**EXHIBIT 13**

 

**FIRST FEDERAL BANCSHARESOF ARKANSAS, INC.**

 

 

**2002**

 

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**AnnualReport**

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**TABLE OFCONTENTS**

 
| President’s Letter to Stockholders                                                     |
|---------------------------------------------------------------------------------------------|
|                                                                                        |
| Corporate Profile                                                                           |
|                                                                                        |
| Selected Consolidated Financial and Other  Data                                             |
|                                                                                        |
| Selected Quarterly Operating Results                                                        |
|                                                                                        |
| Management’s Discussion and Analysis of  Financial Condition and Results of Operations |
|                                                                                        |
| Independent Auditors’ Report                                                           |
|                                                                                        |
| Consolidated Financial Statements                                                           |
|                                                                                        |
| Directors  and Executive Officers                                                           |
|                                                                                        |
| Banking Locations                                                                           |
|                                                                                        |
| Stockholder Information                                                                     |

 

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| ****  | **FIRS**T FEDERALBANCSHARES*of Arkansas, Inc.* |
|------------|------------------------------------------------|

 

DearStockholder:

 

I am very pleased to reportthat 2002 was the most profitable year in our 68 year history.  Our $7.8 million of net income after taxesyielded $2.77 diluted earnings per share, which represents a 42% increase innet income and a 58% increase in diluted earnings per share compared to2001.  The record earnings were attributedprimarily to increased net interest income and noninterest income.  A complete analysis of our financial resultsis contained in the subsequent pages of this report.

 

We continued to be an activebuyer of our stock throughout the year as evidenced by our repurchase of385,500 shares.  We continue to believeour stock is an exceptional value as market prices remain at levels near bookvalue.  Along with our record earnings,we increased our quarterly cash dividend 18% above the previous year dividend.

 

We also had a record year forloan production, originating over $225 million in mortgage loans and over $74million in installment loans.  The saleof long-term fixed-rate mortgages on the secondary market also contributedsubstantially to our noninterest income. Our deposits continue to grow, increasing almost $13 million over theprevious year, with the majority of this growth in checking accounts.

 

In April 2002, we held groundbreaking ceremonies for our new Northtown office and corporate headquarters,which is scheduled for a June 2003 opening. To continue to provide superior customer service in our market area, weopened a new regional loan center in Fayetteville during May 2002 and completedan extensive renovation of our Bentonville regional office in October.  Further expansion in Northwest Arkansas isin progress, with an additional location in Bentonville currently underconstruction. Other potential expansion opportunities are being activelypursued as well.

 

America is still in a waragainst terrorism.  We continue tosalute our Armed Forces and the sacrifices they make to defend ourfreedoms.  Our prayers are with them andtheir families during this time of international crisis.

 

In closing, we appreciate yourconfidence and continued support as stockholders of First Federal Bank ofArkansas.  We pledge to continue to doour best to ensure we are “the financial institution of choice.”

 

 
|   | Sincerely,                            |
|--------|---------------------------------------|
|   |                                  |
|   | /s/ Larry J. Brandt                   |   |
|   |                                  |
|   | Larry J. Brandt                       |
|   | President and Chief Executive Officer |

 

1

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**CORPORATE PROFILE**

 

First Federal Bancshares ofArkansas, Inc. (the “Company”) was incorporated in January 1996 under Texas lawfor the purpose of acquiring all of the capital stock issued by First FederalBank of Arkansas, FA (“First Federal” or the “Bank”) in connection with itsconversion from a federally chartered mutual savings and loan association to afederally chartered stock savings and loan association (the “Conversion”).  The Conversion was consummated on May 3,1996 and, as a result, the Company became a unitary savings and loan holdingcompany of the Bank.  The Company has nosignificant assets other than the shares of the Bank’s common stock acquired inthe Conversion, the Company’s loan to the Employee Stock Ownership Plan (“ESOP”)and the portion of the net Conversion proceeds retained and invested by theCompany.  The Company has no significantliabilities.

 

The Bank is a federallychartered stock savings and loan association which was formed in 1934.  First Federal conducts business from itsmain office and thirteen full service branch offices, all of which are locatedin a six county area in Northcentral and Northwest Arkansas comprised ofBenton, Marion, Washington, Carroll, Baxter and Boone counties.  First Federal’s deposits are insured by theSavings Association Insurance Fund (“SAIF”), which is administered by theFederal Deposit Insurance Corporation (“FDIC”), to the maximum extent permittedby law.  The Bank is a communityoriented savings institution which has traditionally offered a wide variety ofsavings products to its retail customers while concentrating its lendingactivities on the origination of loans secured by real estate.  The Bank’s activities also includeorigination of commercial loans and consumer loans.  In addition, the Bank maintains a significant portfolio ofinvestment securities.

 

At December 31, 2002, theCompany had total assets of $679.9 million, total deposits of $568.8 millionand stockholders’ equity of $69.3 million. The Company’s and the Bank’s principal executive offices are located at200 West Stephenson, Harrison, Arkansas 72601, and their telephone numberis (870) 741-7641.

 

2

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**SELECTED CONSOLIDATEDFINANCIAL AND OTHER DATA**

 

The selected consolidated financial and otherdata of the Company set forth below and on the following page does not purportto be complete and should be read in conjunction with, and is qualified in itsentirety by, the more detailed information, including the Consolidated FinancialStatements and related Notes, appearing elsewhere herein.

 
|                                                |   | **At  or For the  Year Ended December 31,** |    |
|-----------------------------------------------------|--------|---------------------------------------------|---------|
|                                                |   | **2002**                                    |    | **2001** |   | **2000** |   | **1999** |   | **1998** |   |
|                                                |   | **(In  Thousands, Except Per Share Data)**  |    |
|                                                |   |                                        |    |   |   |   |   |   |   |   |   |
| **Selected Financial  Condition Data:**             |   |                                        |    |   |   |   |   |   |   |   |   |
| Total assets                                        |   | $                                           | 679,896 |   | $ | 680,255 |   | $ | 713,902 |   | $ | 680,719 |   | $ | 615,055 |   |
| Cash and cash equivalents                           |   | 44,493                                      |    | 72,326 |   | 11,564 |   | 9,983 |   | 26,163 |   |
| Investment securities                               |   | 114,471                                     |    | 100,878 |   | 184,310 |   | 189,263 |   | 127,175 |   |
| Loans receivable, net                               |   | 483,468                                     |    | 474,494 |   | 498,305 |   | 459,978 |   | 442,486 |   |
| Allowance for loan losses                           |   | 1,529                                       |    | 923 |   | 691 |   | 752 |   | 771 |   |
| Deposits                                            |   | 568,762                                     |    | 555,933 |   | 540,327 |   | 507,875 |   | 481,093 |   |
| Federal Home Loan Bank advances                     |   | 38,610                                      |    | 47,844 |   | 93,359 |   | 83,972 |   | 48,985 |   |
| Stockholders’ equity                           |   | 69,266                                      |    | 71,065 |   | 76,622 |   | 78,815 |   | 81,023 |   |
|                                                |   |                                        |    |   |   |   |   |   |   |   |   |
| **Selected Operating  Data:**                       |   |                                        |    |   |   |   |   |   |   |   |   |
| Interest income                                     |   | $                                           | 44,094  |   | $ | 50,152 |   | $ | 51,982 |   | $ | 47,066 |   | $ | 43,814 |   |
| Interest expense                                    |   | 21,633                                      |    | 31,862 |   | 33,243 |   | 27,799 |   | 25,774 |   |
| Net interest income                                 |   | 22,461                                      |    | 18,290 |   | 18,739 |   | 19,267 |   | 18,040 |   |
| Provision for loan losses                           |   | 1,500                                       |    | 452 |   | — |   | 20 |   | 55 |   |
| Net interest income after provision for loan losses |   | 20,961                                      |    | 17,838 |   | 18,739 |   | 19,247 |   | 17,985 |   |
| Noninterest income                                  |   | 5,346                                       |    | 3,745 |   | 1,998 |   | 1,776 |   | 1,836 |   |
| Noninterest expense                                 |   | 14,524                                      |    | 13,596 |   | 12,398 |   | 11,594 |   | 10,482 |   |
| Income before income taxes                          |   | 11,783                                      |    | 7,987 |   | 8,339 |   | 9,429 |   | 9,339 |   |
| Provision for income taxes                          |   | 4,005                                       |    | 2,527 |   | 2,747 |   | 3,149 |   | 3,309 |   |
| Net income                                          |   | $                                           | 7,778   |   | $ | 5,460 |   | $ | 5,592 |   | $ | 6,280 |   | $ | 6,030 |   |
|                                                |   |                                        |    |   |   |   |   |   |   |   |   |
| **Earnings per Share:**                             |   |                                        |    |   |   |   |   |   |   |   |   |
| Basic                                               |   | $                                           | 2.87    |   | $ | 1.76 |   | $ | 1.60 |   | $ | 1.57 |   | $ | 1.35 |   |
| Diluted                                             |   | 2.77                                        |    | 1.75 |   | 1.60 |   | 1.57 |   | 1.33 |   |
|                                                |   |                                        |    |   |   |   |   |   |   |   |   |
| **Cash Dividends  Declared per Share**              |   | $                                           | 0.52    |   | $ | 0.44 |   | $ | 0.40 |   | $ | 0.32 |   | $ | 0.28 |   |

 

3

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|                                                                              |   | **At or For the Year Ended December 31,** |   |
|-----------------------------------------------------------------------------------|--------|-------------------------------------------|--------|
|                                                                              |   | **2002**                                  |   | **2001** |   | **2000** |   | **1999** |   | **1998** |   |
| **Selected Operating  Ratios(1):**                                                |   |                                      |   |   |   |   |   |   |   |   |   |
| Return on average assets                                                          |   | 1.14                                      | %      | .79 | % | .80 | % | .97 | % | 1.04 | % |
| Return on average equity                                                          |   | 11.01                                     |   | 7.36 |   | 7.21 |   | 7.84 |   | 7.22 |   |
| Average equity to average assets                                                  |   | 10.39                                     |   | 10.74 |   | 11.07 |   | 12.41 |   | 14.36 |   |
| Interest rate spread(2)                                                           |   | 3.30                                      |   | 2.35 |   | 2.29 |   | 2.59 |   | 2.55 |   |
| Net interest margin(2)                                                            |   | 3.50                                      |   | 2.76 |   | 2.77 |   | 3.10 |   | 3.20 |   |
| Net interest income after provision  for  loan losses to noninterest expense |   | 144.32                                    |   | 131.20 |   | 151.14 |   | 166.02 |   | 171.58 |   |
| Noninterest expense to average  assets                                            |   | 2.14                                      |   | 1.97 |   | 1.77 |   | 1.80 |   | 1.80 |   |
| Average interest-earning assets to  average interest-bearing liabilities     |   | 106.10                                    |   | 108.61 |   | 109.77 |   | 111.21 |   | 114.20 |   |
| Operating efficiency(3)                                                           |   | 52.23                                     |   | 61.70 |   | 59.79 |   | 55.15 |   | 52.74 |   |
|                                                                              |   |                                      |   |   |   |   |   |   |   |   |   |
| **Asset Quality  Ratios(4):**                                                     |   |                                      |   |   |   |   |   |   |   |   |   |
| Nonaccrual and restructured loans to  total loans(5)                              |   | 1.37                                      |   | 0.64 |   | 0.32 |   | 0.28 |   | 0.32 |   |
| Nonperforming assets to total  assets(5)                                          |   | 1.07                                      |   | 0.53 |   | 0.27 |   | 0.78 |   | 0.93 |   |
| Allowance for loan losses to non-  performing loans(5)                            |   | 22.01                                     |   | 29.71 |   | 41.96 |   | 55.82 |   | 52.65 |   |
| Allowance for loan losses to total  loans                                         |   | 0.30                                      |   | 0.19 |   | 0.14 |   | 0.16 |   | 0.17 |   |
|                                                                              |   |                                      |   |   |   |   |   |   |   |   |   |
| **Capital Ratios(6):**                                                            |   |                                      |   |   |   |   |   |   |   |   |   |
| Tangible capital to adjusted total  assets                                        |   | 9.78                                      |   | 9.79 |   | 10.37 |   | 11.09 |   | 11.67 |   |
| Core capital to adjusted total  assets                                            |   | 9.78                                      |   | 9.79 |   | 10.37 |   | 11.09 |   | 11.67 |   |
| Risk-based capital to risk-weighted  assets                                  |   | 17.03                                     |   | 17.29 |   | 19.69 |   | 21.52 |   | 22.44 |   |
|                                                                              |   |                                      |   |   |   |   |   |   |   |   |   |
| **Other Data:**                                                                   |   |                                      |   |   |   |   |   |   |   |   |   |
| Dividend payout ratio(7)                                                          |   | 18.91                                     |   | 26.33 |   | 26.39 |   | 21.66 |   | 22.11 |   |
| Full service offices at end  of period                                            |   | 14                                        |   | 14 |   | 14 |   | 13 |   | 12 |   |
|                                                                                   |        |                                           |        |  |  |  |  |  |  |  |  |  |

 

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(1)                                  Ratios arebased on average daily balances.

 

(2)                                  Interestrate spread represents the difference between the weighted average yield onaverage interest-earning assets and the weighted average cost of averageinterest-bearing liabilities, and net interest margin represents net interestincome as a percent of average interest-earning assets.

 

(3)                                  Noninterestexpense to net interest income plus noninterest income.

 

(4)                                  Assetquality ratios are end of period ratios.

 

(5)                                  Nonperforming assets consist ofnonperforming loans and real estate owned (“REO”).  Nonperforming loans consist of nonaccrual loans and restructured loans whileREO consists of real estate acquired in settlement of loans.

 

(6)                                  Capitalratios are end of period ratios for First Federal Bank.

 

(7)                                  Dividendpayout ratio is the total dividends declared divided by net income.

 

4

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**SELECTED QUARTERLY OPERATING RESULTS**

(INTHOUSANDS, EXCEPT SHARE AND PER SHARE DATA)

 
| **YEAR ENDED DECEMBER 31, 2002**                     |   | **FOURTH********QUARTER** |   | **THIRD********QUARTER** |   | **SECOND********QUARTER** |   | **FIRST********QUARTER** |   |
|------------------------------------------------------|--------|---------------------------|--------|--------------------------|--------|---------------------------|--------|--------------------------|--------|
| Interest income                                      |   | $                         | 10,678 |                     | $      | 11,070                    |   | $                        | 11,142 |   | $ | 11,204 |   |
| Interest expense                                     |   | 4,757                     |   | 5,122                    |   | 5,708                     |   | 6,046                    |   |
| Net interest income                                  |   | 5,921                     |   | 5,948                    |   | 5,434                     |   | 5,158                    |   |
| Provision for loan losses                            |   | 518                       |   | 247                      |   | 373                       |   | 362                      |   |
| Net interest income after provision for  loan losses |   | 5,403                     |   | 5,701                    |   | 5,061                     |   | 4,796                    |   |
| Noninterest income                                   |   | 1,477                     |   | 1,323                    |   | 1,259                     |   | 1,287                    |   |
| Noninterest expense                                  |   | 3,920                     |   | 3,617                    |   | 3,570                     |   | 3,417                    |   |
| Income before income taxes                           |   | 2,960                     |   | 3,407                    |   | 2,750                     |   | 2,666                    |   |
| Provision for income taxes                           |   | 996                       |   | 1,183                    |   | 916                       |   | 910                      |   |
| Net income                                           |   | $                         | 1,964  |                     | $      | 2,224                     |   | $                        | 1,834  |   | $ | 1,756 |   |
| Earnings per share(1):                               |   |                      |   |                     |   |                      |   |                     |   |
| Basic                                                |   | $                         | 0.76   |                     | $      | 0.84                      |   | $                        | 0.66   |   | $ | 0.61 |   |
| Diluted                                              |   | $                         | 0.72   |                     | $      | 0.81                      |   | $                        | 0.64   |   | $ | 0.60 |   |
|                                                 |   |                      |   |                     |   |                      |   |                     |   |
| Selected Ratios (Annualized):                        |   |                      |   |                     |   |                      |   |                     |   |
| Net interest margin                                  |   | 3.73                      | %      | 3.73                     | %      | 3.35                      | %      | 3.21                     | %      |
| Return on average assets                             |   | 1.16                      |   | 1.32                     |   | 1.07                      |   | 1.03                     |   |
| Return on average equity                             |   | 11.33                     |   | 12.78                    |   | 10.26                     |   | 9.73                     |   |

 
| **YEAR ENDED DECEMBER 31, 2001**                     |   | **FOURT`H********QUARTER** |   | **THIRD********QUARTER** |   | **SECOND********QUARTER** |   | **FIRST********QUARTER** |   |
|------------------------------------------------------|--------|----------------------------|--------|--------------------------|--------|---------------------------|--------|--------------------------|--------|
| Interest income                                      |   | $                          | 11,781 |                     | $      | 12,412                    |   | $                        | 12,826 |   | $ | 13,133 |   |
| Interest expense                                     |   | 7,124                      |   | 7,747                    |   | 8,304                     |   | 8,687                    |   |
| Net interest income                                  |   | 4,657                      |   | 4,665                    |   | 4,522                     |   | 4,446                    |   |
| Provision for loan losses                            |   | 289                        |   | 102                      |   | 52                        |   | 9                        |   |
| Net interest income after provision for  loan losses |   | 4,368                      |   | 4,563                    |   | 4,470                     |   | 4,437                    |   |
| Noninterest income                                   |   | 1,287                      |   | 927                      |   | 856                       |   | 675                      |   |
| Noninterest expense                                  |   | 3,319                      |   | 3,146                    |   | 3,735                     |   | 3,396                    |   |
| Income before income taxes                           |   | 2,336                      |   | 2,344                    |   | 1,591                     |   | 1,716                    |   |
| Provision for income taxes                           |   | 698                        |   | 727                      |   | 529                       |   | 573                      |   |
| Net income                                           |   | $                          | 1,638  |                     | $      | 1,617                     |   | $                        | 1,062  |   | $ | 1,143 |   |
| Earnings per share(1):                               |   |                       |   |                     |   |                      |   |                     |   |
| Basic                                                |   | $                          | 0.56   |                     | $      | 0.52                      |   | $                        | 0.33   |   | $ | 0.35 |   |
| Diluted                                              |   | $                          | 0.55   |                     | $      | 0.52                      |   | $                        | 0.33   |   | $ | 0.35 |   |
|                                                 |   |                       |   |                     |   |                      |   |                     |   |
| Selected Ratios (Annualized):                        |   |                       |   |                     |   |                      |   |                     |   |
| Net interest margin                                  |   | 2.87                       | %      | 2.86                     | %      | 2.70                      | %      | 2.61                     | %      |
| Return on average assets                             |   | 0.96                       |   | 0.95                     |   | 0.61                      |   | 0.65                     |   |
| Return on average equity                             |   | 9.09                       |   | 8.74                     |   | 5.69                      |   | 6.03                     |   |

 

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(1)  Basicand Diluted Shares Outstanding

 
| **YEAR ENDED DECEMBER 31, 2002**  |   | **FOURTH********QUARTER** |   | **THIRD********QUARTER** |   | **SECOND********QUARTER** |   | **FIRST********QUARTER** |   |
|-----------------------------------|--------|---------------------------|--------|--------------------------|--------|---------------------------|--------|--------------------------|--------|
| Basic weighted - average shares   |   | 2,559,364                 |   | 2,635,219                |   | 2,776,650                 |   | 2,858,994                |   |
| Effect of dilutive securities     |   | 109,992                   |   | 110,849                  |   | 106,737                   |   | 85,263                   |   |
| Diluted weighted - average shares |   | 2,669,356                 |   | 2,746,068                |   | 2,883,387                 |   | 2,944,257                |   |
|                              |   |                      |   |                     |   |                      |   |                     |   |
| YEAR ENDED DECEMBER 31, 2001      |   |                      |   |                     |   |                      |   |                     |   |
| Basic weighted - average shares   |   | 2,928,472                 |   | 3,066,123                |   | 3,146,277                 |   | 3,254,571                |   |
| Effect of dilutive securities     |   | 48,165                    |   | 44,165                   |   | 11,383                    |   | 9,641                    |   |
| Diluted weighted - average shares |   | 2,976,637                 |   | 3,110,288                |   | 3,157,660                 |   | 3,264,212                |   |

 

5

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**MANAGEMENT’S DISCUSSION****AND ANALYSIS OF****FINANCIAL CONDITION AND RESULTS OF OPERATIONS**

 

**General**

 

Management’s discussion and analysis offinancial condition and results of operations is intended to assist inunderstanding the consolidated financial condition and results of operations ofthe Company.  The information containedin this section should be read in conjunction with the Consolidated FinancialStatements and the accompanying Notes to Consolidated Financial Statements andthe other sections contained in this Annual Report.

 

The Company’s results of operations dependprimarily on its net interest income, which is the difference between interestincome on interest-earning assets and interest expense on interest-bearingliabilities.  The Company’s results ofoperations also are affected by the provision for loan losses, the level of itsnoninterest income and expenses, and income tax expense.

 

**Asset and Liability Management**

 

The ability to maximize net interest incomeis largely dependent upon the achievement of a positive interest rate spreadthat can be sustained during fluctuations in prevailing interest rates.  Interest rate sensitivity is a measure ofthe difference between amounts of interest-earning assets and interest-bearingliabilities which either reprice or mature within a given period of time.  The difference, or the interest raterepricing “gap”, provides an indication of the extent to which an institution’sinterest rate spread will be affected by changes in interest rates.  A gap is considered positive when the amountof interest-rate sensitive assets exceeds the amount of interest-rate sensitiveliabilities, and is considered negative when the amount of interest-ratesensitive liabilities exceeds the amount of interest-rate sensitiveassets.  Generally, during a period ofrising interest rates, a negative gap within shorter maturities would adverselyaffect net interest income, while a positive gap within shorter maturitieswould result in an increase in net interest income, and during a period offalling interest rates, a negative gap within shorter maturities would resultin an increase in net interest income while a positive gap within shortermaturities would have the opposite effect. As of December 31, 2002, the Bank estimates that the ratio of itsone-year gap to total assets was a negative 17.9% and its ratio ofinterest-earning assets to interest-bearing liabilities maturing or repricingwithin one year was 71.1%.

 

The Bank focuses its lending activities onthe origination of one-, three-, five- and seven-year adjustable-rateresidential mortgage loans.  Althoughadjustable-rate loans involve certain risks, including increased payments andthe potential for default in an increasing interest rate environment, suchloans decrease the risks associated with changes in interest rates.  As of December 31, 2002, $191.8 million or 66.3%of the Bank’s portfolio of one- to four-family residential mortgage loansconsisted of ARMs, including $102.3 million in seven-year ARMs.

 

The Company’s investment securities portfolioamounted to $114.5 million or 16.8% of the Company’s total assets at December31, 2002.  Of such amount, $35.3 millionor 30.9% is contractually due within one year and $5.6 million or 4.9% iscontractually due after one year to five years.  However, actual maturities can be shorter than contractualmaturities due to the ability of borrowers to call or prepay such obligationswithout call or prepayment penalties. As of December 31, 2002, there was approximately $80 million ofinvestment securities at an average interest rate of 5.58% with call optionsheld by the issuer, of which approximately $68 million, at an average interestrate of 5.63%, are callable within one year. In the prevailing interest rate environment it is likely that asubstantial amount of the higher yielding securities will be called.  To the extent that these higher yieldingsecurities are called, the Company may reinvest such funds at prevailinginterest rates which may have a downward impact on the Company’s interest ratespread.

 

Deposits are the Bank’s primary fundingsource and the Bank prices its deposit accounts based upon competitive factorsand the availability of prudent lending and investment opportunities.  The Bank seeks to lengthen the maturities ofits deposits by soliciting longer term certificates of deposit when marketconditions have created opportunities to attract such deposits. However, theBank does not solicit high-rate jumbo certificates of deposit and does notpursue an aggressive growth strategy which would force the Bank to focusexclusively on competitors’ rates rather than deposit

 

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affordability.  At December 31, 2002 the Bank had $374.1 millionin certificates of deposit of which $207.6 million mature in one year orless.  In 2002, the Bank repaid itsFederal Home Loan Bank (“FHLB”) of Dallas advances upon maturity.  At December 31, 2002, the Bank had $38.6million of FHLB advances of which $19 million is due in one year or less.

### ** **

### **Net Portfolio Value**

 

The value of the Bank’s loan and investmentportfolio will change as interest rates change.  Rising interest rates will generally decrease the Bank’s netportfolio value (“NPV”), while falling interest rates will generally increasethe value of that portfolio.  NPV is thedifference between incoming and outgoing discounted cash flows from assets, liabilities,and off-balance sheet contracts.  Thefollowing tables set forth, quantitatively, as of December 31, 2002 and 2001,the Office of Thrift Supervision (“OTS”) estimate of the projected changes inNPV in the event of a 100, 200 and 300 basis point instantaneous and permanentincrease and a 100 basis point instantaneous and permanent decrease in marketinterest rates.  Due to the current lowprevailing interest rate environment the changes in NPV are not estimated for adecrease in interest rates of 200 or 300 basis points.

 
| **2002**                                      |   |
|-----------------------------------------------|--------|
| **Change in  Interest Rates  (basis points)** |   | **Estimated NPV** |   | **Estimated NPV as a  Percentage of********Present Value****o****f Assets** |   | **Amount********of Change** |   | **Percent********of Change** |   |
| **(Dollars in Thousands)**                    |   |
| +300                                          |   | 70,311 |   | 10.35 | % | $ | (16,750 | ) | (19 | )% |
| +200                                          |   | 77,180 |   | 11.15 |   | (9,881 | ) | (11 | ) |
| +100                                          |   | 83,239 |   | 11.82 |   | (3,822 | ) | (4 | ) |
| 0                                             |   | 87,061 |   | 12.19 |   | — |   | — |   |
| -100                                          |   | 87,588 |   | 12.14 |   | 527 |   | 1 |   |
|                                               |        |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 
| **2001**                                      |   |
|-----------------------------------------------|--------|
| **Change in  Interest Rates  (basis points)** |   | **Estimated NPV** |   | **Estimated NPV as a  Percentage of********Present Value********of Assets** |   | **Amount********of Change** |   | **Percent********of Change** |   |
| **(Dollars in Thousands)**                    |   |
| +300                                          |   | 53,383 |   | 8.04 | % | $ | (34,922 | ) | (40 | )% |
| +200                                          |   | 65,331 |   | 9.62 |   | (22,974 | ) | (26 | ) |
| +100                                          |   | 77,354 |   | 11.12 |   | (10,951 | ) | (12 | ) |
| 0                                             |   | 88,305 |   | 12.43 |   | — |   | — |   |
| -100                                          |   | 93,459 |   | 12.98 |   | 5,154 |   | 6 |   |
|                                               |        |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

Computations of prospective effects ofhypothetical interest rate changes are calculated by the OTS from data providedby the Bank and are based on numerous assumptions, including relative levels ofmarket interest rates, loan repayments and deposit runoffs, and should not berelied upon as indicative of actual results. Further, the computations do not contemplate any actions the Bank mayundertake in response to changes in interest rates.

 

7

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Management cannot predict future interestrates or their effect on the Bank’s NPV. Certain shortcomings are inherent in the method of analysis presented inthe computation of NPV.  For example,although certain assets and liabilities may have similar maturities or periodsto repricing, they may react in differing degrees to changes in market interestrates.  Additionally, certain assets,such as adjustable-rate loans, have features that restrict changes in interestrates during the initial term and over the remaining life of the asset.  In addition, the proportion ofadjustable-rate loans in the Bank’s portfolio could decrease in future periodsdue to refinancing activity if market rates decrease.  Further, in the event of a change in interest rates, prepaymentand early withdrawal levels could deviate significantly from those assumed inthe table.  Finally, the ability of manyborrowers to service their adjustable-rate debt may decrease in the event of aninterest rate increase.

 

### **Critical AccountingPolicies**

 

Various elements of our accounting policies,by their nature, are inherently subject to estimation techniques, valuationassumptions and other subjective assessments. In particular, the methodology for the determination of our allowancefor loan losses, due to the judgments, estimates and assumptions inherent inthat policy, is critical to preparation of our financial statements.  This policy and the judgments, estimates andassumptions are described in greater detail in subsequent sections ofManagement’s Discussion and Analysis and in the notes to the financialstatements included herein.  Inparticular, Note 1 to the Consolidated Financial Statements - “Summary ofSignificant Accounting Policies” describes generally our accountingpolicies.  We believe that the judgments,estimates and assumptions used in the preparation of our Consolidated FinancialStatements are appropriate given the factual circumstances at the time.  However, given the sensitivity of ourConsolidated Financial Statements to this critical accounting policy, the useof other judgments, estimates and assumptions could result in materialdifferences in our results of operations or financial condition.

 

**Changes in Financial Condition**

 

**General.**  At December 31, 2002, the Company’s totalassets amounted to $679.9 million as compared to $680.3 million at December 31,2001.  The $359,000 or .05% decrease wasprimarily due to a decrease of  $27.8million or 38.5% in cash and cash equivalents, offset by an increase of $13.6million in investment securities, a $9 million increase in loans receivable,and a $3.7 million increase in office properties and equipment.  The increase in office properties andequipment was primarily due to the new corporate headquarters building underconstruction in north Harrison.  Liabilitiesincreased $1.4 million or .24% to $610.6 million at December 31, 2002 comparedto $609.2 million at December 31, 2001. The increase in liabilities was primarily due to an increase of $12.8million or 2.3% in deposits, which was partially offset by a decrease of $9.2million or 19.3% in advances from the FHLB of Dallas.   Stockholders’ equity amounted to $69.3 million or 10.2% of totalassets at December 31, 2002 compared to $71.1 million or 10.5% of total assetsat December 31, 2001.

 

Other assets at December 31, 2002 and 2001,includes $16.3 million and $15.4 million, respectively, of bank-owned lifeinsurance. These amounts are comprised of the cash surrender value of wholelife insurance policies on the lives of certain key employees with the Bank asthe sole beneficiary.  The policies areheld with three different insurance companies, whose most recent Standard &Poor’s ratings were A+, AA, and AA+, respectively.

 

Nonperforming assets, consisting of nonaccrualand restructured loans and repossessed assets, amounted to $7.3 million or 1.07%of total assets at December 31, 2002, compared to $3.6 million, or .53% oftotal assets at December 31, 2001.   Suchincrease was primarily due to an increase in restructured loans related to asingle commercial relationship.

 

**Loans Receivable.**  Net loans receivable increased by $9million, or 1.9%, to $483.5 million at December 31, 2002 from $474.5million at December 31, 2001.  The increasein net loans receivable was composed mainly of increases in commercial realestate loans of  $19.7 million, constructionloans, net of undisbursed funds, of  $13.8million, consumer loans of $10.8 million, and commercial loans of $4.8million.  Such increases were partiallyoffset by a decrease in single-family residential loans of $41.7 million.   In recent years, the Bank has placed anincreased

 

8

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emphasison commercial real estate lending, construction lending, commercial lending andconsumer lending to diversify its loan portfolio, increase the average yield onits loan portfolio, expand its operations and provide greater opportunities tocross-sell its products.

 

Unearned loan fees at December 31, 2002amounted to $1.3 million, down from $2.1 million at December 31, 2001.These unearned fees are recognized as an adjustment to yield over thecontractual lives of the related loans.   The decrease in unearned loan fees is due mainly to the decreasein single-family residential loans, to which most of these fees relate.

 

**Allowance for Loan Losses.**  The allowance for loan losses was $1.5million at December 31, 2002, compared to $923,000 at December 31, 2001.  There was an increase of $440,000 in lossallowances on loans individually reviewed for impairment.  The remaining increase of $166,000 resultedfrom the increase in loan balances, as well as an increase in the loss factorsused for single-family residential, commercial and unsecured loans.  Management compared the loan portfolio’s lossexperience ratios from year to year and adjusted the ratios to reflect currentloss experience.

 

The allowance for loan losses is evaluated ona regular basis by management and is based upon management’s periodic review ofthe collectibility of the loans in light of historical experience, the natureand volume of the loan portfolio, adverse situations that may affect theborrower’s ability to repay, estimated value of any underlying collateral andprevailing economic conditions.  Thisevaluation is inherently subjective as it requires estimates that aresusceptible to significant revision as conditions change and more informationbecomes available.

 

The Bank reviews its non-homogeneous loansfor impairment on a quarterly basis. The Bank considers commercial real estate, construction, multi-family,other non-residential real estate, and commercial loans to be non-homogeneousloans.  A loan is considered impairedwhen, based on current information and events, it is probable that the Bankwill be unable to collect the scheduled payments of principal or interest whendue according to the contractual terms of the loan agreement.  Factors considered by management indetermining impairment include payment status, collateral value, and theprobability of collecting scheduled principal and interest payments whendue.  Loans that experienceinsignificant payment delays and payment shortfalls generally are notclassified as impaired.  Managementdetermines the significance of payment delays and payment shortfalls on acase-by-case basis, taking into consideration all of the circumstancessurrounding the loan and the borrower, including the length of the delay, thereasons for the delay, the borrower’s prior payment record, and the amount ofthe shortfall in relation to the principal and interest owed.  Impairment is measured on a loan by loanbasis by either the present value of expected future cash flows discounted atthe loan’s effective interest rate, the loan’s obtainable market price, or thefair value of the collateral if the loan is collateral dependent.

 

Large groups of smaller balance homogeneousloans are collectively evaluated for impairment.  Accordingly, the Bank does not separately identify individualconsumer and residential loans for impairment disclosures.  Homogeneous loans are those that areconsidered to have common characteristics that provide for evaluation on anaggregate or pool basis.  The Bankconsiders the characteristics of (1) one- to four family residential firstmortgage loans; (2) unsecured consumer loans; and (3) collateralized consumerloans to permit consideration of the appropriateness of the allowance forlosses of each group of loans on a pool basis. The primary methodology used to determine the appropriateness of theallowance for losses includes segregating certain specific, poorly performingloans based on their performance characteristics from the pools of loans as totype, grading these loans, and then applying a loss factor to the remainingpool balance based on several factors including past loss experience, inherentrisks, economic conditions in the primary market areas, and other factors whichusually are beyond the control of the Bank.

 

In estimating the amount of credit lossesinherent in our loan portfolio, various judgments and assumptions aremade.  For example, when assessing thecondition of the overall economic environment, assumptions are made regardingfuture market conditions and their impact on the loan portfolio.  In the event the national economy were tosustain a prolonged downturn, the loss factors applied to our portfolios mayneed to be revised, which may significantly impact the measurement of theallowance for loan losses.  For impairedloans that are collateral-dependent, the estimated fair value of the collateralmay deviate significantly from the proceeds received when the collateral issold.

 

9

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Although we consider the allowance for loanlosses of $1.5 million adequate to cover losses inherent in our loan portfolioat December 31, 2002, no assurance can be given that we will not sustain loanlosses that are significantly different from the amount reserved, or thatsubsequent evaluations of the loan portfolio, in light of factors thenprevailing, would not result in a significant change in the allowance for loanlosses.

 

**Investment Securities.**  Investment securities, all of which wereclassified as held to maturity, amounted to $114.5 million as of December 31,2002 compared to $100.9 million as of December 31, 2001.  During 2002, investment securities totaling$148.1 million were purchased and $134.5 million matured or were called,resulting in a net increase of $13.6 million or 13.5%.  In 2002, the Company began purchasingcertificates of deposit from the FHLB of Dallas and at year end held $40.3 millionof such securities.  In addition,municipal securities increased approximately $3.2 million and government agencyobligations decreased approximately $30 million between December 31, 2001 andDecember 31, 2002.

 

**Deposits.**  Deposits at December 31, 2002 amounted to $568.8million, an increase of $12.8 million or 2.3% from the December 31, 2001balance of $555.9 million.  The Bankdoes not advertise for deposits outside of its primary market area,Northcentral and Northwest Arkansas, or utilize the services of depositbrokers.  In the fourth quarter of 2001,the Bank began offering Bounce ProtectionTM and continued toemphasize this program in 2002.  Thisprogram allows customers in good standing to overdraw their checking account upto defined limits.  Customers haveaccess to additional funds while providing the Bank additional feerevenue.  The Bank also experienced achange in the mix of deposits due to the current low interest rateenvironment.  Certificates of depositdecreased $44.1 million while money market and demand deposit accountsincreased $44.9 million and $11 million, respectively.

 

**Borrowed Funds.**  Borrowed funds, which consist entirely ofFHLB of Dallas advances, decreased by $9.2 million or 19.3% to $38.6 million atDecember 31, 2002 from $47.8 million at December 31, 2001.  The FHLB of Dallas advances are being repaidupon maturity.

 

**Stockholders’ Equity.**  Stockholders’ equity decreased $1.8 millionto $69.3 million at December 31, 2002 from $71.1 million at December 31, 2001.The decrease in stockholders’ equity was primarily due to the purchase oftreasury stock totaling $9.5 million during 2002.  In addition, during the twelve months ended December 31, 2002cash dividends aggregating $1.5 million were paid.  Such decreases in stockholders’ equity were partially offset bynet income in the amount of $7.8 million for the year ended December 31, 2002.

 

10

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**Average Balance Sheets**

 

The following table sets forth certain information relating to theCompany’s average balance sheets and reflects the average yield on assets andaverage cost of liabilities for the periods indicated and the yields earned andrates paid at December 31, 2002.  Suchyields and costs are derived by dividing income or expense by the averagebalance of assets or liabilities, respectively, for the periods presented andoutstanding balances at December 31, 2002. Average balances are based on daily balances during the period.

 
|                                                                  |   | **December 31,**           |   | **Year Ended December 31,** |    |
|-----------------------------------------------------------------------|--------|----------------------------|--------|-----------------------------|---------|
|                                                                  |   | **2002**                   |   | **2002**                    |    | **2001** |   | **2000** |   |
|                                                                  |   | **Yield/********Cost**     |   | **Average********Balance**  |    | **Interest** |   | **Average********Yield/********Cost** |   | **Average********Balance** |   | **Interest** |   | **Average********Yield/********Cost** |   | **Average********Balance** |   | **Interest** |   | **Average********Yield/********Cost** |   |
|                                                                  |   | **(Dollars in Thousands)** |   |
|                                                                  |   |                       |   |
| Interest-earning assets:                                              |   |                       |   |                        |    |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Loans receivable(1)                                                   |   | 7.43                       | %      | $                           | 481,330 |   | $ | 36,859 |   | 7.66 | % | $ | 488,942 |   | $ | 39,678 |   | 8.12 | % | $ | 481,112 |   | $ | 38,403 |   | 7.98 | % |
| Investment securities(2)                                              |   | 4.60                       |   | 111,189                     |    | 6,450 |   | 5.80 |   | 144,457 |   | 9,561 |   | 6.62 |   | 194,454 |   | 13,479 |   | 6.93 |   |
| Other interest-earning assets                                         |   | 1.13                       |   | 48,839                      |    | 785 |   | 1.61 |   | 29,457 |   | 913 |   | 3.10 |   | 1,641 |   | 100 |   | 6.07 |   |
| Total interest-earning assets                                         |   | 6.59                       |   | 641,358                     |    | 44,094 |   | 6.88 |   | 662,856 |   | 50,152 |   | 7.57 |   | 677,207 |   | 51,982 |   | 7.68 |   |
| Noninterest-earning assets                                            |   |                       |   | 38,336                      |    |   |   |   |   | 27,662 |   |   |   |   |   | 23,175 |   |   |   |   |   |
| Total assets                                                          |   |                       |   | $                           | 679,694 |   |   |   |   |   | $ | 690,518 |   |   |   |   |   | $ | 700,382 |   |   |   |   |   |
| Interest-bearing liabilities:                                         |   |                       |   |                        |    |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Deposits                                                              |   | 2.99                       |   | $                           | 566,047 |   | 19,446 |   | 3.44 |   | $ | 543,919 |   | 27,497 |   | 5.06 |   | $ | 528,921 |   | 27,659 |   | 5.23 |   |
| Other borrowings                                                      |   | 3.86                       |   | 38,434                      |    | 2,187 |   | 5.69 |   | 66,409 |   | 4,365 |   | 6.57 |   | 87,999 |   | 5,584 |   | 6.35 |   |
| Total interest-bearing liabilities                                    |   | 3.05                       |   | 604,481                     |    | 21,633 |   | 3.58 |   | 610,328 |   | 31,862 |   | 5.22 |   | 616,920 |   | 33,243 |   | 5.39 |   |
| Noninterest-bearing liabilities                                       |   |                       |   | 4,562                       |    |   |   |   |   | 6,033 |   |   |   |   |   | 5,923 |   |   |   |   |   |
| Total liabilities                                                     |   |                       |   | 609,043                     |    |   |   |   |   | 616,361 |   |   |   |   |   | 622,843 |   |   |   |   |   |
| Stockholders’ equity                                             |   |                       |   | 70,651                      |    |   |   |   |   | 74,157 |   |   |   |   |   | 77,539 |   |   |   |   |   |
| Total liabilities and stockholders’  equity                      |   |                       |   | $                           | 679,694 |   |   |   |   |   | $ | 690,518 |   |   |   |   |   | $ | 700,382 |   |   |   |   |   |
|                                                                  |   |                       |   |                        |    |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Net interest income                                                   |   |                       |   |                        |    | $ | 22,461 |   |   |   |   |   | $ | 18,290 |   |   |   |   |   | $ | 18,739 |   |   |   |
| Net earning assets                                                    |   |                       |   | $                           | 36,877  |   |   |   |   |   | $ | 52,528 |   |   |   |   |   | $ | 60,287 |   |   |   |   |   |
| Interest rate spread                                                  |   | 3.54                       | %      |                        |    |   |   | 3.30 | % |   |   |   |   | 2.35 | % |   |   |   |   | 2.29 | % |
| Net interest margin                                                   |   |                       |   |                        |    |   |   | 3.50 | % |   |   |   |   | 2.76 | % |   |   |   |   | 2.77 | % |
| Ratio of interest-earning assets to interest-bearing liabilities |   |                       |   |                        |    |   |   | 106.10 | % |   |   |   |   | 108.61 | % |   |   |   |   | 109.77 | % |

 

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(1)  Includes nonaccrual loans.

(2)  Includes FHLB of Dallas stock.

 

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## **Rate/Volume Analysis**

 

The table below sets forth certain information regarding changes ininterest income and interest expense of the Company for the periodsindicated.  For each category ofinterest-earning assets and interest-bearing liabilities, information isprovided on changes attributable to (i) changes in volume (changes in averagevolume multiplied by prior rate); (ii) changes in rate (change in ratemultiplied by prior average volume); (iii) changes in rate-volume (changes inrate multiplied by the change in average volume); and (iv) the net change.

 
|                               |   | **Year  Ended December 31,**          |   |
|------------------------------------|--------|---------------------------------------|--------|
|                               |   | **2002  vs. 2001**                    |   | **2001  vs. 2000** |   |
|                               |   | **Increase (Decrease)********Due to** |   | **Total********Increase********(Decrease)** |   | **Increase (Decrease)********Due to** |   | **Total********Increase****(Decrease)** |   |
|                               |   | **Volume**                            |   | **Rate** |   | **Rate/********Volume** |   | **Volume** |   | **Rate** |   | **Rate/********Volume** |   |   |
|                               |   | **(In  Thousands)**                   |   |
| Interest Income:                   |   |                                  |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Loans receivable                   |   | $                                     | (618   | ) | $ | (2,236 | ) | $ | 35 |   | $ | (2,819 | ) | $ | 625 |   | $ | 639 |   | $ | 11 |   | $ | 1,275 |   |
| Investment securities              |   | (2,202                                | )      | (1,181 | ) | 272 |   | (3,111 | ) | (3,466 | ) | (609 | ) | 157 |   | (3,918 | ) |
| Other interest-earning assets      |   | 601                                   |   | (440 | ) | (289 | ) | (128 | ) | 1,688 |   | (49 | ) | (826 | ) | 813 |   |
| Total interest-earning assets      |   | (2,219                                | )      | (3,857 | ) | 18 |   | (6,058 | ) | (1,153 | ) | (19 | ) | (658 | ) | (1,830 | ) |
|                               |   |                                  |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest expense:                  |   |                                  |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Deposits                           |   | 1,119                                 |   | (8,811 | ) | (359 | ) | (8,051 | ) | 784 |   | (920 | ) | (26 | ) | (162 | ) |
| Other borrowings                   |   | (1,839                                | )      | (586 | ) | 247 |   | (2,178 | ) | (1,370 | ) | 200 |   | (49 | ) | (1,219 | ) |
| Total interest-bearing liabilities |   | (720                                  | )      | (9,397 | ) | (112 | ) | (10,229 | ) | (586 | ) | (720 | ) | (75 | ) | (1,381 | ) |
| Net change in net interest income  |   | $                                     | (1,499 | ) | $ | 5,540 |   | $ | 130 |   | $ | 4,171 |   | $ | (567 | ) | $ | 701 |   | $ | (583 | ) | $ | (449 | ) |

 

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**Comparison of Results of Operations for the Years EndedDecember 31, 2002 and 2001.**

 

**General. **The Company reported net income of $7.8million for the year ended December 31, 2002 compared to $5.5 millionfor the same period in 2001.  Theincrease of $2.3 million or 42.5% in net income in 2002 compared to 2001 wasprimarily due to an increase in net interest income and noninterest income,offset somewhat by an increase in the provision for loan losses, an increase innoninterest expenses and an increase in the provision for income taxes.

 

**Net Interest Income. **Net interest income is determined by theCompany’s interest rate spread (i.e., the difference between the yields earnedon its interest-earning assets and the rates paid on its interest-bearingliabilities) and the relative amounts of interest-earning assets andinterest-bearing liabilities.  TheCompany’s net interest income amounted to $22.5 million in 2002, an increase of$4.2 million or 22.8% compared to $18.3 million for 2001.  The Company’s interest rate spread increasedto 3.30% for 2002 from 2.35% for 2001. The Company’s net interest margin also increased, from 2.76% in 2001 to3.50% in 2002.

 

**Interest Income. **Interest income amounted to $44.1 million forthe year ended December 31, 2002 compared to $50.2 million for the sameperiod in 2001.  The decrease of $6.1million or 12.1% was primarily due to a decrease in the average balance and inthe average yield earned on loans and investment securities.  Such decrease in interest income waspartially offset by an increase in the average balance of otherinterest-earning assets, primarily overnight interest bearing cashaccounts.    The decrease in the averagebalance of loans was primarily due to a portion of one- to four- familymortgage originations being sold in the secondary market.  The decrease in the average balance ofinvestment securities held to maturity was primarily the result of the call ofgovernment agency bonds.  The decreasein the average yield earned on loans and investment securities was primarilydue to the declining level of interest rates in 2002.  The increase in the balance of overnight interest bearing fundswas primarily due to the proceeds from callable government agency securitiesbeing placed in overnight funds.

 

**Interest Expense. **Interest expense decreased $10.2 million or32.1% to $21.6 million for the year ended December 31, 2002 compared to$31.9 million for the same period in 2001. Such decrease was primarily due to a decrease in the average rate paidon deposit accounts and FHLB advances and a decrease in the average balance ofFHLB advances.  Such decreases werepartially offset by an increase in the average balance of deposits.  The decrease in the average interest ratepaid on deposits was primarily the result of maturing certificates and variableinterest bearing deposits being repriced to lower interest rates.  The average balance of FHLB advancesdecreased due to the use of investment securities proceeds to repay advances.  The average rate on advances repaid was 6.4%and the average rate on new advances was 2.6% during 2002, which contributed tothe reduction in the average rate paid on FHLB advances from 2001 to 2002.

 

**Provision for Loan Losses.** Provisions for loan losses amounted to $1.5 million for 2002 compared to$452,000 for 2001.  Provisions for loanlosses include charges to reduce the recorded balance of loans to theirestimated fair value.  Such provisionand the adequacy of the allowance for loan losses is evaluated quarterly bymanagement of the Bank based on the Bank’s past loan loss experience, known andinherent risks in the portfolio, adverse situations that may affect theborrower’s ability to repay, the estimated value of any underlying collateraland current economic conditions. Factors influencing management’s decision to increase the provisioninclude an increase in loss experience during 2002, an increase in the overallrisk of the loan portfolio due to an increase in commercial real estate,construction, commercial and consumer loans, an increase in nonaccrual andrestructured loans, and general economic conditions.  The aforementioned loan types are generally considered to entailadditional risks as compared to single-family lending due to, among other factors,supply and demand and, in some respects, rapidly depreciating assets, such asautomobiles.

 

**Noninterest Income. **Noninterest income amounted to $5.3 millionfor the year ended December 31, 2002 compared to $3.7 million for thesame period in 2001.  The increase of$1.6 million or 42.8% was due primarily to an increase of $981,000 in depositfee income and an increase of $508,000 in life insurance earnings.  Deposit fee income increased as a result ofthe Bank’s continued promotion of Bounce ProtectionTM that was introduced by the Bank in the

 

13

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fourth quarter of 2001.  Life insurance earnings increased due to afull year of earnings in 2002 compared to a partial year in 2001 as the lifeinsurance was purchased beginning in June 2001.

 

**Noninterest Expense. **Noninterest expenses increased $928,000 or6.8% to $14.5 million for the year ended December 31, 2002 compared to $13.6million for the year ended December 31, 2001. Such increase in noninterest expenses during 2002 was primarily due to increasesin salaries and employee benefits, data processing expenses, net occupancyexpense, advertising and public relations expense, and professional fees.  Such increase in salaries and employeebenefits was due to an increase in personnel, normal salary and meritincreases, and related payroll taxes and insurance totaling approximately$449,000, an increase in the employee stock ownership plan expense of $170,000due to the increase in the Company’s average stock price, and an increase inthe multiemployer pension plan contribution of $108,000.  Such increases in salaries and employeebenefits were partially offset by a decline of $298,000 in the managementrecognition and retention plan expense as a result of the awarded shares beingfully vested in May 2001.  Suchincreases were further offset by the nonrecurring death benefit recognized in2001 of $352,000 in connection with the death of the Company’s former ChiefExecutive Officer in 2001.  There was nosuch expense in 2002.  The increase indata processing expense of $202,000 was due primarily to an upgrade of theBank’s wide area network, increased ATM volume, and growth in electronicbanking services.  The increase in netoccupancy expense of $161,000 was primarily due to an increase in depreciationexpense on buildings and equipment of $101,000.  This increase in depreciation was due to a change in the usefullife of some of the Bank’s computers, as well as a general increase in officeproperties and equipment related to the overall growth of the Bank.  Advertising and public relations expenseincreased $107,000, primarily due to growth and increased advertisingrates.  The increase in professionalfees can be broken down into increased legal fees of $69,000 and increasedaccounting and auditing fees of $51,000. The increase in legal fees was primarily due to increased legal feesrelated to foreclosures and the impact of the implementation of variousrequirements of the Sarbanes-Oxley Act of 2002.  Sarbanes-Oxley also affected the level of audit fees.

 

**Income Taxes. **Income taxes amounted to $4 million and $2.5million for the years ended December 31, 2002 and December 31, 2001,respectively, resulting in effective tax rates of 34.0% and 31.6%,respectively.  The increase in incometax expense was primarily due to an increase in taxable income.  The increase in the effective rate resultedprimarily from the Company being in a taxable position for state taxes during2002 but not in 2001.

 

**Comparison of Results of Operations for the Years EndedDecember 31, 2001 and 2000.**

 

**General. **The Company reported net income of $5.5million for the year ended December 31, 2001 compared to $5.6 millionfor the same period in 2000.  Thedecrease of $132,000 or 2.4% in net income in 2001 compared to 2000 was due toa decrease in net interest income, an increase in the provision for loan lossesand an increase in noninterest expenses which were partially offset by adecrease in income taxes and an increase in noninterest income.

 

**Net Interest Income. **Net interest income is determined by theCompany’s interest rate spread (i.e., the difference between the yields earnedon its interest-earning assets and the rates paid on its interest-bearingliabilities) and the relative amounts of interest-earning assets and interest-bearingliabilities.  The Company’s net interestincome amounted to $18.3 million in 2001, a decrease of $449,000 or 2.4%compared to $18.7 million for 2000.  TheCompany’s interest rate spread increased to 2.35% for 2001 from 2.29% for2000.  The Company’s net interest marginremained relatively stable at 2.76% for 2001 compared to 2.77% for 2000.

 

**Interest Income. **Interest income amounted to $50.2 million forthe year ended December 31, 2001 compared to $52.0 million for the sameperiod in 2000.  The decrease of $1.8million or 3.5% was primarily due to a decrease in the average balance and inthe average yield earned on investment securities.  Such decrease in interest income was partially offset by anincrease in the average balance of other interest-earning assets, primarilyovernight interest bearing cash accounts. The average balance of loans receivable increased as well as the averageyield earned on such assets.

 

14

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**Interest Expense. **Interest expense decreased $1.4 million or4.2% to $31.9 million for the year ended December 31, 2001 compared to$33.3 million for the same period in 2000. Such decrease was primarily due to a decrease in the average balance ofFHLB of Dallas advances, as well as a decrease in the average rate paid ondeposit accounts.  Such decreases werepartially offset by an increase in the average balance of deposits.

 

**Provision for Loan Losses.** Provisions for loan losses amounted to $452,000 for 2001.   No provisions for loan losses were made in2000.  Provisions for loan lossesinclude charges to reduce the recorded balance of loans to their estimated fairvalue.  Such provision and the adequacyof the allowance for loan losses is evaluated quarterly by management of theBank based on the Bank’s past loan loss experience, known and inherent risks inthe portfolio, adverse situations that may affect the borrower’s ability torepay, the estimated value of any underlying collateral and current economicconditions.  The reasons for theincrease in 2001 compared to 2000 were primarily due to an increase innonperforming loans, economic conditions, and an increase in commercial andconsumer loans.

 

**Noninterest Income. **Noninterest income amounted to $3.7 millionfor the year ended December 31, 2001 compared to $2.0 million for thesame period in 2000.  The increase of$1.7 million or 87.4% was due primarily to an increase of $659,000 from $89,000to $748,000 in gain on the sale of mortgage loans in the secondary mortgagemarket, an increase of $119,000 from $36,000 to $155,000 on additional loanfees related to loan sales, an increase of $306,000 or 28.2% from $1.1 millionto $1.4 million in deposit fee income, an increase of $373,000 in earnings onbank owned life insurance purchased in 2001, an increase of $92,000 from$86,000 to $178,000 in loan related insurance commissions and a decline in theloss recognized from the operations of foreclosed property from a loss of$111,000 for 2000 to none in 2001.

 

**Noninterest Expense. **Noninterest expenses increased $1.2 millionor 9.7% to $13.6 million for the year ended December 31, 2001 compared to $12.4million for the year ended December 31, 2000. Such increase in noninterest expenses during 2001 was primarily due toincreases in salaries and employee benefits, data processing expenses, postageand supplies, net occupancy expense, advertising expense and to a nonrecurringexpense.  Salaries and employeebenefits, excluding the nonrecurring death benefit of $352,000 as explainedbelow, amounted to $8.1 million compared to $7.9 million resulting in anincrease of $241,000 or 3.10% for the years ended December 31, 2001 and 2000,respectively.  Such increase in salariesand employee benefits was due to an increase in personnel, normal salary andmerit increases, and to an increase in the employee stock ownership planexpense due to the increase in the Company’s average stock price.  A nonrecurring expense was incurred in theamount of $352,000 for a death benefit payable pursuant to the employment contractof the Bank’s Chief Executive Officer and Chairman of the Board as a result ofhis death in May 2001.  Such increase insalaries and employee benefits was partially offset by a decline of $473,000 inthe management recognition and retention plan expense from $771,000 for theyear ended 2000 to $298,000 for the year ended 2001 as a result of the awardedshares being fully vested.  There willbe no comparable expense for 2002.  Dataprocessing expense increased $184,000 or 20.0% from $921,000 to $1.1 millionbetween 2000 and 2001, respectively. The increase in data processing expense was primarily due to growth inelectronic banking services.  Postageand supplies amounted to $546,000 compared to $479,000 or an increase of$67,000 for the twelve month periods ended December 31, 2001 and 2000,respectively.  Advertising expenseincreased $43,000 or 14.2% from $300,000 to $343,000 between 2000 and 2001,respectively.  The increase inadvertising expense was primarily due to growth and increased advertisingrates.

 

**Income Taxes. **Income taxes amounted to $2.5 million and$2.7 million for the years ended December 31, 2001 and December 31, 2000,respectively, resulting in effective tax rates of 31.6% and 32.9%,respectively.

 

**Liquidity and Capital Resources**

 

The Bank’s liquidity, represented by cash andcash equivalents and eligible investment securities, is a product of itsoperating, investing and financing activities. The Bank’s primary sources of funds are deposits, collections onoutstanding loans, maturities and calls of investment securities and othershort-term investments and funds provided from operations.  While scheduled loan amortization andmaturing investment securities and short-term investments are

 

15

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relativelypredictable sources of funds, deposit flows and loan prepayments are greatlyinfluenced by general interest rates, economic conditions and competition.  The Bank manages the pricing of its depositsto maintain a steady deposit balance.  Inaddition, the Bank invests excess funds in overnight deposits and othershort-term interest-earning assets which provide liquidity to meet lendingrequirements.  The Bank has generallybeen able to generate enough cash through the retail deposit market, itstraditional funding source, to offset the cash utilized in investingactivities.  As an additional source offunds, the Bank has borrowed from the FHLB of Dallas.  At December 31, 2002, the Bank had outstanding advances from theFHLB of Dallas of $38.6 million.  Suchadvances were used in the Bank’s normal operating and investing activities.

 

Liquidity management is both a daily andlong-term function of business management. Excess liquidity is generally invested in short-term investments such asovernight deposits and certificates of deposit.  On a longer-term basis, the Bank maintains a strategy ofinvesting in various lending products.  The Bank uses its sources of funds primarily to meet its ongoingcommitments, to pay maturing savings certificates and savings withdrawals, torepay maturing FHLB of Dallas advances, and to fund loan commitments.  At December 31, 2002, the totalapproved mortgage loan origination commitments outstanding, excluding theundisbursed portion of construction loans, amounted to $18 million.  At the same date, the undisbursed portion ofconstruction loans approximated $21 million. The Bank’s unused lines of credit at December 31, 2002 wereapproximately $11 million.  Certificatesof deposit scheduled to mature in one year or less at December 31, 2002 totaled$208 million.   Management believes thata significant portion of maturing deposits will remain with the Bank. FHLB ofDallas advances scheduled to mature within one year at December 31, 2002totaled $19 million.  Investmentsecurities scheduled to mature in one year or less at December 31, 2002,totaled approximately $35 million. However, actual maturities can be shorter than contractual maturitiesdue to the ability of borrowers to call or prepay such obligations without callor prepayment penalties.  As of December 31,2002, there was approximately $68 million of investment securities with calloptions held by the issuer exercisable within one year.

 

The Bank began construction in May 2002 of anew corporate and full-service branch office in north Harrison.  Construction is expected to be completed inthe spring of 2003.  Capitalexpenditures are estimated to be $6.9 million with disbursements occurringthroughout the period of construction. As of December 31, 2002, $3.0 million had been disbursed for theconstruction of the new office.

 

As of December 31, 2002, the Bank’sregulatory capital was in excess of all applicable regulatoryrequirements.  At December 31, 2002, theBank’s tangible, core and risk-based capital ratios amounted to 9.78%, 9.78%and 17.03%, respectively, compared to regulatory requirements of 1.5%, 4.0% and8.0%, respectively.

 

**Impact of Inflation and Changing Prices**

 

The financialstatements and related financial data presented herein have been prepared inaccordance with generally accepted accounting principles, which require themeasurement of financial position and operating results in terms of historicaldollars, without considering changes in relative purchasing power over time dueto inflation.

 

Unlike most industrial companies, virtuallyall of the Bank’s assets and liabilities are monetary in nature.  As a result, interest rates generally have amore significant impact on a financial institution’s performance than does theeffect of inflation.

 

16

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**Forward-Looking Statements**

 

TheCompany’s Annual Report to Stockholders contains certain forward-lookingstatements and information relating to the Company that are based on thebeliefs of management as well as assumptions made by and information currentlyavailable to management.  In addition,in this document, the words “anticipate”, “believe,” “estimate,”****“expect,” “intend,” “should” and similarexpressions, or the negative thereof, as they relate to the Company or theCompany’s management, are intended to identify forward-looking statements.  Such statements reflect the current views ofthe Company with respect to future looking events and are subject to certainrisks, uncertainties and assumptions.  Should one or more of these risks or uncertainties materialize orshould underlying assumptions prove incorrect, actual results may varymaterially from those described herein as anticipated, believed, estimated, expectedor intended.  The Company does notintend to update these forward-looking statements.

 

17

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***First Federal Bancshares of Arkansas, Inc.***

 

Consolidated Statements ofFinancial Condition as of December 31, 2002 and 2001, and Consolidated Statementsof Income, Stockholders’ Equity, and Cash Flows for Each of the Three Years inthe Period Ended December 31, 2002, and Independent Auditors’ Report

 

18

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**INDEPENDENTAUDITORS’ REPORT**

 

The Board of Directors ofFirst Federal Bancshares of Arkansas, Inc.:

 

We have audited theaccompanying consolidated statements of financial condition of First FederalBancshares of Arkansas, Inc. and its subsidiary (the “Company”) as of December31, 2002 and 2001, and the related consolidated statements of income,stockholders’ equity, and cash flows for each of the three years in the periodended December 31, 2002.  Thesefinancial statements are the responsibility of the Company’s management.  Our responsibility is to express an opinionon these financial statements based on our audits.

 

We conducted our audits inaccordance with auditing standards generally accepted in the United States ofAmerica.  Those standards require thatwe plan and perform the audit to obtain reasonable assurance about whether thefinancial statements are free of material misstatement.  An audit includes examining, on a testbasis, evidence supporting the amounts and disclosures in the financialstatements.  An audit also includesassessing the accounting principles used and significant estimates made bymanagement, as well as evaluating the overall financial statementpresentation.  We believe that ouraudits provide a reasonable basis for our opinion.

 

In our opinion, suchconsolidated financial statements present fairly, in all material respects, thefinancial position of First Federal Bancshares of Arkansas, Inc. and itssubsidiary at December 31, 2002 and 2001, and the results of their operationsand their cash flows for each of the three years in the period ended December31, 2002, in conformity with accounting principles generally accepted in theUnited States of America.

 

 
| /s/ Deloitte & Touche LLP |   |
|-------------------------------|--------|
|                          |
| Little Rock,  Arkansas        |
| March 11,  2003               |

 

19

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**FIRSTFEDERAL BANCSHARES OF ARKANSAS, INC.**

 

**CONSOLIDATED STATEMENTSOF FINANCIAL CONDITION**

**DECEMBER31, 2002 AND 2001 (in thousands, except share data)**

 
|                                                                                                                                                                                                                                                   |   | **2002** |    | **2001** |   |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|----------|---------|----------|--------|
| **ASSETS**                                                                                                                                                                                                                                             |   |     |    |     |   |
| Cash and cash equivalents:                                                                                                                                                                                                                             |   |     |    |     |   |
| Cash and collection items                                                                                                                                                                                                                              |   | $        | 13,791  |     | $      | 11,184 |   |
| Interest-bearing deposits with banks                                                                                                                                                                                                                   |   | 30,702   |    | 61,127   |   |
|                                                                                                                                                                                                                                                   |   |     |    |     |   |
| Total cash and cash equivalents                                                                                                                                                                                                                        |   | 44,493   |    | 72,311   |   |
|                                                                                                                                                                                                                                                   |   |     |    |     |   |
| Investment securities -                                                                                                                                                                                                                                |   |     |    |     |   |
| Held to maturity, at amortized cost (fair value at December 31, 2002  and 2001, of $115,734 and $101,432, respectively)                                                                                                                                |   | 114,471  |    | 100,878  |   |
| Federal Home Loan Bank stock, at cost                                                                                                                                                                                                                  |   | 5,064    |    | 4,918    |   |
| Loans receivable, net of allowance at December 31, 2002 and 2001, of  $1,529 and $923, respectively                                                                                                                                                    |   | 483,468  |    | 474,494  |   |
| Accrued interest receivable                                                                                                                                                                                                                            |   | 4,380    |    | 4,420    |   |
| Real estate acquired in settlement of loans, net                                                                                                                                                                                                       |   | 320      |    | 455      |   |
| Office properties and equipment, net                                                                                                                                                                                                                   |   | 10,690   |    | 7,006    |   |
| Prepaid expenses and other assets                                                                                                                                                                                                                      |   | 17,010   |    | 15,773   |   |
|                                                                                                                                                                                                                                                   |   |     |    |     |   |
| TOTAL                                                                                                                                                                                                                                                  |   | $        | 679,896 |     | $      | 680,255 |   |
|                                                                                                                                                                                                                                                   |   |     |    |     |   |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                                                                                                                                                          |   |     |    |     |   |
|                                                                                                                                                                                                                                                   |   |     |    |     |   |
| LIABILITIES:                                                                                                                                                                                                                                           |   |     |    |     |   |
| Deposits:                                                                                                                                                                                                                                              |   |     |    |     |   |
| Interest-bearing                                                                                                                                                                                                                                       |   | $        | 545,872 |     | $      | 536,924 |   |
| Noninterest-bearing                                                                                                                                                                                                                                    |   | 22,890   |    | 19,009   |   |
|                                                                                                                                                                                                                                                   |   |     |    |     |   |
| Total deposits                                                                                                                                                                                                                                         |   | 568,762  |    | 555,933  |   |
|                                                                                                                                                                                                                                                   |   |     |    |     |   |
| Federal Home Loan Bank advances                                                                                                                                                                                                                        |   | 38,610   |    | 47,844   |   |
| Advance payments by borrowers for taxes and insurance                                                                                                                                                                                                  |   | 760      |    | 929      |   |
| Other liabilities                                                                                                                                                                                                                                      |   | 2,498    |    | 4,484    |   |
|                                                                                                                                                                                                                                                   |   |     |    |     |   |
| Total liabilities                                                                                                                                                                                                                                      |   | 610,630  |    | 609,190  |   |
|                                                                                                                                                                                                                                                   |   |     |    |     |   |
| STOCKHOLDERS’ EQUITY:                                                                                                                                                                                                                             |   |     |    |     |   |
| Preferred stock, no par value, 5,000,000 shares authorized, none  issued Common stock, $.01 par value, 20,000,000 shares authorized, 5,153,751  shares issued, 2,687,359 and 3,050,959 shares outstanding at December 31,  2002 and 2001, respectively |   | 52       |    | 52       |   |
| Additional paid-in capital                                                                                                                                                                                                                             |   | 52,040   |    | 51,434   |   |
| Employee stock benefit plans                                                                                                                                                                                                                           |   | (1,551   | )       | (1,967   | )      |
| Retained earnings - substantially restricted                                                                                                                                                                                                           |   | 67,043   |    | 60,736   |   |
|                                                                                                                                                                                                                                                   |   |     |    |     |   |
|                                                                                                                                                                                                                                                   |   | 117,584  |    | 110,255  |   |
| Treasury stock, at cost, 2,466,392 and 2,102,792 shares at December  31, 2002 and 2001, respectively                                                                                                                                                   |   | (48,318  | )       | (39190   | )      |
| Total Stockholders' equity                                                                                                                                                                                                                             |   | 69,266   |    | 71,065   |   |
| TOTAL                                                                                                                                                                                                                                                  |   | $        | 679,896 |     | $      | 680,255 |   |

 

See notes to consolidated financial statements.

 

20

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**FIRST FEDERAL BANCSHARES OF ARKANSAS, INC.**

 

**CONSOLIDATEDSTATEMENTS OF INCOMEYEARS ENDED DECEMBER 31, 2002, 2001, AND 2000(in thousands, except earnings per share)**

 
|                                                |   | **2002** |   | **2001** |   | **2000** |   |
|-----------------------------------------------------|--------|----------|--------|----------|--------|----------|--------|
| INTEREST INCOME:                                    |   |     |   |     |   |     |   |
| Loans receivable                                    |   | $        | 36,859 |     | $      | 39,678   |   | $ | 38,403 |   |
| Investment securities:                              |   |     |   |     |   |     |   |
| Taxable                                             |   | 6,143    |   | 9,363    |   | 13,306   |   |
| Nontaxable                                          |   | 307      |   | 198      |   | 173      |   |
| Other                                               |   | 785      |   | 913      |   | 100      |   |
| Total interest income                               |   | 44,094   |   | 50,152   |   | 51,982   |   |
| INTEREST EXPENSE:                                   |   |     |   |     |   |     |   |
| Deposits                                            |   | 19,446   |   | 27,497   |   | 27,659   |   |
| Federal Home Loan Bank advances                     |   | 2,187    |   | 4,365    |   | 5,584    |   |
|                                                |   |     |   |     |   |     |   |
| Total interest expense                              |   | 21,633   |   | 31,862   |   | 33,243   |   |
| NET INTEREST INCOME                                 |   | 22,461   |   | 18,290   |   | 18,739   |   |
| PROVISION FOR LOAN LOSSES                           |   | 1,500    |   | 452      |   | —   |   |
| NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES |   | 20,961   |   | 17,838   |   | 18,739   |   |
| NONINTEREST INCOME:                                 |   |     |   |     |   |     |   |
| Deposit fee income                                  |   | 2,375    |   | 1,394    |   | 1,087    |   |
| Earnings on life insurance policies                 |   | 881      |   | 373      |   | —   |   |
| Gain on sale of loans                               |   | 888      |   | 748      |   | 89       |   |
| Other                                               |   | 1,202    |   | 1,230    |   | 822      |   |
| Total noninterest income                            |   | 5,346    |   | 3,745    |   | 1,998    |   |
|                                                |   |     |   |     |   |     |   |
| NONINTEREST EXPENSES:                               |   |     |   |     |   |     |   |
| Salaries and employee benefits                      |   | 8,575    |   | 8,488    |   | 7,895    |   |
| Net occupancy expense                               |   | 1,297    |   | 1,136    |   | 1,087    |   |
| Data processing                                     |   | 1,307    |   | 1,105    |   | 921      |   |
| Professional fees                                   |   | 404      |   | 284      |   | 221      |   |
| Advertising and public relations                    |   | 596      |   | 489      |   | 403      |   |
| Postage and supplies                                |   | 531      |   | 546      |   | 479      |   |
| Other                                               |   | 1,814    |   | 1,548    |   | 1,392    |   |
| Total noninterest expenses                          |   | 14,524   |   | 13,596   |   | 12,398   |   |
|                                                |   |     |   |     |   |     |   |
| INCOME BEFORE INCOME TAXES                          |   | 11,783   |   | 7,987    |   | 8,339    |   |
| INCOME TAX PROVISION                                |   | 4,005    |   | 2,527    |   | 2,747    |   |
| NET INCOME                                          |   | $        | 7,778  |     | $      | 5,460    |   | $ | 5,592 |   |
|                                                |   |     |   |     |   |     |   |
| EARNINGS PER SHARE:                                 |   |     |   |     |   |     |   |
| Basic                                               |   | $        | 2.87   |     | $      | 1.76     |   | $ | 1.60 |   |
| Diluted                                             |   | $        | 2.77   |     | $      | 1.75     |   | $ | 1.60 |   |

 

See notes to consolidated financial statements.

 

21

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**FIRST FEDERAL BANCSHARES OF ARKANSAS, INC.**

 

**CONSOLIDATEDSTATEMENTS OF STOCKHOLDERS’ EQUITYYEARS ENDED DECEMBER 31, 2002, 2001, AND 2000 (in thousands, except share data)**

 
|                                   |   | **Issued  Common Stock** |   | **Additional  Paid-in  Capital** |   | **Employee  Stock  Benefit Plans** |   | **Retained  Earnings** |       | **Treasury Stock** |       | **Total  Stockholders'  Equity** |   |
|----------------------------------------|--------|--------------------------|--------|----------------------------------|--------|------------------------------------|--------|------------------------|------------|--------------------|------------|----------------------------------|--------|
|                                   |   | **Shares**               |   | **Amount**                       |   |                               |   |                   | **Shares** |               | **Amount** |                             |   |
| BALANCE, JANUARY 1, 2000               |   | 5,153,751                |   | $                                | 52     |                               | $      | 50,793                 |       | $                  | (3,867     | )                                | $      | 52,598 |   | 1,114,377 |   | $ | (20,761 | ) | $ | 78,815 |   |
|                                   |   |                     |   |                             |   |                               |   |                   |       |               |       |                             |   |   |   |   |   |
| Net income                             |   |                     |   |                             |   |                               |   |                   |       | 5,592              |       |                             |   |   |   | 5,592 |   |
| Release of ESOP shares                 |   |                     |   |                             |   | 259                                |   | 416                    |       |               |       |                             |   |   |   | 675 |   |
| Stock compensation expense             |   |                     |   |                             |   |                               |   | 771                    |       |               |       |                             |   |   |   | 771 |   |
| Tax effect of stock compensation plans |   |                     |   |                             |   | (7                                 | )      |                   |       |               |       |                             |   |   |   | (7 | ) |
| Purchase of treasury stock, at cost    |   |                     |   |                             |   |                               |   |                   |       |               |       | 485,393                          |   | (7,747 | ) | (7,747 | ) |
| Dividends paid                         |   |                     |   |                             |   |                               |   |                   |       | (1,477             | )          |                             |   |   |   | (1,477 | ) |
| BALANCE, DECEMBER 31, 2000             |   | 5,153,751                |   | 52                               |   | 51,045                             |   | (2,680                 | )          | 56,713             |       | 1,599,770                        |   | (28,508 | ) | 76,622 |   |
|                                   |   |                     |   |                             |   |                               |   |                   |       |               |       |                             |   |   |   |   |   |
| Net income                             |   |                     |   |                             |   |                               |   |                   |       | 5,460              |       |                             |   |   |   | 5,460 |   |
| Release of ESOP shares                 |   |                     |   |                             |   | 434                                |   | 416                    |       |               |       |                             |   |   |   | 850 |   |
| Stock compensation expense             |   |                     |   |                             |   |                               |   | 297                    |       |               |       |                             |   |   |   | 297 |   |
| Tax effect of stock compensation plans |   |                     |   |                             |   | (45                                | )      |                   |       |               |       |                             |   |   |   | (45 | ) |
| Purchase of treasury stock, at cost    |   |                     |   |                             |   |                               |   |                   |       |               |       | 503,022                          |   | (10,682 | ) | (10,682 | ) |
| Dividends paid                         |   |                     |   |                             |   |                               |   |                   |       | (1,437             | )          |                             |   |   |   | (1,437 | ) |
| BALANCE, DECEMBER 31, 2001             |   | 5,153,751                |   | 52                               |   | 51,434                             |   | (1,967                 | )          | 60,736             |       | 2,102,792                        |   | (39,190 | ) | 71,065 |   |
|                                   |   |                     |   |                             |   |                               |   |                   |       |               |       |                             |   |   |   |   |   |
| Net income                             |   |                     |   |                             |   |                               |   |                   |       | 7,778              |       |                             |   |   |   | 7,778 |   |
| Release of ESOP shares                 |   |                     |   |                             |   | 600                                |   | 416                    |       |               |       |                             |   |   |   | 1,016 |   |
| Stock options exercised                |   |                     |   |                             |   | 3                                  |   |                   |       |               |       | (21,900                          | )      | 419 |   | 422 |   |
| Tax effect of stock compensation plans |   |                     |   |                             |   | 3                                  |   |                   |       |               |       |                             |   |   |   | 3 |   |
| Purchase of treasury stock, at cost    |   |                     |   |                             |   |                               |   |                   |       |               |       | 385,500                          |   | (9,547 | ) | (9,547 | ) |
| Dividends paid                         |   |                     |   |                             |   |                               |   |                   |       | (1,471             | )          |                             |   |   |   | (1,471 | ) |
| BALANCE, DECEMBER 31, 2002             |   | 5,153,751                |   | $                                | 52     |                               | $      | 52,040                 |       | $                  | (1,551     | )                                | $      | 67,043 |   | 2,466,392 |   | $ | (48,318 | ) | $ | 69,266 |   |

 

See notes to consolidated financial statements.

 

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**FIRST FEDERAL BANCSHARES OF ARKANSAS, INC.**

** **

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

**YEARSENDED DECEMBER 31, 2002, 2001, AND 2000 (in thousands)**

 
|                                                                               |   | **2002** |   | **2001** |   | **2000** |   |
|------------------------------------------------------------------------------------|--------|----------|--------|----------|--------|----------|--------|
| OPERATING ACTIVITIES:                                                              |   |     |   |     |   |     |   |
| Net income                                                                         |   | $        | 7,778  |     | $      | 5,460    |   | $ | 5,592 |   |
| Adjustments to reconcile net income to net cash provided by operating  activities: |   |     |   |     |   |     |   |
| Provision for loan losses                                                          |   | 1,500    |   | 452      |   | —   |   |
| Provision for real estate losses                                                   |   | 16       |   | 8        |   | 14       |   |
| Deferred tax provision (benefit)                                                   |   | (80      | )      | 22       |   | 251      |   |
| Federal Home Loan Bank stock dividends                                             |   | (146     | )      | (206     | )      | (367     | )      |
| Gain on disposition of fixed assets                                                |   | (3       | )      | (27      | )      | —   |   |
| (Gain) loss on sale of repossessed assets, net                                     |   | 13       |   | 15       |   | (4       | )      |
| Originations of loans held for sale                                                |   | (69,631  | )      | (64,655  | )      | (8,847   | )      |
| Proceeds from sales of loans                                                       |   | 67,815   |   | 60,633   |   | 8,603    |   |
| Gain on sale of mortgage loans originated to sell                                  |   | (888     | )      | (748     | )      | (89      | )      |
| Depreciation                                                                       |   | 819      |   | 704      |   | 670      |   |
| Depreciation on real estate owned                                                  |   | —   |   | —   |   | 32       |   |
| Accretion of deferred loan fees, net                                               |   | (606     | )      | (673     | )      | (444     | )      |
| Release of ESOP shares                                                             |   | 1,016    |   | 850      |   | 675      |   |
| Earnings on life insurance policies                                                |   | (881     | )      | (373     | )      | —   |   |
| Stock compensation expense                                                         |   | —   |   | 297      |   | 771      |   |
| Changes in operating assets and liabilities:                                       |   |     |   |     |   |     |   |
| Accrued interest receivable                                                        |   | 40       |   | 2,490    |   | (933     | )      |
| Prepaid expenses and other assets                                                  |   | (350     | )      | (97      | )      | 224      |   |
| Other liabilities                                                                  |   | (1,891   | )      | (171     | )      | 113      |   |
|                                                                               |   |     |   |     |   |     |   |
| Net cash provided by operating activities                                          |   | 4,521    |   | 3,981    |   | 6,261    |   |
|                                                                               |   |     |   |     |   |     |   |
| INVESTING ACTIVITIES:                                                              |   |     |   |     |   |     |   |
| Purchases of investment securities - held to maturity                              |   | (148,115 | )      | (55,673  | )      | (11,020  | )      |
| Proceeds from maturities of investment securities - held to maturity               |   | 134,522  |   | 141,105  |   | 9,500    |   |
| Federal Home Loan Bank stock redeemed                                              |   | —   |   | 385      |   | —   |   |
| Purchase of bank owned life insurance                                              |   | —   |   | (15,000  | )      | —   |   |
| Loan originations, net of repayments                                               |   | (7,909   | )      | 28,081   |   | (36,789  | )      |
| Proceeds from sales of repossessed assets                                          |   | 833      |   | 472      |   | 2,923    |   |
| Proceeds from sales of office properties and equipment                             |   | 4        |   | 40       |   | —   |   |
| Purchases of office properties and equipment                                       |   | (4,504   | )      | (539     | )      | (1,029   | )      |
|                                                                               |   |     |   |     |   |     |   |
| Net cash provided by (used in) investing activities                                |   | (25,169  | )      | 98,871   |   | (36,415  | )      |
| FINANCING ACTIVITIES:                                                              |   |     |   |     |   |     |   |
| Net increase in deposits                                                           |   | $        | 12,829 |     | $      | 15,606   |   | $ | 32,452 |   |
| Advances from Federal Home Loan Bank                                               |   | 26,000   |   | 2,450    |   | 155,075  |   |
| Repayment of advances from Federal  Home Loan Bank                                 |   | (35,234  | )      | (47,965  | )      | (145,688 | )      |
| Net increase (decrease) in advance  payments by borrowers for taxes and insurance  |   | (169     | )      | (77      | )      | (83      | )      |
| Purchase of treasury stock                                                         |   | (9,547   | )      | (10,682  | )      | (7,747   | )      |
| Dividends paid                                                                     |   | (1,471   | )      | (1,437   | )      | (1,477   | )      |
| Stock options exercised                                                            |   | 422      |   | —   |   | —   |   |
| Distributions related to minority  interest                                        |   | —   |   | —   |   | (797     | )      |
|                                                                               |   |     |   |     |   |     |   |
| Net cash provided by (used in)  financing activities                               |   | (7,170   | )      | (42,105  | )      | 31,735   |   |
|                                                                               |   |     |   |     |   |     |   |
| NET INCREASE (DECREASE) IN CASH AND  CASH EQUIVALENTS                              |   | (27,818  | )      | 60,747   |   | 1,581    |   |
|                                                                               |   |     |   |     |   |     |   |
| CASH AND CASH EQUIVALENTS:                                                         |   |     |   |     |   |     |   |
| Beginning of year                                                                  |   | 72,311   |   | 11,564   |   | 9,983    |   |
|                                                                               |   |     |   |     |   |     |   |
| End of year                                                                        |   | $        | 44,493 |     | $      | 72,311   |   | $ | 11,564 |   |
|                                                                               |   |     |   |     |   |     |   |
| SUPPLEMENTAL DISCLOSURES OF CASH FLOW  INFORMATION -                               |   |     |   |     |   |     |   |
| Cash paid for:                                                                     |   |     |   |     |   |     |   |
| Interest                                                                           |   | $        | 22,020 |     | $      | 32,469   |   | $ | 32,816 |   |
|                                                                               |   |     |   |     |   |     |   |
| Income taxes                                                                       |   | $        | 4,016  |     | $      | 2,587    |   | $ | 2,475 |   |
|                                                                               |   |     |   |     |   |     |   |
| SUPPLEMENTAL SCHEDULE OF NONCASH  INVESTING ACTIVITIES:                            |   |     |   |     |   |     |   |
| Real estate and other assets acquired  in settlement of loans                      |   | $        | 1,017  |     | $      | 642      |   | $ | 380 |   |
|                                                                               |   |     |   |     |   |     |   |
| Loans to facilitate sales of real  estate owned                                    |   | $        | 272    |     | $      | 18       |   | $ | 1,170 |   |
|                                                                               |   |     |   |     |   |     |   |
| Investment securities purchased, not  settled                                      |   | $        | — |     | $      | 2,000    |   | $ | — |   |

 

See notes to consolidated financial statements.

 

23

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**FIRSTFEDERAL BANCSHARES OF ARKANSAS, INC.**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTSYEARS ENDED DECEMBER 31, 2002, 2001, AND 2000**

 

**1.****                                      SUMMARYOF SIGNIFICANT ACCOUNTING POLICIES**

 

***Nature of Operationsand Principles of Consolidation*** - First FederalBancshares of Arkansas, Inc. (the “Company”) is a unitary holding company whichowns all of the stock of First Federal Bank of Arkansas, FA (the “Bank”).  The Bank provides a broad line of financialproducts to individuals and small to medium-sized businesses.  The consolidated financial statements alsoinclude the accounts of the Bank’s wholly-owned subsidiary, First HarrisonService Corporation (“FHSC”), which is inactive.  All material intercompany transactions have been eliminated inconsolidation.

 

***Use of Estimates***- The preparation of financial statements in conformity with accountingprinciples generally accepted in the United States of America requiresmanagement to make estimates and assumptions that affect the reported amountsof assets and liabilities and disclosure of contingent assets and liabilitiesat the date of the financial statements and the reported amounts of revenuesand expenses during the reporting period.  Actual results could differ from those estimates and suchdifferences could be significant.  Theallowance for loan losses is a material estimate that is particularly susceptibleto significant change in the near term.

 

***Cash and CashEquivalents*** - For purposes of reporting cashflows, cash and cash equivalents includes cash on hand and amounts due fromdepository institutions, which includes interest-bearing amounts available upondemand.

 

The FederalReserve Bank (“FRB”) requires all depository institutions to maintain reservesagainst their net transaction accounts and non-personal time deposits.  As of December 31, 2002, no reserves wererequired to be maintained on the first $6.0 million of transaction accounts, reservesof 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 alevel between 8% and 14%) against all remaining net transaction accounts.  Required reserves must be maintained in theform of vault cash or a noninterest-bearing account at a Federal ReserveBank.  The average amount of the reservebalances maintained at the FRB for the years ended December 31, 2002 and2001, was approximately $1,824,000 and $391,000, respectively.

 

***InvestmentSecurities*** - The Company classifies investmentsecurities into one of two categories: held to maturity or available for sale. The Company does not engage in trading activities.  Debt securities that the Company has thepositive intent and ability to hold to maturity are classified as held tomaturity and recorded at cost, adjusted for the amortization of premiums andthe accretion of discounts.

 

Investmentsecurities that the Company intends to hold for indefinite periods of time areclassified as available for sale and are recorded at fair value.  Unrealized holding gains and losses areexcluded from earnings and reported net of tax in other comprehensiveincome.  Investment securities in the availablefor sale portfolio may be used as part of the Company’s asset and liabilitymanagement practices and may be sold in response to changes in interest raterisk, prepayment risk, or other economic factors.  At December 31, 2002 and 2001, the Company did not own anyinvestment securities classified as available for sale.

 

Premiums areamortized into interest income using the interest method to the earlier ofmaturity or call date.  Discounts areaccreted into interest income using the interest method over the period tomaturity.  The specific identificationmethod of accounting is used to compute gains or losses on the sales ofinvestment securities.

 

24

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If the fairvalue of an investment security declines for reasons other than temporarymarket conditions, the carrying value of such a security is written down tofair value by a charge to operations.

 

***Loans Receivable***- Loans receivable that management has the intent and ability to hold for theforeseeable future or until maturity or pay-off are stated at unpaid principalbalances adjusted for any charge-offs, the allowance for loan losses, and anydeferred loan fees or costs.  Deferredloan fees or costs and discounts on first mortgage loans are amortized oraccreted to income using the level-yield method over the remaining period tocontractual maturity.

 

Mortgage loansoriginated and committed for sale in the secondary market are carried at thelower of cost or estimated market value in the aggregate.  Such loans are carried at cost due to theshort period of time between funding and sale, generally two to three weeks.

 

The accrual ofinterest on impaired loans is discontinued when, in management’s opinion, theborrower may be unable to meet payments as they become due or when the loanbecomes 90 days past due, whichever occurs first.  When interest accrual is discontinued, all unpaid accruedinterest is reversed against interest income. Interest income is subsequently recognized only to the extent cash paymentsin excess of principal due are received, until such time that in management’sopinion, the borrower will be able to meet payments as they become due.

 

***Allowance for LoanLosses*** - The allowance for loan losses isestablished as losses are estimated to have occurred through a provision forloan losses charged to earnings.  Loanlosses are charged against the allowance when management believes theuncollectibility of a loan balance is confirmed.  Subsequent recoveries, if any, are credited to the allowance.

 

The allowance for loan losses is evaluated ona regular basis by management and is based upon management’s periodic review ofthe collectibility of the loans in light of historical experience, the natureand volume of the loan portfolio, adverse situations that may affect theborrower’s ability to repay, estimated value of any underlying collateral andprevailing economic conditions.  Thisevaluation is inherently subjective as it requires estimates that are susceptibleto significant revision as more information becomes available.

 

The Bank reviews its non-homogeneous loansfor impairment on a quarterly basis. The Bank considers commercial real estate, construction, multi-family,other non-residential real estate, and commercial loans to be non-homogeneousloans.  A loan is considered impairedwhen, based on current information and events, it is probable that the Bankwill be unable to collect the scheduled payments of principal or interest whendue according to the contractual terms of the loan agreement.  Factors considered by management indetermining impairment include payment status, collateral value, and theprobability of collecting scheduled principal and interest payments when due.  Loans that experience insignificant paymentdelays and payment shortfalls generally are not classified as impaired.  Management determines the significance ofpayment delays and payment shortfalls on a case-by-case basis, taking intoconsideration all of the circumstances surrounding the loan and the borrower,including the length of the delay, the reasons for 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 homogeneousloans are collectively evaluated for impairment.  Accordingly, the Bank does not separately identify individualconsumer and residential loans for impairment disclosures.

 

25

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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 includingpast loss experience, inherent risks, economic conditions in the primary marketareas, and other factors which usually are beyond the control of the Bank.

 

***Loan Funding andSale Commitments*** - The Company makes commitmentsto borrowers to lend money at fixed rates of interest and obtains substantiallysimultaneous commitments to sell such loans, if funded, to third parties.  The Bank measures any changes in value ofthese commitments, records a corresponding asset and liability for thederivative value resulting from such changes and recognizes such changes on anet basis in the statement of income.

 

***Real Estate Acquiredin Settlement of Loans*** - Real estate acquired insettlement of loans is initially recorded at estimated fair value lessestimated costs to sell.  Valuations areperiodically performed by management, and the assets are carried at the lowerof carrying amount or fair value less costs to sell.  Costs relating to the development and improvement of the propertyare capitalized, whereas those relating to holding the property are expensed.

 

***Office Propertiesand Equipment*** - Office properties and equipmentare stated at cost less accumulated depreciation and amortization.  The Company computes depreciation of officeproperties and equipment using the straight-line method over the estimateduseful lives of the individual assets which range from 3 to 40 years.

 

***Loan******Origination******Fees*** - Loan originationfees and certain direct loan origination costs are deferred and the net fee orcost is recognized as an adjustment to interest income using the level-yieldmethod over the contractual life of the loans. When a loan is fully repaid or sold, the amount of unamortized fee orcost is recorded in interest income.

 

***Income Taxes***- The Company recognizes deferred tax liabilities and assets for the expectedfuture tax consequences of temporary differences between the carrying amountsand the tax bases of assets and liabilities.

 

***Interest Rate Risk***- The Bank’s asset base is exposed to risk including the risk resulting fromchanges in interest rates and changes in the timing of cash flows.  The Bank monitors the effect of such risksby considering the mismatch of the maturities of its assets and liabilities inthe current interest rate environment and the sensitivity of assets andliabilities to changes in interest rates. The Bank’s management has considered the effect of significant increasesand decreases in interest rates and believes such changes, if they occurred,would be manageable and would not affect the ability of the Bank to hold itsassets as planned.  However, the Bank isexposed to significant market risk in the event of significant and prolongedinterest rate changes.

 

***Employee StockOwnership Plan*** - Compensation expense for theEmployee Stock Ownership Plan (“ESOP”) is determined based on the average fairvalue of shares committed to be released during the period and is recognized asthe shares are committed to be released. For the purpose of earnings per share, ESOP shares are included inweighted-average common shares outstanding as the shares are committed to bereleased.

 

26

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***Stock CompensationPlans*** - Statement of Financial AccountingStandards No. 123, *Accounting for Stock-Based Compensation*,provides that entities may adopt a fair value based method of accounting foremployee stock compensation plans, whereby compensation cost is measured at thegrant date based on the value of the award and is recognized over the serviceperiod, which is usually the vesting period. However, it also provides that an entity may measure compensation costfor those plans using the intrinsic value based method of accounting prescribedby Accounting Principles Board Opinion No. 25, *Accounting for Stock Issued toEmployees*, whereby compensation cost is the excess, if any, of thequoted market price of the stock at the grant date (or other measurement date)over the amount an employee must pay to acquire the stock.  Stock options issued under the Company’sstock option plan have no intrinsic value at the grant date, and under OpinionNo. 25, no compensation cost is recognized for them.  The Company has elected to use the accounting methodology inOpinion No. 25 and to provide pro forma disclosures of net income and earningsper share and other disclosures, as if the fair value based method ofaccounting had been applied.  The pro formadisclosures include the effects of all awards granted on or after January 1,1995.  (See Note 12.)

 

***Earnings Per CommonShare***- Basic earnings per share represents incomeavailable to common stockholders divided by the weighted-average number ofcommon shares outstanding during the period. Diluted earnings per share reflects additional common shares that wouldhave been outstanding if dilutive potential common shares had been issued, aswell as any adjustment to income that would result from the assumed issuance.  Potential common shares that may be issuedby the Company relate solely to outstanding stock options, and are determinedusing the treasury stock method.

 

***Recently IssuedAccounting Standards***- In April 2002 the FinancialAccounting Standards Board (“FASB”) issued Statement of Financial AccountingStandards No. 145, *Rescission of FASBStatements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and TechnicalCorrections* (“SFAS 145”). SFAS 145 rescinds FASB Statement No. 4, *ReportingGains and Losses From Extinguishment of Debt*, and an amendment ofthat statement, FASB Statement No. 64, *Extinguishmentsof Debt Made to Satisfy Sinking-Fund Requirements*.  SFAS 145 also rescinds FASB Statement No.44, *Accounting for Intangible Assets ofMotor Carriers* and amends FASB Statement No. 13, *Accounting for Leases*, to eliminate aninconsistency between the required accounting for sale-leaseback transactionsand accounting for certain lease modifications which are similar tosale-leaseback transactions.  Therequirements of SFAS 145 related to FASB Statement 4 shall be applied in fiscalyears beginning after May 15, 2002.  Theprovisions in certain paragraphs of SFAS 145 related to FASB Statement 13 areeffective for transactions occurring after May 15, 2002.  All other provisions of SFAS 145 wereeffective for financial statements issued on or after May 15, 2002.

 

In June 2002the FASB issued SFAS No. 146, *Accounting forCosts Associated with Exit or Disposal Activities* (“SFAS 146”).  SFAS 146 addresses financial accounting andreporting for costs associated with exit or disposal activities and nullifiesEmerging Issues Task Force issue No. 94-3, “Liability Recognition for CertainEmployee Termination Benefits and Other Costs to Exit an Activity (includingCertain Costs Incurred in a Restructuring).” SFAS 146 will be effective for exit or disposal activities initiatedafter December 31, 2002.

 

In October2002, the FASB issued SFAS No. 147, *Acquisitionsof Certain Financial Institutions* (“SFAS 147”).  SFAS 147 provides guidance on the accountingfor goodwill, requiring that the accounting under SFAS No. 72, *Accounting for Certain Acquisitions of Banking orThrift Institutions*, not apply after September 30, 2002.  Financial institutions meeting conditionsoutlined in SFAS 147 will be required to restate previously issued financialstatements.  Additionally, the scope ofSFAS 144, 

 

27

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*Accounting for the Impairment or Disposal ofLong-Lived Assets*, is amended by SFAS 147 to includelong-term customer-relationship intangible assets such as depositor- andborrower-relationship intangible assets and credit cardholder intangibleassets.

 

In December2002, the FASB issued SFAS No. 148, *Accountingfor Stock-Based Compensation—Transition and Disclosure, an amendment of FASBStatement No. 123* (“SFAS 148”). SFAS 148 amends SFAS No. 123, *Accountingfor Stock-Based Compensation*, to provide alternative methods oftransition for a voluntary change to the fair value based method of accountingfor stock-based employee compensation. In addition, this Statement amends the disclosure requirements ofStatement 123 to require prominent disclosures in both annual and interimfinancial statements about the method of accounting for stock-based employeecompensation and the effect of the method used on reported results.  The transition provisions are effective forfiscal years ending after December 15, 2002. The provisions of the statement related to interim disclosures areeffective for interim periods beginning after December 31, 2002.

 

FASBInterpretation No. 45, *Guarantor’s Accounting and Disclosure Requirementsfor Guarantees, Including Indirect Guarantees of Indebtedness of Others*(“FIN 45”) elaborates on the disclosures to be made by a guarantor in itsfinancial statements about its obligations under certain guarantees that it hasissued.  It also clarifies that aguarantor is required to recognize, at the inception of a guarantee, aliability for the fair value of the obligation undertaken in issuing theguarantee.  The initial recognition andinitial measurement provisions of FIN 45 are applicable on a prospective basisto guarantees issued or modified after December 31, 2002, irrespective of theguarantor’s fiscal year-end.  Thedisclosure requirements in FIN 45 are effective for financial statements ofannual periods ending after December 15, 2002.

 

The adoptionof the required provisions of these statements and the interpretation did nothave a material effect on the financial position, results operations, or cashflows of the Company as of or for the year ended December 31, 2002.  The amended disclosures required by SFAS 148will be made beginning in the first quarter of 2003.  Based on its current activities, management does not believe thatadoption of the remaining provisions of these statements and the interpretationwill have a material effect on the financial position, results of operations,or cash flows of the Company.

 

***Reclassifications***- Certain amounts in the 2001 and 2000 consolidated financial statements havebeen reclassified to conform to the classifications adopted for reporting in2002.

 

**2.**                                      **INVESTMENT SECURITIES**

 

Investmentsecurities consisted of the following at December 31 (in thousands):

 
|                                   |   | **2002**            |    |
|----------------------------------------|--------|---------------------|---------|
| **HELD TO MATURITY**                   |   | **Amortized  Cost** |    | **Gross  Unrealized  Gains** |   | **Gross  Unrealized  Losses** |   | **Fair  Value** |   |
|                                   |   |                |    |   |   |   |   |   |   |
| Certificates of deposit                |   | $                   | 40,341  |   | $ | 54 |   | $ | — |   | $ | 40,395 |   |
| Municipal securities                   |   | 8,728               |    | 183 |   | 25 |   | 8,886 |   |
| U.S. Government and Agency obligations |   | 65,402              |    | 1,064 |   | 13 |   | 66,453 |   |
|                                   |   |                |    |   |   |   |   |   |   |
|                                   |   | $                   | 114,471 |   | $ | 1,301 |   | $ | 38 |   | $ | 115,734 |   |

 
|                                   |   | **2001**            |    |
|----------------------------------------|--------|---------------------|---------|
| **HELD TO MATURITY**                   |   | **Amortized  Cost** |    | **Gross  Unrealized  Gains** |   | **Gross  Unrealized  Losses** |   | **Fair  Value** | ** ** |
|                                   |   |                |    |   |   |   |   |   |   |
| Municipal securities                   |   | $                   | 5,514   |   | $ | 21 |   | $ | 99 |   | $ | 5,436 |   |
| U.S. Government and Agency obligations |   | 95,364              |    | 837 |   | 205 |   | 95,996 |   |
|                                   |   |                |    |   |   |   |   |   |   |
|                                   |   | $                   | 100,878 |   | $ | 858 |   | $ | 304 |   | $ | 101,432 |   |

 

28

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The Companyhas pledged investment securities held to maturity with carrying values ofapproximately $22.4 million and $16.3 million at December 31, 2002 and 2001,respectively, as collateral for certain deposits in excess of $100,000.

 

The scheduledmaturities of debt securities at December 31, 2002, by contractual maturity areshown below (in thousands).  Expectedmaturities may differ from contractual maturities because borrowers may havethe right to call or prepay obligations with or without call or prepaymentpenalties.

 
|                             |   | **2002**            |       |
|----------------------------------|--------|---------------------|------------|
|                             |   | **Amortized  Cost** |       | **Fair  Value** |   |
|                             |   |                | ** ** |   | ** ** |
| Within one year                  |   | $                   | 35,341     |   | $ | 35,389 |   |
| Due from one year to five years  |   | 5,601               |       | 5,640 |   |
| Due from five years to ten years |   | 26,715              |       | 27,115 |   |
| Due after ten years              |   | 46,814              |       | 47,590 |   |
|                             |   |                |       |   |   |
| Total                            |   | $                   | 114,471    |   | $ | 115,734 |   |

 

As of December31, 2002 and 2001, investments with carrying values of approximately $80million and $100 million, respectively, have call options held by the issuer,of which approximately $68 million and $82 million, respectively, were callablewithin one year.

 

**3.**                                      **LOANS RECEIVABLE**

 

Loansreceivable consisted of the following at December 31 (in thousands):

 
|                            |   | **2002** |    | **2001** |   |
|---------------------------------|--------|----------|---------|----------|--------|
| First mortgage loans:           |   |     |    |     |   |
| One- to four-family residences  |   | $        | 289,106 |     | $      | 330,844 |   |
| Commercial                      |   | 64,888   |    | 46,897   |   |
| Multifamily                     |   | 5,821    |    | 4,385    |   |
| Other                           |   | 1,735    |    | —   |   |
| Construction                    |   | 49,144   |    | 24,842   |   |
| Less:                           |   |     |    |     |   |
| Unearned discounts              |   | (178     | )       | (216     | )      |
| Undisbursed loan funds          |   | (20,618  | )       | (10,144  | )      |
| Deferred loan fees, net         |   | (1,414   | )       | (2,127   | )      |
| Total first mortgage loans      |   | 388,484  |    | 394,481  |   |
|                            |   |     |    |     |   |
| Consumer and other loans:       |   |     |    |     |   |
| Commercial loans                |   | 28,213   |    | 23,451   |   |
| Automobile                      |   | 22,570   |    | 20,506   |   |
| Consumer loans                  |   | 7,741    |    | 7,083    |   |
| Home equity and second mortgage |   | 31,670   |    | 24,933   |   |
| Savings loans                   |   | 2,158    |    | 1,464    |   |
| Other                           |   | 3,907    |    | 3,234    |   |
| Deferred loan costs             |   | 254      |    | 265      |   |
| Total consumer and other loans  |   | 96,513   |    | 80,936   |   |
| Allowance for loan losses       |   | (1,529   | )       | (923     | )      |
| Loans receivable, net           |   | $        | 483,468 |     | $      | 474,494 |   |

 

The Bank originates and maintains loans receivablewhich are substantially concentrated in its lending territory (primarilyNorthwest and Northcentral Arkansas). The majority of the Bank’s loans are residential mortgage loans,commercial loans, and construction loans for residential property.  The

 

29

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Bank’s policy calls for collateral or other forms ofrepayment assurance to be received from the borrower at the time of loanorigination.  Such collateral or otherform of repayment assurance is subject to changes in economic value due tovarious factors beyond the control of the Bank.

 

At December 31, 2002 and 2001, loans receivableincluded loans committed to be sold with net book values of $8.3 and $5.5million, respectively.

 

In the normal course of business, the Bank has madeloans to its directors, officers, and their related business interests.  In the opinion of management, related partyloans are made on substantially the same terms, including interest rates andcollateral, as those prevailing at the time for comparable transactions withunrelated persons and do not involve more than the normal risk ofcollectibility.  The aggregate dollaramount of loans outstanding to directors, officers, and their related businessinterests was approximately $3.0 and $1.9 million at December 31, 2002 and2001, respectively.

 

At December 31, 2002, the total recorded investment inimpaired loans was approximately $4.2 million. The allowance for credit losses recorded for these loans wasapproximately $442,000 at December 31, 2002. The average recorded investment in impaired loans was approximately $4.4million for the year ended December 31, 2002. Interest income recognized on these loans during the year endedDecember 31, 2002, was approximately $332,000.  At December 31, 2001, loans identified by management as impairedwere not significant.  The Bank is notcommitted to lend additional funds to debtors whose loans have been modified.

 

**4.**                                      LOAN SERVICING

 

Mortgage loans serviced for others are not included inthe accompanying consolidated statements of financial condition.  The unpaid principal balances of these loansat December 31, 2002 and 2001, were $2.0 million and $377,000,respectively.  Servicing loans forothers generally consists of collecting mortgage payments, maintaining escrowaccounts, disbursing payments to investors, and foreclosure processing.

 

**5.**                                      ACCRUED INTERESTRECEIVABLE

 

Accrued interest receivable consisted of the followingat December 31 (in thousands):

 
|                  |   | **2002** |   | **2001** |   |
|-----------------------|--------|----------|--------|----------|--------|
|                  |   |     |   |     |   |
| Loans                 |   | $        | 2,992  |     | $      | 2,840 |   |
| Investment securities |   | 1,388    |   | 1,580    |   |
|                  |   |     |   |     |   |
| Total                 |   | $        | 4,380  |     | $      | 4,420 |   |

 

30

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**6.**                                      ALLOWANCES FORLOAN AND REAL ESTATE LOSSES

 

A summary of the activity in the allowances for loanand real estate losses is as follows for the years ended December 31 (inthousands):

 
|                            |   | **2002**  |   | **2001**        |   | **2000**  |   |
|---------------------------------|--------|-----------|--------|-----------------|--------|-----------|--------|
|                            |   | **Loans** |   | **Real Estate** |   | **Loans** |   | **Real Estate** |   | **Loans** |   | **Real Estate** |   |
|                            |   |      |   |            |   |      |   |   |   |   |   |   |   |
| Balance, beginning of year      |   | $         | 923    |            | $      | —    |   | $ | 691 |   | $ | — |   | $ | 752 |   | $ | — |   |
|                            |   |      |   |            |   |      |   |   |   |   |   |   |   |
| Provisions for estimated losses |   | 1,500     |   | 16              |   | 452       |   | 8 |   | — |   | 14 |   |
| Recoveries                      |   | 92        |   | —          |   | 17        |   | — |   | 27 |   | — |   |
| Losses charged off              |   | (986      | )      | (16             | )      | (237      | )      | (8 | ) | (88 | ) | (14 | ) |
|                            |   |      |   |            |   |      |   |   |   |   |   |   |   |
| Balance, end of year            |   | $         | 1,529  |            | $      | —    |   | $ | 923 |   | $ | — |   | $ | 691 |   | $ | — |   |

 

**7.**                                      FEDERAL HOME LOANBANK STOCK

 

The Bank is a member of the Federal Home Loan BankSystem.  As a member of this system, itis required to maintain an investment in capital stock of the Federal Home LoanBank (“FHLB”) in an amount equal to the greater of 1% of residential mortgageassets as of the previous December 31 or 5% of outstanding advances.  No ready market exists for such stock and ithas no quoted market value.  Thecarrying value of the stock is its cost.

** **

**8.**                                      OFFICE PROPERTIESAND EQUIPMENT

 

Office properties and equipment consisted of thefollowing at December 31 (in thousands):

 
|                                 |   | **2002** |   | **2001** |   |
|--------------------------------------|--------|----------|--------|----------|--------|
|                                 |   |     |   |     |   |
| Land                                 |   | $        | 2,508  |     | $      | 2,508 |   |
| Buildings and improvements           |   | 5,152    |   | 4,334    |   |
| Furniture and equipment              |   | 5,273    |   | 4,716    |   |
| Automobiles                          |   | 680      |   | 645      |   |
| Construction in progress             |   | 2,986    |   | —   |   |
|                                 |   |     |   |     |   |
| Total                                |   | 16,599   |   | 12,203   |   |
|                                 |   |     |   |     |   |
| Accumulated depreciation             |   | (5,909   | )      | (5,197   | )      |
|                                 |   |     |   |     |   |
| Office properties and equipment, net |   | $        | 10,690 |     | $      | 7,006 |   |

 

31

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Depreciation expense for the years ended December 31,2002, 2001, and 2000, amounted to approximately $819,000, $704,000, and$670,000, respectively.

 

The Bank began construction in May 2002 of a newcorporate and full-service branch office building in Harrison, Arkansas.  Construction is expected to be completed inthe spring of 2003.  Total constructioncost, including furniture and fixtures, is estimated to be $6.9 million, ofwhich $3.0 million had been incurred and recorded in construction in progressat December 31, 2002.  The Bank intendsto utilize the current corporate office building as a full-service branchoffice.

** **

**9.**                                      DEPOSITS

 

Deposits are summarized as follows at December 31 (inthousands):

 
|                                                                                                                    |   | **2002** |       | **2001** |       |
|-------------------------------------------------------------------------------------------------------------------------|--------|----------|------------|----------|------------|
|                                                                                                                    |   |     | ** ** |     | ** ** |
| Demand and NOW accounts, including  noninterest-bearing deposits of $22,890 and $19,009 in 2002 and 2001,  respectively |   | $        | 86,851     |     | $          | 75,849 |   |
| Money market                                                                                                            |   | 80,020   |       | 35,119   |       |
| Regular savings                                                                                                         |   | 27,772   |       | 26,784   |       |
| Certificates of deposit                                                                                                 |   | 374,119  |       | 418,181  |       |
|                                                                                                                    |   |     |       |     |       |
| Total                                                                                                                   |   | $        | 568,762    |     | $          | 555,933 |   |

 

The aggregate amount of time deposits in denominationsof $100 thousand or more was approximately $88 million and $98 million atDecember 31, 2002 and 2001, respectively.

 

At December 31, 2002, scheduled maturities ofcertificates of deposit are as follows (in thousands):

 
| Years ending December 31: |   |   | ** ** |
|---------------------------|--------|--------|------------|
| 2003                      |   | $      | 207,598    |   |
| 2004                      |   | 67,544 |       |
| 2005                      |   | 22,891 |       |
| 2006                      |   | 27,599 |       |
| 2007                      |   | 27,172 |       |
| 2008 and thereafter       |   | 21,315 |       |
|                      |   |   |       |
| Total                     |   | $      | 374,119    |   |

 

Interest expense on deposits consisted of thefollowing (in thousands):

 
|                                      |   | **Years Ended  December 31,** |   |
|-------------------------------------------|--------|-------------------------------|--------|
|                                      |   | **2002**                      |   | **2001** |   | **2000** | ** ** |
|                                      |   |                          |   |   |   |   |   |
| NOW and money market                      |   | $                             | 2,401  |   | $ | 1,923 |   | $ | 1,688 |   |
| Regular savings and certificate  accounts |   | 17,106                        |   | 25,662 |   | 26,094 |   |
| Early withdrawal penalties                |   | (61                           | )      | (88 | ) | (123 | ) |
|                                      |   |                          |   |   |   |   |   |
| Total                                     |   | $                             | 19,446 |   | $ | 27,497 |   | $ | 27,659 |   |

 

Eligible deposits of the Bank are insured up to $100,000by the Savings Association Insurance Fund (“SAIF”) of the Federal DepositInsurance Corporation (“FDIC”).

 

32

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**10.**                               FEDERAL HOME LOAN BANKADVANCES

 

The Bank pledges eligible collateral for its FHLBadvances as defined in its blanket lien agreement with the FHLB as well as itsFHLB demand deposit account and FHLB stock. Eligible collateral under the blanket lien includes First MortgageCollateral (as defined), multifamily residential mortgages meeting therequirements for eligibility as First Mortgage Collateral, U.S. Government andAgency Securities (as defined), privately issued mortgage-backed securitiesthat qualify as eligible collateral under applicable regulations, Federal HomeLoan Bank Term Deposit Accounts, and other non-securitized real estate relatedcollateral.  Advances at December 31,2002 and 2001, consisted of the following (in thousands):

 
|                                           |   | **2002**                    |       | **2001**   |       |
|------------------------------------------------|--------|-----------------------------|------------|------------|------------|
|                                           |   | **Weighted  Average  Rate** |       | **Amount** |       | **Weighted  Average  Rate** |   | **Amount** |   |
| Amounts maturing in years ending  December 31: |   |                        | ** ** |       | ** ** |   | ** ** |   | ** ** |
| 2002                                           |   |                        |       |       |       | 6.40 | % | $ | 34,944 |   |
| 2003                                           |   | 3.41                        | %          | $          | 19,000     |   | 6.41 | % | 6,000 |   |
| 2004                                           |   | 4.07                        | %          | 2,000      |       | 6.07 | % | 1,000 |   |
| 2005                                           |   | 6.54                        | %          | 4,900      |       | 6.54 | % | 4,900 |   |
| 2007                                           |   | 3.78                        | %          | 5,724      |       | — |   | — |   |
| Thereafter                                     |   | 3.20                        | %          | 6,986      |       | 6.44 | % | 1,000 |   |
|                                           |   |                        |       |       |       |   |   |   |   |
| Total                                          |   | 3.86                        | %          | $          | 38,610     |   | 6.41 | % | $ | 47,844 |   |
|                                                |        |                             |            |            |            |  |  |  |  |  |  |  |  |  |  |  |

 

**11.**                               INCOME TAXES

 

The provisions (benefits) for income taxes aresummarized as follows (in thousands):

 
|                            |   | **Years Ended  December 31,** |
|---------------------------------|--------|-------------------------------|
|                            |   | **2002**                      |   | **2001** |   | **2000** |   |
|                            |   |                          |   |   |   |   |   |
| Income tax provision (benefit): |   |                          |   |   |   |   |   |
| Current                         |   | $                             | 4,085 |   | $ | 2,505 |   | $ | 2,496 |   |
| Deferred                        |   | (80                           | ) | 22 |   | 251 |   |
|                            |   |                          |   |   |   |   |   |
| Total                           |   | $                             | 4,005 |   | $ | 2,527 |   | $ | 2,747 |   |

 

The reasons for the differences between the statutoryfederal income tax rates and the effective tax rates are summarized as follows(in thousands):

 
|                                |   | **Years Ended  December 31,** |
|-------------------------------------|--------|-------------------------------|
|                                |   | **2002**                      | ** ** | **2001** | ** ** | **2000** | ** ** |
| Taxes at statutory rate             |   | $                             | 4,006 |   | 34.0 | % | $ | 2,715 |   | 34.0 | % | $ | 2,835 |   | 34.0 | % |
| Increase (decrease) resulting from: |   |                          |   |   |   |   |   |   |   |   |   |   |   |
| State income tax, net               |   | 244                           |   | 2.1 | % | — |   | — |   | — |   | — |   |
| Earnings on life insurance policies |   | (299                          | ) | (2.6 | )% | — |   | — |   | — |   | — |   |
| Other, net                          |   | 54                            |   | 0.5 | % | (188 | ) | (2.4 | )% | (88 | ) | (1.1 | )% |
| Total                               |   | $                             | 4,005 |   | 34.0 | % | $ | 2,527 |   | 31.6 | % | $ | 2,747 |   | 32.9 | % |

 

33

----

 

The Company’s net deferred tax liability account wascomprised of the following at December 31 (in thousands):

 
|                                         |   | **2002** |   | **2001** |   |
|----------------------------------------------|--------|----------|--------|----------|--------|
|                                         |   |     |   |     |   |
| Deferred tax assets:                         |   |     |   |     |   |
| Stock based compensation                     |   | $        | 146    |     | $      | 140 |   |
| Real estate acquired in settlement of  loans |   | —   |   | 26       |   |
| Allowance for loan losses                    |   | 500      |   | 164      |   |
|                                         |   |     |   |     |   |
| Total deferred tax assets                    |   | 646      |   | 330      |   |
|                                         |   |     |   |     |   |
| Deferred tax liabilities:                    |   |     |   |     |   |
| Office properties                            |   | (285     | )      | (243     | )      |
| Federal Home Loan Bank stock                 |   | (923     | )      | (770     | )      |
| Pension plan contribution                    |   | (41      | )      | —   |   |
|                                         |   |     |   |     |   |
| Total deferred tax liabilities               |   | (1,249   | )      | (1,013   | )      |
|                                         |   |     |   |     |   |
| Net deferred tax liability                   |   | $        | (603   | )        | $      | (683 | ) |

 

Specifically exempted from deferred tax recognitionrequirements are bad debt reserves for tax purposes of U.S. savings and loansin the institution’s base year, as defined. Base year reserves totaled approximately $4.2 million.  Consequently, a deferred tax liability ofapproximately $1.6 million related to such reserves was not provided for in theconsolidated statements of financial condition at December 31, 2002 and2001.  Payment of dividends toshareholders out of retained earnings deemed to have been made out of earningspreviously set aside as bad debt reserves may create taxable income to theBank.  No provision has been made forincome tax on such a distribution as the Bank does not anticipate making suchdistributions.

** **

**12.**                               BENEFIT PLANS

 

***Stock Option Plan***- The Stock Option Plan (“SOP”) provides for a committee of the Company’s Boardof Directors to award incentive stock options, non-qualified or compensatorystock options and stock appreciation rights representing up to 515,375 sharesof Company stock.  One-fifth of theoptions granted vested immediately upon grant, with the balance vesting inequal amounts on the four subsequent anniversary dates of the grant.  Options granted vest immediately in theevent of retirement, disability, or death. Stock options granted expire in ten years.

 

Under the SOP, options have been granted to directorsand key employees to purchase common stock of the Company.  The exercise price in each case equals thefair market value of the Company’s stock at the date of grant.  Options granted are summarized as follows:

 
| **Year  Granted** |   | **Range of  Exercise Prices** |       | **Weighted Average  Remaining  Contract Life** |       |
|-------------------|--------|-------------------------------|------------|------------------------------------------------|------------|
|              |   |                          | ** ** |                                           | ** ** |
| 1997              |   | $19.25 - 20.38                |       | 4.1 years                                      |       |
| 1998              |   | 23.25 - 24.00                 |       | 4.8 years                                      |       |
| 1999              |   | 17.06 - 18.63                 |       | 5.5 years                                      |       |
| 2000              |   | 14.75 - 18.25                 |       | 7.7 years                                      |       |
| 2001              |   | 18.69 - 22.70                 |       | 8.5 years                                      |       |
| 2002              |   | 24.40 - 24.63                 |       | 9.6 years                                      |       |

 

34

----

 

A summary of the status of the Company’s SOP as ofDecember 31, 2002, 2001, and 2000, and changes during the years ending on thosedates are presented below:

 
|                                      |   | **Shares** |   | **Weighted  Average  Exercise  Price** |   |
|-------------------------------------------|--------|------------|--------|----------------------------------------|--------|
| Outstanding at January 1, 2000            |   | 497,365    |   | $                                      | 19.35  |   |
| Granted                                   |   | 5,000      |   | 17.55                                  |   |
| Forfeited                                 |   | (1,800     | )      | 18.98                                  |   |
| Outstanding at December 31, 2000          |   | 500,565    |   | 19.34                                  |   |
| Granted                                   |   | 8,000      |   | 20.53                                  |   |
| Forfeited                                 |   | —     |   |                                   |   |
| Outstanding at December 31, 2001          |   | 508,565    |   | 19.36                                  |   |
| Exercised                                 |   | (21,900    | )      | 19.30                                  |   |
| Granted                                   |   | 5,000      |   | 24.58                                  |   |
| Forfeited                                 |   | (400       | )      | 17.06                                  |   |
| Outstanding at December 31, 2002          |   | 491,265    |   | $                                      | 19.41  |   |
| Options exercisable at December 31,  2002 |   | 479,865    |   | $                                      | 19.37  |   |

 

The Company applies the provisions of APB Opinion No.25 in accounting for its stock option plan, as allowed under SFAS No. 123, *Accountingfor Stock-Based Compensation*(“SFAS 123”).  Accordingly, no compensation cost has been recognized for optionsgranted to employees.  Had compensationcost for these plans been determined based on the fair value at the grant datesfor awards under those plans consistent with the methods of SFAS 123, theCompany’s pro forma net income and pro forma earnings per share would have beenas follows:

 
|                      |   | **2002**        |   | **2001**      |   | **2000**        |   |
|---------------------------|--------|-----------------|--------|---------------|--------|-----------------|--------|
|                      |   | **As Reported** |   | **Pro forma** |   | **As Reported** |   | **Pro forma** |   | **As Reported** |   | **Pro forma** |   |
|                      |   |            |   |          |   |            |   |   |   |   |   |   |   |
| Net income (in thousands) |   | $               | 7,778  |          | $      | 7,748           |   | $ | 5,460 |   | $ | 4,934 |   | $ | 5,592 |   | $ | 5,072 |   |
| Earnings per share:       |   |            |   |          |   |            |   |   |   |   |   |   |   |
| Basic                     |   | $               | 2.87   |          | $      | 2.86            |   | $ | 1.76 |   | $ | 1.59 |   | $ | 1.60 |   | $ | 1.45 |   |
|                      |   |            |   |          |   |            |   |   |   |   |   |   |   |
| Diluted                   |   | $               | 2.77   |          | $      | 2.76            |   | $ | 1.75 |   | $ | 1.58 |   | $ | 1.60 |   | $ | 1.45 |   |

 

The fair value of options granted during 2000 wasestimated on the date of grant using the Binomial option-pricing model with thefollowing assumptions:  expectedvolatility - 25%, expected life of options - 7.0 years, risk-free interest rate- 6.04% to 6.20% and expected dividend rate - 2.19% to 2.71%.  The weighted average fair value of optionsgranted during the fiscal year ended December 31, 2000, was $6.36 per share.

 

The fair value of options granted during 2001 wasestimated on the date of grant using the Binomial option-pricing model with thefollowing assumptions:  expectedvolatility - 18% to 22%, expected life of options - 7.0 years, risk-free interestrate - 4.89% to 5.11% and expected dividend rate - 1.90% to 2.10%.  The weighted average fair value of optionsgranted during the fiscal year ended December 31, 2001, was $6.25 per share.

 

35

----

 

The fair value of options granted during 2002 wasestimated on the date of grant using the Binomial option-pricing model with thefollowing assumptions:  expectedvolatility - 17% to 18%, expected life of options - 7 years, risk-free interestrate – 4.43% to 5.22% and expected dividend rate – 2.3%.  The weighted average fair value of optionsgranted during the fiscal year ended December 31, 2002, was $5.26 per share.

 

***ManagementRecognition and Retention Plan*** - The ManagementRecognition and Retention Plan (“MRR Plan”) provides for a committee of the Company’sBoard of Directors to award restricted stock to key officers as well asnon-employee directors.  The MRR Planauthorizes the Company to grant up to 206,150 shares of the Company stock, ofwhich 195,844 shares have been granted through December 31, 2002.  Compensation expense has been recognizedbased on the fair market value of the shares on the grant date of $19.25 overthe vesting period which ended in May 2001. Shares granted will be deemed vested in the event of disability ordeath.  All shares granted under the MRRPlan have been purchased in the open market at a total cost of $4.4million.  Approximately $298,000, and$771,000 in compensation expense was recognized during the years ended December31, 2001 and 2000, respectively.  Nocompensation expense was recognized during the year ended December 31, 2002.

 

***Employee StockOwnership Plan*** - The Company established an EmployeeStock Ownership Plan on May 3, 1996. During 1996, the ESOP borrowed $4.1 million from the Company to purchaseshares of Company stock.  The loan iscollateralized by the shares that were purchased with the proceeds of theloan.  As the loan is repaid, ESOPshares will be allocated to participants of the ESOP and are available forrelease to the participants subject to the vesting provisions of the ESOP.

 

Forfeitures of nonvested benefits will be reallocatedamong remaining participating employees in the same proportion ascontributions.  During each of the yearsended December 31, 2002, 2001, and 2000, 41,604 shares were released by theESOP to participant accounts.  AtDecember 31, 2002, there were 265,848 shares allocated to participant accountsand 135,212 unallocated shares.  Thefair value of the unallocated shares amounted to approximately $3.4 million atDecember 31, 2002.

 

During the years ended December 31, 2002, 2001, and2000, ESOP expense was approximately $924,000, $754,000, and $571,000,respectively.

 

***OtherPostretirement Benefits*** - The Bank is a participant in amulti-employer retirement plan and therefore separate information is notavailable.  The plan is noncontributoryand covers substantially all employees. The plan provides a retirement benefit and a death benefit.  Retirement benefits are payable in monthlyinstallments for life and must begin not later than the first day of the monthcoincident with or the next month following the seventieth birthday or theparticipant may elect a lump-sum distribution. Death benefits are paid in a lump-sum distribution, the amount of whichdepends on years of service. Net pension expense was approximately $108,000 forthe year ended December 31, 2002.  Therewas no net pension cost for the years ended December 31, 2001 and 2000.

 

36

----

 

**13           EARNINGS PER SHARE**

 
|                                                                           |   | **Year Ended December 31, 2002**        |   |
|--------------------------------------------------------------------------------|--------|-----------------------------------------|--------|
|                                                                           |   | **Income  (In Thousands)  (Numerator)** |   | **Shares  (Denominator)** |   | **Per Share  Amount** |   |
|                                                                           |   |                                    |   |   |
| Basic EPS -  Income available to common stockholders                           |   | $                                       | 7,778  |   | 2,706,538 |   | $ | 2.87 |   |
| Effect of dilutive securities –  Stock options                            |   | —                                  |   | 103,681 |   |   |   |
| Diluted EPS -  Income available to common stockholders and assumed conversions |   | $                                       | 7,778  |   | 2,810,219 |   | $ | 2.77 |   |
|                                                                                |        |                                         |        |  |  |  |  |  |  |  |

 
|                                                                           |   | **Year Ended December 31, 2001**        |   |
|--------------------------------------------------------------------------------|--------|-----------------------------------------|--------|
|                                                                           |   | **Income  (In Thousands)  (Numerator)** |   | **Shares  (Denominator)** |   | **Per Share  Amount** |   |
|                                                                           |   |                                    |   |   |
| Basic EPS -  Income available to common stockholders                           |   | $                                       | 5,460  |   | 3,097,877 |   | $ | 1.76 |   |
| Effect of dilutive securities –  Stock options                            |   | —                                  |   | 29,020 |   |   |   |
| Diluted EPS -  Income available to common stockholders and assumed conversions |   | $                                       | 5,460  |   | 3,126,897 |   | $ | 1.75 |   |
|                                                                                |        |                                         |        |  |  |  |  |  |  |  |

 
|                                                                          |   | **Year Ended December 31, 2000**        |   |
|-------------------------------------------------------------------------------|--------|-----------------------------------------|--------|
|                                                                          |   | **Income  (In Thousands)  (Numerator)** |   | **Shares  (Denominator)** |   | **Per Share  Amount** |   |
|                                                                          |   |                                    |   |   |
| Basic EPS -  Income available to common stockholders                          |   | $                                       | 5,592  |   | 3,504,859 |   | $ | 1.60 |   |
| Effect of dilutive securities –  Stock options                           |   | —                                  |   | 79 |   |   |   |
| Diluted EPS -  Income available to common stockholdersand assumed conversions |   | $                                       | 5,592  |   | 3,504,938 |   | $ | 1.60 |   |
|                                                                               |        |                                         |        |  |  |  |  |  |  |  |

 

**14.**                               FINANCIAL INSTRUMENTSWITH OFF-BALANCE SHEET RISK

 

The Bank is a party to financial instruments withoff-balance sheet risk in the normal course of business to meet the financingneeds of its customers.  These financialinstruments include commitments to extend credit and standby letters ofcredit.  Those instruments involve, tovarying degrees, elements of credit risk in excess of the amount recognized inthe consolidated statements of financial condition.

 

The Bank does not use financial instruments withoff-balance sheet risk as part of its asset/liability management program or fortrading purposes.  The Bank’s exposureto credit loss in the event of nonperformance by the other party to thefinancial instrument for commitments to extend credit and standby letters ofcredit is represented by the contractual amounts of those instruments.  The Bank uses the same credit policies inmaking commitments and conditional obligations as it does for on-balance sheetinstruments.

 

Commitments to extend credit are agreements to lend toa customer as long as there is no violation of any condition established in thecontract.  Commitments generally havefixed expiration dates or other termination clauses.  The Bank evaluates each customer’s creditworthiness on acase-by-case basis.

 

37

----

 

The amount of collateral obtained, if deemed necessaryby the Bank upon extension of credit, is based on management’s creditevaluation of the counterparty.  Suchcollateral consists primarily of residential properties.  Standby letters of credit are conditionalcommitments issued by the Bank to guarantee the performance of a customer to a thirdparty.  The credit risk involved inissuing letters of credit is essentially the same as that involved in extendingloan facilities to customers.

 

The funding period for construction loans is generallyless than nine months and commitments to originate mortgage loans are generallyoutstanding for 60 days or less.

 

The Bank had the following outstanding commitments atDecember 31, 2002 (in thousands):

 
| Rate lock agreements                     |   | $      | 9,213  |   |
|------------------------------------------|--------|--------|--------|--------|
| Undisbursed construction loans           |   | 20,618 |   |
| Commitments to originate mortgage  loans |   | 17,791 |   |
| Letters of credit                        |   | 1,077  |   |
| Unused lines of credit                   |   | 11,387 |   |

 

Commitments to originate loans above includeapproximately $5.2 million of loans committed for sale to investors.

 

Also, in connection with loans originated to sell, theBank enters into rate lock agreements with customers subject to satisfactoryunderwriting of the loan.  Atapproximately the same time, the price for the sale of the loan is locked withan investor.  At December 31, 2002,there were approximately $9.2 million in rate lock agreements with customers,all of which had been locked with an investor.

 

Total unfunded commitments to originate loans for saleand the related commitments to sell of $10.9 million meet the definition of aderivative financial instrument and as such the related asset and liabilityhave been recorded at their estimated fair values of approximately $85,000 atDecember 31, 2002.

** **

**15.**                               FAIR VALUE OF FINANCIALINSTRUMENTS

 

The estimated fair value amounts have been determinedby the Company using available market information and appropriate valuationmethodologies.  However, considerablejudgment is required to interpret market data to develop the estimates of fairvalue.  Accordingly, the estimatespresented herein are not necessarily indicative of the amounts the Companycould realize in a current market exchange. The use of different market assumptions and/or estimation methodologiesmay have a material effect on the estimated fair value amounts.  The estimated fair values of financial instrumentsare as follows (in thousands):

 
|                                                   |   | **December 31, 2002** |   | **December 31, 2001**      |   |
|--------------------------------------------------------|--------|-----------------------|--------|----------------------------|--------|
|                                                   |   | **Carrying  Value**   |   | **Estimated  Fair  Value** |   | **Carrying  Value** |   | **Estimated  Fair  Value** |   |
|                                                   |   |                  |   |                       |   |   |   |   |   |
| ASSETS:                                                |   |                  |   |                       |   |   |   |   |   |
| Cash and cash equivalents                              |   | $                     | 44,493 |                       | $      | 44,493 |   | $ | 72,311 |   | $ | 72,311 |   |
| Investment securities -                                |   |                  |   |                       |   |   |   |   |   |
| Held to maturity                                       |   | 114,471               |   | 115,734                    |   | 100,878 |   | 101,432 |   |
| Federal Home Loan Bank stock                           |   | 5,064                 |   | 5,064                      |   | 4,918 |   | 4,918 |   |
| Loans receivable, net                                  |   | 483,468               |   | 492,750                    |   | 474,494 |   | 482,349 |   |
| Accrued interest receivable                            |   | 4,380                 |   | 4,380                      |   | 4,420 |   | 4,420 |   |
| Commitments                                            |   | 85                    |   | 85                         |   | — |   | — |   |
|                                                   |   |                  |   |                       |   |   |   |   |   |
| LIABILITIES:                                           |   |                  |   |                       |   |   |   |   |   |
| Deposits:                                              |   |                  |   |                       |   |   |   |   |   |
| Demand, NOW, money market and regular  savings         |   | 194,643               |   | 194,643                    |   | 137,752 |   | 137,752 |   |
| Certificates of deposit                                |   | 374,119               |   | 380,574                    |   | 418,181 |   | 422,183 |   |
| Federal Home Loan Bank advances                        |   | 38,610                |   | 39,664                     |   | 47,844 |   | 49,507 |   |
| Accrued interest payable                               |   | 331                   |   | 331                        |   | 718 |   | 718 |   |
| Advance payments by borrowers for taxes  and insurance |   | 760                   |   | 760                        |   | 929 |   | 929 |   |
| Commitments                                            |   | 85                    |   | 85                         |   | — |   | — |   |
|                                                        |        |                       |        |                            |        |  |  |  |  |  |  |  |  |

 

38

----

 

For cash and cash equivalents, Federal Home Loan Bankstock and accrued interest receivable, the carrying value is a reasonableestimate of fair value, primarily because of the short-term nature of theinstruments or, as to Federal Home Loan Bank stock, the ability to sell thestock back to the Federal Home Loan Bank at cost.  The fair value of investment securities is based on quoted marketprices, dealer quotes and prices obtained from independent pricingservices.  The fair value of variablerate loans is based on repricing dates. Fixed-rate loans were valued using discounted cash flows.  The discount rates used to determine thepresent value of these loans were based on interest rates currently beingcharged by the Bank on comparable loans as to credit risk and term.

 

The fair value of demand deposit accounts, NOWaccounts, savings accounts and money market deposits is the amount payable ondemand at the reporting date.  The fairvalue of fixed-maturity certificates of deposit and Federal Home Loan Bankadvances is estimated using the rates currently offered for deposits of similarterms and advances of similar remaining maturities at the reporting date.  For advance payments by borrowers, for taxesand insurance and for accrued interest payable the carrying value is areasonable estimate of fair value, primarily because of the short-term natureof the instruments.

 

The fair value estimates presented herein are based onpertinent information available to management as of December 31, 2002 and2001.  Although management is not awareof any factors that would significantly affect the estimated fair valueamounts, such amounts have not been comprehensively revalued for purposes ofthese financial statements since the reporting date and, therefore, currentestimates of fair value may differ significantly from the amounts presentedherein.

** **

**16.**                               COMMITMENTS ANDCONTINGENCIES

 

In the ordinary course of business, the Company hasvarious outstanding commitments and contingent liabilities that are notreflected in the accompanying consolidated financial statements (see Note14).  In addition, the Company is adefendant in certain claims and legal actions arising in the ordinary course ofbusiness.  In the opinion of management,after consultation with legal counsel, the ultimate disposition of thesematters is not expected to have a material adverse effect on the consolidatedfinancial statements of the Company.

** **

**17.**                               RETAINED EARNINGS -SUBSTANTIALLY RESTRICTED

 

Upon conversion, the Company established a specialliquidation account for the benefit of eligible account holders and thesupplemental eligible account holders in an amount equal to the net worth ofthe Bank as of the date of its latest statement of financial conditioncontained in the final offering circular used in connection with theconversion.  The liquidation accountwill be maintained for the benefit of eligible account holders and supplementaleligible account holders who continue to maintain their accounts in the Bankafter conversion.  In the event of acomplete liquidation (and only in such event), each eligible and supplementaleligible account holder will be entitled to receive a liquidation distributionfrom the liquidation account in an amount proportionate to the current adjustedqualifying balances for accounts then held.

 

The Company may not declare or pay cash dividends onits shares of common stock if the effect thereof would cause the Company’sstockholders’ equity to be reduced below applicable regulatory capitalmaintenance requirements for insured institutions or below the specialliquidation account referred to above.

 

39

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**18.**                               REGULATORY MATTERS

 

The Bank is subject to various regulatory capitalrequirements administered by the Office of Thrift Supervision (“OTS”).  Failure to meet minimum capital requirementscan initiate certain mandatory—and possible additional discretionary—actions byregulators that, if undertaken, could have a direct and material effect on theBank’s financial statements.  Undercapital adequacy guidelines and the regulatory framework for prompt correctiveaction, the Bank must meet specific capital guidelines that involvequantitative measures of the Bank’s assets, liabilities, and certainoff-balance sheet items as calculated under regulatory accountingpractices.  The Bank’s capital amountsand classification are also subject to qualitative judgments by the regulatorsabout components, risk weightings, and other factors.

 

Quantitative measures established by regulation toensure capital adequacy require the Bank to maintain minimum amounts and ratios(set forth in the table below) of tangible capital (as defined in theregulations) to tangible assets (as defined) and core capital (as defined) toadjusted tangible assets (as defined), and of total risk-based capital (asdefined) to risk-weighted assets (as defined). Management believes, as of December 31, 2002, that the Bank meets allcapital adequacy requirements to which it is subject.

 

At December 31, 2002 and 2001, the most recentnotification from the OTS categorized the Bank as well capitalized under theregulatory framework for prompt corrective action.  To be categorized as well capitalized the Bank must maintainminimum core (Tier I leverage), Tier I risk-based, and total risk-based ratiosas set forth in the table.  There are noconditions or events since that notification that management believes havechanged the Bank’s category.

 

The Bank’s actual capital amounts (in thousands) andratios are also presented in the table:

 
|                                      |   | **Actual** |   | **For Capital  Adequacy Purposes** |   | **To be Categorized  as Well  Capitalized Under  Prompt Corrective  Action Provisions** |   |
|-------------------------------------------|--------|------------|--------|------------------------------------|--------|-----------------------------------------------------------------------------------------|--------|
|                                      |   | **Amount** |   | **Ratio**                          |   | **Amount**                                                                              |   | **Ratio** |   | **Amount** |   | **Ratio** |   |
|                                      |   |       |   |                               |   |                                                                                    |   |   |   |   |   |   |   |
| As of December 31, 2002:                  |   |       |   |                               |   |                                                                                    |   |   |   |   |   |   |   |
|                                      |   |       |   |                               |   |                                                                                    |   |   |   |   |   |   |   |
| Tangible Capital to Tangible Assets       |   | $          | 66,509 |                               | 9.78   | %                                                                                       | $      | 10,196 |   | 1.50 | % | N/A |   | N/A |   |
|                                      |   |       |   |                               |   |                                                                                    |   |   |   |   |   |   |   |
| Core Capital to Adjusted Tangible  Assets |   | 66,509     |   | 9.78                               | %      | 27,190                                                                                  |   | 4.00 | % | $ | 33,988 |   | 5.00 | % |
|                                      |   |       |   |                               |   |                                                                                    |   |   |   |   |   |   |   |
| Total Capital to Risk-Weighted Assets     |   | 67,413     |   | 17.03                              | %      | 31,675                                                                                  |   | 8.00 | % | 39,593 |   | 10.00 | % |
|                                      |   |       |   |                               |   |                                                                                    |   |   |   |   |   |   |   |
| Tier I Capital to Risk-Weighted Assets    |   | 66,509     |   | 16.80                              | %      | N/A                                                                                     |   | N/A |   | 23,756 |   | 6.00 | % |
|                                      |   |       |   |                               |   |                                                                                    |   |   |   |   |   |   |   |
| As of December 31, 2001:                  |   |       |   |                               |   |                                                                                    |   |   |   |   |   |   |   |
|                                      |   |       |   |                               |   |                                                                                    |   |   |   |   |   |   |   |
| Tangible Capital to Tangible Assets       |   | $          | 66,597 |                               | 9.79   | %                                                                                       | $      | 10,203 |   | 1.50 | % | N/A |   | N/A |   |
|                                      |   |       |   |                               |   |                                                                                    |   |   |   |   |   |   |   |
| Core Capital to Adjusted Tangible  Assets |   | 66,597     |   | 9.79                               | %      | 27,207                                                                                  |   | 4.00 | % | $ | 34,009 |   | 5.00 | % |
|                                      |   |       |   |                               |   |                                                                                    |   |   |   |   |   |   |   |
| Total Capital to Risk-Weighted Assets     |   | 67,335     |   | 17.29                              | %      | 31,160                                                                                  |   | 8.00 | % | 38,950 |   | 10.00 | % |
|                                      |   |       |   |                               |   |                                                                                    |   |   |   |   |   |   |   |
| Tier I Capital to Risk-Weighted Assets    |   | 66,597     |   | 17.10                              | %      | N/A                                                                                     |   | N/A |   | 23,370 |   | 6.00 | % |
|                                           |        |            |        |                                    |        |                                                                                         |        |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

40

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**19.**                               PARENT COMPANY ONLYFINANCIAL INFORMATION

 

The following condensed statements of financialcondition, as of December 31, 2002 and 2001, and condensed statements of incomeand of cash flows for each of the three years in the period ended December 31,2002, for First Federal Bancshares of Arkansas, Inc. should be read inconjunction with the consolidated financial statements and the notes herein.

 

**FIRST FEDERAL BANCSHARES OF ARKANSAS,INC.**

(PARENT COMPANY ONLY) 

 

**CONDENSED STATEMENTS OF FINANCIALCONDITION (in thousands)DECEMBER 31, 2002 AND 2001**

 
|                                             |   | **2002** |   | **2001** | ** ** |
|--------------------------------------------------|--------|----------|--------|----------|------------|
| **ASSETS**                                       |   |     |   |     |       |
|                                             |   |     |   |     |       |
| Cash and cash  equivalents (deposits in Bank)    |   | $        | 391    |     | $          | 178 |   |
| Loan to Bank  subsidiary                         |   | 1,967    |   | 4,096    |       |
| Accrued  interest receivable                     |   | 2        |   | 6        |       |
| Investment in  Bank                              |   | 66,509   |   | 66,597   |       |
| Other assets                                     |   | 747      |   | 511      |       |
|                                             |   |     |   |     |       |
| TOTAL ASSETS                                     |   | $        | 69,616 |     | $          | 71,388 |   |
|                                             |   |     |   |     |       |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**    |   |     |   |     |       |
|                                             |   |     |   |     |       |
| Accrued  expenses and other liabilities          |   | $        | 350    |     | $          | 323 |   |
| Stockholders’  equity                       |   | 69,266   |   | 71,065   |       |
|                                             |   |     |   |     |       |
| TOTAL  LIABILITIES AND STOCKHOLDERS’ EQUITY |   | $        | 69,616 |     | $          | 71,388 |   |

 

41

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**FIRST FEDERALBANCSHARES OF ARKANSAS, INC.**

(PARENT COMPANY ONLY)

 

**CONDENSED STATEMENTS OFINCOME****(in thousands)**

**YEARS ENDED DECEMBER31, 2002, 2001, AND 2000**

 
|                                                                                                         |   | **2002** |   | **2001** |   | **2000** |   |
|--------------------------------------------------------------------------------------------------------------|--------|----------|--------|----------|--------|----------|--------|
| INCOME:                                                                                                      |   |     |   |     |   |     |   |
| Dividends from the Bank                                                                                      |   | $        | 8,000  |     | $      | 12,900   |   | $ | 7,000 |   |
| Interest income - loan to the Bank                                                                           |   | 34       |   | 139      |   | 124      |   |
|                                                                                                         |   |     |   |     |   |     |   |
| Total income                                                                                                 |   | 8,034    |   | 13,039   |   | 7,124    |   |
|                                                                                                         |   |     |   |     |   |     |   |
| EXPENSES:                                                                                                    |   |     |   |     |   |     |   |
| Management fees                                                                                              |   | 66       |   | 66       |   | 66       |   |
| Other operating expenses                                                                                     |   | 184      |   | 144      |   | 125      |   |
|                                                                                                         |   |     |   |     |   |     |   |
| Total expenses                                                                                               |   | 250      |   | 210      |   | 191      |   |
|                                                                                                         |   |     |   |     |   |     |   |
| INCOME BEFORE INCOME TAX PROVISION  (BENEFIT) AND EQUITY IN UNDISTRIBUTED EARNINGS (LOSS) OF BANK SUBSIDIARY |   | 7,784    |   | 12,829   |   | 6,933    |   |
|                                                                                                         |   |     |   |     |   |     |   |
| INCOME TAX PROVISION (BENEFIT)                                                                               |   | (82      | )      | (24      | )      | (23      | )      |
|                                                                                                         |   |     |   |     |   |     |   |
| INCOME BEFORE EQUITY IN UNDISTRIBUTED  EARNINGS (LOSS) OF BANK SUBSIDIARY                                    |   | 7,866    |   | 12,853   |   | 6,956    |   |
|                                                                                                         |   |     |   |     |   |     |   |
| EQUITY IN UNDISTRIBUTED EARNINGS  (LOSS) OF BANK SUBSIDIARY                                                  |   | (88      | )      | (7,393   | )      | (1,364   | )      |
|                                                                                                         |   |     |   |     |   |     |   |
| NET INCOME                                                                                                   |   | $        | 7,778  |     | $      | 5,460    |   | $ | 5,592 |   |

 

42

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**FIRST FEDERALBANCSHARES OF ARKANSAS, INC.**

(PARENT COMPANY ONLY)

 

**CONDENSED STATEMENTS OFCASH FLOWS (in thousands)YEARS ENDED DECEMBER 31, 2002, 2001, AND 2000**

 
|                                                                               |   | **2002** |   | **2001** |   | **2000** |   |
|------------------------------------------------------------------------------------|--------|----------|--------|----------|--------|----------|--------|
| OPERATING ACTIVITIES:                                                              |   |     |   |     |   |     |   |
| Net income                                                                         |   | $        | 7,778  |     | $      | 5,460    |   | $ | 5,592 |   |
| Adjustments to reconcile net income to  net cash provided by operating activities: |   |     |   |     |   |     |   |
| Equity in undistributed net loss of  Bank                                          |   | 88       |   | 7,393    |   | 1,364    |   |
| Release of ESOP shares                                                             |   | 1,016    |   | 850      |   | 675      |   |
| Stock compensation expense                                                         |   | —   |   | 297      |   | 771      |   |
| Changes in operating assets and  liabilities:                                      |   |     |   |     |   |     |   |
| Accrued interest receivable                                                        |   | 4        |   | 5        |   | (7       | )      |
| Other assets                                                                       |   | (236     | )      | 297      |   | 80       |   |
| Accrued expenses and other liabilities                                             |   | 30       |   | 114      |   | 4        |   |
|                                                                               |   |     |   |     |   |     |   |
| Net cash provided by operating  activities                                         |   | 8,680    |   | 14,416   |   | 8,479    |   |
|                                                                               |   |     |   |     |   |     |   |
| INVESTING ACTIVITIES -                                                             |   |     |   |     |   |     |   |
| Loan to bank, net of repayments                                                    |   | 2,129    |   | (2,278   | )      | 786      |   |
|                                                                               |   |     |   |     |   |     |   |
| Net cash provided by (used in)  investing activities                               |   | 2,129    |   | (2,278   | )      | 786      |   |
|                                                                               |   |     |   |     |   |     |   |
| FINANCING ACTIVITIES:                                                              |   |     |   |     |   |     |   |
| Purchase of treasury stock                                                         |   | (9,547   | )      | (10,682  | )      | (7,747   | )      |
| Dividends paid                                                                     |   | (1,471   | )      | (1,437   | )      | (1,477   | )      |
| Stock options exercised                                                            |   | 422      |   | —   |   | —   |   |
|                                                                               |   |     |   |     |   |     |   |
| Net cash used in financing activities                                              |   | (10,596  | )      | (12,119  | )      | (9,224   | )      |
|                                                                               |   |     |   |     |   |     |   |
| NET INCREASE IN CASH AND CASH  EQUIVALENTS                                         |   | 213      |   | 19       |   | 41       |   |
|                                                                               |   |     |   |     |   |     |   |
| CASH AND CASH EQUIVALENTS:                                                         |   |     |   |     |   |     |   |
| Beginning of period                                                                |   | 178      |   | 159      |   | 118      |   |
|                                                                               |   |     |   |     |   |     |   |
| End of period                                                                      |   | $        | 391    |     | $      | 178      |   | $ | 159 |   |

 

*  * *  *  *  *

 

43

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**FIRST FEDERAL BANCSHARES OFARKANSAS, INC.**

**FIRST FEDERAL BANK OFARKANSAS, FA**

 

| **DIRECTORS**                                                                                          |   | **EXECUTIVE OFFICERS**                                                                  |
|--------------------------------------------------------------------------------------------------------|--------|-----------------------------------------------------------------------------------------|
|                                                                                                   |   |                                                                                    |
| **John P. Hammerschmidt**Chairman of the Board and  U. S. Congressman, Retired                         |   | **Larry J. Brandt**President  and Chief Executive Officer                               |
|                                                                                                   |   |                                                                                    |
| **Larry J. Brandt**President  and Chief Executive Officer                                              |   | **Tommy W. Richardson**Executive  Vice President, Chief Operating Officerand  Secretary |
|                                                                                                   |   |                                                                                    |
| **James D. Heuer**Farming  and Investments                                                             |   | **Sherri R. Billings**Executive  Vice President and Chief Financial Officer             |
|                                                                                                   |   |                                                                                    |
| **Kenneth C. Savells**Insurance  and Investmentswith  securities offered through Linsco/Private Ledger |   | **Ross Mallioux**Executive Vice President and Chief Lending Officer                     |
|                                                                                                   |   |                                                                                    |
| **Jeffrey L. Brandt**Senior  Vice President and Regional Manager                                       |   | **Scott H. Tennyson**Executive Vice President and Chief Retail Officer                  |

 

**BANKING LOCATIONS**

 

 

**Main Office**

 

200 West Stephenson

Harrison, Arkansas  72601

 

 
|                                                  |   | **Branch Offices**                                        |   |                                                    |
|-------------------------------------------------------|--------|-----------------------------------------------------------|--------|---------------------------------------------------------|
|                                                  |   |                                                      |   |                                                    |
| 128 West Stephenson  Harrison, Arkansas 72601         |   | Ozark Mall - Highway 62-65 NorthHarrison,  Arkansas 72601 |   | 301 Highway 62 WestYellville,  Arkansas 72687           |
|                                                  |   |                                                      |   |                                                    |
| Corner Central & Willow  Harrison, Arkansas 72601 |   | 324 Highway 62-65 Bypass  Harrison, Arkansas 72601        |   | 307 North Walton Blvd.  Bentonville, Arkansas 72712     |
|                                                  |   |                                                      |   |                                                    |
| 210 South Main Berryville,  Arkansas 72616            |   | 1303 West HudsonRogers,  Arkansas 72756                   |   | 3460 North CollegeFayetteville,  Arkansas 72703         |
|                                                  |   |                                                      |   |                                                    |
| 668 Highway 62 EastMountain  Home, Arkansas 72653     |   | 2030 West ElmRogers,  Arkansas 72756                      |   | 2025  North Crossover RoadFayetteville, AR 72703        |
|                                                  |   |                                                      |   |                                                    |
| 1337 Hwy 62 SWMountain  Home, Arkansas 72653          |   | 249  West Main StreetFarmington, AR 72730                 |   | 201 East Henri De Tonti Blvd.Tontitown,  Arkansas 72764 |
|                                                  |   |                                                      |   |                                                    |
|                                                  |   | 1023 East Millsap RoadFayetteville,  AR 72703             |   |                                                    |

 

44

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**STOCKHOLDER INFORMATION**

 

First Federal Bancshares of Arkansas, Inc. isa unitary savings and loan holding company conducting business through itswholly-owned subsidiary, First Federal Bank of Arkansas, FA.  The Bank is a federally-chartered,SAIF-insured savings institution operating through its main office and thirteenfull service branch offices.  TheCompany’s and the Bank’s principal executive office is located at 200 WestStephenson, Harrison, Arkansas 72601.

 

**TRANSFERAGENT/REGISTRAR**

 

Registrar and TransferCompany

10 Commerce Drive

Cranford, New Jersey  07016

Phone:  (800) 368-5948

 

**STOCKHOLDERREQUESTS**

 

Requestfor annual reports, quarterly reports and related stockholder literature shouldbe directed to Investor Relations, First Federal Bancshares of Arkansas, Inc.,P. O. Box 550, Harrison, Arkansas 72602.

 

Stockholdersneeding assistance with stock records, transfers or lost certificates, shouldcontact the Company’s transfer agent, Registrar and Transfer Company, at thetelephone number listed above.

 

**COMMON STOCK INFORMATION**

 

Shares of the Company’s common stock aretraded under the symbol “FFBH” on the Nasdaq National Market System.  At March 20, 2003, the Company had 2,665,743shares of common stock outstanding and had approximately 926 stockholders ofrecord.  Such holdings do not reflectthe number of beneficial owners of common stock.

 

The following table sets forth the dividendsdeclared and the reported high and low sale prices of a share of the Company’scommon stock as reported by Nasdaq for the periods indicated.

 
| **QUARTER  ENDED** |   | **YEAR ENDED********DECEMBER 31, 2002** |       | **YEAR ENDED********DECEMBER 31, 2001** |       |
|--------------------|--------|-----------------------------------------|------------|-----------------------------------------|------------|
|               |   | **High**                                |       | **Low**                                 |       | **Dividend** |   | **High** |   | **Low** |   | **Dividend** |   |
| **March 31**       |   | **$**                                   | **24.00**  | ** **                              | **$**      | **22.25** | ** ** | **$** | **0.12** | ** ** | **$** | **20.30** | ** ** | **$** | **18.21** | ** ** | **$** | **0.11** | ** ** |
|               |   |                                    | ** ** |                                    | ** ** |   | ** ** |   | ** ** |   | ** ** |   | ** ** |
| **June 30**        |   | **$**                                   | **26.35**  | ** **                              | **$**      | **23.26** | ** ** | **$** | **0.12** | ** ** | **$** | **21.28** | ** ** | **$** | **18.85** | ** ** | **$** | **0.11** | ** ** |
|               |   |                                    | ** ** |                                    | ** ** |   | ** ** |   | ** ** |   | ** ** |   | ** ** |
| **September 30**   |   | **$**                                   | **25.80**  | ** **                              | **$**      | **24.10** | ** ** | **$** | **0.14** | ** ** | **$** | **22.85** | ** ** | **$** | **19.72** | ** ** | **$** | **0.11** | ** ** |
|               |   |                                    | ** ** |                                    | ** ** |   | ** ** |   | ** ** |   | ** ** |   | ** ** |
| **December 31**    |   | **$**                                   | **25.94**  | ** **                              | **$**      | **23.80** | ** ** | **$** | **0.14** | ** ** | **$** | **23.27** | ** ** | **$** | **19.16** | ** ** | **$** | **0.11** | ** ** |

 

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