Edgar Filing: COMMUNITY BANCSHARES INC /DE/

SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

Form 10-Q

|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2002
OR

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

Commission File No. 000-16461

COMMUNITY BANCSHARES, INC.
(Exact name of registrant as specified in its charter)

Delaware 63-0868361
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)

68149 Main Street
Blountsville, Alabama 35031
(Address of principal executive offices)

(205) 429-1000
(Registrant's telephone number)

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

APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY
PROCEEDINGS DURING THE PRECEDING 5 YEARS:

Indicate by check mark whether the registrant has filed all documents
and reports required to be filed by Sections 12, 13 or 15(d) of the Securities
Exchange Act of 1934 subsequent to the distribution of securities under a plan
confirmed by a court. |_|yes |_|no

APPLICABLE ONLY TO CORPORATE ISSUERS:

As of May 8, 2002, there were 4,637,855 shares of the registrant's
common stock, $.10 par value shares, outstanding.

Form 10-Q

COMMUNITY BANCSHARES, INC.

March 31, 2002

TABLE OF CONTENTS

Page No.
Part 1 - Financial Information

Item 1 - Consolidated Financial Statements (Unaudited)

Consolidated Statements of Financial Condition as of March 31, 2002
and December 31, 2001....................................................................... 3

Consolidated Statements of Income For The Three Months Ended
March 31, 2002 and 2001..................................................................... 4

Consolidated Statements of Cash Flows For The Three Months
Ended March 31, 2002 and 2001............................................................... 6

Notes to Consolidated Financial Statements..................................................... 8

Item 2 - Management's Discussion and Analysis of
Financial Condition and Results of Operations.................................................. 16

Item 3 - Quantitative and Qualitative Disclosures About Market Risk..................................... 22

Part 2 - Other Information

Item 1 - Legal Proceedings.............................................................................. 23

Item 6 - Exhibits and Reports on Form 8-K............................................................... 23

Signatures

PART 1
Item 1 - Financial Statements

CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
COMMUNITY BANCSHARES, INC. AND SUBSIDIARIES
(UNAUDITED)

March 31, 2002 December 31, 2001
---------------- ------------------

Assets
Cash ................................................................ $ 6,619,405 $ 8,312,263
Due from banks ....................................................... 11,098,037 14,724,745
Interest-bearing deposits with banks. ................................ 200,000 200,000
Federal funds sold ................................................... 45,395,000 30,000,000
Securities available for sale ........................................ 111,383,948 121,679,303
Loans ................................................................ 465,532,536 501,583,650
Less: Unearned income. ............................................... 57,627 63,991
Allowance for loan losses ......................................... 7,201,046 7,292,370
---------------- ----------------
Net Loans ......................................................... 458,273,863 494,227,289
Premises and equipment, net .......................................... 37,192,064 39,626,868
Accrued interest. .................................................... 5,730,234 7,061,043
Intangibles, net. .................................................... 2,608,855 2,629,682
Other real estate .................................................... 4,446,638 4,287,273
Other assets ......................................................... 7,653,850 6,733,102
---------------- ----------------
Total Assets....................................................... $ 690,601,894 $ 729,481,568
================ ================

Liabilities and Shareholders' Equity
Deposits:
Noninterest-bearing................................................ $ 68,880,565 $ 67,695,615
Interest-bearing................................................... 508,756,203 550,010,415
---------------- ----------------
Total Deposits ................................................. 577,636,768 617,706,030
Other short-term borrowings .......................................... 4,835,216 4,359,927
Accrued interest. .................................................... 4,471,008 4,400,000
FHLB borrowing ....................................................... 38,000,000 38,000,000
Capitalized lease obligations ........................................ 5,735,087 5,766,076
Long-term debt ....................................................... 4,396,052 4,666,599
Guaranteed preferred beneficial interest in the Company's junior
subordinated deferrable interest debentures ....................... 10,000,000 10,000,000
Other liabilities .................................................... 3,759,551 3,917,567
---------------- ----------------
Total Liabilities ................................................. 648,833,682 688,816,199

Shareholders' Equity
Preferred stock, par value $.01 per share, 200,000 shares
authorized, no shares issued ...................................... - -
Common stock, par value $.10 per share, 20,000,000 shares
authorized, 4,826,601and 4,808,331 shares issued, as of
March 31, 2002 and December 31 2001, respectively.................. 482,660 480,833
Capital surplus ...................................................... 30,933,881 30,753,008
Retained earnings .................................................... 13,622,813 12,390,300
Treasury Stock, 20,803 shares ........................................ (396,768) (396,768)
Unearned ESOP shares - 167,943 and 174,267 shares as of
March 31, 2002 and December 31, 2001, respectively................. (2,254,662) (2,317,902)
Accumulated other comprehensive loss.................................. (619,712) (244,102)
---------------- ----------------
Total Shareholders' Equity ........................................ 41,768,212 40,665,369
---------------- ----------------

Total Liabilities and Shareholders' Equity............................... $ 690,601,894 $ 729,481,568
================ ================

See notes to consolidated financial statements

CONSOLIDATED STATEMENTS OF INCOME
COMMUNITY BANCSHARES, INC. AND SUBSIDIARIES
(UNAUDITED)

For the Three Months Ended March 31,
2002 2001
---------------- ---------------

Interest Income
Interest and fees on loans............................................ $ 11,014,615 $ 13,416,990
Interest on investment securities:
Taxable securities.................................................. 1,550,545 1,344,085
Securities exempt from federal income taxes ........................ 145,088 199,809
Interest on federal funds sold ....................................... 143,083 127,021
Interest on deposits in other banks .................................. 6,994 17,315
---------------- ---------------
Total Interest Income .............................................. 12,860,325 15,105,220
---------------- ---------------

Interest Expense
Interest on deposits ................................................. 4,899,885 7,697,670
Interest on other short-term borrowings .............................. 18,897 36,691
Interest on capitalized lease obligations............................. 68,698 569,609
FHLB borrowings ...................................................... 563,350 122,499
Interest on long-term debt. .......................................... 53,898 116,208
Interest on guaranteed preferred beneficial interest in the
Company's junior subordinated deferrable interest debentures........ 280,303 271,875
---------------- ---------------
Total Interest Expense. ............................................ 5,885,031 8,814,552
---------------- ---------------

Net Interest Income...................................................... 6,975,294 6,290,668
Provision for loan losses ............................................ 1,040,419 951,118
---------------- ---------------

Net Interest Income After Provision For Loan Losses...................... 5,934,875 5,339,550

Noninterest Income
Service charges on deposits .......................................... 985,081 1,026,102
Insurance commissions................................................. 535,128 540,842
Bank club dues ....................................................... 156,396 169,431
Debt cancellation fees ............................................... 72,955 152,067
Gain on sale of branches.............................................. 1,551,443 --
Other operating income ............................................... 217,060 433,526
Investment securities gains .......................................... 16,646 353,015
---------------- ---------------
Total Noninterest Income............................................ 3,534,709 2,674,983
---------------- ---------------

Noninterest Expenses
Salaries and employee benefits ....................................... 3,978,539 4,081,442
Occupancy expense .................................................... 755,347 712,088
Furniture and equipment expense. ..................................... 464,014 449,806
Director and committee fees .......................................... 107,600 117,498
Loss on disposal of premises and equipment............................ 395,575 13,195
Other operating expenses ............................................. 1,921,876 1,503,755
---------------- ----------------
Total Noninterest Expenses ......................................... 7,622,951 6,877,784
---------------- ---------------

Income before income taxes .............................................. 1,846,633 1,136,749
Income tax expense....................................................... 614,120 331,659
---------------- ---------------

Net Income.......................................................... $ 1,232,513 $ 805,090
================ ===============

Earnings per common share - basic........................................ $ 0.27 $ 0.18
Earnings per common share - diluted...................................... $ 0.27 $ 0.18
Dividends per share...................................................... $ -- $ --

See notes to consolidated financial statements

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
COMMUNITY BANCSHARES, INC. AND SUBSIDIARIES
(UNAUDITED)

For the Three Months Ended March 31,
2002 2001
---------------- ---------------

Net Income................................................................ $ 1,232,513 $ 805,090

Components of other comprehensive income:
Unrealized holding gains (losses) arising during the period
before income tax and reclassification adjustments .................. (609,370) 864,531
Reclassification adjustments for net gains (losses)
included in net income............................................... (16,646) (353,015)
------------ -------------
Other comprehensive gains (losses), before income taxes ............... (626,016) 511,516
Income tax expense (benefit) related to other comprehensive income..... (250,406) 204,607
---------------- ---------------
Total other comprehensive income (loss), net of income tax............. (375,610) 306,909
---------------- ---------------

Comprehensive income...................................................... $ 856,903 $ 1,111,999
================ ==============

See notes to consolidated financial statements

CONSOLIDATED STATEMENTS OF CASH FLOWS
COMMUNITY BANCSHARES, INC. AND SUBSIDIARIES
(UNAUDITED)

For the Three Months Ended March 31,
2002 2001
---------------- ---------------

Operating Activities:
Net income........................................................... $ 1,232,513 $ 805,090
Adjustments to reconcile net income to net cash provided by
operating activities:
Provision for loan losses ........................................... 1,040,419 951,118
Provision for depreciation and amortization ......................... 566,866 632,593
Amortization of investment security premiums and accretion
of discounts............... ...................................... 73,075 20,335
Deferred tax expense (benefit) ...................................... 164,908 (146,684)
Realized investment security gains. ................................. (16,646) (353,015)
Gain on sale of branches............................................ (1,551,443) -
Loss on sale of premises and equipment .............................. 395,575 13,195
Decrease in accrued interest receivable. ............................ 1,133,827 1,157,456
Increase in accrued interest payable ................................ 244,834 299,310
Other ............................................................... (844,973) (1,417,245)
---------------- ----------------
Net cash provided by operating
activities .................................................... 2,438,955 1,962,153
--------------- ----------------
Investing Activities:
Proceeds from sales of securities available for sale ................ 11,597,387 9,652,796
Proceeds from maturity of securities available for sale ............. 2,000,000 15,692,087
Purchase of securities available for sale .......................... (3,984,476) (27,916,121)
Net decrease in loans to customers .................................. 10,719,993 2,385,997
Proceeds from sale of premises and equipment. ....................... 60,350 87,478
Capital expenditures ................................................ (136,100) (959,358)
Net proceeds from sale of other real estate ......................... 177,903 --
Cash paid in branch sale............................................. (8,294,497) --
--------------- ----------------
Net cash provided by (used) in investing activities .............. 12,140,560 (1,057,121)
--------------- ----------------
Financing Activities:
Net increase (decrease) in demand deposits, NOW accounts, savings
and time open deposit accounts.................................... 6,614,878 (2,975,141)
Net (decrease) increase in certificates of deposit .................. (11,355,951) 8,731,988
Net increase (decrease) in short-term borrowings .................... 475,289 (682,837)
Net decrease in capitalized lease obligations ....................... (30,989) (18,399)
Repayment of long-term debt ......................................... (207,308) (239,851)
Issuance of common stock. ........................................... -- 209,865
--------------- ----------------
Net cash (used) provided by financing activities .............. (4,504,081) 5,025,625
---------------- ----------------
Net increase in cash and cash equivalents .............................. 10,075,434 5,930,657
Cash and cash equivalents at beginning of year ......................... 53,037,008 29,006,611
--------------- ----------------

Cash and cash equivalents at end of period.............................. $ 63,112,442 $ 34,937,268
=============== ================

6
7

CONSOLIDATED STATEMENTS OF CASH FLOWS - (Continued)
COMMUNITY BANCSHARES, INC. AND SUBSIDIARIES
(UNAUDITED)

For the Three Months Ended March 31,
2002 2001
---------------- ---------------

Supplemental disclosures of cash flow information:

Cash paid during the period for:
Interest............................................................. $ 5,814,023 $ 9,122,290
Income taxes......................................................... 947 3,530

Supplemental schedule of non-cash investing and financing activities:

Real estate acquired through foreclosure............................. $ 1,246,862 $ 469,994
Assets (except cash) disposed of in branch sale...................... 25,660,924 --
Deposit liabilities including accrued interest released in
branch sale........................................................ 35,502,014 --

See notes to consolidated financial statements

[The remainder of this page intentionally left blank]

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
COMMUNITY BANCSHARES, INC. AND SUBSIDIARIES
(UNAUDITED)

NOTE 1 - GENERAL

The consolidated financial statements include the accounts of Community
Bancshares, Inc. and its wholly-owned subsidiaries, collectively, hereinafter
referred to as the "Company". The accompanying unaudited consolidated financial
statements have been prepared in accordance with accounting principles generally
accepted in the United States for interim financial information and with the
instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do
not include all of the information and footnotes required by accounting
principles generally accepted in the United States for complete financial
statements. In the opinion of management, all adjustments (consisting of normal
recurring accruals) considered necessary for a fair presentation have been
included. Operating results for the three month period ending March 31, 2002 are
not necessarily indicative of the results that may be expected for the year
ending December 31, 2002. For further information, refer to the consolidated
financial statements and footnotes thereto included in the Company's Annual
Report on Form 10-K for the year ended December 31, 2001.

Certain reclassifications of prior years' amounts have been made to
conform to current year presentation. These reclassifications had no effect on
net income, total assets, total liabilities, or shareholders' equity.

NOTE 2 - BUSINESS COMBINATIONS

Community Bank closed on the sale of loans, deposits and property of
its two bank offices located in Pulaski, Tennessee on March 31, 2002. The
Company paid cash of $8,294,497 (includes vault cash and cash items) in
settlement of the sale and recognized a gain on the sale of $1,551,443
representing the premium received on deposits less the discount given on loans
and fixed assets. Total assets sold in the transaction approximated $25,925,000
of which loans (including accrued interest) and fixed assets were sold totaling
$23,965,982 and $1,568,940, respectively, while deposit liabilities (including
accrued interest) of $35,502,014 were sold.

NOTE 3 - CAPITAL SECURITIES

In March 2000, the Company formed a wholly-owned Delaware statutory
business trust, Community (AL) Capital Trust I (the "Trust"), which issued
$10,000,000 of guaranteed preferred securities representing undivided beneficial
interests in the assets of the Trust ("Capital Securities"). All of the common
securities of the Trust are owned by the Company. The proceeds from the issuance
of the Capital Securities ($10,000,000) and common securities ($310,000) were
used by the Trust to purchase $10,310,000 of junior subordinated deferrable
interest debentures of the Company which carry an annual interest rate of
10.875%. Under the terms of the indenture, the Company may elect to defer
payments of interest for up to ten semiannual payment periods. The Company
elected to defer its March 2002 interest payment and may elect to do so again
based on the liquidity needs of the Company when future payments become due. For
the duration of such deferral period, the Company is restricted from paying
dividends to shareholders or paying debt that is junior to the debenture. The
debentures represent the sole asset of the Trust. The debentures and related
income statement effects are eliminated in the Company's consolidated financial
statements. The Company is entitled to treat the aggregate liquidation amount of
the debentures as Tier I capital under Federal Reserve guidelines.

The Capital Securities accrue and pay distributions semiannually at a
rate of 10.875% per annum of the stated liquidation value of $1,000 per capital
security. The Company has entered into an agreement which fully and
unconditionally guarantees payment of: (i) accrued and unpaid distributions
required to be paid on the Capital Securities; (ii) the redemption price with
respect to any Capital Securities called for redemption by the Trust; and (iii)
payments due upon a voluntary or involuntary liquidation, winding up or
termination of the Trust.

NOTE 3 - CAPITAL SECURITIES - Continued

The Capital Securities are mandatorily redeemable upon the maturity of
the debentures on March 8, 2030, or upon earlier redemption as provided in the
indenture pursuant to which the debentures were issued. The Company has the
right to redeem the debentures purchased by the Trust: (i) in whole or in part,
on or after March 8, 2010; and (ii) in whole (but not in part) at any time
within 90 days following the occurrence and during the continuation of a tax
event, capital treatment event or investment company event (each as defined in
the indenture). As specified in the indenture, if the debentures are redeemed
prior to maturity, the redemption price will be a percentage of the principal
amount, ranging from 105.438% in 2010 to 100.00% in and after 2020, plus accrued
but unpaid interest.

NOTE 4 - SEGMENT REPORTING

All of the Company's offices offer similar products and services, are
located in the same geographic region and serve the same customer segments of
the market. As a result, management considers all units as one operating segment
and therefore feels that the basic financial statements and related footnotes
provide sufficent detail related to segment reporting.

NOTE 5 - CONTINGENCIES

Background

At a meeting of Community Bank's Board of Directors on June 20, 2000, a
director brought to the attention of the Board the total amount of money
Community Bank had paid subcontractors in connection with the construction of a
new Community Bank office. Management of the Company commenced an investigation
of the expenditures. At the request of management, the architects and
subcontractors involved in the construction project made presentations to the
Boards of Directors of the Company and Community Bank on July 15 and July 18,
2000, respectively. At the July 18, 2000 meeting of the Board of Directors of
Community Bank, another director made a presentation alleging that Community
Bank had been overcharged by subcontractors on that construction project and
another ongoing construction project. On July 18, 2000, the Boards of Directors
of the Company and Community Bank appointed a joint committee comprised of
independent directors of the Company and of Community Bank to investigate the
alleged overcharges. Upon completion of its investigation, the joint committee
is to inform the Boards of Directors of the Company and Community Bank of its
findings and recommendations. The joint committee retained legal counsel and an
independent accounting firm to assist the committee in its investigation.
Management has also been informed that the directors of Community Bank who
alleged the construction overcharges have contacted bank regulatory agencies and
law enforcement authorities. Management believes that these agencies and
authorities either have conducted or are currently conducting investigations
regarding this matter.

Benson Litigation

On July 21, 2000, three shareholders of the Company, M. Lewis Benson,
Doris E. Benson and John M. Packard, Jr., filed a lawsuit in the state Circuit
Court of Marshall County, Alabama against the Company, Community Bank, certain
directors and officers of the Company and Community Bank, an employee of
Community Bank and two construction subcontractors. The plaintiffs purported to
file the lawsuit as a shareholder derivative action, which relates to the
alleged construction overcharges being investigated by the joint committee of
the Boards of Directors of the Company and Community Bank. The complaint alleges
that the directors, officers and employee named as defendants

NOTE 5 - CONTINGENCIES - Continued

in the complaint breached their fiduciary duties, failed to properly supervise
officers and agents of the Company and Community Bank, and permitted waste of
corporate assets by allegedly permitting the subcontractor defendants to
overcharge Community Bank in connection with the construction of two new
Community Bank offices, and to perform the construction work without written
contracts, budgets, performance guarantees and assurances of indemnification. In
addition, the complaint alleges that Kennon R. Patterson, Sr., the Chairman,
President and Chief Executive Officer of the Company, breached his fiduciary
duties by allegedly permitting the two named subcontractors to overcharge for
work performed on the two construction projects in exchange for allegedly
discounted charges for work these subcontractors performed in connection with
the construction of Mr. Patterson's residence. The complaint further alleges
that the director defendants knew or should have known of this alleged
arrangement between Mr. Patterson and the subcontractors. The complaint also
alleges that Mr. Patterson, the Community Bank employee and the two
subcontractor defendants made false representations and suppressed information
about the alleged overcharges and arrangement between Mr. Patterson and the
subcontractors.

On August 15, 2000, the plaintiffs filed an amended complaint adding
Andy C. Mann, a shareholder of the Company, as a plaintiff and adding a former
director of the Company and Community Bank as a defendant. The amended complaint
generally reiterates the allegations of the original complaint. In addition, the
amended complaint alleges that Community Bank was overcharged on all
construction projects from January 1997 to August 2000. The amended complaint
also alleges that the defendants breached their fiduciary duties and were guilty
of gross financial mismanagement, including allegations concerning the making or
approval of certain loans and taking allegedly improper actions to conceal the
fact that certain loans were uncollectible. On September 18, 2000 the plaintiffs
filed a second amended complaint. The second amended complaint generally
reiterates the allegations of the original and first amended complaints. In
addition, the second amended complaint alleges that the plaintiffs were
improperly denied their rights to inspect and copy certain records of the
Company and Community Bank. The second amended complaint also alleges that the
directors of the Company abdicated their roles as directors either by express
agreement or as a result of wantonness and gross negligence. The second amended
complaint asserts that the counts involving inspection of corporate records and
director abdication are individual, nonderivative claims. The second amended
complaint seeks, on behalf of the Company, an unspecified amount of compensatory
damages in excess of $1 million, punitive damages, disgorgement of allegedly
improperly paid profits and appropriate equitable relief. Upon motion of the
defendants, the case was transferred to the state Circuit Court in Blount
County, Alabama by order dated September 21, 2000, as amended on October 12,
2000.

On August 24, 2000, the Board of Directors of the Company designated
the directors of the Company who serve on the joint investigative committee as a
special litigation committee to investigate and evaluate the allegations and
issues raised in this lawsuit and to arrive at such decisions and take such
action as the special litigation committee deems appropriate. On June 8, 2001,
the special litigation committee filed its report under seal with the court. On
June 18, 2001, the court entered an order affirming the confidentiality of the
special committee's report. On June 28, 2001, the Company, Community Bank and
various other defendants filed a motion with the court to adopt the report of
the special committee, for partial summary judgment and to realign the Company
and Community Bank as plaintiffs in the lawsuit. Following a hearing on August
29, 2001, the court denied these motions on November 8, 2001. The court also
ruled that the plaintiffs were entitled to conduct discovery except as it
related to one of the subcontractor defendants and granted the plaintiffs'
motion to unseal the report of the special litigation committee. On November 14,
2001, the directors of the Company filed a motion for the court to alter, amend
or vacate its November 8, 2001 rulings. On February 7, 2002, the Company and
Community Bank filed a motion to disqualify Maynard, Cooper & Gale, P.C., the
law firm representing the plaintiffs, due to conflicts of interest. The court
held a hearing on these motions on February 22, 2002 and the parties are
awaiting a ruling. On February 25, 2002, the Company and Community Bank filed a
motion for limited discovery relating to its motion to disqualify the
plaintiffs' law firm. As a result of the inherent

NOTE 5 - CONTINGENCIES - Continued

uncertainties of the litigation process, the Company is unable at this time to
predict the outcome of this lawsuit and its effect on the Company's financial
condition and results of operations. Regardless of the outcome, however, this
lawsuit could be costly, time-consuming and a diversion of management's
attention.

Towns Derivative Litigation

On November 19, 1998, Mr. William Towns, a shareholder of the Company,
filed a shareholder derivative action against the directors of the Company in
the state Circuit Court of Blount County, Alabama. Mr. Towns amended his
complaint on January 14, 1999 to add the Company and Community Bank as
defendants in the action. On February 11, 1999, the complaint was again amended
to add Mr. Pat Bellew and Mrs. Mary Bellew, who are also shareholders of the
Company, as additional plaintiffs. The complaint alleged that the directors of
the Company breached their fiduciary duty to the Company and its shareholders,
engaged in fraud, fraudulent concealment, suppression of material fact and
suppression of the plaintiff shareholders, failed to supervise management, and
conspired to conceal wrongful acts from the Company's shareholders and paid
themselves excessive director fees. The complaint also alleged that the Board of
Directors acquiesced in mismanagement and misconduct by Kennon R. Patterson,
Sr., the Chairman of the Board, Chief Executive Officer and President of the
Company, including alleged self dealing, payment of excessive compensation,
misappropriation of corporate opportunities and misappropriation of funds. The
complaint sought an unspecified amount of compensatory and punitive damages,
removal of the current directors, appointment of a new Board of Directors, and
attorneys fees and cost.

On December 21, 1998, the Company and its directors filed a motion with
the court seeking to have the complaint dismissed. On March 1, 1999, the
Company's Board of Directors appointed a special Board committee comprised of
non-employee directors of the Company, to review the plaintiffs' allegations in
accordance with Delaware law. On April 6, 1999, each of the parties to the
action requested that the court stay the litigation and related discovery,
motions and hearings, pending completion of the special committee's review. On
April 30, 1999, the court entered an order staying the litigation and related
discovery, motions and hearing in accordance with the parties' request. On
October 15, 1999, the special committee filed its final report with the court.
On October 21, 1999, the parties forwarded to the court an agreed-upon order
governing the confidentiality of the special committee's report, which the court
entered on January 2, 2000. On August 3, 2000, the Company, Community Bank and
the Company's directors filed a motion to stay the proceedings until the
Company's and Community Bank's joint investigative committee had completed its
investigation of the alleged construction overcharges discussed above. At the
request of the Company and the other defendants in the action, the court
continued a hearing on the motion to dismiss. On February 23, 2001, the court
indicated that there was no reason to continue the stay of this action. The
parties are awaiting a hearing on the defendants' motion to dismiss the case.
Management of the Company believes that the plaintiffs' allegations are false
and that the action lacks merit. The Company and its directors intend to defend
the action vigorously, and management of the Company believes that the action
will not have a material adverse effect on the Company's financial condition or
results of operations. Regardless of the outcome, however, this lawsuit could be
costly, time consuming and a diversion of management's attention.

Corr Family Litigation

On September 14, 2000, another action was filed in the state Circuit
Court of Blount County, Alabama, against the Company, Community Bank and certain
directors and officers of the Company and Community Bank by Bryan A. Corr and
six other related shareholders of the Company alleging that the directors
actively participated in or ratified the misappropriation of corporate income.
The action was not styled as a shareholder derivative action. On

NOTE 5 - CONTINGENCIES - Continued

January 3, 2001, the defendants filed a motion for summary judgment on the basis
that these claims are derivative in nature and cannot be brought on behalf of
individual shareholders. The court has not ruled on the motion. The Company and
its directors believe that this lawsuit is without merit and intend to defend
the action vigorously. Although management currently believes that this action
will not have a material adverse effect on the Company's financial condition or
results of operations, regardless of the outcome, the action could be costly,
time consuming and a diversion of management's attention.

Auto Loan Litigation

On June 28, 2000, Community Bank filed an action in the United States
District Court for the Northern District of Alabama against Carl Gregory Ford
L-M, Inc., an automobile dealership located in Ft. Payne, Alabama, Carl Gregory
and Doug Broaddus, the owners of the dealership, several employees and former
employees of the dealership and Gerald Scot Parrish, a former employee of
Community Bank, with respect to certain loans originated during 1998 in
Community Bank's Wal-Mart office in Ft. Payne, Alabama. In the complaint
Community Bank alleged that the defendants willingly and knowingly conducted,
participated in, were employed by or associated with, or aided and abetted an
enterprise within the meaning of the Racketeer Influenced and Corrupt
Organizations Act (RICO) for the purpose of defrauding Community Bank. The
complaint also asserted that the defendants committed fraud, misrepresentation
and deceit by submitting to Community Bank and/or approving applications for
automobile loans which contained false and/or fraudulent information for the
purpose of deceiving, influencing and persuading Community Bank to provide loans
to customers of the automobile dealership who were otherwise not qualified to
receive such loans, and suppressed material facts regarding the veracity of
information contained in loan applications and the ability of persons seeking
the loans to repay them. Community Bank also alleged in the complaint that the
automobile dealership is responsible for the acts of its officers, agents and
employees, and that the dealership and its management failed to adequately train
and/or supervise its employees. The complaint stated that the defendants
participated in a conspiracy to violate RICO and Alabama statutes dealing with
fraud, misrepresentation and suppression of material facts, and asserted civil
liability under Alabama law for violation of federal statutes dealing with
financial institution fraud, mail and wire fraud and making false statements for
the purpose of influencing the actions of a financial institution upon an
application or loan.

On June 29, 2000 and August 31, 2000, the court granted Community
Bank's motions to dismiss without prejudice two of the employees of the
automobile dealership as defendants in the action. On September 13, 2000, the
court granted Mr. Parrish's action to dismiss the complaint, but granted
Community Bank 15 days to amend the complaint. On September 27, 2000, Community
Bank filed an amended complaint which generally reiterated the allegations of
the original complaint and added specific information concerning the allegedly
fraudulent activity and the use of the United States mail, telephone and other
wire transmissions in the conduct of such activity. On December 1, 2000, the
court dismissed Community Bank's claims based upon mail and wire fraud in the
amended complaint but otherwise denied Mr. Parrish's motion to dismiss the
complaint. On October 10, 2001, the court granted a joint motion to bifurcate
the trial into separate stages of liability and damages. On October 23 and
November 19, 2001, the court granted Community Bank's motion to dismiss without
prejudice three of the employees of the automobile dealership as defendants in
the action.

The defendants have filed answers to the amended complaint which
generally deny the material allegations in the complaint and allege that any
injury suffered by Community Bank was the result of the contributory negligence
of Community Bank, its officers, employees and agents. In the lawsuit, Community
Bank seeks damages of an unspecified amount to recover losses incurred in
connection with the loans made at Community Bank's Wal-Mart office in Ft. Payne,
Alabama, along with all costs associated with the lawsuit. Any amounts received
by Community Bank as a result of this litigation will be treated as a recovery
on loan losses.

12
13

NOTE 5 - CONTINGENCIES - Continued

Employee Litigation

On November 15, 2000, Michael W. Alred and Michael A. Bean, two former
directors and executive officers of Community Bank, filed suit against Community
Bank in the United States District Court for the Northern District of Alabama
alleging that their employment was wrongfully terminated for allegedly providing
information to bank regulatory and law enforcement authorities concerning
possible violations of laws and regulations, gross mismanagement, gross waste of
funds and abuse of authority by Community Bank, its directors, officers and
employees. According to the complaint, the information which these two
individuals provided to authorities concerned certain bank construction
projects, specific loans, charge-offs, expenses and past due accounts. The
complaint seeks reinstatement of the plaintiffs to their former positions as
officers and directors of Community Bank as well as compensatory and punitive
damages. Community Bank and its directors believe this lawsuit is without merit
and intend to defend the action vigorously. Management of the Company believes
that this action will not have a material adverse effect on the Company's
financial condition or results of operations. Regardless of the outcome, the
litigation could be costly, time consuming and a diversion of management's
attention.

General

The Company and its subsidiaries are from time to time also parties to
other legal proceedings arising in the ordinary course of business. Management
believes, after consultation with legal counsel, that no such proceedings, if
resulting in an outcome unfavorable to the Company, will, individually or in the
aggregate, have a material adverse effect on the Company's financial condition
or results of operations.

The Company's Certificate of Incorporation provides that, in certain
circumstances, the Company will indemnify and advance expenses to its directors
and officers for judgments, settlements and legal expenses incurred as a result
of their service as officers and directors of the Company. Community Bank's
Bylaws contain a similar provision for indemnification of directors and officers
of Community Bank.

NOTE 6 - SUBSEQUENT EVENTS

On May 03, 2002, Community Bank consummated the sale of its Rainsville
and Ft. Payne bank offices and recorded a gain of approximately $1,588,000,
representing an 8% premium on the 30-day average of core deposits equaling
approximately $1,645,000 less a discount on loans of approximately $57,000.

The sale of the Bank's Marshall County offices is expected to occur on
May 31, 2002, assuming satisfaction of customary conditions prior to closing.
This transaction is expected to result in a gain representing an 8% premium on
the 30 day average of core deposits less the agreed upon discount on loans.

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NOTE 7 - RECENTLY ISSUED ACCOUNTING STANDARDS

In June 1998, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 133, Accounting for
Derivative Instruments and Hedging Activities. This statement establishes
accounting and reporting standards for derivative instruments and for hedging
activities. It requires that an entity recognize all derivatives as either
assets or liabilities in the statement of financial condition and measure those
instruments at fair value. The accounting for changes in the fair value of a
derivative is to be determined based upon the intended use of the derivative.
For certain hedge designations (cash flow and foreign currency exposure) the
derivative's gain or loss is reported as a component of other comprehensive
income. Other designations require the gain or loss to be recognized in earnings
in the period of change. This statement, amended as to effective date by SFAS
No. 137, is effective for financial statements for periods beginning after June
15, 2000. In June 2000, the Financial Accounting Standards Board also issued
SFAS No. 138, Accounting for Certain Derivative Instruments and Certain Hedging
Activities - an Amendment of SFAS No. 133. The adoption of SFAS No. 133, as
amended by SFAS No. 138 did not have a material impact on the Company's
consolidated financial statements.

In September 2000, the FASB issued SFAS No. 140, Accounting for
Transfers and Servicing of Financial Assets and Extinguishments of Liabilities -
a replacement of FASB Statement No. 125. While SFAS No. 140 carries over most of
the provisions of SFAS No. 125, Accounting for Transfers and Servicing of
Financial Assets and Extinguishments of Liabilities, it provides new standards
for reporting financial assets transferred as collateral and new standards for
the derecognition of financial assets, in particular transactions involving the
use of special purpose entities. SFAS No. 140 also prescribes additional
disclosures for collateral transactions and for securitization transactions
accounted for as sales. The new collateral standards and disclosure requirements
are effective for fiscal years ending after December 15, 2000, while the new
standards for the derecognition of financial assets are effective for transfers
made after March 31, 2001. The adoption of this statement did not have a
material effect on the Company's consolidated financial statements.

In June 2001, the FASB issued SFAS No. 141, Business Combinations. This
statement addresses financial accounting and reporting for business combinations
and supersedes ABP Opinion No. 16, Business Combinations, and SFAS No. 38,
Accounting for Preacquisition Contingencies of Purchased Enterprises. All
business combinations in the scope of SFAS No. 141 are to be accounted for using
one method, the purchase method. Prior to the issuance of this statement,
subject to certain criteria, business combinations were accounted for using one
of two methods, the pooling-of-interests method or the purchase method. The two
methods produce different financial statement results. The single-method
approach used in SFAS No. 141 reflects the conclusion that virtually all
business combinations are acquisitions and therefore should be accounted for in
the same manner as other asset acquisitions based on the values exchanged. This
statement provides expanded and revised guidance related to the allocation of
the purchase price to goodwill and other intangibles arising from the business
combination. The provisions of SFAS No. 141 apply to all business combinations
initiated after June 30, 2001. The adoption of SFAS No. 141 has not had a
material effect on the Company's consolidated financial statements.

In June 2001, the FASB issued SFAS No. 142, Goodwill and Other
Intangible Assets, which addresses financial accounting and reporting for
acquired goodwill and other intangible assets and supersedes APB Opinion No. 17,
Intangible Assets. SFAS No. 142 provides new standards for accounting relating
to intangible assets after initial recognition in the financial statements. This
statement proscribes the accounting practice of amortizing or expensing
intangibles ratably over a prescribed period of time and imposes new guidance
requiring that goodwill and certain other intangibles be tested for impairment
at least annually by comparing fair values of those assets with their recorded
amounts. Additional disclosure requirements also are provided. The provisions of
SFAS No. 142 are required to be applied in fiscal years beginning after December
15, 2001. The adoption of this statement is not expected to have a material
effect on the Company's consolidated financial statements.

14
15

NOTE 7 - RECENTLY ISSUED ACCOUNTING STANDARDS - Continued

In June 2001, the FASB issued SFAS No. 143, Accounting for Asset
Retirement Obligations. This statement requires that the fair value of a
liability for an asset retirement obligation be recognized in the period in
which it is incurred if a reasonable estimate of fair value can be made. The
associated asset retirement costs are capitalized as part of the carrying amount
of the long-lived asset. This statement is effective for financial statements
issued for fiscal years beginning after June 15, 2002. The adoption of this
statement is not expected to have a material effect on the Company's
consolidated financial statements.

In August 2001, the FASB issued SFAS No. 144, Accounting for the
Impairment or Disposal of Long-lived Assets. This statement addresses financial
accounting and reporting for the impairment or disposal of long-lived assets.
This statement supersedes FASB Statement No. 121, Accounting for the Impairment
of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of, and the
accounting and reporting provisions of APB Opinion No. 30, Reporting the Results
of Operations - Reporting the Effects of Disposal of a Segment of a Business,
and Extraordinary, Unusual and Infrequently Occurring Events and Transactions,
for the disposal of a segment of a business (as previously defined in that
opinion). This statement also amends Accounting Research Bulletin No. 51,
Consolidated Financial Statements, to eliminate the exception to consolidation
for a subsidiary for which control is likely to be temporary. The major changes
resulting from this statement relate to the establishment of a single method for
the recognition of impairment losses on long-lived assets to be held and used
whether from discontinuance of a business segment or otherwise. This statement
is effective for financial statements issued for fiscal years beginning after
December 15, 2001. The adoption of this statement has not had a material effect
on the Company's consolidated financial statements.

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Item 2 - Management's Discussion and Analysis of Financial Condition and Results
of Operations

This discussion is intended to assist in an understanding of the
financial condition and results of operations of Community Bancshares, Inc. (the
"Company) and its subsidiaries. Unless the context otherwise indicates, the
Company shall include the Company and its subsidiaries. This analysis should be
read in conjunction with the financial statements and related notes appearing in
Item 1 of this Report and Management's Discussion and Analysis of Financial
Condition and Results of Operations appearing in the Company's Annual Report on
Form 10-K for the year ended December 31, 2001.

Forward looking information

Certain statements in this Report are "forward-looking statements"
within the meaning of Section 27A of the Securities Act of 1933, as amended, and
Section 21E of the Securities Exchange Act of 1934, as amended. These
forward-looking statements are not based on historical facts and may be
identified by their reference to a future period or by the use of
forward-looking terminology, such as "anticipate," "estimate," "expect," "may"
and "should." These forward-looking statements include, without limitation,
those relating to the Company's future growth and profitability, economic
prospects of market areas, dividends, pending litigation, branch office
divestitures, non-compliant or impaired loans, capital requirements, operating
strategy, deposits, consumer base, allowance for loan losses, non-performing
assets, interest rate sensitivity, market risk and impact of inflation. We
caution you not to place undue reliance on these forward-looking statements.
Actual results could differ materially from those indicated in such
forward-looking statements due to a variety of factors. These factors include,
but are not limited to, changes in economic conditions and government fiscal and
monetary policies, changes in prevailing interest rates and effectiveness of the
Company's interest rate strategies, laws, regulations and regulatory authorities
affecting financial institutions, changes in and effectiveness of the Company's
operating or expansion strategies, geographic concentration of the Company's
assets and operations, competition from other financial services companies,
unexpected financial results or outcomes of legal proceedings, and other risks
detailed from time to time in the Company's press releases and filings with the
Securities and Exchange Commission. We undertake no obligation to update these
forward-looking statements to reflect events or circumstances occurring after
the date of this Report.

FINANCIAL CONDITION

March 31, 2002 compared to December 31, 2001

Summary

Total assets at March 31, 2002 were approximately $690,602,000, down
from approximately $729,482,000 at December 31, 2001. The decrease in total
assets was mainly attributable to both the sale of Community Bank's Pulaski,
Tennessee branches as well as an overall decrease in loan volume. Refer to
"Notes to Consolidated Financial Statements, Note 2-Business Combinations"
throughout the discussion of financial condition.

Earning Assets

The earning assets of the Company are mainly composed of investment
securities, federal funds sold and loans. Investment securities decreased
$10,295,000, or 8.5%, to approximately $111,384,000 at March 31, 2002 from
approximately $121,679,000 at December 31, 2001. The investment securities
portfolio is used to make various term investments, to provide a source of
liquidity and to serve as collateral to secure certain government deposits.
Short-term investments in the form of interest-bearing deposits with banks were
$200,000 at both March 31, 2002 and December 31, 2001. The Company had
$45,395,000 in federal funds sold at March 31, 2002, compared to $30,000,000 at
December 31, 2001, representing an increase of $15,395,000, or 51.3%. The
increase in federal funds sold was primarily due to the decline in outstanding
loans during the first quarter of 2002. Management has also kept federal funds
sold balances at high levels in anticipation of funding necessary to consummate
the sale of its branch offices.

Loans comprise the largest single category of the Company's earning
assets. Loans, net of unearned income, were approximately $465,475,000 at March
31, 2002 down $36,045,000, or 7.2%, from $501,520,000 at December 31, 2001. This
decrease is partly attributable to the sale of the loan portfolio in the
Pulaski, Tennessee branches sale, but the Company continues to experience a
decline in total loans because of economic downturns, the tightening of the
Company's credit standards, and increased charge-offs of loans made in previous
years.

Nonperforming Assets and Past Due Loans

Between December 31, 2001 and March 31, 2002, the ratio of the
allowance for loan losses to total nonperforming assets (defined as nonaccruing
loans, loans past due 90 days or greater, restructured loans, nonaccruing
securities, and other real estate) declined from 58.37% at year-end 2001 to
55.19% at March 31, 2002. The ratio of total nonperforming assets to total
assets increased to 1.89% at March 31, 2002 from 1.71% at year-end 2001, while
the ratio of nonperforming loans to total loans, net of unearned income,
increased to 1.85% at March 31, 2002 from 1.64% at December 31, 2001. These
changes were primarily due to an increase in nonaccruing loans of $764,000, or
13.0%, to approximately $6,623,000 at March 31, 2002 from $5,859,000 at December
31, 2001 and an increase in other real estate of $160,000, or 3.7%, to
approximately $4,447,000 at March 31, 2002 from approximately $4,287,000 at
December 31, 2001. These increases were partially offset by a decline in loans
past due 90 days or more of $368,000, or 15.7%, to approximately $1,978,000 at
March 31, 2002 from approximately $2,346,000 at December 31, 2001. Total
nonperforming assets increased $556,000, or 4.5%, to approximately $13,048,000
at March 31, 2002 from approximately $12,492,000 at December 31, 2001. In their
efforts to improve the asset quality and credit standards of the Company,
management continues to recognize problem credits in a more timely manner
through the loan review process implemented in 2001.

Funding

The Company's primary sources of funding are from deposits from the
customers of Community Bank and from other short-term and long-term borrowings.
Total deposits of approximately $577,637,000 at March 31, 2002 reflected a
decrease of $40,069,000, or 6.5%, from approximately $617,706,000 at year-end
2001. Deposits are Community Bank's primary source of funds. Noninterest-bearing
deposits increased $1,185,000, or 1.8%, to approximately $68,881,000 at March
31, 2002 from approximately $67,696,000 at December 31, 2001, while
interest-bearing deposits decreased $41,254,000, or 7.5%, to approximately
$508,756,000 at March 31, 2002 from approximately $550,010,000 at December 31,
2001. Certificates of deposit of $100,000 or more decreased $12,299,000, or
10.3%, to approximately $107,237,000 at March 31, 2002 from, approximately
$119,536,000 at December 31, 2001. The sale of the Pulaski, Tennessee branches
attributed to approximately $35,328,000 of the decrease in total deposits.

Total short-term liabilities increased approximately $475,000, or
10.9%, to approximately $4,835,000 at March 31, 2002 from approximately
$4,360,000 at December 31, 2001. FHLB borrowings remained constant at
$38,000,000 for both March 31, 2002 and December 31, 2001 while long-term debt
decreased $271,000, or 5.8%, to approximately $4,396,000 at March 31, 2002 from
approximately $4,667,000 at December 31, 2001.

Liquidity

The following is a discussion of cash flows. The Company experienced an
approximate $10,075,000 increase in cash and cash equivalents during the first
three months of 2002. Cash provided by operating activities was approximately
$2,439,000. Investing activities provided an increase of approximately
$12,141,000 despite a cash payment of approximately $8,294,000 in the sale of
Community Bank's Pulaski, Tennessee branches. This payment was offset by
increases in cash from other investing activities such as proceeds from the sale
or calls of securities and decreases in loans to customers. Financing activities
used approximately $4,504,000 of cash and cash equivalents for the first quarter
of 2002. Certificates of deposits decreased approximately $11,356,000 excluding
any decreases for the Pulaski, Tennessee branches, but was partially offset by
increases in cash from the growth of demand deposits, NOW deposits, and other
savings deposits totaling approximately $6,615,000 also excluding any decreases
due to the sale of the Pulaski, Tennessee branches.

In addition to the sale of the Pulaski, Tennessee branches, Community
Bank has entered into agreements to sell eight more of its banking offices in
the second quarter of 2002. Under each agreement the purchaser will receive the
assets of each banking office mostly consisting of loans and fixed assets and
will assume the liabilities, most of which are deposits. The cash transaction
will be based upon the assets, liabilities and premium due to Community Bank at
the time of each closing. Since the remaining offices, as a whole, carry more
deposits than loans and other assets, Community Bank will disburse funds as a
result of the transactions. The DeKalb County sale closed on May 3, 2002. After
all settlements are finalized, the cash paid out in the sale will be
approximately $9.0 million. The Marshall County sale is expected to close on May
31, 2002 and although settlement amounts can not be determined until closing,
management expects to pay as much as $12 to $13 million cash at settlement.
Management expects the federal funds sold balance to remain at levels high
enough to provide the funding of any cash disbursements upon the closing of
these branch sales; however, these transactions will decrease the availability
of liquid funds.

Dividends paid by Community Bank are the primary source of funds
available to the Company. The Company relies on dividends from Community Bank in
order to pay expenses, service debt and pay dividends to shareholders. Certain
restrictions exist regarding the ability of Community Bank to transfer funds to
the Company in the form of cash dividends, loans or advances. Although dividends
from Community Bank are the primary source of funding, the Company also receives
cash from Community Bank in the form of management fee income and generally
retains cash for its portion of tax benefit on intercompany income tax
settlements. Without dividends or management fee income from Community Bank, the
Company would not be able to pay expenses or service debt. Management fees for
the first quarter of 2002 were $75,000. Community Bank is unable to pay a
dividend to the Company without prior approval of the regulatory authorities nor
is the Company able to increase the management fee charged to Community Bank
without the prior written approval of the Federal Reserve.

Capital Resources

Total shareholders' equity at March 31, 2002 was 6.05% of total assets
as compared to 5.57% at December 31, 2001. The increase experienced during the
first three months of 2002 is primarily a result of increased retained earnings
from net income of approximately $1,233,000 offset slightly by a decrease in
accumulated other comprehensive income coupled with a decline in total assets
attributable to the sale of the Pulaski, Tennessee branches.

Bank regulatory authorities have issued risk-based capital guidelines
that take into consideration risk factors associated with various categories of
assets, both on and off the balance sheet. Under the guidelines, capital
strength is measured in two tiers, which are used in conjunction with
risk-adjusted assets to determine the risk-based capital ratios. The Company's
Tier I capital, which includes common stock, retained earnings and guaranteed
preferred beneficial interest in the Company's junior subordinate deferrable
interest debentures, amounted to approximately $49,355,000 at March 31, 2002,
compared to approximately $49,118,000 at December 31, 2001. Tier II capital
components include supplemental capital components, such as qualifying allowance
for loan losses and qualifying subordinated debt. Tier I capital plus the Tier
II capital components are referred to as Total Risk-based capital, which was
approximately $56,654,000 at March 31, 2002 as compared to $56,833,000 at
year-end 2001. The percentage ratios, as calculated under the guidelines, for
Tier I and Total Risk-based capital were 10.77% and 12.37%, respectively, at
March 31, 2002, compared to 10.02% and 11.59%, respectively, at year-end 2001.
At March 31, 2002, both Tier I and Total Risk-based capital of the Company
exceeded the regulatory minimum ratios of 4% and 8%, respectively.

Another important indicator of capital adequacy in the banking industry
is the leverage ratio. The Tier I Leverage ratio is defined as the ratio that
the Company's Tier I capital bears to total average assets minus goodwill. The
Company's Tier I Leverage ratios were 6.83% and 6.70% at March 31, 2002 and
December 31, 2001, respectively, exceeding the regulatory minimum requirement of
4%.

RESULTS OF OPERATIONS

Three months ended March 31, 2002 and 2001

Summary

The Company's net income for the three months ended March 31, 2002 was
approximately $1,233,000, an increase of $428,000, or 53.2%, from $805,000 for
the same period in 2001. Both basic and diluted net income per share was $0.27
for the three months ended March 31, 2002, as compared to $0.18 for the same
period in 2001. This increase during the first quarter of 2002 compared to the
same period of 2001 resulted from an increase of approximately $684,000 or 10.9%
in net interest income, before provision for loan losses, and an increase of
$860,000, or 32.1%, in noninterest income offsetting an increase of
approximately $745,000, or 10.8%, in noninterest expense during the first
quarter of 2002 compared to the first quarter of 2001. The provision for loan
losses increased $89,000, or 9.4%, to approximately $1,040,000 during the three
months ended March 31, 2002, from approximately $951,000 in the same period of
2001.

Net Interest Income

The following discussion is on a fully taxable equivalent basis. Net
interest income, the difference between interest earned on assets and the cost
of interest-bearing liabilities, was approximately $7,092,000 for the three
months ended March 31, 2002. Net interest income, before provision for loan
losses, increased $649,000, or 10.1%, from approximately $6,443,000 for the same
period of 2001. Revenues from interest earning assets of the Company decreased
$2,279,000, or 14.9%, to approximately $12,978,000 for the three months ended
March 31, 2002 from approximately $15,257,000 for the same period in 2001. This
decrease was due to lower yields on interest earning assets. Average earning
assets outstanding during the first quarter of 2002 were approximately
$646,085,000, which represents an increase of approximately $7,256,000, or
1.14%, from approximately $638,829,000 for the first quarter of 2001. The
Company's fully taxable equivalent yield on its average earning assets decreased
154 basis points to 8.15% for the first three months of 2002, compared to 9.69%
for the same period of 2001. This decrease is reflective of the overall decrease
in interest rates experienced during the year 2001. Interest expense for the
three months ended March 31, 2002 decreased approximately $2,928,000, or 33.2%,
to $5,886,000 from $8,814,000 for the corresponding period of 2001. This
decrease occurred due to a decline in rates paid on interest-bearing liabilities
and more than offset the decline in income on interest-bearing assets. Average
interest-bearing liabilities during the first quarter of 2002 were approximately
$605,001,000, which represents an increase of $8,198,000, or 1.4%, from
approximately $596,803,000 for the same period of 2002. The rate paid on average
interest-bearing liabilities decreased 204 basis points to 3.95% for the three
month period ended March 31, 2002, compared to 5.99% for the first three months
of 2001. This decrease is also attributable to the overall decline in interest
rates during the year 2001.

The Company's net interest margin, on a fully taxable equivalent basis, for
the three months ended March 31, 2002 increased 36 basis points to 4.45%, from
4.09% for the three months ended March 31, 2001, due to the increase in net
interest income, on a fully taxable equivalent basis. Net interest margin is
computed by dividing net interest income, on a fully taxable equivalent basis,
by average interest earning assets. This ratio represents the difference between
the average yield returned on average interest earning assets and the average
rate paid on funds used to support those interest earning assets, including both
interest-bearing and noninterest-bearing sources.

The Company's net interest spread, on a fully taxable equivalent basis, for
the three months ended March 31, 2002 increased 50 basis points to 4.20%, from
3.70% for the three months ended March 31, 2001, as the average cost of
interest-bearing sources of funds decreased 204 basis points while the fully
taxable equivalent average yield on interest earning assets decreased 154 basis
points. Net interest spread measures the difference between the average yield on
interest earning assets and the average rate paid on interest-bearing sources of
funds.

Provision for Loan Losses and Allowance for Loan Losses

At March 31, 2002, the allowance for loan losses was $7,201,000 which
represented a decrease of $91,000, or 1.2%, from the December 31, 2001 amount of
$7,292,000. This decrease includes a decrease of approximately $278,000 as a
result of the sale of the Pulaski, Tennessee branches. The provision for loan
losses was $1,040,000 and $951,000 for the three months ended March 31, 2002 and
2001, respectively. This increase resulted from management's decision to make
provisions for current losses in the loan portfolio as it continues its effort
to improve the overall credit quality of the Company. In this effort, management
has increased the allowance for loan losses account as a percent of loans to
reserve for potential losses in the loan portfolio by recognizing additional
provisions for loan loss expense. As a percentage of total loans, net of
unearned income, the allowance for loan losses increased to 1.54% at March 31,
2002, compared to 1.45% at December 31, 2001. Loan charge-offs exceeded
recoveries by $854,000 during the first three months of 2002, which represented
an increase of $289,000, or 51.2%, from $565,000 for the same period during
2001. Management believes that the allowance for loan losses at March 31, 2002
is adequate; however, no assurance can be given that additional losses may not
occur or that additional provisions to the allowance for loan losses will not be
necessary.

Noninterest Income

Noninterest income for the three months ended March 31, 2002 increased
$860,000, or 32.1%, to approximately $3,535,000, from approximately $2,675,000
for the same period of 2001, due to a gain recognized on the sale of Community
Bank's Pulaski, Tennessee branches. Service charges on deposit accounts
decreased $41,000, or 4.0%, to approximately $985,000 for the first quarter of
2002 from approximately $1,026,000 in the first quarter of 2001. Debt
cancellation fees decreased during the first quarter of 2002, as compared to the
first quarter of 2001, approximately $79,000, or 52.0%, due to decreased volume
in debt cancellation coverage associated with the decline in the Company's loan
portfolio. Other operating income decreased $217,000, or 50.0%, to approximately
$217,000 for the first quarter of 2002 from approximately $434,000 for the same
period of 2001. The Company recorded net gains on the sale of investment
securities of approximately $17,000 during the three months ended March 31,
2002, compared to net gains on the sale of investment securities of
approximately $353,000 for the same period of 2001. The Company also recognized
a gain on the sale of its Pulaski, Tennessee branches of approximately
$1,551,000 representing a 7% premium on the 30 day average of core deposits less
an agreed upon discount on loans and fixed assets.

Noninterest Expenses

Noninterest expenses for the three months ended March 31, 2002 were
approximately $7,623,000, representing a $745,000, or 10.8%, increase from
$6,878,000 for the same period of 2001. This increase is in most part due to a
loss recognized on the disposal of one building located in Uniontown, Alabama
and one building located in New Hope, Alabama. The primary components of
noninterest expenses are salaries and employee benefits, which decreased
$102,000, or 2.5%, to approximately $3,979,000 for the three months ended March
31, 2002 from approximately $4,081,000 for the same period of 2001. The decrease
in salaries and employee benefits is attributable to management's continued
effort to lower staff costs by increasing efficiencies. Occupancy costs
increased $43,000, or 6.0%, to approximately $755,000 for the first quarter of
2002 from approximately $712,000 for the same period of 2001. Furniture and
equipment expenses for the three month periods ended March 31, 2002 increased
$14,000, or 3.1%, to approximately $464,000 from approximately $450,000 for the
same period of 2001. Director and committee fees decreased $10,000, or 8.5%, to
approximately $108,000 for the first quarter of 2002 from approximately $118,000
for the first quarter of 2001. Other operating expenses were approximately
$1,922,000 and $1,504,000 for the three month periods ended March 31, 2002 and
2001, respectively. This increase of approximately $418,000, or 27.8%, was
primarily due to increased expenses, especially legal fees, related to the
continued litigation against the Company.

Income Taxes

The Company attempts to maximize its net income through active tax
planning. The provision for income taxes increased $282,000, or 84.9%, to
approximately $614,000 for the three months ended March 31, 2002 from
approximately $332,000 for the same period of 2001. The effective tax rate of
approximately 33.3% for the first quarter of 2002 represents an increase from
the effective tax rate of approximately 29.2% for the same period of 2001.

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Item 3 - Quantitative and Qualitative Disclosures About Market Risk

Interest Rate Sensitivity

Community Bank's net interest income, and the fair value of its
financial instruments, are influenced by changes in the level of interest rates.
Community Bank manages its exposure to fluctuations in interest rates through
policies established by its Asset/Liability Committee ("ALCO"). The ALCO meets
periodically to monitor its interest rate risk exposure and implement strategies
that might improve its balance sheet positioning and/or earnings. Management
utilizes an Interest Rate Simulation model to estimate the sensitivity of the
Bank's net interest income and net income to changes in interest rates. Such
estimates are based upon a number of assumptions for each scenario, including
balance sheet growth, deposit repricing characteristics and prepayment rates.

The estimated impact on Community Banks net interest income sensitivity
over a one year time horizon at March 31, 2002 is shown below. Such analysis
assumes an immediate and nonparallel shift in interest rates and the Bank's
estimates of how interest-bearing transaction accounts will reprice.

RATE SHOCK ANALYSIS

-100 +100
Basis Basis
Points Level Points
(Dollars in thousands)

Prime Rate.................................................... 3.75% 4.75% 5.75%

Interest Income............................................... $ 44,345 $ 46,711 $ 48,948
Interest Expense.............................................. 16,463 18,416 20,297
----------- ----------- -----------
Net Interest Income...................................... $ 27,882 $ 28,295 $ 28,651
=========== =========== ===========

Dollar change from Level...................................... $ (413) $ 356

Percentage change from Level.................................. -1.46% 1.26%

As shown above, in a 100 basis point rising rate environment, the net
interest margin should increase 1.26% and in a 100 basis point falling rate
environment, the net interest margin should decrease 1.46%. These percent
changes from a level rate scenario fall comfortably within Community Bank's ALCO
policy limit of +/-7.00%.

PART II OTHER INFORMATION

Item 1 - Legal Proceedings

No reportable events or material developments have occurred since the filing of
the Company's Annual Report on Form 10-K, for the year ended December 31, 2001,
and filed on April 16, 2002.

Item 6 - Exhibits and Reports on Form 8-K

(a) Exhibits

11 Statement of computation of per share earnings

(b) Reports on Form 8-K

The Company did not file any reports on Form 8-K during the first
quarter ended March 31, 2002.

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, hereunto duly authorized, in the city of
Blountsville, State of Alabama, on ______________.

COMMUNITY BANCSHARES, INC.

By: /s/ KENNON R. PATTERSON, SR.
-----------------------------------------------
Kennon R. Patterson, Sr.
Chairman, Chief Executive Officer and President

By: /s/ KERRI C. NEWTON
-----------------------------------------------
Kerri C. Newton
Chief Financial Officer

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