% > 4,155 > 10.0% Subsidiary - Kingsland 2,914 12.7% > 1,841 8.0% > 2,302 > 10.0% Subsidiary - Metter 4,924 8.9% > 4,435 8.0% > 5,544 > 10.0% F37 SOUTH BANKING COMPANY ALMA, GEORGIA NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2001 To Be Well Capitalized Under For Capital Prompt Corrective Actual Adequacy Purposes Action Provisions: Amount Ratio Amount Ratio Amount Ratio As of December 31, 2000: Tier I Capital (to Risk Weighted Assets) Consolidated $ 16,441 9.4% > $6,963 4.0% > $10,444 > 6.0% Subsidiary - Alma 6,739 11.7% > 2,298 4.0% > 3,448 > 6.0% Subsidiary - Baxley 5,924 14.8% > 1,662 4.0% > 2,493 > 6.0% Subsidiary - Kingsland 2,625 11.4% > 921 4.0% > 1,381 > 6.0% Subsidiary - Metter 4,251 7.7% > 2,217 4.0% > 3,326 > 6.0% As of December 31, 2000: Tier I Capital (to Average Assets) Consolidated $ 16,441 9.3% > $7,038 4.0% > $8,797 > 5.0% Subsidiary - Alma 6,739 9.1% > 2,977 4.0% > 3,721 > 5.0% Subsidiary - Baxley 5,924 12.2% > 1,938 4.0% > 2,422 > 5.0% Subsidiary - Kingsland 2,625 8.8% > 1,182 4.0% > 1,477 > 5.0% Subsidiary - Metter 4,251 6.9% > 2,461 4.0% > 3,077 > 5.0% F38 SOUTH BANKING COMPANY (PARENT CORPORATION ONLY) ALMA, GEORGIA FINANCIAL STATEMENTS DECEMBER 31, 2001 F39 REPORT OF INDEPENDENT ACCOUNTANTS Board of Directors South Banking Company Alma, Georgia 31510 Under date of February 14, 2002, we reported on the consolidated balance sheets of South Banking Company, as of December 31, 2001 and 2000, and the related statements of income, cash flows and stockholders' equity for the three years in the period ended December 31, 2001. In connection with our examination of the aforementioned consolidated financial statements, we also audited the accompanying balance sheets (Parent Corporation Only) as of December 31, 2001 and 2000 and the related statements of income, cash flows and stockholders' equity for each of the three years in the period ended December 31, 2001. These financial statements are the responsibility of the company's management. Our responsibility is to express an opinion on the financial statements based on our audit. We conducted our audit in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of South Banking Company (Parent Corporation Only) as of December 31, 2001 and 2000, and the results of its operations, stockholders' equity and its cash flows for the three years then ended in conformity with accounting principles generally accepted in the United States of America. Respectfully submitted, H. H. BURNET & COMPANY, P. C. February 14, 2002 F40 SOUTH BANKING COMPANY (PARENT CORPORATION ONLY) ALMA, GEORGIA BALANCE SHEETS December 31, December 31, 2001 2000 ASSETS Cash and due from banks Interest bearing $ 1,243,497 $ 1,064,896 Non-interest bearing 36,862 32,846 Investment in bank's subsidiaries 22,543,800 21,420,680 Investment in nonbank subsidiaries 463,535 341,298 Investment-Habersham Bank Corp.-available for sale - 215,760 Investment-Nexity Financial-available for sale 250,000 250,000 Other assets 16,423 60,948 Prepaid income taxes 351,370 214,577 Due from subsidiaries - - Total Assets $24,905,487 $23,601,005 LIABILITIES AND STOCKHOLDERS' EQUITY Current Liabilities Accounts payable $ 186 $ 186 Other liabilities 3,018 788 Accrued income taxes - - Notes payable 4,725,000 5,200,000 Due to subsidiaries 319,044 129,471 Total Liabilities $ 5,047,248 $ 5,330,445 Stockholders' Equity Common stock of $1 par value; authorized 1,000,000 shares; issued and outstanding, 2000 and 1999 399,500 and 399,500, respectively $ 399,500 $ 399,500 Surplus 3,070,831 3,070,831 Undivided profits 16,291,126 14,887,046 Accumulated other comprehensive income 96,782 ( 86,807) Total Stockholders' Equity $19,858,239 $ 18,270,560 Total Liabilities and Stockholders'Equity $24,905,487 $ 23,601,005 The accompanying note is an integral part of these financial statements. F41 SOUTH BANKING COMPANY (PARENT CORPORATION ONLY) ALMA, GEORGIA STATEMENT OF INCOME Year Ended Year Ended Year Ended December 31, December 31, December 31, 2001 2000 1999 Income Dividends from bank Subsidiaries $ 994,156 $ 985,387 $ 977,614 Miscellaneous income - 788 682 Interest income 45,641 23,479 18,431 Management fees 108,000 102,000 102,000 Dividends - other 2,673 5,345 10,091 Loss on sale of stock ( 4,906) - - Total Income $ 1,145,564 $1,116,999 $ 1,108,818 Expenses Salaries $ 80,543 $ 83,169 $ 79,300 Amortization 1,498 13,526 13,526 Interest 337,286 318,822 212,684 Professional fees 25,791 75,045 33,045 Other 67,837 75,621 63,109 Total Expenses $ 512,955 $ 566,183 $ 401,664 Income before income taxes and equity in undistributed income (loss) of subsidiaries $ 632,609 $ 550,816 $ 707,154 Provision (credit) for income taxes ( 136,526) ( 164,606) ( 95,172) Income before equity in undistributed income in subsidiaries $ 769,135 $ 715,422 $ 802,326 Equity in undistributed income of bank subsidiaries $ 792,336 $1,904,756 $ 1,251,684 Equity in undistributed income (loss) of nonbank subsidiaries 122,237 25,882 74,491 $ 914,573 $1,930,638 $ 1,326,175 Net Income $ 1,683,708 $2,646,060 $ 2,128,501 The accompanying note is an integral part of these financial statements. F42 SOUTH BANKING COMPANY (PARENT CORPORATION ONLY) ALMA, GEORGIA STATEMENT OF INCOME (con't) Year Ended Year Ended Year Ended December 31, December 31, December 31, 2001 2000 1999 Other Comprehensive Income before tax Unrealized gain on securities $ 278,166 $ 151,160 $( 402,268) Other Comprehensive Income before tax $ 278,166 $ 151,160 $( 402,268) Income tax expenses related to items of other comprehensive income 94,577 57,048 ( 136,771) Other comprehensive income, net of tax $ 183,589 $ 94,112 $( 265,497) Comprehensive income $ 1,867,297 $2,740,172 $ 1,863,004 Per share data based on weighted outstanding shares: Weighted average outstanding 399,500 399,500 399,500 Net Income $ 4.21 $ 6.62 $ 5.33 The accompanying note is an integral part of these financial statements. F43 SOUTH BANKING COMPANY (PARENT CORPORATION ONLY) ALMA, GEORGIA STATEMENT OF STOCKHOLDERS' EQUITY Accumulated Other Total Common Undivided Comprehensive Stockholders' Stock Surplus Profits Income Equity Balance, December 31, 1998 $ 399,500 $3,070,831 $10,651,788 $ 84,568 $ 14,206,687 Net income - - 2,128,501 - 2,128,501 Cash dividends - - ( 259,675) - ( 259,497) Unrealized gain (loss) on securities available for sale - - - (265,497) ( 265,497) Balance, December 31, 1999 $ 399,500 $3,070,831 $12,520,614 $( 180,929) $ 15,810,016 Net income - - 2,646,060 - 2,646,060 Cash dividends - - ( 279,628) - ( 279,628) Unrealized gain (loss) on securities available for sale - - - 94,112 94,112 Redemption of shares - - - - - Balance, December 31, 2000 $ 399,500 $3,070,831 $14,887,046 $( 86,817) $ 18,270,560 Net income - - 1,683,708 - 1,683,708 Cash dividends - - ( 279,628) - ( 279,628) Unrealized gain (loss) on securities available for sale - - - 183,599 183,599 Redemption of shares - - - - - Balance, December 31, 2001 $ 399,500 $3,070,831 $16,291,126 $ 96,782 $ 19,858,239 The accompanying note is an integral part of these financial statements. F44 SOUTH BANKING COMPANY (PARENT CORPORATION ONLY) ALMA, GEORGIA STATEMENT OF CASH FLOWS Year Ended Year Ended Year Ended December 31, December 31, December 31, 2001 2000 1999 Cash Flows From Operating Activities: Net income $ 1,683,708 $ 2,646,060 $ 2,128,501 Add expenses not requiring cash: Depreciation and Amortization 11,731 21,870 17,649 Undistributed earnings of Subsidiaries ( 914,573) (1,930,638) ( 1,326,175) Loss on sale of stock ( 4,906) - - Increase (decrease) in other liabilities 2,230 788 - Increase (decrease) in accrued income taxes - ( 21,653) 21,652 (Increase) decrease in other assets 1,369 635 ( 1,979) (Increase) decrease in prepaid income taxes ( 136,793) ( 214,577) 145,937 (Increase) decrease in due from subsidiary-taxes - 105,672 ( 129,928) Increase (decrease) in due to subsidiary 189,573 129,471 - Net Cash Provided by Operating Activities $ 842,151 $ 737,718 $ 855,657 Cash Flows From Investing Activities: Capital contribution to Subsidiary $( 200,000) $(2,700,000) $ - Purchase of Nexity Financial Stock - - ( 250,000) Purchase of C B Financial Stock Purchase of fixed assets - ( 27,532) - Sale of CB Financial 295,094 - - Net Cash Used by Investing Activities $ 95,094 $( 2,727,532) $( 250,000) The accompanying note is an integral part of these financial statements. F45 SOUTH BANKING COMPANY (PARENT CORPORATION ONLY) ALMA, GEORGIA STATEMENT OF CASH FLOWS (con't) Year Ended Year Ended Year Ended December 31, December 31, December 31, 2001 2000 1999 Cash Flows From Financing Activities: Payments on note payable bank $( 475,000) $( 60,000) $( 390,000) Proceeds from notes payable to banks - 2,900,000 - Dividends paid ( 279,628) ( 279,628) ( 259,675) Redemption of common stock - - - Net Cash Provided (Used) by Financing Activities $( 754,628) $ 2,560,372 $( 649,675) Net increase (decrease) in cash and cash equivalents $ 182,617 $ 570,558 $( 44,018) Cash and Cash Equivalents at beginning of year 1,097,742 527,184 571,202 Cash and Cash Equivalents at end of year $ 1,280,359 $ 1,097,742 $ 527,184 The accompanying note is an integral part of these financial statements. F46 SOUTH BANKING COMPANY (PARENT CORPORATION ONLY) ALMA, GEORGIA NOTES TO FINANCIAL STATEMENTS (A) Summary of Significant Accounting Policies General- The following notes to the financial statements of South Banking Corporation, formed on July 28, 1981, (parent corporation only) (the corporation) includes only that information which is in addition to information presented in the consolidated financial statements and notes to consolidated financial statements. Investment in subsidiaries- The corporation reports its investment in the common stock of its subsidiaries at its equity in the net assets of the subsidiaries. Organization costs- Organization costs have been deferred and are being amortized on a straight-line basis over a period of five years. F47