# **SECURITIESAND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

# **FORM10-K**

 

| **ý**                                                                                                                                                        |   | **ANNUAL  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**     |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|-----------------------------------------------------------------------------------------------|
|                                                                                                                                                              |   |                                                                                          |
| **For the fiscal year ended December 31, 2002**                                                                                                                   |
|                                                                                                                                                              |   |                                                                                          |
| **OR**                                                                                                                                                            |
|                                                                                                                                                              |   |                                                                                          |
| **o**                                                                                                                                                             |   | **TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE  SECURITIES EXCHANGE ACT OF 1934** |
|                                                                                                                                                              |   |                                                                                          |
| **For the transition period from             to            ** |
|                                                                                                                                                              |   |                                                                                          |
| **Commission File No.:   0-28312**                                                                                                                           |

 

| **First Federal Bancshares of Arkansas, Inc.**                                     |
|------------------------------------------------------------------------------------|
| (Exact name of registrant as specified in its charter)                             |
|                                                                               |   |   |
| **Texas**                                                                          |   | **71-0785261** |
| (State  or other jurisdiction  of incorporation or organization)                   |   | (I.R.S.  Employer  Identification Number) |
|                                                                               |   |   |
| **200 West Stephenson   Harrison, Arkansas**                                       |   | **72601** |
| (Address)                                                                          |   | (Zip  Code) |
|                                                                               |   |   |
| Registrant’s  telephone number, including area code:**  (870) 741-7641** |
|                                                                               |   |   |
| Securities  registered pursuant to Section 12(b) of the Act:                       |
| **Not Applicable**                                                                 |
|                                                                               |   |   |
| Securities  registered pursuant to Section 12(g) of the Act                        |
|                                                                               |   |   |
| **Common Stock (par value $.01 per share)**                                        |
| (Title  of Class)                                                                  |

 

Indicate by check mark whether the Registrant(1) has filed all reports required by Section 13 or 15(d) of the SecuritiesExchange Act of 1934 during the preceding 12 months (or for such shorter periodthat the Registrant was required to file such reports), and (2) has beensubject to such filing requirements for the past 90 days.

Yes   ý No   o

 

Indicate by check mark if disclosure ofdelinquent filers pursuant to Item 405 of Regulation S-K is not containedherein, and will not be contained, to the best of Registrant’s knowledge, indefinitive proxy or information statements incorporated by reference in PartIII of this Form 10-K or any amendment to this Form 10-K.  ý

 

Indicate by check mark whether the registrantis an accelerated filer (as defined in Rule 12b-2 of the Act).

Yes o   No ý

 

As of June 28, 2002, theaggregate value of the 2,607,833 shares of Common Stock of the Registrantissued and outstanding on such date, which excludes 237,926 shares held bydirectors and officers of the Registrant as a group, was approximately $66.7million.  This figure is based on thelast sales price of $25.56 per share of the Registrant’s Common Stock on June28, 2002.

 

Number of shares of Common Stock outstandingas of March 17, 2003:  2,665,743

 

**DOCUMENTS INCORPORATED BY REFERENCE**

 

List hereunder the followingdocuments incorporated by reference and the Part of the Form 10-K into whichthe document is incorporated.

 

(1) Portions of the Annual Report to Stockholders for the year endedDecember 31, 2002 are incorporated into Part II, Items 5 through 8 of this Form10-K.

 

(2)  Portions of the definitive proxy statement for the 2003 AnnualMeeting of Stockholders are incorporated into Part III, Items 10 through 13 ofthis Form 10-K.

 

 

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**PART I.**

 

**Item1.  Business**

 

**General**

 

**First Federal Bancshares of Arkansas, Inc. **First Federal Bancshares of Arkansas, Inc. (the “Company”) is a Texascorporation organized in January 1996 by First Federal Bank of Arkansas, FA(“First Federal” or the “Bank”) for the purpose of becoming a unitary holdingcompany of the Bank.  The onlysignificant assets of the Company are the capital stock of the Bank, theCompany’s loan to the Employee Stock Ownership Plan (“ESOP”), and the portionof the net proceeds retained by the Company in connection with the Bank’sconversion to stock form and the concurrent offering of the Company’s commonstock (the “Conversion”).  The businessand management of the Company consists of the business and management of theBank.  The Company does not presentlyown or lease any property, but instead uses the premises, equipment andfurniture of the Bank.  At the presenttime, the Company does not employ any persons other than officers of the Bank,and the Company utilizes the support staff of the Bank from time to time.  Additional employees will be hired asappropriate to the extent the Company expands or changes its business in thefuture.  At December 31, 2002, theCompany had $679.9 million in total assets, $568.8 million in total depositsand $69.3 million in stockholders’ equity.

 

The Company’s executive office is located atthe home office of the Bank at 200 West Stephenson Avenue, Harrison, Arkansas72601, and its telephone number is (870) 741-7641.

 

**First Federal Bank of Arkansas, FA. **The Bank is a federally chartered stock savings and loan associationwhich was formed in 1934.  First Federalconducts business from its main office and thirteen full service branchoffices, all of which are located in a six county area in Northcentral andNorthwest Arkansas comprised of Benton, Marion, Washington, Carroll, Baxter andBoone counties.  First Federal’sdeposits are insured by the Savings Association Insurance Fund (“SAIF”), whichis administered by the Federal Deposit Insurance Corporation (“FDIC”), to themaximum extent permitted by law.

 

The Bank is a community oriented savings institution which hastraditionally offered a wide variety of savings products to its retailcustomers while concentrating its lending activities on the origination ofloans collateralized by real estate. The Bank’s activities have also included origination of commercial loansand consumer loans.  In addition, theBank maintains a significant portfolio of investment securities.  In addition to interest and dividend incomeon loans and investments, the Bank receives other income from loan fees andvarious service charges.  The Bank’sgoal is to continue to serve its market area as an independent communityoriented financial institution dedicated primarily to financing home ownership whileproviding financial services to its customers in an efficient manner.

 

The Bank is subject to examination and comprehensive regulation by theOffice of Thrift Supervision (“OTS”), which is the Bank’s chartering authorityand primary regulator.  The Bank is alsoregulated by the FDIC, the administrator of the SAIF.  The Bank is also subject to certain reserve requirementsestablished by the Board of Governors of the Federal Reserve System (“FRB”) andis a member of the Federal Home Loan Bank (“FHLB”) of Dallas, which is one ofthe 12 regional banks comprising the FHLB System.

 

This Form 10-K and the Company’s AnnualReport to Stockholders contain certain forward-looking statements andinformation relating to the Company that are based on the beliefs of managementas well as assumptions made by and information currently available tomanagement.  In addition, in those andother portions of this document and the Company’s Annual Report toStockholders, the words “anticipate”, “believe,” “estimate,” “expect,”“intend,” “should” and similar expressions, or the negative thereof, as theyrelate to the Company or the Company’s management, are intended to identifyforward-looking statements.  Suchstatements reflect the current views of the Company with respect to futurelooking events and are subject to certain risks, uncertainties andassumptions.  Should one or more ofthese risks or uncertainties materialize or should underlying assumptions proveincorrect, actual results may vary materially from those described herein asanticipated, believed, estimated, expected or intended.  The Company does not intend to update theseforward-looking statements.

 

1

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**LendingActivities**

 

**General. **At December 31, 2002, the Bank’s totalportfolio of loans receivable (“total loan portfolio”), amounted to $507.0million or 74.6% of the Company’s total assets.  The Bank has traditionally concentrated its lending activities onconventional first mortgage loans collateralized by single-family (one- tofour-family) residential property. Consistent with such approach, $289.1 million or 57.0% of the Bank’stotal loan portfolio consisted of one- to four-family residential loans atDecember 31, 2002.

 

In recent years, the Bank has placed an increased emphasis oncommercial real estate lending, construction lending, commercial lending andconsumer lending.  Between December 31,1998 and December 31, 2002, commercial real estate loans, construction loans,commercial loans and consumer loans increased as follows (dollars in millions):

 
|                   |   | **December  31,** |   |
|------------------------|--------|-------------------|--------|
|                   |   | **2002**          |   | **1998** |   |
| **Type**               |   | **Amount**        |   | **Percentage    of Loans** |   | **Amount** |   | **Percentage    of Loans** |   |
| Commercial real estate |   | $                 | 66.6   |   | 13.1 | % | $ | 23.2 |   | 5.1 | % |
| Construction           |   | 49.1              |   | 9.7 |   | 18.2 |   | 4.0 |   |
| Commercial             |   | 28.2              |   | 5.6 |   | 8.4 |   | 1.9 |   |
| Consumer               |   | 68.0              |   | 13.4 |   | 31.7 |   | 7.0 |   |
| Total                  |   | $                 | 211.9  |   | 41.8 | % | $ | 81.5 |   | 18.0 | % |

 

The Bank hasplaced an increased emphasis on these loan types to diversify its loanportfolio, increase the average yield on its loan portfolio, expand itsoperations and provide greater opportunities to cross-sell its products.

 

2

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**Loan Composition. **The followingtable sets forth certain data relating to the composition of the Bank’s loanportfolio by type of loan at the dates indicated.

 

 
|                                                      |   | **December  31,**           |    |
|-----------------------------------------------------------|--------|-----------------------------|---------|
|                                                      |   | **2002**                    |    | **2001** |   | **2000** |   | **1999** |   | **1998** |   |
|                                                      |   | **Amount**                  |    | **Percentage********of  Loans** |   | **Amount** |   | **Percentage********of  Loans** |   | **Amount** |   | **Percentage********of  Loans** |   | **Amount** |   | **Percentage********of  Loans** |   | **Amount** |   | **Percentage********of  Loans** |   |
|                                                      |   | **(Dollars  in Thousands)** |    |
| Real estate loans:                                        |   |                        |    |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Single-family residential                                 |   | $                           | 289,106 |   | 57.03 | % | $ | 330,844 |   | 67.85 | % | $ | 377,341 |   | 73.87 | % | $ | 368,589 |   | 77.73 | % | $ | 370,211 |   | 81.66 | % |
| Multi-family residential                                  |   | 5,821                       |    | 1.15 |   | 4,386 |   | .90 |   | 3,666 |   | .72 |   | 2,812 |   | .59 |   | 1,540 |   | .34 |   |
| Commercial real estate                                    |   | 66,622                      |    | 13.14 |   | 46,896 |   | 9.62 |   | 38,085 |   | 7.46 |   | 26,018 |   | 5.49 |   | 23,196 |   | 5.12 |   |
| Construction                                              |   | 49,144                      |    | 9.69 |   | 24,842 |   | 5.09 |   | 24,937 |   | 4.88 |   | 25,797 |   | 5.44 |   | 18,226 |   | 4.02 |   |
| Total real estate loans                                   |   | 410,693                     |    | 81.01 |   | 406,968 |   | 83.46 |   | 444,029 |   | 86.93 |   | 423,216 |   | 89.25 |   | 413,173 |   | 91.14 |   |
|                                                      |   |                        |    |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Commercial loans                                          |   | 28,213                      |    | 5.57 |   | 23,451 |   | 4.81 |   | 20,239 |   | 3.96 |   | 14,171 |   | 2.99 |   | 8,437 |   | 1.86 |   |
|                                                      |   |                        |    |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Consumer loans:                                           |   |                        |    |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Home equity and second mortgage loans                     |   | 31,670                      |    | 6.25 |   | 24,933 |   | 5.11 |   | 19,797 |   | 3.87 |   | 15,009 |   | 3.17 |   | 13,308 |   | 2.94 |   |
| Automobile                                                |   | 22,570                      |    | 4.45 |   | 20,506 |   | 4.20 |   | 16,051 |   | 3.14 |   | 13,205 |   | 2.78 |   | 10,693 |   | 2.36 |   |
| Other                                                     |   | 13,807                      |    | 2.72 |   | 11,781 |   | 2.42 |   | 10,703 |   | 2.10 |   | 8,577 |   | 1.81 |   | 7,712 |   | 1.70 |   |
| Total consumer loans                                      |   | 68,047                      |    | 13.42 |   | 57,220 |   | 11.73 |   | 46,551 |   | 9.11 |   | 36,791 |   | 7.76 |   | 31,713 |   | 7.00 |   |
|                                                      |   |                        |    |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Total loans receivable                                    |   | 506,953                     |    | 100.00 | % | 487,639 |   | 100.00 | % | 510,819 |   | 100.00 | % | 474,178 |   | 100.00 | % | 453,323 |   | 100.00 | % |
|                                                      |   |                        |    |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Less:                                                     |   |                        |    |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Undisbursed loan funds                                    |   | (20,618                     | )       |   |   | (10,144 | ) |   |   | (9,126 | ) |   |   | (10,437 | ) |   |   | (6,770 | ) |   |   |
| Unearned discounts and net  deferred  loan fees |   | (1,338                      | )       |   |   | (2,078 | ) |   |   | (2,697 | ) |   |   | (3,011 | ) |   |   | (3,296 | ) |   |   |
| Allowance for loan losses                                 |   | (1,529                      | )       |   |   | (923 | ) |   |   | (691 | ) |   |   | (752 | ) |   |   | (771 | ) |   |   |
| Total loans receivable, net                               |   | $                           | 483,468 |   |   |   | $ | 474,494 |   |   |   | $ | 498,305 |   |   |   | $ | 459,978 |   |   |   | $ | 442,486 |   |   |   |

 

3

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**Loan Maturity and Interest Rates. **The following table sets forth certain information at December 31, 2002regarding the dollar amount of loans maturing in the Bank’s loan portfoliobased on their contractual terms to maturity. Demand loans and loans having no stated schedule of repayments and nostated maturity are reported as due in one year or less.  All other loans are included in the periodin which the final contractual repayment is due.

 
|                      |   | **Within****One  Year** |   | **One  Year  Through Five  Years** |   | **After  Five  Years** |   | **Total** |    |
|---------------------------|--------|-------------------------|--------|------------------------------------|--------|------------------------|--------|-----------|---------|
|                      |   | **(In  Thousands)**     |   |
|                      |   |                    |   |
| Real estate loans:        |   |                    |   |                               |   |                   |   |      |    |
| Single-family residential |   | $                       | 474    |                               | $      | 7,210                  |   | $         | 281,422 |   | $ | 289,106 |   |
| Multi-family residential  |   | —                  |   | 1,024                              |   | 4,797                  |   | 5,821     |    |
| Commercial real estate    |   | 4,921                   |   | 35,540                             |   | 26,161                 |   | 66,622    |    |
| Construction              |   | 18,611                  |   | 4,565                              |   | 25,968                 |   | 49,144    |    |
| Commercial loans          |   | 13,242                  |   | 10,793                             |   | 4,178                  |   | 28,213    |    |
| Consumer loans            |   | 16,076                  |   | 46,206                             |   | 5,765                  |   | 68,047    |    |
| Total(1)                  |   | $                       | 53,324 |                               | $      | 105,338                |   | $         | 348,291 |   | $ | 506,953 |   |

 

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(1)  Grossof undisbursed loan funds, unearned discounts and net deferred loan fees andthe allowance for loan losses.

 

The following table sets forth the dollar amount of the Bank’s loans atDecember 31, 2002 due after one year from such date which have fixed interestrates or which have floating or adjustable interest rates.

 
|                      |   | **Fixed-Rates**     |    | **Floating  or********Adjustable-Rates** |   | **Total** |   |
|---------------------------|--------|---------------------|---------|------------------------------------------|--------|-----------|--------|
|                      |   | **(In  Thousands)** |    |
| Real estate loans:        |   |                |    |                                     |   |      |   |
| Single-family residential |   | $                   | 96,870  |                                     | $      | 191,762   |   | $ | 288,632 |   |
| Multi-family residential  |   | 4,644               |    | 1,177                                    |   | 5,821     |   |
| Commercial real estate    |   | 61,421              |    | 280                                      |   | 61,701    |   |
| Construction              |   | 10,460              |    | 20,073                                   |   | 30,533    |   |
| Commercial loans          |   | 14,859              |    | 112                                      |   | 14,971    |   |
| Consumer loans            |   | 50,924              |    | 1,047                                    |   | 51,971    |   |
| Total                     |   | $                   | 239,178 |                                     | $      | 214,451   |   | $ | 453,629 |   |

 

Scheduled contractual maturities of loans donot necessarily reflect the actual term of the Bank’s portfolio.  The average life of mortgage loans issubstantially less than their average contractual terms because of loan prepaymentsand refinancing.  The average life ofmortgage loans tends to increase, however, when current mortgage loan ratessubstantially exceed rates on existing mortgage loans and, conversely, decreasewhen rates on existing mortgage loans substantially exceed current mortgageloan rates.

 

**Origination, Purchase and Sale of Loans.**  Thelending activities of the Bank are subject to the written, non-discriminatoryunderwriting standards and policies established by the Bank’s Board ofDirectors and management.  Loanoriginations are obtained from a variety of sources, including realtorreferrals, walk-in customers to the Bank’s branch locations, solicitation byloan officers, radio, television and newspaper advertising, and to a lesserextent, through the Bank’s Internet website. The Bank continually emphasizes its community ties and its practice ofquick and efficient underwriting and loan approval processes.  The Bank believes it provides exceptionalpersonalized service to its customers, in part through the use of automatedunderwriting software (Loan Prospector). The Bank requires hazard insurance, title insurance, and to the extentapplicable, flood insurance on all secured real property.

 

4

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Applications are initiallyreceived by branch managers or loan officers. All first mortgage real estate loans up to $150,000 must be approved byone member of the Bank’s Loan Committee.  Loans between $150,000 and $250,000 must be approved by twomembers of the Bank’s Loan Committee, one of which must be a senior vicepresident or above.  Real estate loansbetween $250,000 and $500,000 must be approved by three members of the Bank’sLoan Committee, one of which must be a senior vice president or above.  Real estate loans between $500,000 and$1,000,000 must initially be approved by three Loan Committee members, one ofwhich must be an executive vice president or above.  Loans in excess of $1,000,000 must be approved by the Bank’sBoard of Directors in advance of closing. Consumer loans are initially processed by consumer loan officers and arerequired to be approved by designated officers of the Bank depending on theamount of the loan.  All loans areratified, subsequent to the loan being closed, by the Board of Directors.

 

Historically, the Bank has not been an active purchaser of loans due toconsistent loan demand.  No loans werepurchased during the last three years.

 

To minimize interest rate risk, loans withfixed-rate terms greater than fifteen years are typically sold to specificinvestors in the secondary mortgage market. The rights to service such loans are typically sold with the loans.  This allows the Bank to provide itscustomers competitive long-term fixed-rate mortgage products which are verypopular financing products for home buyers in today’s market, while notexposing the Bank to undue interest rate risk. These loans are originated subject to Fannie Mae and/or Freddie Macunderwriting guidelines and are typically underwritten and validated by a thirdparty prior to loan closing.  TheSecondary Market Department of the Bank typically locks and confirms thepurchase price of the loan on the day of the loan application which protectsthe Bank from market price movements and insures that the Bank will receive afair and reasonable price on the sale of the respective loan.  Due to the loans being underwritten by athird party, the repurchase risk associated with these loans is mostly assumedby the underwriter.  The Bank believesit has minimal risk of repurchase of these loans based upon the contracts withthe specific investors.  This risktypically involves potential early prepayments of the mortgage or an earlydefault of a loan.   In 2002, 2001, and2000 the Bank was not subject to any loan repurchases.  In 2002, 2001 and 2000 the Bank’s loan salesamounted to $67.4 million, $60.5 million, and $8.6 million, respectively.  The Bank is not involved in loan hedging orother speculative mortgage loan origination activities.

 

Set forth below is a table showing the Bank’s originations, sales andrepayments of loans during the periods indicated.

 
|                                   |   | **Year Ended  December 31,** |    |
|----------------------------------------|--------|------------------------------|---------|
|                                   |   | **2002**                     |    | **2001** |   | **2000** |   |
|                                   |   | **(In  Thousands)**          |    |
| Loans receivable at beginningof period |   | $                            | 487,639 |   | $ | 510,819 |   | $ | 474,178 |   |
| Loan originations:                     |   |                         |    |   |   |   |   |
| Real estate:                           |   |                         |    |   |   |   |   |
| Single-family residential              |   | 136,154                      |    | 129,181 |   | 79,327 |   |
| Multi-family residential               |   | 2,756                        |    | 2,643 |   | 1,017 |   |
| Commercial real estate                 |   | 31,878                       |    | 16,713 |   | 14,913 |   |
| Construction                           |   | 54,504                       |    | 28,876 |   | 30,522 |   |
| Commercial loans                       |   | 16,880                       |    | 14,943 |   | 14,626 |   |
| Consumer:                              |   |                         |    |   |   |   |   |
| Home equity and secondmortgage loans   |   | 24,653                       |    | 22,884 |   | 15,512 |   |
| Automobile                             |   | 17,348                       |    | 18,392 |   | 13,597 |   |
| Other                                  |   | 15,207                       |    | 11,307 |   | 11,206 |   |
| Total loan originations                |   | 299,380                      |    | 244,939 |   | 180,720 |   |
| Repayments                             |   | (212,166                     | )       | (207,059 | ) | (134,408 | ) |
| Loan sales                             |   | (67,350                      | )       | (60,452 | ) | (8,590 | ) |
| Other                                  |   | (550                         | )       | (608 | ) | (1,081 | ) |
| Net loan activity                      |   | 19,314                       |    | (23,180 | ) | 36,641 |   |
| Loans receivableat  end of period      |   | $                            | 506,953 |   | $ | 487,639 |   | $ | 510,819 |   |

 

5

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**Loans-to-One Borrower. **Asavings institution generally may not make loans-to-one borrower and relatedentities in an amount which exceeds 15% of its unimpaired capital and surplus,although loans in an amount equal to an additional 10% of unimpaired capitaland surplus may be made to a borrower if the loans are fully secured by readilymarketable securities.  At December 31,2002, the Bank’s limit on loans-to-one borrower was approximately $10.1million.  At December 31, 2002, theBank’s largest loan or group of loans-to-one borrower, including persons orentities related to the borrower, amounted to $9.1 million.  Such amount consists of sixteen loans,primarily commercial real estate loans, one of which was past due at December31, 2002.  The Bank’s ten largest loansor groups of loans-to-one borrower, including persons or entities related tothe borrower, totaled $52.9 million at December 31, 2002.  None of these loans were 90 days or morepast due at December 31, 2002.  Severalloans to one of these borrowers totaling approximately $4.2 million wererestructured and an allowance for loan losses of approximately $440,000 wasrecorded as of December 31, 2002.

 

**One- to Four-Family Residential Real EstateLoans. **The Bank has historically concentrated itslending activities on the origination of loans collateralized by first mortgageliens on existing one- to four-family residences.  At December 31, 2002, $289.1 million or 57.0% of the Bank’s totalloan portfolio consisted of one- to four-family residential real estateloans.   Of the $289.1 million of suchloans at December 31, 2002, $191.8 million or 66.3% had adjustable-ratesof interest (including $102.3 million of seven-year adjustable rate loans) and$97.3 million or 33.7% had fixed-rates of interest.

 

The Bank currently originates both fixed-rate and adjustable-rate one-to four-family residential mortgage loans. The Bank’s fixed-rate loans for portfolio are typically originated withmaximum terms of 15 years and are fully amortizing with monthly paymentssufficient to repay the total amount of the loan with interest by the end ofthe loan term.  The Bank does offerfixed-rate loans with terms exceeding fifteen years and such loans aretypically sold in the secondary market. The Bank’s one- to four-family loans are typically originated underterms, conditions and documentation which permit them to be sold to U.S.Government-sponsored agencies such as the Federal Home Loan MortgageCorporation (“FHLMC”) and the Federal National Mortgage Association (“FNMA”).  However, as stated above, such loans withterms of 15 years or less are generally originated for portfolio whilesubstantially all of such loans over 15 years are sold in the secondarymarket.  The Bank’s fixed-rate loanstypically include “due on sale” clauses.

 

The Bank’s adjustable-rate mortgage loans typically provide for aninterest rate which adjusts every one-, three-, five- or seven-years inaccordance with a designated index plus a margin.  Such loans are typically based on a 25- or 30-year amortizationschedule.  The Bank generally does notoffer below market rates, and the amount of any increase or decrease in theinterest rate per one- or three-year period is generally limited to 2%, with alimit of 6% over the life of the loan. The Bank’s five-year adjustable rate loans provide that any increase ordecrease in the interest rate per period is limited to 3%, with a limit of 6%over the life of the loan.  The Bank’sseven-year adjustable rate loans provide that any increase or decrease in theinterest rate per period is limited to 5% with a limit of 5% over the life ofthe loan.  The Bank’s adjustable-rateloans are assumable (generally without release of the initial borrower), do notcontain prepayment penalties and do not provide for negative amortization.  The Bank’s adjustable-rate mortgage loanstypically include “due on sale” clauses. Such loans may be converted to a fixed-rate loan at the discretion ofthe Bank.  The Bank generallyunderwrites its one- and three-year adjustable-rate loans on the basis of the borrowers’ability to pay at the rate after the first adjustment.  Adjustable-rate loans decrease the risksassociated with changes in interest rates but involve other risks, primarilybecause as interest rates rise, the payment by the borrower rises to the extentpermitted by the terms of the loan, thereby increasing the potential fordefault.  At the same time, themarketability of the underlying property may be adversely affected by higherinterest rates.

 

The Bank’s residential mortgage loanstypically do not exceed 80% of the appraised valueO of the secured property.However, pursuant to the underwriting guidelines adopted by the Board ofDirectors, the Bank may lend up to 97% of the appraised value of the propertysecuring a one- to-four family residential loan with private mortgage insuranceto protect the portion of the loan that exceeds 80% of the appraisedvalue.  The Bank may, on occasion,extend a loan up to 90% of the appraised value of the secured property withoutprivate mortgage insurance coverage. However, these exceptions are minimal and are only approved on loanswith exceptional credit scores, sizeable asset reserves, or other compensatingfactors.  At December 31, 2002, theBank had $2.2 million of nonperforming, single-family residential loans.  See “Asset Quality”.

 

**Multi-Family Residential Real Estate Loans. **The Bank offers mortgage loans for the acquisition and refinancing ofmulti-family residential properties.  Inthe past, this area has not been emphasized. However, in recent months, this area of lending has been expanded by theBank, and continues to grow in order to increase the Bank’s loan portfolio andits interest rate yield.  At December31, 2002, $5.8 million or 1.2% of the Bank’s total loan portfolio consisted ofloans collateralized by existing multi-family residential real estateproperties.

 

The Bank currently originates both fixed- and adjustable- ratemulti-family loans.  Fixed rate loansare generally originated with amortization periods not to exceed 20 years, andtypically have balloon periods of 5 or 7 years.  Adjustable rate loans are

 

6

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typicallyamortized over terms up to 30 years, with interest rate adjustments every 5 to7 years.  Loan-to-value ratios on theBank’s multi-family real estate loans are currently limited to 80%.  It is also the Bank’s general policy toobtain corporate or personal guarantees, as applicable, on its multi-familyresidential real estate loans from the principals of the borrower.

 

Multi-family real estate lending entails significant additional risksas compared with one- to four-family residential property lending.  Such loans typically involve large loanbalances to single borrowers or groups of related borrowers.  The payment experience on such loans istypically dependent on the successful operation of the real estateproject.  The success of such projectsis sensitive to changes in supply and demand conditions in the market formulti-family real estate as well as economic conditions generally.  At December 31, 2002, the Bank did not haveany nonperforming multi-family real estate loans.  See “Asset Quality”.

 

**Commercial Real Estate Loans. **The Bank originates mortgage loans for the acquisition and refinancingof commercial real estate properties. At December 31, 2002, $66.6 million or 13.1% of the Bank’s total loanportfolio consisted of loans collateralized by existing commercial real estateproperties.   The Bank has placed anincreased emphasis on this type of lending in recent periods.  The Bank intends to continue this emphasisand in February 2002 hired a commercial lending officer with over 20 years ofexperience.

 

The majority of the Bank’s commercial realestate loans are collateralized by office buildings, convenience stores, servicestations, mini-storage facilities, motels, churches, and small shopping mallsand strip centers.  The majority ofthese loans are collateralized by properties located in the Bank’s marketareas.  These loans have increased inthe last few years and are underwritten specifically in correlation with thetype of property being collateralized. Cash flows and vacancy rates are primary considerations whenunderwriting loans collateralized by office buildings, convenience stores,mini-storage facilities, motels, etc. Loans with borrowers that are corporations, limited liability companies,trusts, or other legal entities are also typically personally guaranteed by theprincipals of the respective entity.

 

At December 31, 2002, the Bank had approximately $11.3 million of loanswhich are either for the construction of service station and convenience storefacilities or are collateralized by such facilities.  The Bank requires that construction loans for such facilities meetpresent standards established by the Environmental Protection Agency.  To date, the Bank has not experienced anyenvironmental problems with such loans.

 

The Bank’s policy requires real estateappraisals of all properties securing commercial real estate loans by licensedreal estate appraisers pursuant to state licensing requirements.  The Bank considers the quality and locationof the real estate, the credit of the borrower, the cash flow of the project,and the quality of management involved with the property.  The Bank’s commercial real-estate-loans aretypically originated with amortizations not to exceed 20 years, and typicallyhave balloon periods of three-, five-, or seven-year terms.  The Bank does offer a limited number offixed-rate commercial real estate loans with terms not to exceed 15 yearperiods.  As part of the criteria forunderwriting multi-family and commercial real estate loans, the Bank generallyprepares a cash flow analysis that includes a vacancy rate estimation, expensesfor taxes, insurance, maintenance, and repair reserves, and debt coverageratios.

 

Commercial real estate lending entailsadditional risks, as compared to the Bank’s single-family residential propertyloans.  Commercial real estate loansgenerally involve larger loan balances to single borrowers or groups of relatedborrowers.  The payment experience onsuch loans is typically dependent on the successful operation of the realestate project. The success of such projects is sensitive to changes in supplyand demand conditions in the market for commercial real estate, as well asregional and economic conditions generally.  At December 31, 2002, the Bank had $4.3 million of nonperforming andrestructured commercial real estate loans. See “Asset Quality”.

 

**Construction Loans. **The Bank originates residential, multi-family, andcommercial real estate construction loans. However the Bank’s primary emphasis has been residential constructionlending.  The Bank’s constructionlending activities are typically limited to the Bank’s primary marketareas.  At December 31, 2002,construction loans amounted to $49.1 million or 9.7% of the Bank’s total loanportfolio, of which, $37.1 million consisted of one-to four-family residentialconstruction loans, and $12.0 million consisted of commercial real estate andmulti-family residential construction loans. The Bank’s construction loans generally have fixed interest rates andare typically issued for a term of six- to nine-months. However, the Bank ispermitted to originate construction loans with terms up to two years under itsloan policy.  This practice is typicallylimited to larger projects that cannot be completed in the Bank’s six- tonine-month period.  Construction loansare typically made with a maximum loan-to-value ratio of 80%.

 

7

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With limited exceptions, the Bank’s construction loans are made toindividual homeowners and local builders and developers for the purpose of constructing one- tofour-family residential homes. Construction loans to individuals are typically made in connection withthe granting of the permanent financing on the property.  Such loans convert to a fully amortizingadjustable- or fixed-rate loan at the end of the construction term.  The Bank typically requires that permanentfinancing with the Bank or some other lender be in place prior to closing anyconstruction loan to an individual homeowner. Interest on construction/permanent loans is due upon completion of theconstruction phase of the loan.  At suchtime, the loan automatically converts to a permanent loan at the interest rateestablished at the initial closing of the construction/permanent loan.

 

The Bank makes construction loans to localbuilders for the purpose of construction of speculative (or unsold) residentialproperties, and for the construction of pre-sold single-family homes.  These loans are subject to credit review,analysis of personal and, if applicable, corporate financial statements, and anappraisal of the property to be constructed. The Bank also reviews and inspects the project prior to the disbursementof funds (draws) during the construction term. Loan proceeds are disbursed after a satisfactory inspection of theproject has been made based upon a percentage of completion or presentation ofsubstantiated costs incurred.  Intereston these construction loans is due upon maturity.  The Bank will extend a construction loan upon the payment of theinterest accrued if the property has not been sold by the maturity date.  The Bank has not experienced any materialcredit or delinquency problems in this regard.

 

Construction lending is generally consideredto involve a higher level of risk as compared to one- to four-familyresidential loans.  This is due, inpart, to the concentration of principal in a limited number of loans andborrowers, and the effects of general economic conditions on developers andbuilders.  For this reason, the Bankanalyzes each borrower involved in speculative building and limits theprincipal amount of dollars that the Bank concentrates at any one time, withany one borrower.  The nature of theseloans is such that they are generally more difficult to monitor andevaluate.  In addition, constructionloans to a builder for construction of homes that are not pre-sold possess agreater potential risk to the Bank than construction loans to individuals ontheir personal residences or on houses that are pre-sold prior to the inceptionof the loan.

 

The Bank has attempted to minimize the risksas outlined above by limiting the extent of its construction loans generally toresidential type properties.  Inaddition, the Bank has adopted underwriting guidelines that impose stricterloan-to-value ratios, debt service, and other requirements to protect the Bankfor lending areas that involve higher credit risks.  Additionally, these loans are priced such that they provide ahigher yield to the loan portfolio than do the Bank’s single-family residentialportfolio loans.  At December 31, 2002,the Bank did not have any nonperforming construction loans.  See “Asset Quality”.

 

**Commercial Loans. **The Bank alsooffers commercial loans which primarily consist of equipment and inventoryloans which are typically cross-collateralized by commercial real estate.  The Bank does not actively market such loansand offers such loans primarily as an accommodation to its presentcustomers.  At December 31, 2002,such loans amounted to $28.2 million or 5.6% of the total loan portfolio.  At December 31, 2002, the Bank hadnonperforming commercial loans totaling $245,000.  See “Asset Quality”.

 

The Bank’s commercial loans are originated with fixed interest ratesand call provisions between one and five years.  Such loans are typically based on a fifteen year amortizationschedule.

 

**Consumer Loans. **The Bankoffers consumer loans in order to provide a full range of financial services toits customers while increasing the yield on its overall loan portfolio. Theconsumer loans offered by the Bank include primarily home equity and secondmortgage loans, automobile loans, deposit account secured loans and unsecuredloans.  Consumer loans amounted to $68.0million or 13.4% of the total loan portfolio at December 31, 2002, of which$31.7 million, $22.5 million and $13.8 million consisted of home equity andsecond mortgage loans, automobile loans and other consumer loans,respectively.  The Bank intends tocontinue its emphasis on consumer loans in furtherance of its role as acommunity oriented financial institution.

 

The Bank’s home equity and second mortgage loans are typicallyfixed-rate loans with terms of up to fifteen years.  Longer-term amortization loans typically have a balloonfeature.  Although the Bank does notrequire that it hold the first mortgage on the secured property, the Bank doeshold the first mortgage on a significant majority of its home equity and secondmortgage loans.  The Bank generallylimits the total loan to value on these mortgages to 90% of the value of thesecured property.

 

8

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The Bank’s automobile loans are typically originated for the purchaseof new and used cars and trucks.  Suchloans are generally originated with a maximum term of five years.

 

Other consumer loans consist primarily of deposit account loans andunsecured loans.  Loans secured bydeposit accounts are originated for up to 95% of the account balance, with ahold placed on the account restricting the withdrawal of the account balance.

 

Consumer loans entail greater risk than do residential mortgage loans,particularly in the case of consumer loans which are unsecured or secured byrapidly depreciating assets such as automobiles.  In such cases, any repossessed collateral for a defaultedconsumer loan may not provide an adequate source of repayment of the outstandingloan balance as a result of the greater likelihood of damage, loss ordepreciation.  The remaining deficiencyoften does not warrant further substantial collection efforts against theborrower beyond obtaining a deficiency judgment.  In addition, consumer loan collections are dependent on theborrower’s continuing financial stability, and thus are more likely to beadversely affected by job loss, divorce, illness or personal bankruptcy.  Furthermore, the application of variousfederal and state laws, including federal and state bankruptcy and insolvencylaws, may limit the amount which can be recovered on such loans.  At December 31, 2002, the Bank had $175,000of nonperforming consumer loans.  See“Asset Quality”.

 

**AssetQuality**

 

When a borrower fails to make a required payment on a loan, the Bankattempts to cure the deficiency by contacting the borrower and seeking thepayment.  Depending upon the type ofloan, late notices are sent and/or personal contacts are made. In most cases,deficiencies are cured promptly.  Whilethe Bank generally prefers to work with borrowers to resolve such problems,when a mortgage loan becomes 90 days delinquent, the Bank generally institutesforeclosure or other proceedings, as necessary, to minimize any potential loss.

 

Loans are placed on nonaccrual status when, in the judgment ofmanagement, the probability of collection of interest is deemed to beinsufficient to warrant further accrual. When a loan is placed on nonaccrual status, previously accrued butunpaid interest is deducted from interest income.  The Bank does not accrue interest on loans past due 90 days ormore.  Loans may be reinstated toaccrual status when payments are made to bring the loan under 90 days past dueand, in the opinion of management, collection of the remaining balance can bereasonably expected.

 

Real estate properties acquired through, or in lieu of, loanforeclosure are initially recorded at fair value at the date offoreclosure.  After foreclosure,valuations are periodically performed by management and the real estate is carriedat the lower of carrying amount or fair value less cost to sell.  Revenue and expenses from operations areincluded in the current period income. Additions to the valuation allowance are included in the provision forreal estate losses.

 

9

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**Delinquent Loans. **The followingtable sets forth information concerning delinquent loans at December 31,2002, in dollar amounts and as a percentage of the Bank’s total loanportfolio.  The amounts presented representthe total outstanding principal balances of the related loans, rather than theactual payment amounts which are past due.

 
|              |   | **Single-family********Residential** |   | **Construction**                |   | **Commercial********Real  Estate** |   | **Commercial**                  |   | **Consumer** |   |
|-------------------|--------|--------------------------------------|--------|---------------------------------|--------|------------------------------------|--------|---------------------------------|--------|--------------|--------|
|              |   | **Amount**                           |   | **Percentage  of Total  Loans** |   | **Amount**                         |   | **Percentage  of Total  Loans** |   | **Amount**   |   | **Percentage  of Total  Loans** |   | **Amount** |   | **Percentage  of Total  Loans** |   | **Amount** |   | **Percentage  of Total  Loans** |   |
|              |   | **(Dollars  in Thousands)**          |   |
| Loans delinquent: |   |                                 |   |                            |   |                               |   |                            |   |         |   |   |   |   |   |   |   |   |   |   |   |
| 30-59 days        |   | $                                    | 2,322  |                            | .46    | %                                  | $      | 162                             |   | .03          | %      | $ | 299 |   | .06 | % | $ | 521 |   | .10 | % | $ | 538 |   | .11 | % |
| 60-89 days        |   | 657                                  |   | .13                             |   | 20                                 |   | —                          |   | 1,400        |   | .28 |   | 1,699 |   | .34 |   | 120 |   | .02 |   |
| 90 days and over  |   | 2,184                                |   | .43                             |   | —                             |   | —                          |   | 124          |   | .02 |   | 245 |   | .05 |   | 175 |   | .03 |   |
| Total             |   | $                                    | 5,163  |                            |   |                               | $      | 182                             |   |         |   | $ | 1,823 |   |   |   | $ | 2,465 |   |   |   | $ | 833 |   |   |   |
|                   |        |                                      |        |                                 |        |                                    |        |                                 |        |              |        |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

Interest income that would have been recorded under the original termsof the Bank’s nonaccruing loans for the year ended December 31, 2002 amountedto $525,000, and the interest recognized during this period amounted to$413,000.

 

The following table sets forth the amounts and categories of the Bank’snonperforming assets at the dates indicated.

 
|                                                                               |   | **December  31,**           |   |
|------------------------------------------------------------------------------------|--------|-----------------------------|--------|
|                                                                               |   | **2002**                    |   | **2001** |   | **2000** |   | **1999** |   | **1998** |   |
|                                                                               |   | **(Dollars  in Thousands)** |   |
| Nonaccrual loans:                                                                  |   |                        |   |   |   |   |   |   |   |   |   |
| Single-family residential                                                          |   | $                           | 2,184  |   | $ | 2,024 |   | $ | 1,438 |   | $ | 1,203 |   | $ | 1,275 |   |
| Multi-family residential                                                           |   | —                      |   | — |   | — |   | — |   | — |   |
| Construction loans                                                                 |   | —                      |   | 350 |   | — |   | — |   | — |   |
| Commercial real estate                                                             |   | 124                         |   | 269 |   | 48 |   | — |   | — |   |
| Commercial loans                                                                   |   | 245                         |   | 54 |   | 20 |   | 23 |   | 30 |   |
| Consumer loans                                                                     |   | 175                         |   | 409 |   | 140 |   | 121 |   | 159 |   |
| Total nonaccrual loans                                                             |   | 2,728                       |   | 3,106 |   | 1,646 |   | 1,347 |   | 1,464 |   |
|                                                                               |   |                        |   |   |   |   |   |   |   |   |   |
| Restructured loans                                                                 |   | 4,219                       |   | — |   | — |   | — |   | — |   |
| Real estate owned                                                                  |   | 320                         |   | 455 |   | 261 |   | 3,940 | (1) | 4,270 | (1) |
|                                                                               |   |                        |   |   |   |   |   |   |   |   |   |
| Total nonperforming assets                                                         |   | $                           | 7,267  |   | $ | 3,561 |   | $ | 1,907 |   | $ | 5,287 |   | $ | 5,734 |   |
|                                                                               |   |                        |   |   |   |   |   |   |   |   |   |
| Total nonaccrual and restructured loans as a percentage of total  loans receivable |   | 1.37                        | %      | 0.64 | % | 0.32 | % | 0.28 | % | 0.32 | % |
|                                                                               |   |                        |   |   |   |   |   |   |   |   |   |
| Total nonperforming assets as a percentage of total assets                         |   | 1.07                        | %      | 0.53 | % | 0.27 | % | 0.78 | % | 0.93 | % |

 

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(1) The Bank reclassified apreviously reported nonaccrual commercial real estate loan secured by a 202room hotel in Oklahoma to real estate owned in 1998.  Real estate owned at such dates primarily consists of the Bank’s75% ownership of this property.  As aresult of such 75% ownership interest, the Bank is required to include the 25%minority interest ownership in the real estate owned amount shown above.  Such property was disposed of in the secondquarter of 2000.

 

10

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**Classified Assets. **Federalregulations require that each insured savings association classify its assetson a regular basis.  In addition, inconnection with examinations of insured institutions, federal examiners haveauthority to identify problem assets and, if appropriate, classify them.  There are three classifications for problemassets: “substandard,” “doubtful” and “loss.” Substandard assets have one or more defined weaknesses and arecharacterized by the distinct possibility that the insured institution willsustain some loss if the deficiencies are not corrected.  Doubtful assets have the weaknesses ofsubstandard assets with the additional characteristic that the weaknesses makecollection or liquidation in full on the basis of currently existing facts,conditions and values questionable, and there is a high possibility ofloss.  An asset classified loss isconsidered uncollectible and of such little value that continuance as an assetof the institution is not warranted.  AtDecember 31, 2002, the Bank had $7.3 million of classified assets, $6.7million of which were classified as substandard and $625,000 of which wereclassified as loss.  In addition, atsuch date, the Bank had $122,000 of assets designated as special mention.

 

**Allowance for Loan Losses.**  Theallowance for loan losses is established as losses are estimated to haveoccurred through a provision for loan losses charged to earnings.  Loan losses are charged against theallowance when management believes the uncollectibility of a loan balance isconfirmed.  Subsequent recoveries, ifany, are credited to the allowance.

 

The allowance for loan losses is evaluated on a regular basis bymanagement and is based upon management’s periodic review of the collectibilityof the loans in light of historical experience, the nature and volume of theloan portfolio, adverse situations that may affect the borrower’s ability torepay, estimated value of any underlying collateral and prevailing economicconditions.  This evaluation isinherently subjective as it requires estimates that are susceptible tosignificant revision as more information becomes available.

 

The Bank reviews its non-homogeneous loans for impairment on aquarterly basis.  The Bank considerscommercial real estate, construction, multi-family, other non-residential realestate, and commercial loans to be non-homogeneous loans.  A loan is considered impaired when, based oncurrent information and events, it is probable that the Bank will be unable tocollect the scheduled payments of principal or interest when due according tothe contractual terms of the loan agreement. Factors considered by management in determining impairment includepayment status, collateral value, and the probability of collecting scheduledprincipal and interest payments when due. Loans that experience insignificant payment delays and paymentshortfalls generally are not classified as impaired.  Management determines the significance of payment delays andpayment shortfalls on a case-by-case basis, taking into consideration all ofthe circumstances surrounding the loan and the borrower, including the lengthof the delay, the reasons for the delay, the borrower’s prior payment record,and the amount of the shortfall in relation to the principal and interestowed.  Impairment is measured on a loanby loan basis by either the present value of expected future cash flowsdiscounted at the loan’s effective interest rate, the loan’s obtainable marketprice, or the fair value of the collateral if the loan is collateral dependent.

 

Large groups of smaller balance homogeneous loans are collectivelyevaluated for impairment.  Accordingly,the Bank does not separately identify individual consumer and residential loansfor impairment disclosures.  Homogeneousloans are those that are considered to have common characteristics that providefor evaluation on an aggregate or pool basis. The Bank considers the characteristics of (1) one- to- four familyresidential first mortgage loans; (2) unsecured consumer loans; and (3)collateralized consumer loans to permit consideration of the appropriateness ofthe allowance for losses of each group of loans on a pool basis.  The primary methodology used to determinethe appropriateness of the allowance for losses includes segregating certainspecific, poorly performing loans based on their performance characteristicsfrom the pools of loans as to type, grading these loans, and then applying aloss factor to the remaining pool balance based on several factors including pastloss experience, inherent risks, economic conditions in the primary marketareas, and other factors which usually are beyond the control of the Bank.

 

11

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Estimates of the probability of loan losses involve judgment.  While it is possible that in the near termthe Bank may sustain losses which are substantial in relation to the allowancefor loan losses, it is the judgment of management that the allowance for loan lossesreflected in the consolidated statements of financial condition is appropriateconsidering the estimated probable losses in the portfolio.

 

The following table summarizes changes in the allowance for loan lossesand other selected statistics for the periods presented.

 
|                                                                                   |   | **Year Ended  December 31,** |    |
|----------------------------------------------------------------------------------------|--------|------------------------------|---------|
|                                                                                   |   | **2002**                     |    | **2001** |   | **2000** |   | **1999** |   | **1998** |   |
|                                                                                   |   | **(Dollars  in Thousands)**  |    |
| Total loans outstanding at end of period                                               |   | $                            | 506,953 |   | $ | 487,639 |   | $ | 510,819 |   | $ | 474,178 |   | $ | 453,323 |   |
| Average loans outstanding                                                              |   | $                            | 481,330 |   | $ | 488,942 |   | $ | 481,112 |   | $ | 447,631 |   | $ | 441,702 |   |
| Allowance at beginning of period                                                       |   | $                            | 923     |   | $ | 691 |   | $ | 752 |   | $ | 771 |   | $ | 1,196 |   |
| Charge-offs:                                                                           |   |                         |    |   |   |   |   |   |   |   |   |
| Single-family residential                                                              |   | (54                          | )       | (75 | ) | (28 | ) | (9 | ) | (17 | ) |
| Commercial real estate                                                                 |   | (471                         | )       | — |   | — |   | — |   | (369 | ) |
| Commercial loans                                                                       |   | —                       |    | (41 | ) | (20 | ) | — |   | — |   |
| Consumer loans                                                                         |   | (461                         | )       | (121 | ) | (40 | ) | (57 | ) | (103 | ) |
| Total charge-offs                                                                      |   | (986                         | )       | (237 | ) | (88 | ) | (66 | ) | (489 | ) |
| Recoveries:                                                                            |   |                         |    |   |   |   |   |   |   |   |   |
| Single-family residential                                                              |   | 6                            |    | — |   | — |   | — |   | — |   |
| Commercial real estate                                                                 |   | 2                            |    | — |   | — |   | — |   | — |   |
| Consumer loans                                                                         |   | 84                           |    | 17 |   | 27 |   | 27 |   | 9 |   |
| Total recoveries                                                                       |   | 92                           |    | 17 |   | 27 |   | 27 |   | 9 |   |
| Net charge-offs                                                                        |   | (894                         | )       | (220 | ) | (61 | ) | (39 | ) | (480 | ) |
| Total provisions for losses                                                            |   | 1,500                        |    | 452 |   | — |   | 20 |   | 55 |   |
| Allowance at end of period                                                             |   | $                            | 1,529   |   | $ | 923 |   | $ | 691 |   | $ | 752 |   | $ | 771 |   |
|                                                                                   |   |                         |    |   |   |   |   |   |   |   |   |
| Allowance for loan losses as a percentage of total loans outstanding  at end of period |   | 0.30                         | %       | 0.19 | % | 0.14 | % | 0.16 | % | 0.17 | % |
| Net loans charged-off as a percentage of average loans outstanding                     |   | 0.19                         | %       | 0.05 | % | 0.01 | % | 0.01 | % | 0.11 | % |

 

The increase in the level of charge-offs during 2002 was primarily theresult of a $450,000 charge-off on a single commercial real estate loan andincreases in the level of charge-offs on automobile loans and account balancesrelated to the Bank’s overdraft protection program introduced in the fourthquarter of 2001.

 

12

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The following table presents the allocation of the Bank’s allowance forloan losses by the type of loan at each of the dates indicated.

 
|                      |   | **December 31,**           |   |
|---------------------------|--------|----------------------------|--------|
|                      |   | **2002**                   |   | **2001** |   | **2000** |   | **1999** |   | **1998** |   |
|                      |   | **Amount**                 |   | **Percentage  of Total  Loans by  Category** |   | **Amount** |   | **Percentage  of Total  Loans  by Category** |   | **Amount** |   | **Percentage of  Total Loans  by Category** |   | **Amount** |   | **Percentage of   Total Loans  by Category** |   | **Amount** |   | **Percentage of  Total Loans  by Category** |   |
|                      |   | **(Dollars in Thousands)** |   |
| Single-family residential |   | $                          | 128    |   | 57.03 | % | $ | 66 |   | 67.85 | % | $ | 57 |   | 73.87 | % | $ | 50 |   | 77.73 | % | $ | 46 |   | 81.66 | % |
| Multi-family residential  |   | 1                          |   | 1.15 |   | 1 |   | .90 |   | — |   | .72 |   | — |   | .59 |   | — |   | .34 |   |
| Commercial real estate    |   | 719                        |   | 13.14 |   | 240 |   | 9.62 |   | 190 |   | 7.46 |   | 149 |   | 5.49 |   | 147 |   | 5.12 |   |
| Construction loans        |   | —                     |   | 9.69 |   | 25 |   | 5.09 |   | — |   | 4.88 |   | — |   | 5.44 |   | — |   | 4.02 |   |
| Commercial loans          |   | 209                        |   | 5.57 |   | 133 |   | 4.81 |   | 101 |   | 3.96 |   | 31 |   | 2.99 |   | 60 |   | 1.86 |   |
| Consumer loans            |   | 463                        |   | 13.42 |   | 327 |   | 11.73 |   | 158 |   | 9.11 |   | 144 |   | 7.76 |   | 135 |   | 7.00 |   |
| Unallocated               |   | 9                          |   | — |   | 131 |   | — |   | 185 |   | — |   | 378 |   | — |   | 383 |   | — |   |
| Total                     |   | $                          | 1,529  |   | 100.00 | % | $ | 923 |   | 100.00 | % | $ | 691 |   | 100.00 | % | $ | 752 |   | 100.00 | % | $ | 771 |   | 100.00 | % |
|                           |        |                            |        |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

13

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**Investment Activities**

 

**Investment Securities. **Theinvestment policy of the Bank, as established by the Board of Directors, isdesigned primarily to provide and maintain liquidity and to generate afavorable return on investments.  TheBank’s investment policy is currently implemented by the Bank’s President/ChiefExecutive Officer within the parameters set by the investment committee and theBoard of Directors.  The Bank isauthorized to invest in obligations issued or fully guaranteed by the U.S.Government, certain federal agency obligations, certain time deposits,negotiable certificates of deposit issued by commercial banks and other insuredfinancial institutions, municipal securities, investment grade corporate debtsecurities and other specified investments.

 

Investment securities that management has the positive intent andability to hold to maturity are classified as held to maturity and are reportedat amortized cost.  Investmentsecurities classified as available for sale are reported at fair value, withunrealized gains and losses excluded from earnings, net of taxes, and reportedas a separate component of equity.  AtDecember 31, 2002, the Bank held no investment securities classified asavailable for sale.  AtDecember 31, 2002, approximately $22.4 million of the Bank’sinvestment securities were pledged as collateral for certain deposits in excessof $100,000.  In addition, certain U.S.Government and agency securities are pledged as collateral for FHLB advances underthe FHLB’s blanket lien.  At December31, 2002, investments in the debt and/or equity securities of any one issuer,other than those issued by U.S. Government agencies, did not exceed more than10% of the Company’s stockholders’ equity.

 

The following table sets forth the amount of investment securities heldto maturity which contractually mature during each of the periods indicated andthe weighted average yields for each range of maturities at December 31,2002.  Weighted average yields for municipalobligations have not been adjusted to a tax-equivalent basis.  Expected maturities may differ fromcontractual maturities because issuers may have the right to call or prepay theobligation without prepayment penalties.

 
|                                   |   | **Less Than   One Year** |   | **One to Five   Years** |   | **Five to Ten   Years** |   | **After Ten   Years** |   | **Total**  |   |
|----------------------------------------|--------|--------------------------|--------|-------------------------|--------|-------------------------|--------|-----------------------|--------|------------|--------|
|                                   |   | **Amount**               |   | **Yield**               |   | **Amount**              |   | **Yield**             |   | **Amount** |   | **Yield** |   | **Amount** |   | **Yield** |   | **Amount** |   | **Yield** |   |
|                                   |   | **(In  Thousands)**      |   |
|                                   |   |                     |   |
| Certificates of deposit                |   | $                        | 35,341 |                    | 1.88   | %                       | $      | 5,000                 |   | 4.00       | %      | $ | — |   | — | % | $ | — |   | — | % | $ | 40,341 |   | 2.14 | % |
| Municipal securities                   |   | —                   |   | —                  |   | 100                     |   | 4.45                  |   | 715        |   | 4.34 |   | 7,913 |   | 4.77 |   | 8,728 |   | 4.73 |   |
| U.S. Government and agency obligations |   | —                   |   | —                  |   | 501                     |   | 5.25                  |   | 26,000     |   | 5.57 |   | 38,901 |   | 6.05 |   | 65,402 |   | 5.85 |   |
| Total                                  |   | $                        | 35,341 |                    | 1.88   | %                       | $      | 5,601                 |   | 4.12       | %      | $ | 26,715 |   | 5.54 | % | $ | 46,814 |   | 5.84 | % | $ | 114,471 |   | 4.48 | % |

 

As of December 31, 2002, there were approximately $80 million ofinvestments with issuer call options, of which approximately $68 million arecallable within one year.

 

The following table sets forth the carrying value of the Company’sinvestment securities classified as held to maturity.  The Company held no investment securities as available for saleat the dates indicated.

 
|                                    |   | **December  31,**   |    |
|-----------------------------------------|--------|---------------------|---------|
|                                    |   | **2002**            |    | **2001** |   | **2000** |   |
|                                    |   | **(In  Thousands)** |    |
| Investment securities held to maturity: |   |                |    |   |   |   |   |
| Certificates of deposit                 |   | $                   | 40,341  |   | $ | — |   | $ | — |   |
| Municipal securities                    |   | 8,728               |    | 5,514 |   | 3,460 |   |
| U.S. Government and agency obligations  |   | 65,402              |    | 95,364 |   | 180,850 |   |
| Total                                   |   | $                   | 114,471 |   | $ | 100,878 |   | $ | 184,310 |   |

 

14

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As a member of the FHLB of Dallas, the Bank is required to maintain aninvestment in FHLB stock.  AtDecember 31, 2002, the Bank’s investment in FHLB stock amounted to $5.1million.  No ready market exists forsuch stock and it has no quoted market value.

 

**Sources ofFunds**

 

**General. **Deposits are the primary source of the Bank’sfunds for lending and other investment purposes.  In addition to deposits, the Bank derives funds from loanprincipal repayments and prepayments and interest payments, maturities ofinvestment securities and advances from the FHLB of Dallas.  Loan repayments are a relatively stablesource of funds, while deposit inflows and outflows are significantlyinfluenced by general interest rates and money market conditions.  Borrowings may be used on a short-term basisto compensate for reductions in the availability of funds from othersources.  They may also be used on alonger term basis for general business purposes.

** **

**Deposits. **The Bank’s deposit products include a broadselection of deposit instruments, including negotiable order of withdrawal(“NOW”) accounts, demand deposit accounts (“DDA”), money market accounts,regular savings accounts and term certificate accounts.  Deposit account terms vary, with theprincipal differences being the minimum balance required, the time period thefunds must remain on deposit, early withdrawal penalties and the interest rate.

 

The Bank considers its primary market area to be Northcentral andNorthwest Arkansas.  The Bank utilizestraditional marketing methods to attract new customers and savingsdeposits.  The Bank does not advertisefor deposits outside of its primary market area or utilize the services ofdeposit brokers, and management believes that an insignificant number of depositaccounts were held by non-residents of Arkansas at December 31, 2002.

 

The Bank has been competitive in the types of accounts and in interestrates it has offered on its deposit products but does not necessarily seek tomatch the highest rates paid by competing institutions.  Although market demand generally dictateswhich deposit maturities and rates will be accepted by the public, the Bankintends to continue to promote longer-term deposits to the extent possible andconsistent with its asset and liability management goals.

 

The following table shows the distribution of, and certain otherinformation relating to, the Bank’s deposits by type of deposit, as of thedates indicated.

 
|                           |   | **December  31,**          |    |
|--------------------------------|--------|----------------------------|---------|
|                           |   | **2002**                   |    | **2001** |   | **2000** |   |
|                           |   | **Amount**                 |    | **%** |   | **Amount** |   | **%** |   | **Amount** |   | **%** |   |
|                           |   | **(Dollars in Thousands)** |    |
| Certificate accounts:          |   |                       |    |   |   |   |   |   |   |   |   |   |   |
| Less than 3.00%                |   | $                          | 136,015 |   | 23.9 | % | $ | 46,651 |   | 8.4 | % | $ | — |   | — | % |
| 3.00% - 3.99%                  |   | 78,571                     |    | 13.8 |   | 36,284 |   | 6.5 |   | 379 |   | .1 |   |
| 4.00% - 5.99%                  |   | 118,401                    |    | 20.8 |   | 212,212 |   | 38.2 |   | 155,948 |   | 28.8 |   |
| 6.00% - 7.99%                  |   | 34,547                     |    | 6.1 |   | 116,809 |   | 21.0 |   | 270,733 |   | 50.1 |   |
| 8.00% and over                 |   | 6,585                      |    | 1.2 |   | 6,225 |   | 1.1 |   | 5,961 |   | 1.1 |   |
| Total certificate accounts     |   | 374,119                    |    | 65.8 |   | 418,181 |   | 75.2 |   | 433,021 |   | 80.1 |   |
|                           |   |                       |    |   |   |   |   |   |   |   |   |   |   |
| Transaction accounts:          |   |                       |    |   |   |   |   |   |   |   |   |   |   |
| Passbook and statement savings |   | 27,772                     |    | 4.9 |   | 26,784 |   | 4.8 |   | 24,300 |   | 4.5 |   |
| Money market accounts          |   | 80,020                     |    | 14.1 |   | 35,119 |   | 6.3 |   | 16,980 |   | 3.2 |   |
| NOW accounts/DDA               |   | 86,851                     |    | 15.2 |   | 75,849 |   | 13.7 |   | 66,026 |   | 12.2 |   |
| Total transaction accounts     |   | 194,643                    |    | 34.2 |   | 137,752 |   | 24.8 |   | 107,306 |   | 19.9 |   |
| Total deposits                 |   | $                          | 568,762 |   | 100.0 | % | $ | 555,933 |   | 100.0 | % | $ | 540,327 |   | 100.0 | % |

 

15

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The following table presents the averagebalance of each type of deposit and the average rate paid on each type ofdeposit and/or total deposits for the periods indicated.

 
|                                    |   | **Year Ended****December 31,** |    |
|-----------------------------------------|--------|--------------------------------|---------|
|                                    |   | **2002**                       |    | **2001** |   | **2000** |   |
|                                    |   | **Average Balance**            |    | **Average   Rate   Paid** |   | **Average Balance** |   | **Average   Rate   Paid** |   | **Average Balance** |   | **Average   Rate   Paid** |   |
|                                    |   | **(Dollars in Thousands)**     |    |
| Passbook and statement savings accounts |   | $                              | 27,955  |   | 1.04 | % | $ | 25,669 |   | 2.41 | % | $ | 25,760 |   | 2.72 | % |
| Money market accounts and NOW accounts  |   | 129,346                        |    | 1.87 |   | 74,861 |   | 2.57 |   | 66,767 |   | 2.53 |   |
| Demand deposit accounts                 |   | 19,619                         |    | — |   | 16,312 |   | — |   | 14,449 |   | — |   |
| Certificates of deposit                 |   | 389,127                        |    | 4.30 |   | 427,077 |   | 5.84 |   | 421,945 |   | 5.99 |   |
| Total deposits                          |   | $                              | 566,047 |   | 3.44 | % | $ | 543,919 |   | 5.06 | % | $ | 528,921 |   | 5.23 | %  |

 

Thefollowing table presents, by various interest rate categories, the amount ofcertificates of deposit at December 31, 2002 and 2001 and the amountsat December 31, 2002 which mature during the periods indicated.

 
|                       |   | **December  31,**  |    | **Balance at December 31, 2002   Maturing in the 12 Months Ending December 31,** |   |
|----------------------------|--------|--------------------|---------|----------------------------------------------------------------------------------|--------|
|                       |   | **2002**           |    | **2001**                                                                         |   | **2003** |   | **2004** |   | **2005** |   | **Thereafter** |   |
|                       |   | **(In Thousands)** |    |
| Certificate accounts:      |   |               |    |                                                                             |   |   |   |   |   |   |   |   |   |
| Less than 3.00%            |   | $                  | 136,015 |                                                                             | $      | 46,651 |   | $ | 131,755 |   | $ | 3,821 |   | $ | 439 |   | $ | — |   |
| 3.00% - 3.99%              |   | 78,571             |    | 36,284                                                                           |   | 34,671 |   | 38,868 |   | 945 |   | 4,087 |   |
| 4.00% - 5.99%              |   | 118,401            |    | 212,212                                                                          |   | 21,631 |   | 19,572 |   | 13,449 |   | 63,749 |   |
| 6.00% - 7.99%              |   | 34,547             |    | 116,809                                                                          |   | 13,317 |   | 5,283 |   | 8,058 |   | 7,889 |   |
| 8.00% and over             |   | 6,585              |    | 6,225                                                                            |   | 6,224 |   | — |   | — |   | 361 |   |
| Total certificate accounts |   | $                  | 374,119 |                                                                             | $      | 418,181 |   | $ | 207,598 |   | $ | 67,544 |   | $ | 22,891 |   | $ | 76,086 |   |

 

The following table sets forth the savings flows of the Bank during theperiods indicated.

 
|                                         |   | **Year Ended December 31,** |   |
|----------------------------------------------|--------|-----------------------------|--------|
|                                         |   | **2002**                    |   | **2001** |   | **2000** |   |
|                                         |   | **(In Thousands)**          |   |
|                                         |   |                        |   |
| Increase (decrease) before interest credited |   | $                           | (2,369 | ) | $ | (6,597 | ) | $ | 11,064 |   |
| Interest credited                            |   | 15,198                      |   | 22,203 |   | 21,388 |   |
|                                         |   |                        |   |   |   |   |   |
| Net increase in deposits                     |   | $                           | 12,829 |   | $ | 15,606 |   | $ | 32,452 |   |

 

The following table sets forth maturities of the Bank’s certificates ofdeposit of $100,000 or more at December 31, 2002 by time remaining tomaturity.

 
| **Period  Ending:**                                             |   | **Amount**         |   |
|-----------------------------------------------------------------|--------|--------------------|--------|
|                                                            |   | **(In Thousands)** |   |
|                                                            |   |               |   |
| March 31, 2003                                                  |   | $                  | 20,049 |   |
| June 30, 2003                                                   |   | 16,536             |   |
| September 30, 2003                                              |   | 6,442              |   |
| December 31, 2003                                               |   | 5,144              |   |
| After December 31, 2003                                         |   | 39,606             |   |
| Total certificates of deposit with balances of $100,000 or more |   | $                  | 87,777 |   |

 

16

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**Borrowed funds.**  TheBank utilizes FHLB advances in its normal operating and investingactivities.  The Bank pledges ascollateral for FHLB advances its FHLB stock and has entered into a blanketcollateral agreement with the FHLB.  TheBank pledges eligible collateral for their FHLB advances as defined in itsblanket lien agreement with the FHLB as well as its FHLB demand deposit accountand FHLB stock.  Eligible collateralunder the blanket lien includes First Mortgage Collateral (as defined),multifamily residential mortgages meeting the requirements for eligibility asFirst Mortgage Collateral, U.S. Government and Agency Securities (as defined),privately issued mortgage-backed securities that qualify as eligible collateralunder applicable regulations, Federal Home Loan Bank Term Deposit Accounts, andother non-securitized real estate related collateral.

 

Advances at December 31, 2002, have maturity dates and weighted averagerates as follows:

 

| **Year Ending   December 31** |   | **Weighted   Average   Rate** |   | **Amount**                  |   |
|-------------------------------|--------|-------------------------------|--------|-----------------------------|--------|
|                          |   |                          |   | **(Dollars  in Thousands)** |   |
| 2003                          |   | 3.41                          | %      | $                           | 19,000 |   |
| 2004                          |   | 4.07                          |   | 2,000                       |   |
| 2005                          |   | 6.54                          |   | 4,900                       |   |
| 2007                          |   | 3.78                          |   | 5,724                       |   |
| Thereafter                    |   | 3.20                          |   | 6,986                       |   |
| Total                         |   | 3.86                          | %      | $                           | 38,610 |   |

 

The following table sets forth information with respect to theCompany’s FHLB advances at and during the periods indicated.

 
|                            |   | **At or For  the Year Ended December 31,** |   |
|---------------------------------|--------|--------------------------------------------|--------|
|                            |   | **2002**                                   |   | **2001** |   | **2000** |   |
|                            |   | **(Dollars  in Thousands)**                |   |
| Maximum balance                 |   | $                                          | 47,844 |   | $ | 93,359 |   | $ | 97,963 |   |
| Average balance                 |   | 38,434                                     |   | 66,409 |   | 87,999 |   |
| Year end balance                |   | 38,610                                     |   | 47,844 |   | 93,359 |   |
| Weighted average interest rate: |   |                                       |   |   |   |   |   |
| At end of year                  |   | 3.86                                       | %      | 6.41 | % | 6.60 | % |
| During the year                 |   | 5.69                                       |   | 6.57 |   | 6.35 |   |
|                                 |        |                                            |        |  |  |  |  |  |  |  |

 

## **Employees**

 

The Bank had 222 full-time employees and 33 part-time employees atDecember 31, 2002.  None of theseemployees is represented by a collective bargaining agent, and the Bankbelieves that it enjoys good relations with its personnel.

 

## **Subsidiaries**

 

The Bank is permitted to invest up to 2% of its assets in the capitalstock of, or secured or unsecured loans to, subsidiary corporations, with anadditional investment of 1% of assets when such additional investment isutilized

 

17

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primarily for community development purposes.  The Bank’s only subsidiary, First HarrisonService Corporation (the “Service Corporation”), was formed in 1971.  At December 31, 2002, the ServiceCorporation was inactive.

 

## **Competition**

 

The Bank faces strong competition both in attracting deposits andmaking real estate loans.  Its mostdirect competition for deposits has historically come from other savingsassociations, credit unions and commercial banks, including many largefinancial institutions which have greater financial and marketing resourcesavailable to them.  In addition, theBank has faced additional significant competition for investors’ funds fromshort-term money market securities, mutual funds and other corporate andgovernment securities.  The ability ofthe Bank to attract and retain savings deposits depends on its ability togenerally provide a rate of return, liquidity and risk comparable to thatoffered by competing investment opportunities.

 

The Bank experiences strong competition for real estate loansprincipally from savings associations, commercial banks and mortgagecompanies.  The Bank competes for loansprincipally through the interest rates and loan fees it charges and theefficiency and quality of services it provides borrowers.  Competition has increased as a result of thecontinuing reduction of restrictions on the interstate operations of financialinstitutions.

 

**REGULATION**

 

*Set forth below is a brief description of those lawsand regulations which, together with the descriptions of laws and regulationscontained elsewhere herein, are deemed material to an investor’s understandingof the extent to which the Company and the Bank are regulated.  The description of the laws and regulationshereunder, as well as descriptions of laws and regulations contained elsewhereherein, does not purport to be complete and is qualified in its entirety byreference to applicable laws and regulations.*

 

**The Company**

 

**General. **The Company, as a savings and loan holdingcompany within the meaning of the Home Owners Loan Act (“HOLA”), has registeredwith the OTS and is subject to OTS regulations, examinations, supervision andreporting requirements.  As a subsidiaryof a savings and loan holding company, the Bank is subject to certainrestrictions in its dealings with the Company and affiliates thereof.

 

**Holding Company Acquisitions. **Federal law generally prohibits a savings and loan holding company,without prior OTS approval, from acquiring the ownership or control of anyother savings institution or savings and loan holding company, or all, orsubstantially all, of the assets or more than 5% of the voting sharesthereof.  These provisions alsoprohibit, among other things, any director or officer of a savings and loanholding company, or any individual who owns or controls more than 25% of thevoting shares of such holding company, from acquiring control of any savingsinstitution not a subsidiary of such savings and loan holding company, unlessthe acquisition is approved by the OTS.

 

**Holding Company Activities. **TheCompany operates as a unitary savings and loan holding company.  As a result of recently enacted legislation,the activities of a new unitary savings and loan holding company like theCompany and its non-savings institution subsidiaries are restricted toactivities traditionally permitted to multiple savings and loan holdingcompanies and to financial holding companies under newly added provisions ofthe Bank Holding Company Act.  Multiplesavings and loan holding companies may:

 

•                                          furnish or perform management services for asavings association subsidiary of a savings and loan holding company;

 

•                                          hold, manage or liquidate assets owned oracquired from a savings association subsidiary of a savings and loan holdingcompany;

 

•                                          hold or manage properties used or occupied bya savings association subsidiary of a savings and loan holding company;

 

18

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•                                          engage in activities determined by theFederal Reserve to be closely related to banking and a proper incident thereto;and

 

•                                          engage in services and activities previouslydetermined by the Federal Home Loan Bank Board by regulation to be permissiblefor a multiple savings and loan holding company as of March 5, 1987.

 

The activities financial holding companies may engage in include:

 

•                                          lending, exchanging, transferring orinvesting for others, or safeguarding money or securities;

 

•                                          insuring, guaranteeing or indemnifyingothers, issuing annuities, and acting as principal, agent or broker forpurposes of the foregoing;

 

•                                          providing financial, investment or economicadvisory services, including advising an investment company;

** **

•                                          issuingor selling interests in pooled assets that a bank could hold directly;

 

•                                          underwriting, dealing in or making a marketin securities; and

 

•                                          merchant banking activities.

 

If the OTS determines that there is reasonable cause to believe thatthe continuation by a savings and loan holding company of an activityconstitutes a serious risk to the financial safety, soundness or stability ofits subsidiary savings institution, the OTS may impose such restrictions asdeemed necessary to address such risk. These restrictions include limiting the following:

 

•                                          the payment of dividends by the savingsinstitution;

 

•                                          transactions between the savings institutionand its affiliates; and

 

•                                          any activities of the savings institutionthat might create a serious risk that the liabilities of the holding companyand its affiliates may be imposed on the savings institution.

** **

Every savings institution subsidiary of a savings and loan holdingcompany is required to give the OTS at least 30 days’ advance notice of anyproposed dividends to be made on its guarantee, permanent or othernon-withdrawable stock, or else such dividend will be invalid.

 

**Restrictions on Transactions with Affiliates**.  Transactions between a savings institution and its “affiliates” aresubject to quantitative and qualitative restrictions under Sections 23A and 23Bof the Federal Reserve Act and OTS regulations.  Affiliates of a savings institution generally include, amongother entities, the savings institution’s holding company and companies thatare controlled by or under common control with the savings institution.

 

In general, a savings institution or its subsidiaries may engage incertain “covered transactions” with affiliates up to certain limits.  In addition, a savings institution and itssubsidiaries may engage in covered transactions and certain other transactionsonly on terms and under circumstances that are substantially the same, or atleast as favorable to the savings institution or its subsidiary, as thoseprevailing at the time for comparable transactions with nonaffiliatedcompanies.  A “covered transaction” isdefined to include a loan or extension of credit to an affiliate; a purchase ofinvestment securities issued by an affiliate; a purchase of assets from anaffiliate, with certain exceptions; the acceptance of securities issued by anaffiliate as collateral for a loan or extension of credit to any party; or theissuance of a guarantee, acceptance or letter of credit on behalf of anaffiliate.  In addition, a savingsinstitution may not:

 

•                                          make a loan or extension of credit to anaffiliate unless the affiliate is engaged only in activities permissible forbank holding companies;

 

•                                          purchase or invest in securities of anaffiliate other than shares of a subsidiary;

 

19

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•                                          purchase a low-quality asset from anaffiliate; or

 

•                                          engage in covered transactions and certainother transactions between a savings institution or its subsidiaries and anaffiliate except on terms and conditions that are consistent with safe andsound banking practices.

 

With certain exceptions, each loan orextension of credit by a savings institution to an affiliate must be secured bycollateral with a market value ranging from 100% to 130% (depending on the typeof collateral) of the amount of the loan or extension of credit.

** **

**Sarbanes-Oxley Act of 2002*.**** *OnJuly 30, 2002, President George W. Bush signed into law the Sarbanes-Oxley Actof 2002, which generally establishes a comprehensive framework to modernize andreform the oversight of public company auditing, improve the quality andtransparency of financial reporting by those companies and strengthen theindependence of auditors.  Certain ofthe new legislation’s more significant reforms are noted below.

 

The new legislation creates a public companyaccounting oversight board which is empowered to set auditing, quality controland ethics standards, to inspect registered public accounting firms, to conductinvestigations and to take disciplinary actions, subject to SEC oversight andreview.  The new board will be funded bymandatory fees paid by all public companies.  The new legislation also improves the Financial Accounting StandardsBoard, giving it full financial independence from the accounting industry.

 

The new legislation strengthens auditorindependence from corporate management by, among other things, limiting thescope of consulting services that auditors can offer their public company auditclients.

 

The new legislation heightens theresponsibility of public company directors and senior managers for the qualityof the financial reporting and disclosure made by their companies.  Among other things, the new legislation providesfor a strong public company audit committee that will be directly responsiblefor the appointment, compensation and oversight of the work of the publiccompany auditors.

 

The new legislation contains a number ofprovisions to deter wrongdoing.  CEOsand CFOs will have to certify that company financial statements fairly presentthe company’s financial condition.  If amisleading financial statement later resulted in a restatement, the CEO and CFOmust forfeit and return to the company any bonus, stock or stock optioncompensation received in the twelve months following the misleading financialreport.  The new legislation alsoprohibits any company officer or director from attempting to mislead or coercean auditor.  Among other reforms, thenew legislation empowers the SEC to bar certain persons from serving asofficers or directors of a public company; prohibits insider trades duringpension fund “blackout periods;” directs the SEC to adopt rules requiringattorneys to report securities law violations; and requires that civilpenalties imposed by the SEC go into a disgorgement fund to benefit harmedinvestors.

 

The new legislation imposes a range of newcorporate disclosure requirements. Among other things, the new legislation requires public companies toreport all off-balance-sheet transactions and conflicts, as well as to presentany pro forma disclosures in a way that is not misleading and in accordancewith requirements to be established by the SEC.  The new legislation also accelerated the required reporting ofinsider transactions, which now generally must be reported by the end of thesecond business day following a covered transaction; requires that annualreports filed with the SEC include a statement by management asserting that itis responsible for creating and maintaining adequate internal controls andassessing the effectiveness of those controls; and requires companies todisclose whether or not they have adopted an ethics code for senior financialofficers, and, if not, why not, and whether the audit committee includes atleast one “financial expert,” a term which is to be defined by the SEC inaccordance with specified requirements. The new legislation also requires the SEC, based on certain enumeratedfactors, to regularly and systematically review corporate filings.

 

The new legislation contains provisions whichgenerally seek to limit and expose to public view possible conflicts ofinterest affecting securities analysts.

 

Finally, the new legislation imposes a rangeof new criminal penalties for fraud and other wrongful acts, as well as extendsthe period during which certain types of lawsuits can be brought against acompany or its insiders.

 

20

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**The Bank**

 

**General. **The OTS has extensive authority over theoperations of federally chartered savings institutions.  As part of this authority, savingsinstitutions are required to file periodic reports with the OTS and are subjectto periodic examinations by the OTS and the FDIC.  The last regulatory examination of the Bank by the OTS wascompleted in November, 2002.  The Bankwas not required to make any material changes to its operations as a result ofsuch examination.  The investment andlending authority of savings institutions are prescribed by federal laws andregulations, and such institutions are prohibited from engaging in anyactivities not permitted by such laws and regulations.  Those laws and regulations generally areapplicable to all federally chartered savings institutions and may also applyto state-chartered savings institutions. Such regulation and supervision is primarily intended for the protectionof depositors.

 

The OTS’ enforcement authority over all savings institutions and theirholding companies includes, among other things, the ability to assess civilmoney penalties, to issue cease and desist or removal orders and to initiateinjunctive actions.  In general, theseenforcement actions may be initiated for violations of laws and regulations andunsafe or unsound practices.  Otheractions or inactions may provide the basis for enforcement action, includingmisleading or untimely reports filed with the OTS.

 

**Insurance of Accounts. **Thedeposits of the Bank are insured to the maximum extent permitted by the SAIF,which is administered by the FDIC, and are backed by the full faith and creditof the U.S. Government.  As insurer, theFDIC is authorized to conduct examinations of, and to require reporting by,FDIC-insured institutions.  It also mayprohibit any FDIC-insured institution from engaging in any activity the FDICdetermines by regulation or order to pose a serious threat to the FDIC.  The FDIC also has the authority to initiateenforcement actions against savings institutions, after giving the OTS anopportunity to take such action.

 

Currently, FDIC deposit insurance rates generally range from zero basispoints to 27 basis points, depending on the assessment risk classificationassigned to the depository institution. The FDIC also assesses depository institutions the Financing Corporation(“FICO”) debt service assessment which became applicable to all insuredinstitutions as of January 1, 1997, in accordance with the Deposit InsuranceAct of 1996.  SAIF and Bank InsuranceFund (“BIF”) members both paid approximately 1.75 basis points and 1.90 basispoints in 2002 and 2001, respectively, for the FICO debt service assessment.

 

The FDIC may terminate the deposit insurance of any insured depositoryinstitution, including the Bank, if it determines after a hearing that the institutionhas engaged or is engaging in unsafe or unsound practices, is in an unsafe orunsound condition to continue operations, or has violated any applicable law,regulation, order or any condition imposed by an agreement with the FDIC.  It also may suspend deposit insurancetemporarily during the hearing process for the permanent termination ofinsurance, if the institution has no tangible capital.  If insurance of accounts is terminated, theaccounts at the institution at the time of the termination, less subsequentwithdrawals, shall continue to be insured for a period of six months to twoyears, as determined by the FDIC. Management is aware of no existing circumstances which would result intermination of the Bank’s deposit insurance.

 

**Regulatory Capital Requirements. **Federally insured savings institutions are required to maintain minimumlevels of regulatory capital.  The OTShas established capital standards applicable to all savings institutions.  These standards generally must be asstringent as the comparable capital requirements imposed on nationalbanks.  The OTS also is authorized toimpose capital requirements in excess of these standards on individualinstitutions on a case-by-case basis.

** **

Current OTS capital standards require savings institutions to satisfythree different capital requirements. Under these standards, savings institutions must maintain “tangible”capital equal to at least 1.5% of adjusted total assets, “core” capital equalto at least 4.0% of adjusted total assets and “total” capital (a combination ofcore and “supplementary” capital) equal to at least 8.0% of “risk-weighted”assets.  For purposes of the regulation,core capital generally consists of common stockholders’ equity (includingretained earnings), noncumulative perpetual preferred stock and relatedsurplus, minority interests in the equity accounts of fully consolidatedsubsidiaries, certain nonwithdrawable accounts and pledged deposits and“qualifying supervisory goodwill.” Tangible capital is given the same definition as core capital but doesnot include qualifying supervisory goodwill and is reduced by the amount of allthe savings institution’s intangible assets, with only a limited exception forpurchased mortgage servicing rights. The Bank had no goodwill or other intangible

 

21

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assetsat December 31, 2002.  Both core andtangible capital are further reduced by an amount equal to a savingsinstitution’s debt and equity investments in subsidiaries engaged in activitiesnot permissible to national banks (other than subsidiaries engaged inactivities undertaken as agent for customers or in mortgage banking activitiesand subsidiary depository institutions or their holding companies).  These adjustments do not materially affectthe Bank’s regulatory capital.  AtDecember 31, 2002, the Bank exceeded its tangible, core and risk-based capitalrequirements.

 

In determining compliance with the risk-based capital requirement, asavings institution is allowed to include both core capital and supplementarycapital in its total capital, provided that the amount of supplementary capitalincluded does not exceed the savings institution’s core capital.  Supplementary capital generally consists ofhybrid capital instruments; perpetual preferred stock which is not eligible tobe included as core capital; subordinated debt and intermediate-term preferredstock; and general allowances for loan losses up to a maximum of 1.25% ofrisk-weighted assets.  In determiningthe required amount of risk-based capital, total assets, including certainoff-balance sheet items, are multiplied by a risk weight based on the risksinherent in the type of assets.  Therisk weights assigned by the OTS for principal categories of assets are (i) 0%for cash and securities issued by the U.S. Government or unconditionally backedby the full faith and credit of the U.S. Government; (ii) 20% for securities(other than equity securities) issued by U.S. Government-sponsored agencies andmortgage-backed securities issued by, or fully guaranteed as to principal andinterest by, the FNMA or the FHLMC, except for those classes with residualcharacteristics or stripped mortgage-related securities; (iii) 50% forprudently underwritten permanent one-to four-family first lien mortgage loansnot more than 90 days delinquent and having a loan-to-value ratio of not morethan 90% at origination unless insured to such ratio by an insurer approved bythe FNMA or the FHLMC, qualifying residential bridge loans made directly for theconstruction of one- to four-family residences and qualifying multi-familyresidential loans; and (iv) 100% for all other loans and investments, includingconsumer loans, commercial loans, and one- to four-family residentialreal estate loans more than 90 days delinquent, and for repossessed assets.

 

**Qualified Thrift Lender Test. **All savings institutions are required to meet a QTL test to avoidcertain restrictions on their operations. A savings institution that does not meet the QTL test must either convertto a bank charter or comply with the following restrictions on its operations:(i) the institution may not engage in any new activity or make any newinvestment, directly or indirectly, unless such activity or investment ispermissible for a national bank; (ii) the branching powers of the institutionshall be restricted to those of a national bank; (iii) the institution shallnot be eligible to obtain any advances from its FHLB; and (iv) payment ofdividends by the institution shall be subject to the rules regarding payment ofdividends by a national bank.  Upon theexpiration of three years from the date the savings institution ceases to be aQTL, it must cease any activity and not retain any investment not permissiblefor a national bank and immediately repay any outstanding FHLB advances(subject to safety and soundness considerations).

 

Currently, the QTL test requires that 65% of an institution’s“portfolio assets” (as defined) consist of certain housing and consumer-relatedassets on a monthly average basis in nine out of every 12 months.  Assets that qualify without limit forinclusion as part of the 65% requirement are loans made to purchase, refinance,construct, improve or repair domestic residential housing and manufacturedhousing; home equity loans; mortgage-backed securities (where the mortgages aresecured by domestic residential housing or manufactured housing); stock issuedby the FHLB of Dallas; and direct or indirect obligations of the FDIC.  In addition, the following assets, among others,may be included in meeting the test subject to an overall limit of 20% of thesavings institution’s portfolio assets: 50% of residential mortgage loansoriginated and sold within 90 days of origination; 100% of consumer andeducational loans (limited to 10% of total portfolio assets); and stock issuedby the FHLMC or the FNMA.  Portfolioassets consist of total assets minus the sum of (i) goodwill and otherintangible assets, (ii) property used by the savings institution to conduct itsbusiness, and (iii) liquid assets up to 20% of the institution’s totalassets.  At December 31, 2002, thequalified thrift investments of the Bank were approximately 74.6% of itsportfolio assets.

 

**Federal Home Loan Bank System. **The Bank is a member of the FHLB of Dallas, which is one of 12 regionalFHLBs that administers the home financing credit function of savingsinstitutions.  Each FHLB serves as areserve or central bank for its members within its assigned region.  It is funded primarily from proceeds derivedfrom the sale of consolidated obligations of the FHLB System.  It makes loans to members (i.e., advances)in accordance with policies and procedures established by the Board ofDirectors of the FHLB.  At December 31,2002, the Bank had $38.6 million of outstanding FHLB advances.

 

22

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As a member, the Bank is required to purchase and maintain stock in theFHLB of Dallas in an amount equal to at least 1% of its aggregate unpaidresidential mortgage loans, home purchase contracts or similar obligations atthe beginning of each year.  At December31, 2002, the Bank had $5.1 million in FHLB stock, which was in compliance withthis requirement.  No ready marketexists for such stock and it has no quoted market value.

 

The FHLBs are required to provide funds for the resolution of troubledsavings institutions and to contribute to affordable housing programs throughdirect loans or interest subsidies on advances targeted for communityinvestment and low- and moderate-income housing projects.  These contributions have adversely affectedthe level of FHLB dividends paid in the past and could continue to do so in thefuture.  These contributions also couldhave an adverse effect on the value of FHLB stock in the future.

 

**Federal Reserve System. **The FRBrequires all depository institutions to maintain reserves against theirtransaction accounts and non-personal time deposits.  As of December 31, 2002, no reserves were required to bemaintained on the first $6.0 million of transaction accounts, reserves of 3%were required to be maintained against the next $42.1 million of nettransaction accounts (with such dollar amounts subject to adjustment by theFRB), and a reserve of 10% (which is subject to adjustment by the FRB to a levelbetween 8% and 14%) against all remaining net transaction accounts.  Because required reserves must be maintainedin the form of vault cash or a noninterest-bearing account at a Federal ReserveBank, the effect of this reserve requirement is to reduce an institution’searning assets.

 

**TAXATION**

 

**FederalTaxation**

 

**General. **The Company and Bank are subject to thegenerally applicable corporate tax provisions of the Internal Revenue Code of1986, as amended (“Code”), and the Bank is subject to certain additionalprovisions of the Code which apply to thrift and other types of financialinstitutions.  The following discussionof federal taxation is intended only to summarize certain pertinent federalincome tax matters material to the taxation of the Company and the Bank and isnot a comprehensive discussion of the tax rules applicable to the Company andBank.

 

**Year. **The Bank files a federal income tax return onthe basis of a fiscal year ending on December 31.  The Company filed a consolidated federal income tax return withboth the Bank and the Service Corporation.

 

**Bad Debt Reserves. **Prior to theenactment of the Small Business Jobs Protection Act (the “Act”), which wassigned into law on August 21, 1996, certain thrift institutions, such as theBank, were allowed deductions for bad debts under methods more favorable thanthose granted to other taxpayers. Qualified thrift institutions could compute deductions for bad debtsusing either the specific charge off method of Section 166 of the Code or thereserve method of Section 593 of the Code.

 

Under Section 593, a thrift institution annually could elect to deductbad debts under either (i) the “percentage of taxable income” method applicableonly to thrift institutions, or (ii) the “experience” method that also wasavailable to small banks.  Under thepercentage of taxable income method, a thrift institution generally was alloweda deduction for an addition to its bad debt reserve equal to 8% of its taxableincome (determined without regard to this deduction and with additionaladjustments).  Under the experiencemethod, a thrift institution was generally allowed a deduction for an additionto its bad debt reserve equal to the greater of (i) an amount based on itsactual average experience for losses in the current and five preceding taxableyears, or (ii) an amount necessary to restore the reserve to its balance as ofthe close of the base year.  A thriftinstitution could elect annually to compute its allowable addition to bad debtreserves for qualifying loans either under the experience method or thepercentage of taxable income method.

 

Section 1616(a) of the Act repealed the Section 593 reserve method ofaccounting for bad debts by thrift institutions, effective for taxable yearsbeginning after 1995.  Thriftinstitutions that are treated as “small banks” are allowed to utilize theexperience method applicable to such institutions, while thrift institutionsthat are treated as “large banks” are required to use only the specific chargeoff method.  The percentage of taxableincome method of accounting for bad debts is no longer available for anyfinancial institution.

 

A thrift institution required to change its method of computingreserves for bad debts will treat such change as a change in the method ofaccounting, initiated by the taxpayer and having been made with the consent ofthe Secretary of

 

23

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the Treasury.  Section 481(a) of the Code requires certain amounts to berecaptured with respect to such change. Generally, the amounts to be recaptured will be determined solely withrespect to the “applicable excess reserves” of the taxpayer.  The amount of the applicable excess reserveswill be taken into account ratably over a period of six taxable years, beginningwith the first taxable year after 1995, subject to the residential loanrequirement described below.  In thecase of a thrift institution that is treated as a large bank, the amount of theinstitution’s applicable excess reserves generally is the excess of (i) thebalance of its reserve for losses on qualifying real property loans (generallyloans secured by improved real estate) and its reserve for losses onnonqualifying loans (all other types of loans) as of the close of its lasttaxable year beginning before January 1, 1996, over (ii) the balances of suchreserves as of the close of its last taxable year beginning before January 1,1988 (i.e., the “pre-1988 reserves”). In the case of a thrift institution that is treated as a small bank, theamount of the institution’s applicable excess reserves generally is the excessof (i) the balance of its reserve for losses on qualifying real property loansand its reserve for losses on nonqualifying loans as of the close of its lasttaxable year beginning before January 1, 1996, over (ii) the greater of thebalance of (a) its pre-1988 reserves or, (b) what the thrift’s reserves wouldhave been at the close of its last year beginning before January 1, 1996, hadthe thrift always used the experience method.

 

For taxable years that begin after December 31, 1995, and beforeJanuary 1, 1998, if a thrift meets the residential loan requirement for a taxyear, the recapture of the applicable excess reserves otherwise required to betaken into account as a Code Section 481(a) adjustment for the year will besuspended.  A thrift meets theresidential loan requirement if, for the tax year, the principal amount ofresidential loans made by the thrift during the year is not less than its baseamount.  The “base amount” generally isthe average of the principal amounts of the residential loans made by thethrift during the six most recent tax years beginning before January 1,1996.  A residential loan is a loan asdescribed in Section 7701(a) (19) (C) (v) (generally a loan secured byresidential or church property and certain mobile homes), but only to theextent that the loan is made to the owner of the property.  As of December 31, 2002, the Bank’sapplicable excess reserves remaining to be recaptured are $220,513.

 

The balance of the pre-1988 reserves is subject to the provisions ofSection 593(e), as modified by the Act, which requires recapture in the case ofcertain excessive distributions to shareholders.  The pre-1988 reserves may not be utilized for payment of cashdividends or other distributions to a shareholder (including distributions indissolution or liquidation) or for any other purpose (except to absorb bad debtlosses).  Distribution of a cashdividend by a thrift institution to a shareholder is treated as made:  first, out of the institution’s post-1951accumulated earnings and profits; second, out of the pre-1988 reserves; andthird, out of such other accounts as may be proper.  To the extent a distribution by the Bank to the Company is deemedpaid out of its pre-1988 reserves under these rules, the pre-1988 reserveswould be reduced and the Bank’s gross income for tax purposes would beincreased by the amount which, when reduced by the income tax, if any,attributable to the inclusion of such amount in its gross income, equals theamount deemed paid out of the pre-1988 reserves.  As of December 31, 2002, the Bank’s pre-1988 reserves for taxpurposes totaled approximately $4.2 million.

 

**Minimum Tax. **The Code imposes an alternative minimum taxat a rate of 20%.  The alternativeminimum tax generally applies to a base of regular taxable income plus certaintax preferences (“alternative minimum taxable income” or “AMTI”) and is payableto the extent such AMTI is in excess of an exemption amount.  The Code provides that an item of taxpreference is the excess of the bad debt deduction allowable for a taxable yearpursuant to the percentage of taxable income method over the amount allowableunder the experience method.  Other itemsof tax preference that constitute AMTI include (a) tax-exempt interest on newlyissued (generally, issued on or after August 8, 1986) privateactivity bonds other than certain qualified bonds and (b) 75% of the excess (ifany) of (i) adjusted current earnings as defined in the Code, over (ii) AMTI(determined without regard to this preference and prior to reduction by netoperating losses).

 

**Net Operating Loss Carryovers. **A financial institution may, for federal income tax purposes, carryback net operating losses (“NOLs”) to the preceding two taxable years andforward to the succeeding 20 taxable years. This provision applies to losses incurred in taxable years beginningafter 1997.  The Job Creation and WorkerAssistance Act of 2002 temporarily increased the general NOL carryback periodfrom two years to five years for NOLs arising in taxable years ending in 2001and 2002.  At December 31, 2002, theBank had no NOL carryforwards for federal income tax purposes.

 

24

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**Capital Gains and Corporate Dividends-ReceivedDeduction. **Corporate net capital gains are taxed at amaximum rate of 35%.  The corporatedividends-received deduction is 80% in the case of dividends received from a“20-percent-owned corporation”, i.e., a corporation having at least twentypercent (but generally less than 80 percent) of its stock owned by therecipient corporation and corporations which own less than 20% of the stock ofa corporation distributing a dividend may deduct only 70% of dividends receivedor accrued on their behalf.  However, acorporation may deduct 100% of dividends from a member of the same affiliatedgroup of corporations.

 

**Other Matters. **Federallegislation is introduced from time to time that would limit the ability ofindividuals to deduct interest paid on mortgage loans.  Individuals are currently not permitted todeduct interest on consumer loans. Significant increases in tax rates or further restrictions on thedeductibility of mortgage interest could adversely affect the Bank.

 

The Bank’s federal income tax returns for the tax years ended December31, 1999 forward are open under the statute of limitations and are subject toreview by the IRS.

 

**StateTaxation**

 

The Bank will continue to be subject to Arkansas corporation income taxwhich is a progressive rate up to a maximum of 6.5% of all taxable earnings.

 

The Company is incorporated under Texas law and, accordingly, issubject to Texas franchise tax in an amount equal to 4.5% of net incomeallocated to Texas pursuant to apportionments of gross receipts based uponwhere the Company conducts business.

 

25

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**Item2.  Properties****.**

 

At December 31, 2002, the Bank conducted its business from itsexecutive office in Harrison, Arkansas, and thirteen full service offices, allof which are located in Northcentral and Northwest Arkansas.

 

The following table sets forth the net book value (including leaseholdimprovements and equipment) and certain other information with respect to theoffices and other properties of the Bank at December 31, 2002.

 
| **Description/Address**                                    |   | **Leased/  Owned** |   | **Net Book  Value   of Property** |   | **Amount of  Deposits** |   |
|------------------------------------------------------------|--------|--------------------|--------|-----------------------------------|--------|-------------------------|--------|
|                                                       |   |               |   | **(In  Thousands)**               |   |
| 200 West Stephenson   Harrison, AR 72601                   |   | Owned              |   | $                                 | 4,758  | (1)                     | $      | 162,805 |   |
|                                                       |   |               |   |                              |   |                    |   |
| 128 West Stephenson   Harrison, AR  72601             |   | Owned              |   | 212                               |   | —                  | (2)    |
|                                                       |   |               |   |                              |   |                    |   |
| Corner Central &  Willow   Harrison, AR  72601    |   | Owned              |   | 218                               |   | —                  | (2)    |
|                                                       |   |               |   |                              |   |                    |   |
| Ozark Mall - Hwy. 62-65   North Harrison, AR  72601   |   | Leased             | (3)    | 17                                |   | 25,354                  |   |
|                                                       |   |               |   |                              |   |                    |   |
| 324 Hwy. 62-65 Bypass   Harrison, AR  72601           |   | Owned              |   | 265                               |   | 49,415                  |   |
|                                                       |   |               |   |                              |   |                    |   |
| 210 South Main   Berryville, AR  72616                |   | Owned              |   | 231                               |   | 30,972                  |   |
|                                                       |   |               |   |                              |   |                    |   |
| 668 Highway 62 East   Mountain Home, AR  72653        |   | Owned              |   | 544                               |   | 140,566                 |   |
|                                                       |   |               |   |                              |   |                    |   |
| 1337 Highway 62 SW   Mountain Home, AR 72653               |   | Owned              |   | 896                               |   | 14,509                  |   |
|                                                       |   |               |   |                              |   |                    |   |
| 301 Highway 62 West   Yellville, AR  72687            |   | Owned              |   | 123                               |   | 20,018                  |   |
|                                                       |   |               |   |                              |   |                    |   |
| 307 North Walton Blvd.   Bentonville, AR  72712       |   | Owned              |   | 432                               |   | 34,310                  |   |
|                                                       |   |               |   |                              |   |                    |   |
| 3460 North College   Fayetteville, AR  72703          |   | Owned              |   | 437                               |   | 42,154                  |   |
|                                                       |   |               |   |                              |   |                    |   |
| 1303 West Hudson   Rogers, AR  72756                  |   | Owned              |   | 200                               |   | 3,740                   |   |
|                                                       |   |               |   |                              |   |                    |   |
| 201 East Henri De Tonti  Blvd.   Tontitown, AR  72764 |   | Owned              |   | 207                               |   | 12,192                  |   |
|                                                       |   |               |   |                              |   |                    |   |
| 2025 North Crossover Road   Fayetteville, AR 72703         |   | Owned              |   | 721                               |   | 10,064                  |   |
|                                                       |   |               |   |                              |   |                    |   |
| 249 West Main Street   Farmington, AR 72730                |   | Leased             |   | 167                               |   | 9,520                   |   |
|                                                       |   |               |   |                              |   |                    |   |
| 2030 West Elm   Rogers, AR 72756                           |   | Owned              |   | 541                               |   | 13,143                  |   |
|                                                       |   |               |   |                              |   |                    |   |
| 1023 East Millsap Road   Fayetteville, AR  72703      |   | Owned              |   | 721                               |   | —                  | (2)    |
|                                                            |        |                    |        |                                   |        |                         |        |  |  |

 

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(1)                                  Includesproperty acquisition for expansion in north Harrison.

(2)                                  Suchoffices do not open deposit accounts.

(3)                                  Suchproperty is subject to a month-to-month lease.

(4)                                  Suchproperty is subject to a five-year lease expiring November 1, 2007.

 

26

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**Item3.  Legal Proceedings.**

 

Neither the Company nor the Bank is involved in any pending legalproceedings other than nonmaterial legal proceedings occurring in the ordinarycourse of business.

 

**Item4.  Submission of Matters to Vote ofSecurity Holders.**

 

None.

 

**PART II.**

 

**Item5.  Market for Registrant’s CommonEquity and Related Stockholder Matters.**

 

The information required herein, to the extent applicable, isincorporated by reference from page 47 of the Company’s 2002 Annual Report toStockholders (“2002 Annual Report”).

 

**Item6.  Selected Financial Data****.**

 

The information required herein is incorporated by reference from pages4 and 5 of the 2002 Annual Report.

 

**Item7.  Management’s Discussion and Analysisof Financial Condition and Results of Operations.**

 

The information required herein is incorporated by reference from pages7 to 18 of the 2002 Annual Report.

 

**Item 7A.Quantitative and Qualitative Disclosure about Market Risk****.**

 

The information required herein is incorporated by reference from pages7 to 9 of the 2002 Annual Report.

 

**Item8.  Financial Statements andSupplementary Data.**

 

The information required herein is incorporated by reference from page6 and pages 19 to 45 of the 2002 Annual Report.

 

**Item9.  Changes in and Disagreements withAccountants on Accounting and Financial Disclosure.**

 

Not Applicable.

 

**PART III.**

 

**Item10.  Directors and Executive Officers ofthe Registrant.**

 

The information required herein is incorporated by reference from pages3 to 5 of the definitive proxy statement of the Company for the Annual Meetingof Stockholders to be held on April 30, 2003 (“Definitive Proxy Statement”).

 

**Item11.  Executive Compensation.**

 

The information required herein is incorporated by reference from pages10 to 14 of the Definitive Proxy Statement.

 

**Item12.  Security Ownership of CertainBeneficial Owners and Management and Related Stockholder Matters.**

 

The information required herein is incorporated by reference from pages6 to 9 of the Definitive Proxy Statement.

 

**Item13.  Certain Relationships and RelatedTransactions.**

 

The information required herein is incorporated by reference from page13 of the Definitive Proxy Statement.

 

27

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**PART IV.**

 

**Item 14.Controls and Procedures**

 

Within 90 days prior to the date of thisAnnual Report on Form 10-K, the Company carried out an evaluation, under thesupervision and with the participation of the Company’s management, includingthe Company’s Chief Executive Officer and Chief Financial Officer, of theeffectiveness of the design and operation of the Company’s disclosure controlsand procedures.  Based upon thatevaluation, the Chief Executive Officer and Chief Financial Officer concludedthat the Company’s disclosure controls and procedures are effective.  There were no significant changes in theCompany’s internal controls or in other factors that could significantly affectthese controls subsequent to the date of their evaluation.

 

Disclosure controls and procedures are thecontrols and other procedures of the Company that are designed to ensure thatthe information required to be disclosed by the Company in its reports filed orsubmitted under the Securities Exchange Act of 1934, as amended (“ExchangeAct”) is recorded, processed, summarized and reported, within the time periodsspecified in the Securities and Exchange Commission’s rules and forms.  Disclosure controls and procedures include,without limitation, controls and procedures designed to ensure that informationrequired to be disclosed by the Company in its reports filed under the ExchangeAct is accumulated and communicated to the Company’s management, including theprincipal executive officer and principal financial officer, as appropriate toallow timely decisions regarding required disclosure.

 

**Item 15.Exhibits, Financial Statement Schedules and Reports on Form 8-K.**

 

**(a)  DocumentsFiled as Part of this Report**

 

(1) The following financial statements are incorporated by referencefrom Item 8 hereof (see Exhibit 13):

 

Independent Auditors’ Report

ConsolidatedStatements of Financial Condition at December 31, 2002 and 2001

Consolidated Statements ofIncome for the years ended December 31, 2002, 2001, and 2000

ConsolidatedStatements of Changes in Stockholders’ Equity for the years ended December 31,2002, 2001, and 2000.

ConsolidatedStatements of Cash Flows for the years ended December 31, 2002, 2001, and 2000.

Notes to ConsolidatedFinancial Statements.

 

(2) All schedules for which provision is made in the applicableaccounting regulation of the SEC are omitted because of the absence ofconditions under which they are required or because the required information isincluded in the financial statements and related notes thereto.

 

(3) The following exhibits are filed as part of this Form 10-K and thislist includes the Exhibit Index.

 

28

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ExhibitIndex

 
| 2.1*  |   | Plan of Conversion                                                                                                              |
|-------|--------|---------------------------------------------------------------------------------------------------------------------------------|
| 3.1*  |   | Articles of Incorporation  of First Federal Bancshares of Arkansas, Inc.                                                        |
| 3.2*  |   | Bylaws of First Federal Bancshares  of Arkansas, Inc.                                                                           |
| 4.0** |   | Stock Certificate of First  Federal Bancshares of Arkansas, Inc.                                                                |
| 10.6* |   | Employment Agreement  between the Company, the Bank and Larry J. Brandt                                                         |
| 10.7  |   | Employment Agreement  between the Company, the Bank and Tommy W. Richardson                                                     |
| 10.8  |   | Employment Agreement  between the Company, the Bank and Sherri R. Billings                                                      |
| 13.0  |   | 2002 Annual Report to  Stockholders                                                                                             |
| 21.0  |   | Subsidiaries of the  Registrant - Reference is made to “Item 1 Business - Subsidiaries” for the  required information |
| 99.1  |   | Section 906 Certification  of the CEO                                                                                           |
| 99.2  |   | Section 906 Certification  of the CFO                                                                                           |

 

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(*)   Incorporated herein by reference from theCompany’s Registration Statement on Form S-1 (File No. 333-612) filed with theSEC.

 

(**)  Incorporated herein by reference from theCompany’s Registration Statement on Form 8-A filed with the SEC.

 

29

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**SIGNATURES**

 

Pursuant to the requirements of Section 13 or 15(d) of the SecuritiesExchange Act of 1934, the Registrant has duly caused this report to be signedon its behalf by the undersigned, thereunto duly authorized.

 

 
|   | FIRST FEDERAL BANCSHARES  OF ARKANSAS, INC. |
|--------|---------------------------------------------|
|   |                                        |
|   | By:                                         | /s/ Larry J. Brandt |   |
|   | Larry J. Brandt                             |
|   | President and Chief  Executive Officer      |
|        |                                             |  |  |  |

 

Pursuant to the requirements of the Securities Exchange Act of 1934,this report has been signed below by the following persons on behalf of theRegistrant and in the capacities and on the dates indicated.

 
| /s/ Larry J. Brandt                                     |   | March  21, 2003 |
|---------------------------------------------------------|--------|-----------------|
| Larry J. Brandt                                         |   |
| President  and Chief   Executive Officer                |   |
|                                                    |   |
|                                                    |   |
| /s/ John P. Hammerschmidt                               |   | March  21, 2003 |
| John P. Hammerschmidt                                   |   |
| Chairman                                                |   |
|                                                    |   |
|                                                    |   |
| /s/ James D. Heuer                                      |   | March  21, 2003 |
| James D. Heuer                                          |   |
| Director                                                |   |
|                                                    |   |
|                                                    |   |
| /s/ Kenneth C. Savells                                  |   | March  21, 2003 |
| Kenneth C. Savells                                      |   |
| Director                                                |   |
|                                                    |   |
|                                                    |   |
| /s/ Jeffrey L. Brandt                                   |   | March  21, 2003 |
| Jeffrey L. Brandt                                       |   |
| Director                                                |   |
|                                                    |   |
|                                                    |   |
| /s/ Sherri R. Billings                                  |   | March  21, 2003 |
| Sherri R. Billings                                      |   |
| Executive  Vice President and   Chief Financial Officer |   |

 

30

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**SECTION 302CERTIFICATION OF THE CHIEF EXECUTIVE OFFICER**

** **

I, Larry J. Brandt, the ChiefExecutive Officer of First Federal Bancshares of Arkansas, Inc., certify that:

 

1.  I have reviewed this annualreport on Form 10-K of First Federal Bancshares of Arkansas, Inc.;

 

2. Based on my knowledge, this annual report does not contain any untruestatement of a material fact or omit to state a material fact necessary to makethe statements made, in light of the circumstances under which such statementswere made, not misleading with respect to the period covered by this annualreport;

 

3. Based on my knowledge, the financial statements, and other financialinformation included in this annual report, fairly present in all materialrespects the financial condition, results of operations and cash flows of theregistrant as of, and for, the periods presented in this annual report;

 

4. The registrant’s other certifying officers and I are responsible forestablishing and maintaining disclosure controls and procedures (as defined inExchange Act Rules 13a-14 and 15d-14) for the registrant and we have:

 

a)              designedsuch disclosure controls and procedures to ensure that material informationrelating to the registrant, including its consolidated subsidiaries, is madeknown to us by others within those entities, particularly during the period inwhich this annual report is being prepared;

 

b)             evaluatedthe effectiveness of the registrant’s disclosure controls and procedures as ofa date within 90 days prior to the filing date of this annual report (the“Evaluation Date”); and

 

c)              presentedin this annual report our conclusions about the effectiveness of the disclosurecontrols and procedures based on our evaluation as of the Evaluation Date;

 

5. The registrant’s other certifying officers and I have disclosed, basedon our most recent evaluation, to the registrant’s auditors and the auditcommittee of registrant’s board of directors (or persons performing theequivalent functions):

 

a)              allsignificant deficiencies in the design or operation of internal controls whichcould adversely affect the registrant’s ability to record, process, summarizeand report financial data and have identified for the registrant’s auditors anymaterial weaknesses in internal controls; and

 

b)             anyfraud, whether or not material, that involves management or other employees whohave a significant role in the registrant’s internal controls; and

 

6. The registrant’s other certifying officers and I have indicated in thisannual report whether or not there were significant changes in internalcontrols or in other factors that could significantly affect internal controlssubsequent to the date of our most recent evaluation, including any correctiveactions with regard to significant deficiencies and material weaknesses.

 
| Date:  March 21, 2003 | /s/ Larry J.  Brandt     |   |
|----------------------------|--------------------------|--------|
|                       | Larry J.  Brandt         |
|                       | Chief  Executive Officer |

 

31

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**SECTION 302CERTIFICATION OF CHIEF FINANCIAL OFFICER**

 

I, Sherri R. Billings, theChief Financial Officer of First Federal Bancshares of Arkansas, Inc.**,**certifythat:

 

1.  I have reviewed this annual report on Form 10-K of First FederalBancshares of Arkansas, Inc.;

 

2. Based on my knowledge, this annual report does not contain any untruestatement of a material fact or omit to state a material fact necessary to makethe statements made, in light of the circumstances under which such statementswere made, not misleading with respect to the period covered by this annualreport;

 

3. Based on my knowledge, the financial statements, and other financialinformation included in this annual report, fairly present in all materialrespects the financial condition, results of operations and cash flows of theregistrant as of, and for, the periods presented in this annual report;

 

4. The registrant’s other certifying officers and I are responsible forestablishing and maintaining disclosure controls and procedures (as defined inExchange Act Rules 13a-14 and 15d-14) for the registrant and we have:

 

a)                          designedsuch disclosure controls and procedures to ensure that material informationrelating to the registrant, including its consolidated subsidiaries, is madeknown to us by others within those entities, particularly during the period inwhich this annual report is being prepared;

 

b)                         evaluatedthe effectiveness of the registrant’s disclosure controls and procedures as ofa date within 90 days prior to the filing date of this annual report (the“Evaluation Date”); and

 

c)                          presentedin this annual report our conclusions about the effectiveness of the disclosurecontrols and procedures based on our evaluation as of the Evaluation Date;

 

5. The registrant’s other certifying officers and I have disclosed, basedon our most recent evaluation, to the registrant’s auditors and the auditcommittee of registrant’s board of directors (or persons performing theequivalent functions):

 

a)                    allsignificant deficiencies in the design or operation of internal controls whichcould adversely affect the registrant’s ability to record, process, summarizeand report financial data and have identified for the registrant’s auditors anymaterial weaknesses in internal controls; and

 

b)                   anyfraud, whether or not material, that involves management or other employees whohave a significant role in the registrant’s internal controls; and

 

6. The registrant’s other certifying officers and I have indicated in thisannual report whether or not there were significant changes in internalcontrols or in other factors that could significantly affect internal controlssubsequent to the date of our most recent evaluation, including any correctiveactions with regard to significant deficiencies and material weaknesses.

 
| Date: March  21, 2003 | /s/ Sherri  R. Billings  |   |
|-----------------------|--------------------------|--------|
|                  | Sherri R.  Billings      |
|                  | Chief  Financial Officer |

 

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