**Exhibit13**

 

**INDEPENDENTAUDITORS’ REPORT**

 

 

The Board of Directors

FNB Bancshares, Inc.

Gaffney, South Carolina

 

 

We have audited the accompanying consolidatedbalance sheet of FNB Bancshares, Inc., and subsidiary as of December 31, 2001and the related consolidated statement of income, changes in shareholders’equity and cash flows for the year ended December 31, 2001.  These financial statements are theresponsibility of the Company’s management. Our responsibility is to express an opinion on these consolidatedfinancial statements based on our audit.

 

We conducted our audit in accordance withauditing standards generally accepted in the United States of America.  Those standards require that we plan andperform the audit to obtain reasonable assurance about whether the consolidatedfinancial statements are free of material misstatement.  An audit includes examining, on a testbasis, evidence supporting the amounts and disclosures in the consolidatedfinancial statements.  An audit alsoincludes assessing the accounting principles used and significant estimatesmade by management, as well as evaluating the overall financial statementpresentation.  We believe that our auditprovides a reasonable basis for our opinion.

 

In our opinion, the consolidated financialstatements referred to above present fairly, in all material respects, theconsolidated financial position of FNB Bancshares, Inc., and subsidiary as ofDecember 31, 2001 and the consolidated results of their operations and cashflows for the year ended December 31, 2001 in conformity with accountingprinciples generally accepted in the United States of America.

 

 
| /s/ Elliott Davis, LLC   |   |
|--------------------------|--------|
| Elliott Davis, LLC       |
| Columbia, South Carolina |
| January 6, 2004          |   |

 

1

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# **INDEPENDENTAUDITORS’ REPORT**

 

 

The Board of Directors

FNB Bancshares, Inc.

Gaffney, South Carolina

 

 

We have audited the accompanying consolidated balance sheet of FNBBancshares, Inc., and subsidiary as of December 31, 2002 and the relatedconsolidated statements of income, changes in shareholders’ equity andcomprehensive income and cash flows for the year then ended.  These financial statements are theresponsibility of the Company’s management. Our responsibility is to express an opinion on these consolidatedfinancial statements based on our audit.

 

We conducted our audit in accordance with auditing standards generallyaccepted in the United States of America. Those standards require that we plan and perform the audit to obtainreasonable assurance about whether the consolidated financial statements arefree of material misstatement.  An auditincludes examining, on a test basis, evidence supporting the amounts anddisclosures in the consolidated financial statements.  An audit also includes assessing the accounting principles usedand significant estimates made by management, as well as evaluating the overallfinancial statement presentation.  Webelieve that our audit provides a reasonable basis for our opinion.

 

In our opinion, the 2002 consolidated financial statements referred toabove present fairly, in all material respects, the financial position of FNBBancshares, Inc., and subsidiary as of December 31, 2002 and the results oftheir operations and their cash flows for the year then ended in conformitywith accounting principles generally accepted in the United States of America.

 

 
| /s/ Dixon Odom PLLC                                                                                                                                      |   |
|----------------------------------------------------------------------------------------------------------------------------------------------------------|--------|
| Dixon Odom PLLC                                                                                                                                          |
| Sanford, North Carolina                                                                                                                                  |
| February 20,  2003, except for the effects of the 5% stock  dividend in 2003, discussed in Notes 1, 13 and 17, as to which the  date is January 14, 2004 |

 

2

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**FNB Bancshares, Inc. Financial Statements**

 

## **Consolidated Balance Sheets**

**December31, 2002 and 2001**

 
|                                                                                                |   | **2002**   |       | **2001**   |   |
|-----------------------------------------------------------------------------------------------------|--------|------------|------------|------------|--------|
| **Assets:**                                                                                         |   |       |       |       |   |
| Cash and cash  equivalents:                                                                         |   |       |       |       |   |
| Cash and due  from banks                                                                            |   | $          | 4,409,643  |       | $      | 2,769,532 |   |
| Federal funds  sold                                                                                 |   | 3,972,000  |       | 738,000    |   |
| Total cash and  cash equivalents                                                                    |   | 8,381,643  |       | 3,507,532  |   |
| Investment  securities:                                                                             |   |       |       |       |   |
| Securities  available for sale (amortized cost:  2002 - $5,451,438)                                 |   | 5,546,468  |       | —     |   |
| Securities held  to maturity (estimated fair value:  2002 - $810,500; 2001 - $3,780,078)            |   | 799,854    |       | 3,749,464  |   |
| Non-marketable  equity securities                                                                   |   | 358,311    |       | 358,311    |   |
| Total investment  securities                                                                        |   | 6,704,633  |       | 4,107,775  |   |
| Loans receivable:                                                                                   |   | 51,792,893 |       | 40,099,660 |   |
| Less allowance  for loan losses                                                                     |   | (575,923   | )          | (546,376   | )      |
| Loans, net                                                                                          |   | 51,216,970 |       | 39,553,284 |   |
| Premises and  equipment, net                                                                        |   | 3,416,316  |       | 3,409,580  |   |
| Accrued interest  receivable                                                                        |   | 281,245    |       | 312,075    |   |
| Real estate  owned                                                                                  |   | 55,000     |       | 81,050     |   |
| Other assets                                                                                        |   | 150,629    |       | 265,054    |   |
| Total assets                                                                                        |   | $          | 70,206,436 |       | $      | 51,236,350 |   |
|                                                                                                |   |       |       |       |   |
| **Liabilities:**                                                                                    |   |       |       |       |   |
| Deposits:                                                                                           |   |       |       |       |   |
| Noninterest-bearing  transaction accounts                                                           |   | $          | 8,658,167  |       | $      | 7,302,392 |   |
| Interest-bearing  transaction accounts                                                              |   | 7,327,123  |       | 6,152,178  |   |
| Savings                                                                                             |   | 17,647,774 |       | 6,090,582  |   |
| Time deposits  $100,000 and over                                                                    |   | 6,347,568  |       | 4,958,558  |   |
| Other time  deposits                                                                                |   | 17,948,417 |       | 15,915,481 |   |
| Total deposits                                                                                      |   | 57,929,049 |       | 40,419,191 |   |
| Securities sold  under agreements to repurchase                                                     |   | 1,951,169  |       | 1,125,204  |   |
| Advances from  the Federal Home Loan Bank                                                           |   | 3,000,000  |       | 3,000,000  |   |
| Accrued interest  payable                                                                           |   | 47,997     |       | 60,597     |   |
| Other  liabilities                                                                                  |   | 149,012    |       | 94,847     |   |
| Total  liabilities                                                                                  |   | 63,077,227 |       | 44,699,839 |   |
|                                                                                                |   |       |       |       |   |
| Commitments and  contingencies (Notes 4 and 16)                                                     |   |       |       |       |   |
|                                                                                                |   |       |       |       |   |
| **Shareholders’  Equity:**                                                                     |   |       |       |       |   |
| Preferred stock,  $.01 par value, 10,000,000 shares authorized and unissued                         |   | —     |       | —     |   |
| Common stock,  $.01 par value, 10,000,000 shares authorized; 647,123 shares issued and  outstanding |   | 6,471      |       | 6,163      |   |
| Capital surplus                                                                                     |   | 6,450,645  |       | 6,112,318  |   |
| Retained  earnings                                                                                  |   | 611,274    |       | 418,030    |   |
| Accumulated  other comprehensive income                                                             |   | 60,819     |       | —     |   |
| Total  shareholders’ equity                                                                    |   | 7,129,209  |       | 6,536,511  |   |
| Total  liabilities and shareholders’ equity                                                    |   | $          | 70,206,436 |       | $      | 51,236,350 |   |

 

See Accompanying Notes to ConsolidatedFinancial Statements

 

1

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**FNB Bancshares, Inc. Financial Statements**

 

**ConsolidatedStatements of Income**

**For theyears ended December 31, 2002 and 2001**

 
|                                                     |   | **2002**  |      | **2001**  |   |
|----------------------------------------------------------|--------|-----------|-----------|-----------|--------|
| **Interest  and dividend income:**                       |   |      |      |      |   |
| Loans, including  fees                                   |   | $         | 3,622,513 |      | $      | 3,409,651 |   |
| Investment  securities:                                  |   |      |      |      |   |
| Taxable                                                  |   | 195,531   |      | 193,538   |   |
| Nontaxable                                               |   | 8,351     |      | —    |   |
| Non-marketable  equity securities                        |   | 19,168    |      | 16,375    |   |
| Federal funds  sold                                      |   | 33,187    |      | 77,985    |   |
| Other                                                    |   | 1,383     |      | 590       |   |
| Total                                                    |   | 3,880,133 |      | 3,698,139 |   |
| **Interest  expense:**                                   |   |      |      |      |   |
| Deposits                                                 |   | 972,498   |      | 1,397,364 |   |
| Securities sold  under agreements to repurchase          |   | 27,283    |      | 32,718    |   |
| Advances from  the Federal Home Loan Bank                |   | 78,850    |      | 48,942    |   |
| Federal funds  purchased                                 |   | 118       |      | 421       |   |
| Total                                                    |   | 1,078,749 |      | 1,479,445 |   |
| **Net  interest income**                                 |   | 2,801,384 |      | 2,218,694 |   |
| Provision for  loan losses                               |   | 186,000   |      | 104,000   |   |
| **Net  interest income after provision for loan losses** |   | 2,615,384 |      | 2,114,694 |   |
| **Other  operating income:**                             |   |      |      |      |   |
| Service charges  on deposit accounts                     |   | 409,809   |      | 231,093   |   |
| Mortgage  origination fees                               |   | 99,734    |      | 78,790    |   |
| Brokerage  service fees                                  |   | 46,748    |      | 59,150    |   |
| Other service  charges, commissions, and fees            |   | 103,328   |      | 91,120    |   |
| Total                                                    |   | 659,619   |      | 460,153   |   |
| **Other  operating expenses:**                           |   |      |      |      |   |
| Salaries and  benefits                                   |   | 1,194,451 |      | 1,078,970 |   |
| Occupancy  expense                                       |   | 189,244   |      | 146,765   |   |
| Furniture and  equipment                                 |   | 223,265   |      | 211,315   |   |
| Write-down on  disposal of assets                        |   | 24,734    |      | 76,654    |   |
| Office supplies                                          |   | 61,765    |      | 55,588    |   |
| Data processing                                          |   | 212,335   |      | 171,363   |   |
| Other operating  expenses                                |   | 541,891   |      | 447,678   |   |
| Total                                                    |   | 2,447,685 |      | 2,188,333 |   |
| **Income  before income taxes**                          |   | 827,318   |      | 386,514   |   |
| Income tax  expense                                      |   | 295,071   |      | 138,989   |   |
| **Net  income**                                          |   | $         | 532,247   |      | $      | 247,525 |   |
| **Per  Share**                                           |   |      |      |      |   |
| Average shares  outstanding - basic                      |   | 679,279   |      | 679,279   |   |
| Net income -  basic                                      |   | $         | 0.78      |      | $      | 0.36 |   |
| Average shares  outstanding - diluted                    |   | 693,859   |      | 689,528   |   |
| Net income -  diluted                                    |   | $         | 0.77      |      | $      | 0.36 |   |

 

See Accompanying Notes to Consolidated Financial Statements

 

2

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**FNB Bancshares, Inc. Financial Statements**

 

**ConsolidatedStatements of Changes in Shareholders’ Equity and Comprehensive IncomeFor the years ended December 31, 2002 and 2001**

 
|                                                                                  |   | **Common Stock** |   | **Capital  Surplus** |   | **Retained  Earnings** |   | **Accumulated  Other  Comprehensive** |   |      |    |
|---------------------------------------------------------------------------------------|--------|------------------|--------|----------------------|--------|------------------------|--------|---------------------------------------|--------|-----------|---------|
|                                                                                  |   | **Shares**       |   | **Amount**           |   |                   |   | **Income**                            |   | **Total** |    |
| **Balance,  December 31, 2000**                                                       |   | 616,338          |   | 6,163                |   | 6,112,318              |   | 170,505                               |   |      |    | 6,288,986 |   |
| Net income                                                                            |   |             |   |                 |   |                   |   | 247,525                               |   |      |    | 247,525 |   |
| **Balance,  December 31, 2001**                                                       |   | 616,338          |   | 6,163                |   | 6,112,318              |   | 418,030                               |   |      |    | 6,536,511 |   |
| Comprehensive  income:                                                                |   |             |   |                 |   |                   |   |                                  |   |      |    |   |   |
| Net income                                                                            |   |             |   |                 |   |                   |   | 532,247                               |   |      |    | 532,247 |   |
| Net unrealized  gains on securities available for sale (net of tax effect of $34,211) |   |             |   |                 |   |                   |   |                                  |   | 60,819    |    | 60,819 |   |
| Total  comprehensive income                                                           |   |             |   |                 |   |                   |   |                                  |   |      |    | 593,066 |   |
| Issuance of 5%  common stock dividend                                                 |   | 30,785           |   | 308                  |   | 338,327                |   | (338,635                              | )      |      |    | — |   |
| Cash in lieu of  fractional shares                                                    |   |             |   |                 |   |                   |   | (368                                  | )      |      |    | (368 | ) |
| **Balance,  December 31, 2002**                                                       |   | 647,123          |   | $                    | 6,471  |                   | $      | 6,450,645                             |   | $         | 611,274 |   | $ | 60,819 |   | $ | 7,129,209 |   |
|                                                                                       |        |                  |        |                      |        |                        |        |                                       |        |           |         |  |  |  |  |  |  |  |

 

See Accompanying Notes toConsolidated Financial Statements

 

3

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**FNB Bancshares, Inc. Financial Statements**

 

**ConsolidatedStatements of Cash Flows**

**For theyears ended December 31, 2002 and 2001**

 
|                                                                               |   | **2002**    |      | **2001**   |   |
|------------------------------------------------------------------------------------|--------|-------------|-----------|------------|--------|
| **Cash  flows from operating activities:**                                         |   |        |      |       |   |
| Net income                                                                         |   | $           | 532,247   |       | $      | 247,525 |   |
| Adjustments to  reconcile net income to net cash provided by operating activities: |   |        |      |       |   |
| Provision for loan  losses                                                         |   | 186,000     |      | 104,000    |   |
| Depreciation and  amortization expense                                             |   | 249,611     |      | 219,500    |   |
| Amortization  (accretion) of premiums/discounts on investment securities           |   | 4,674       |      | (2,004     | )      |
| Write-down on  disposal of assets                                                  |   | 24,734      |      | 76,654     |   |
| Loss on sale of  real estate owned                                                 |   | 7,483       |      | 19,054     |   |
| Deferred income  taxes                                                             |   | 32,352      |      | (16,830    | )      |
| Decrease in  interest receivable                                                   |   | 30,830      |      | 5,196      |   |
| Decrease in  interest payable                                                      |   | (12,600     | )         | (15,035    | )      |
| Decrease in  other assets                                                          |   | 47,862      |      | 64,283     |   |
| Increase  (decrease) in other liabilities                                          |   | 54,165      |      | (58,304    | )      |
| Net cash  provided by operating activities                                         |   | 1,157,358   |      | 644,039    |   |
|                                                                               |   |        |      |       |   |
| **Cash  flows from investing activities:**                                         |   |        |      |       |   |
| Purchases of  securities held to maturity                                          |   | (699,465    | )         | (5,802,730 | )      |
| Maturities of  securities held to maturity                                         |   | 3,650,000   |      | 5,600,000  |   |
| Purchase of  securities available for sale                                         |   | (5,718,718  | )         | —     |   |
| Principal  repayments on securites available for sale                              |   | 261,681     |      | —     |   |
| Purchase of  nonmarketable equity securities                                       |   | —      |      | (50,000    | )      |
| Net increase in  loans                                                             |   | (11,936,619 | )         | (4,557,582 | )      |
| Proceeds from  sale of real estate owned                                           |   | 105,500     |      | 23,856     |   |
| Purchases of  premises and equipment                                               |   | (281,081    | )         | (1,108,198 | )      |
| Net cash used in  investing activities                                             |   | (14,618,702 | )         | (5,894,654 | )      |
|                                                                               |   |        |      |       |   |
| **Cash  flows from financing activities:**                                         |   |        |      |       |   |
| Net increase in  deposits                                                          |   | 17,509,858  |      | 3,633,974  |   |
| Net increase in  securities sold under agreements to repurchase                    |   | 825,965     |      | 486,216    |   |
| Increase in  advances from the Federal Home Loan Bank                              |   | —      |      | 2,000,000  |   |
| Cash in lieu of  fractional shares                                                 |   | (368        | )         | —     |   |
| Net cash  provided by financing activities                                         |   | 18,335,455  |      | 6,120,190  |   |
|                                                                               |   |        |      |       |   |
| **Net  increase in cash and cash equivalents**                                     |   | 4,874,111   |      | 869,575    |   |
|                                                                               |   |        |      |       |   |
| **Cash  and cash equivalents, beginning of period**                                |   | 3,507,532   |      | 2,637,957  |   |
|                                                                               |   |        |      |       |   |
| **Cash  and cash equivalents, end of period**                                      |   | $           | 8,381,643 |       | $      | 3,507,532 |   |
|                                                                               |   |        |      |       |   |
| **Supplemental  disclosure of cash flow data:**                                    |   |        |      |       |   |
| Cash paid during  the year for interest                                            |   | $           | 1,091,349 |       | $      | 1,494,480 |   |
| Cash paid during  the year for taxes                                               |   | $           | 160,737   |       | $      | 144,600 |   |
| **Supplemental  disclosure of non-cash investing activity:**                       |   |        |      |       |   |
| Change in  unrealized gain on securities available for sale, net of income taxes   |   | $           | 60,819    |       | $      | — |   |
| Real estate  acquired through foreclosure                                          |   | $           | 86,933    |       | $      | 36,536 |   |

 

See Accompanying Notes to Consolidated FinancialStatements

 

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### **NOTE 1 - ORGANIZATION AND SUMMARY OF SIGNIFICANTACCOUNTING POLICIES**

 

**Organization and Consolidation**- FNB Bancshares, Inc., a bank holding company (the “Company”), and itssubsidiary, First National Bank of the Carolinas (the “Bank”), provide bankingservices to domestic markets principally in Cherokee County, SouthCarolina.  The Bank commenced operationson October 18, 1996.  The consolidatedfinancial statements include the accounts of the parent company and itswholly-owned subsidiary after elimination of all significant intercompanybalances and transactions.

 

**Management’s 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.

 

Material estimates that are particularly susceptible to significantchange relate to the determination of the allowance for loan losses, includingvaluation allowances for impaired loans, and the valuation of real estateowned.  In connection with thedetermination of the allowances loan for losses and real estate owned,management obtains independent appraisals for significant properties.

 

While management uses available information to recognize losses onloans and real estate owned, future additions to the allowances may benecessary based on changes in local economic conditions.  In addition, regulatory agencies, as anintegral part of their examination process, periodically review the Company’sallowances for loan losses and real estate owned.  Such agencies may require the Company to recognize adjustments tothe allowances based on their judgments about information available to them atthe time of their examination.  Becauseof these factors, it is reasonably possible that the allowances for loan lossesand real estate owned may change materially in the near term.

 

**Concentrations of Credit Risk**- Financial instruments, which potentially subject the Bank to concentrationsof credit risk, consist principally of loans receivable, investment securities,federal funds sold and amounts due from banks. Management is not aware of any concentrations of loans to classes ofborrowers or industries that would be similarly affected by economicconditions.  Although the Bank’s loanportfolio is diversified, a substantial portion of its borrower’s ability tohonor the terms of their loans is dependent on business and economic conditionsin Cherokee County and surrounding areas. Management does not believe credit risk is associated with obligationsof the United States, its agencies or corporations.  The Bank places its deposits and correspondent accounts with andsells federal funds to high credit quality financial institutions.  By policy, time deposits are limited toamounts insured by the FDIC.  Managementbelieves credit risk associated with these financial instruments is not significant.

 

**Investment Securities**- Investment securities are accounted for in accordance with Statement ofFinancial Accounting Standards (“SFAS”) 115, “Accounting for CertainInvestments in Debt and Equity Securities”. At the time of purchase, investment securities are classified by managementinto three categories as follows:  (1)Investments held to maturity: securities which the Company has the positiveintent and ability to hold to maturity, which are reported at amortizedcost;  (2) Trading securities:securities that are bought and held principally for the purpose of selling themin the near future, which are reported at fair value with unrealized gains andlosses included in earnings; and (3) Investments available for sale: securitiesthat may be sold under certain conditions, which are reported at fair value,  with unrealized gains and losses excludedfrom earnings and reported as a separate component of shareholders’ equity, netof income taxes. The amortization of premiums and accretion of discounts oninvestment securities are recorded as adjustments to interest income.  Gains or losses on sales of investmentsecurities are based on the net proceeds and the adjusted carrying amount ofthe securities sold,  using the specificidentification method.  Fair value ofsecurities is determined using quoted market prices.  Unrealized losses on securities, reflecting a decline in value orimpairment judged by the Company to be other than temporary, are charged toincome in the consolidated statements of income.

 

5

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**Non-marketable Equity Securities-**Nonmarketable equity securities include the Company’s investment in thestock of the Federal Home Loan Bank, the Federal Reserve Bank, and CommunityFinancial Services, Inc.  These stocksare recorded at cost have no quoted market value and no ready marketexists.  Investment in Federal Home LoanBank stock is a condition of borrowing from the Federal Home Loan Bank, and thestock is pledged to secure the borrowings. There were $3,000,000 in outstanding advances at December 31, 2002.  At December 31, 2002 and 2001, theinvestment in Federal Home Loan Bank stock was $150,000.  Investment in Federal Reserve Bank stock isrequired by law of every national bank. The investment in Federal Reserve Bank Stock was $132,450 at December31, 2002 and 2001.  The investment inCommunity Financial Services, Inc. was $75,861 at December 31, 2002 and 2001.

 

**Real Estate Owned**- Assets acquired through, or in lieu of, loan foreclosure are held for saleand are initially recorded at fair value at the date of foreclosure,establishing a new cost basis. Subsequent to foreclosure, valuations are periodically performed bymanagement and the assets are carried at the lower of the carrying amount orfair value less cost to sell.  Revenueand expenses from operations and changes in the valuation allowance areincluded in other expenses on the consolidated statements of income.

 

**Loans** - Loansare stated at their unpaid principal balance. Interest income is computed using the simple interest method and isrecorded in the period earned.

 

When serious doubt exists as to the collectibility of a loan or when aloan becomes contractually 90 days past due as to principal or interest,interest income is generally discontinued unless the estimated net realizablevalue of the collateral exceeds the principal balance and accruedinterest.  When interest accruals arediscontinued, income earned but not collected is reversed. Amounts received onnon-accrual loans generally are applied against principal prior to therecognition of any interest income.

 

**Allowance for Loan Losses**- An allowance for loan losses is maintained at a level deemed appropriate bymanagement to provide adequately for known and inherent losses in the loanportfolio.  Additions to the allowanceare based upon a continuing review of past loan loss experience, currenteconomic conditions which may affect the borrowers’ ability to pay, and theunderlying collateral value of the loans. Loans which are deemed to be uncollectible are charged-off against theallowance and subsequent recoveries of loans previously charged-off are addedto the allowance.

 

Loans are considered to be impaired when, in management’s judgment, thecollection of all amounts of principal and interest is not probable inaccordance with the terms of the loan agreement. The Company accounts forimpaired loans in accordance with SFAS 114, “Accounting by Creditors forImpairment of a Loan”, as amended by SFAS 118 in the areas of disclosurerequirements and methods of recognizing income. SFAS 114 requires that impairedloans be measured using fair value, which is determined based upon the presentvalue of expected cash flows discounted at the loan’s effective interest rate,the market price of the loan, if available, or the value of the underlying collateral.All cash receipts on impaired loans are applied to principal until such time asthe principal is brought current, and thereafter according to the contractualterms of the agreement. After principal has been satisfied, future cashreceipts are applied to interest income, to the extent that any interest hasbeen foregone.

 

A loan is also considered impaired if its terms are modified in atroubled debt restructuring.   For theseaccruing impaired loans, cash receipts are typically applied to principal andinterest receivable in accordance with the terms of the restructured loanagreement. Interest income is recognized on these loans using the accrualmethod of accounting, provided they are performing in accordance with theirrestructured terms.

 

6

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**Premises and Equipment**- Premises and equipment are stated at cost, less accumulateddepreciation.  The provision fordepreciation is computed by the straight-line method, based on the followingestimated useful lives:  buildings - 40years; furniture and equipment - 5 to 10 years.  Maintenance and repairs are charged to operating expenses asincurred.  The costs of major renewalsand improvements are capitalized.

 

**RetirementPlan** - The Company has a contributory 401(k) plan whichcovers substantially all employees. Under the plan, participants are permittedto make discretionary contributions up to 15% of annual compensation.  At its discretion, the Company can makematching contributions of $.25 per $1.00 up to 6% of the participants’ annualcompensation.  Expenses charged toearnings in 2002 and 2001 for the plan were $8,188 and $8,275, respectively.

 

**IncomeTaxes** - The Company accounts for income taxes inaccordance with SFAS No. 109. Under the asset and liability method of SFAS No.109, deferred tax assets and liabilities are recognized for future taxconsequences attributable to differences between the financial statementcarrying amounts of existing assets and liabilities and their respective taxbases. Deferred tax assets and liabilities are measured using the enacted taxrates expected to apply to taxable income in the years in which those temporarydifferences are expected to be recovered or settled. Under SFAS No. 109, theeffect on deferred tax assets and liabilities of a change in tax rates isrecognized in income in the period that includes the enactment date.

 

**Stock Compensation Plans** - In December 2002, the FASB issued SFAS No. 148, Accounting for Stock-Based Compensation – Transition and Disclosure. SFAS No. 148 amends SFAS No. 123, Accounting for Stock-Based Compensation, to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation.  In addition, this Statement amends the disclosure requirements of SFAS No. 123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results.  SFAS No. 148 is effective for financial statements for fiscal years ending after December 15, 2002.  Early application of the disclosure provisions is encouraged.  The Company continues to account for its stock-based compensation in accordance with Accounting Principles Bulletin (“APB”) Opinion No. 25 and has adopted the disclosureprovisions of Statement 148 effective for all periods presented herein.

 

The Company applies APB Opinion No. 25 and related interpretations inaccounting for stock options.  Accordingly,no compensation cost has been recognized. Had compensation cost for the Company’s stock options been determinedbased on the fair value at the grant dates consistent with the method of SFAS123, the Company’s net income and earnings per share for the years endedDecember 31, 2002 and 2001 would have been reduced to the pro forma amountsindicated below:

 
|                                                                  |   | **2002** |    | **2001** |   |
|-----------------------------------------------------------------------|--------|----------|---------|----------|--------|
| Net income:                                                           |   |     |    |     |   |
| As reported                                                           |   | $        | 532,247 |     | $      | 247,525 |   |
| Less:  Stock-based compensation expense  using fair value method |   | 37,717   |    | 58,125   |   |
| Pro forma                                                             |   | 494,530  |    | 189,400  |   |
|                                                                  |   |     |    |     |   |
| Basic earnings  per share:                                            |   |     |    |     |   |
| As reported                                                           |   | $        | 0.78    |     | $      | 0.36 |   |
| Pro forma                                                             |   | 0.73     |    | 0.28     |   |
|                                                                  |   |     |    |     |   |
| Diluted earnings  per share:                                          |   |     |    |     |   |
| As reported                                                           |   | $        | 0.77    |     | $      | 0.36 |   |
| Pro forma                                                             |   | 0.71     |    | 0.27     |   |

 

7

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**PerShare Data** - Earnings per share (“EPS”) are computed inaccordance with SFAS 128, “Earnings per Share.”  SFAS 128 requires companies to report basic and diluted EPS.  Basic EPS includes no dilution and is computedby dividing income available to common shareholders by the weighted averagenumber of common shares outstanding for the period.  Diluted EPS reflects the potential dilution of securities thatcould occur if the Company’s dilutive stock options were exercised.  Weighted average share and per share datahave been restated to reflect the 5% stock dividend issued April 19, 2002.  Weighted average share and per share datahave been restated to reflect the 5% stock dividend issued April 25, 2003.

 

**ComprehensiveIncome****-**SFAS No. 130,“Reporting Comprehensive Income,” establishes standards for the reporting andpresentation of comprehensive income and its components in a full set offinancial statements. Comprehensive income consists of net income and net unrealizedgains (losses) on securities and is presented in the statements of changes inshareholders’ equity and comprehensive income. The statement requires onlyadditional disclosures in the consolidated financial statements; it does notaffect the Company’s financial position or results of operations.  The Company’s only component of accumulatedother comprehensive income is net unrealized gains on securities available forsale.

 

**SegmentInformation****- **SFAS No. 131, “Disclosuresabout Segments of an Enterprise and Related Information”, requires selectedsegment information of operating segments based on a management approach. Anoperating segment is defined as any component of a company that engages inbusiness activities from which it may earn revenues and incur expenses. Themanagement approach is based on the way that management organizes the segmentswithin the company for making operating decisions and assessing performance.The Company operates as one business segment.

 

**Statementsof Cash Flows** - For purposes of reporting cash flows inthe financial statements, the Company considers certain investments purchasedwith an original maturity of three months or less to be cash equivalents.  Cash equivalents include amounts due frombanks and federal funds sold. Generally, federal funds are sold for one-day periods.

 

**Recent Accounting Pronouncements** - InOctober 2001, the FASB issued SFAS No. 144, “Accounting for the Impairment orDisposal of Long-Lived Assets.” SFAS No.144 addresses financial accounting andreporting for the impairment or disposal of long-lived assets. SFAS No. 144supersedes SFAS No. 121, “Accounting for the Impairment of Long-Lived Assetsand for Long-Lived Assets to Be Disposed Of,” and the accounting and reportingprovisions of APB No. 30, “Reporting the Results of Operations — Reporting theeffects of Disposal of a Segment of a Business, and Extraordinary, Unusual andInfrequently occurring Events and Transactions,” for the disposal of a segmentof business (as previously defined in that Opinion). SFAS No. 144 improvesfinancial reporting by requiring that one accounting model be used forlong-lived assets to be disposed of by sale, whether previously held and usedor newly acquired, and by broadening the presentation of discontinued operationsto include more disposed transactions. This Statement is effective for fiscalyears beginning after December 15, 2001. The Company adopted this statement asof January 1, 2002 with no impact on its consolidated financial statements.

 

**Reclassifications**- Certain captions and amounts in the 2001 financial statements werereclassified to conform with the 2002 presentation.

 

8

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**NOTE 2 -CASH AND DUE FROM BANKS**

 

The Company is requiredby regulation to maintain average reserve balances with the Federal ReserveBank computed as a percentage of deposits. These requirements were satisfied by vault cash and cash on hand.

 

### **NOTE3 - INVESTMENT SECURITIES**

 

The amortized costs andestimated market values of securities available for sale at December 31, 2002were:

 
|                         |   | **Amortized  Cost** |      | **Gross  Unrealized  Gains** |   | **Gross  Unrealized  Losses** |   | **Estimated  Fair Value** |   |
|------------------------------|--------|---------------------|-----------|------------------------------|--------|-------------------------------|--------|---------------------------|--------|
| **December  31, 2002**       |   |                |      |                         |   |                          |   |                      |   |
| U.S. government agencies     |   | 1,799,616           |      | 16,558                       |   | —                        |   | 1,816,174                 |   |
| Mortgage  -backed securities |   | 3,400,990           |      | 66,920                       |   | (1,449                        | )      | 3,466,461                 |   |
| Municipal  securities        |   | 250,832             |      | 13,001                       |   | —                        |   | 263,833                   |   |
|                         |   | $                   | 5,451,438 |                         | $      | 96,479                        |   | $                         | (1,449 | ) | $ | 5,546,468 |   |
|                              |        |                     |           |                              |        |                               |        |                           |        |  |  |  |  |

 

The following is asummary of maturities of securities available for sale as of December 31,2002.  The amortized cost and estimatedfair values are based on the contractual maturity dates.  Actual maturities may differ fromcontractual maturities because borrowers may have the right to call or prepayobligations with or without penalty.

 
|                                      |   | **Securities  Available for Sale** |       |
|-------------------------------------------|--------|------------------------------------|------------|
|                                      |   | **Amortized  Cost**                |       | **Estimated  Fair Value** |   |
|                                      |   |                               | ** ** |   | ** ** |
| Due  after one year but within five years |   | $                                  | 2,824,716  |   | $ | 2,842,674 |   |
| Due  after five years but within 10 years |   | 2,626,722                          |       | 2,703,794 |   |
|                                      |   | $                                  | 5,451,438  |   | $ | 5,546,468 |   |

 

The amortized costs andestimated market values of securities held to maturity at December 31, 2002 and2001 were:

 
|                      |   | **Amortized  Cost** |      | **Gross  Unrealized  Gains** |   | **Gross  Unrealized  Losses** |   | **Estimated  Fair Value** |   |
|---------------------------|--------|---------------------|-----------|------------------------------|--------|-------------------------------|--------|---------------------------|--------|
| **December 31, 2002**     |   |                |      |                         |   |                          |   |                      |   |
| U.S.  government agencies |   | $                   | 799,854   |                         | $      | 10,646                        |   | $                         | — |   | $ | 810,500 |   |
|                      |   |                |      |                         |   |                          |   |                      |   |
| **December 31, 2001**     |   |                |      |                         |   |                          |   |                      |   |
| U.S.  government agencies |   | $                   | 3,749,464 |                         | $      | 35,536                        |   | $                         | (4,922 | ) | $ | 3,780,078 |   |

 

9

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The following is asummary of maturities of securities held to maturity as of December 31,2002.  The amortized cost and estimatedfair values are based on the contractual maturity dates.  Actual maturities may differ from contractualmaturities because borrowers may have the right to call or prepay obligationswith or without penalty.

 
|                 |   | **Securities  Held to Maturity** |       |
|----------------------|--------|----------------------------------|------------|
|                 |   | **Amortized  Cost**              |       | **Estimated  Fair Value** |   |
|                 |   |                             | ** ** |   | ** ** |
| Due  within one year |   | $                                | 799,854    |   | $ | 810,500 |   |
|                      |        |                                  |            |  |  |  |  |

 

The Company had no salesof investment securities during the years ended December 31, 2002 or 2001.

 

At December 31, 2002 and2001, investment securities with a amortized cost of $6,023,721 and $3,599,464,respectively, and a fair value of $6,122,663 and $3,632,188, respectively, werepledged as collateral to secure public deposits and for other purposes asrequired and permitted by law.

 

**NOTE 4 -LOANS**

 

Major classifications ofloans receivable as of December 31, 2002 and 2001 are summarized as follows:

 
|                                     |   | **December 31,** |       |
|------------------------------------------|--------|------------------|------------|
|                                     |   | **2002**         |       | **2001** |   |
| Commercial,  financial, and agricultural |   | $                | 6,797,575  |   | $ | 7,597,065 |   |
| Real  estate - construction              |   | 4,154,989        |       | 2,165,128 |   |
| Real  estate - other                     |   | 35,007,437       |       | 23,926,931 |   |
| Consumer  and other                      |   | 5,832,892        |       | 6,410,536 |   |
|                                     |   |             |       |   |   |
| Total  gross loans                       |   | $                | 51,792,893 |   | $ | 40,099,660 |   |

 

At December 31, 2002 and2001, management has determined that no impairment of loans existed that wouldhave a material effect on the Company’s financial statements.

 

As of December 31, 2002and 2001, the Company had loans on non-accrual totaling $229,510 and $279,231,respectively. The additional amount of gross income that would have beenrecorded during 2002 and 2001 if these loans had performed as agreed would havebeen $10,339 and $7,579, respectively. The Company did not recognize anyinterest income on non-accrual loans in 2002 or 2001. The Company had onerestructured loan in the amount of $160,085 at December 31, 2002.  The Company recognized $8,460 in interestincome on this loan during 2002.  TheCompany did not have any restructured loans in 2001.

 

10

----

 

Activityin the allowance for loan losses for the years ended December 31, 2002 and 2001is summarized below:

 
|                                        |   | **2002** |    | **2001** |   |
|---------------------------------------------|--------|----------|---------|----------|--------|
| Balance,  beginning of year                 |   | $        | 546,376 |     | $      | 466,835 |   |
| Provision  for loan losses                  |   | 186,000  |    | 104,000  |   |
| Recoveries  on loans previously charged off |   | 24,474   |    | 34,618   |   |
| Loans  charged off                          |   | (180,927 | )       | (59,077  | )      |
|                                        |   |     |    |     |   |
| Balance,  end of year                       |   | $        | 575,923 |     | $      | 546,376 |   |

 

The Company is a party tofinancial instruments with off-balance-sheet risk in the normal course of businessto meet the financing needs of its customers. These financial instruments consist of commitments to extendcredit.  Commitments to extend creditare agreements to lend to a customer as long as there is no violation of anycondition established in the contract. Commitments generally have fixedexpiration dates or other termination clauses and may require payment of afee.  A commitment involves, to varyingdegrees, elements of credit and interest rate risk in excess of the amountrecognized in the consolidated balance sheets. The Company’s exposure to credit loss in the event of nonperformance bythe other party to the instrument is represented by the contractual notionalamount of the instrument.  Since certaincommitments are expected to expire without being drawn upon, the totalcommitment amounts do not necessarily represent future cash requirements.  The Company uses the same credit policies inmaking commitments to extend credit as it does for on-balance-sheetinstruments.

 

The following table summarizesthe Company’s off-balance-sheet financial instruments whose contract amountsrepresent credit risk as of December 31, 2002 and 2001:

 
|                          |   | **2002** |      | **2001** |   |
|-------------------------------|--------|----------|-----------|----------|--------|
| Commitments  to extend credit |   | $        | 8,587,595 |     | $      | 8,412,920 |   |
|                               |        |          |           |          |        |  |  |

 

### **NOTE5 - PREMISES AND EQUIPMENT**

 

Premisesand equipment consisted of the following at December 31, 2002 and 2001:

 
|                            |   | **2002**  |      | **2001**  |   |
|---------------------------------|--------|-----------|-----------|-----------|--------|
| Land                            |   | $         | 436,037   |      | $      | 436,037 |   |
| Building  and land improvements |   | 2,618,488 |      | 2,618,488 |   |
| Furniture  and equipment        |   | 1,066,229 |      | 1,043,625 |   |
| Construction  in progress       |   | 900       |      | 3,896     |   |
| Total                           |   | 4,121,654 |      | 4,102,046 |   |
| Less  accumulated depreciation  |   | 705,338   |      | 692,466   |   |
|                            |   |      |      |      |   |
| Premises  and equipment, net    |   | $         | 3,416,316 |      | $      | 3,409,580 |   |

 

11

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### **NOTE6 - DEPOSITS**

 

At December 31, 2002, thescheduled maturities of time deposits are as follows:

 
| **Maturing  In** |   | **Amount** |       |
|------------------|--------|------------|------------|
| 2003             |   | $          | 16,021,029 |   |
| 2004             |   | 1,967,593  |       |
| 2005             |   | 4,619,051  |       |
| 2006             |   | 567,037    |       |
| 2007             |   | 1,121,275  |       |
|             |   |       |       |
| Total            |   | $          | 24,295,985 |   |

 

### **NOTE7 - ADVANCES FROM THE FEDERAL HOME LOAN BANK**

 

Advances from the FederalHome Loan Bank consist of a $1,000,000 fixed rate advance bearing an interestrate of 3.90% and a $2,000,000 fixed rate advance bearing an interest rateof  2.93%.  The $1,000,000 advance is scheduled to mature on July 16, 2012and the $2,000,000 advance is scheduled to mature November 7, 2003.

 

Ascollateral, the Company has pledged first mortgage loans on one to four familyresidences totaling $9,086,063 at December 31, 2002.  In addition, the Company’s Federal Home Loan Bank stock ispledged to secure the borrowings.

 

**NOTE 8 -SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE**

 

At December 31, 2002 and2001, the Bank had arrangements to sell securities under agreements torepurchase from a local electric cooperative. Under the terms of the arrangement, the Bank may borrow at mutuallyagreed-upon rates for one to seven day periods.  Either party may cancel the arrangement without penalty.  Information concerning securities sold underagreements to repurchase for the years ended December 31, 2002 and 2001 issummarized as follows:

 
|                                       |   | **2002** |      | **2001** |   |
|--------------------------------------------|--------|----------|-----------|----------|--------|
| Average  balance during the year           |   | $        | 1,505,524 |     | $      | 891,057 |   |
|                                       |   |     |      |     |   |
| Average  interest rate during the year     |   | 2.20     | %         | 3.67     | %      |
|                                       |   |     |      |     |   |
| Maximum  month-end balance during the year |   | $        | 8,267,140 |     | $      | 2,247,924 |   |

 

As of December 31, 2002and 2001, the amortized costs and estimated fair values of the securitiesunderlying the agreements were $3,454,519 and $3,480,134 and $1,549,732 and$1,500,000, respectively.

 

### **NOTE9 - RELATED PARTY TRANSACTIONS**

 

Certain parties(principally certain directors and executive officers of the Company, theirimmediate families and business interests) were loan customers of and had othertransactions in the normal course of business with the Company.  Related party loans are made onsubstantially the same terms, including interest rates and collateral, as thoseprevailing at the time for comparable transactions with unrelated persons anddo not involve more than the normal risk of collectibility.  As of December 31, 2002 and 2001, theCompany had related party loans totaling $847,048, and $432,128,respectively.  During 2002, $1,053,016of new loans were made to related parties and repayments totaled $638,096.

 

12

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### **NOTE10 - RESTRICTIONS ON SUBSIDIARY DIVIDENDS, LOANS, OR ADVANCES**

 

The ability of FNBBancshares, Inc., to pay cash dividends is dependent upon receiving cash in theform of dividends from the Bank. However, certain restrictions exist regarding the ability of the subsidiaryto transfer funds to FNB Bancshares, Inc., in the form of cash dividends,loans, or advances.  The approval of theOffice of the Comptroller of the Currency is required to pay dividends inexcess of the Bank’s net profits (as defined) for the current year plusretained net profits (as defined) for the preceding two years, less anyrequired transfers to surplus.

 

**NOTE 11- INCOME TAXES**

 

Income tax expense forthe years ended December 31, 2002 and 2001 is summarized as follows:

 
|                              |   | **2002** |    | **2001** |   |
|-----------------------------------|--------|----------|---------|----------|--------|
| Currently  payable:               |   |     |    |     |   |
| Federal                           |   | $        | 241,095 |     | $      | 142,746 |   |
| State                             |   | 21,624   |    | 13,073   |   |
| Total  current                    |   | 262,719  |    | 155,819  |   |
| Change  in deferred income taxes: |   |     |    |     |   |
| Federal                           |   | 28,571   |    | (14,697  | )      |
| State                             |   | 3,781    |    | (2,133   | )      |
| Total  deferred                   |   | 32,352   |    | (16,830  | )      |
|                              |   |     |    |     |   |
| Income  tax expense               |   | $        | 295,071 |     | $      | 138,989 |   |

 

The gross amounts ofdeferred tax assets and deferred tax liabilities as of December 31, 2002 and2001 are as follows:

 
|                                                   |   | **December 31,** |    |
|--------------------------------------------------------|--------|------------------|---------|
|                                                   |   | **2002**         |    | **2001** |   |
| Deferred  tax assets:                                  |   |             |    |   |   |
| Allowance  for loan losses                             |   | $                | 187,761 |   | $ | 186,674 |   |
| Net  operating loss carryforward                       |   | —           |    | 696 |   |
| Other  real estate owned                               |   | —           |    | 8,126 |   |
| Other                                                  |   | 4,677            |    | 2,918 |   |
| Total  deferred tax assets                             |   | 192,438          |    | 198,414 |   |
| Deferred  tax liabilities:                             |   |             |    |   |   |
| Accummulated  depreciation                             |   | 37,340           |    | 10,964 |   |
| Net  unrealized gains on securities available for sale |   | 34,211           |    | — |   |
| Total  deferred tax liabilities                        |   | 71,551           |    | 10,964 |   |
| Net  deferred tax assets                               |   | $                | 120,887 |   | $ | 187,450 |   |

 

Deferred tax assetsrepresent the future tax benefit of future deductible differences and, if it ismore likely than not that a tax asset will not be realized, a valuationallowance is required to reduce the recorded deferred tax assets to netrealizable value.  Management hasdetermined that it is more likely than not that the entire deferred tax assetat December 31, 2002 will be realized and, accordingly, has not established avaluation allowance.  The net deferredtax asset is included in other assets on the consolidated balance sheets.  A portion of the change in the net deferredtax asset relates to the unrealized gains and losses on securities availablefor sale.  The related current perioddeferred tax expense of $34,211 has been recorded directly to shareholders’equity in 2002.

 

13

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A reconciliation betweenthe income tax expense and the amount computed by applying the federalstatutory rate of 34% to income before income taxes is as follows:

 
|                                                 |   | **2002** |    | **2001** |   |
|------------------------------------------------------|--------|----------|---------|----------|--------|
| Tax  expense at statutory rate                       |   | $        | 281,288 |     | $      | 131,415 |   |
| State  income tax, net of federal income tax benefit |   | 16,767   |    | 8,628    |   |
| Other,  net                                          |   | (2,984   | )       | (1,054   | )      |
|                                                 |   |     |    |     |   |
|                                                 |   | $        | 295,071 |     | $      | 138,989 |   |

 

**NOTE 12 - OTHER EXPENSES**

 

Other expenses for theyears ended December 31, 2002 and 2001 are summarized as follows:

 
|                       |   | **2002** |    | **2001** |   |
|----------------------------|--------|----------|---------|----------|--------|
| Correspondent  bank fees   |   | 44,728   |    | 38,541   |   |
| Printing  and postage      |   | 46,021   |    | 35,675   |   |
| Advertising  and promotion |   | 67,254   |    | 36,461   |   |
| Legal  and accounting      |   | 72,650   |    | 58,019   |   |
| Telephone  expenses        |   | 26,520   |    | 26,641   |   |
| Other                      |   | 284,718  |    | 252,341  |   |
|                       |   |     |    |     |   |
| Total                      |   | $        | 541,891 |     | $      | 447,678 |   |
|                            |        |          |         |          |        |  |  |

 

### **NOTE13 - STOCK-BASED COMPENSATION**

 

The Company has anIncentive Stock Option Plan (Stock Plan) that provides for the granting ofoptions to purchase up to 168,075 shares of the Company’s common stock todirectors, officers, or employees of the Company.  The per-share exercise price of incentive stock options grantedunder the Stock Plan may not be less than the fair market value of a share onthe date of grant, nor can the exercise date of any incentive stock optionsgranted be less than one year from the date of the grant.  The per-share exercise price of stockoptions granted is determined by a committee appointed by the Board ofDirectors.  The expiration date of anyincentive stock option may not be greater than ten years from the date ofgrant.  Options granted becomeexercisable at a rate of 20% per year on the first five anniversaries of thedate of grant.  Options that expireunexercised or are canceled become available for issuance.  At December 31, 2002 and 2001, there were32,007 and 36,732 options available for grant, respectively.

 

All outstanding optionsand option activity have been retroactively restated to reflect the effects ofthe 5% stock dividend issued April 19, 2002. All outstanding options and option activity have been retroactivelyrestated to reflect the effects of the 5% stock dividend issued April 25, 2003.

 

The fair value of optionsgranted is estimated as of the date granted using the Black-Scholes optionpricing model with the following weighted-average assumptions used for grantsin 2002: dividend yield of 0 percent; expected volatility of 0 percent;risk-free interest rates of 3.69% for 2002; and an expected life of 10 yearsfor all option grants.  There were nooptions granted in 2001.

 

The weighted-average fairvalue of options, calculated using the Black-Scholes option-pricing model,granted during 2002 was $3.22.

 

14

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A summary of the statusof the Company’s stock option plan as of December 31, 2002 and 2001 and changesduring the years ended on those dates is presented below:

 
|                              |   | **2002**    |       | **2001**                             |       |
|-----------------------------------|--------|-------------|------------|--------------------------------------|------------|
|                              |   | **Options** | ** ** | **Weighted  Average  ExercisePrice** | ** ** | **Options** | ** ** | **Weighted  Average  ExercisePrice** | ** ** |
| Outstanding  at beginning of year |   | 131,343     |       | $                                    | 9.07       |   | 131,343 |   | $ | 9.07 |   |
| Granted                           |   | 15,750      |       | 10.00                                |       | — |   | — |   |
| Exercised                         |   | —      |       | —                               |       | — |   | — |   |
| Cancelled                         |   | (11,025     | )          | 9.07                                 |       | — |   | — |   |
|                              |   |        |       |                                 |       |   |   |   |   |
| Outstanding  at ending of year    |   | 136,068     |       | $                                    | 9.17       |   | 131,343 |   | $ | 9.07 |   |

 

Optionsexercisable at December 31, 2002 and 2001 were 101,828 and 93,545,respectively.

 

AtDecember 31, 2002, the outstanding stock options had a weighted averageremaining life of 5.71 years and a remaining life of 5.00 years for those stockoptions that were exercisable.

 

### **NOTE14 - UNUSED LINES OF CREDIT**

 

As of December 31, 2002,the Bank had unused lines of credit to purchase federal funds from unrelatedbanks totaling $1,800,000.  These linesof credit are available on a one to fourteen-day basis for general corporatepurposes.  In addition, the Bank has aline of credit with Federal Home Loan Bank of fifteen percent of the totalassets of the Bank or $10,524,000 at December 31, 2002.  As of December 31, 2002, the Bank hadborrowed $3,000,000 on this line of credit.

 

### **NOTE15 - FAIR VALUE OF FINANCIAL INSTRUMENTS**

 

The fair value of afinancial instrument is the amount at which the asset or obligation could beexchanged in a current transaction between willing parties, other than in aforced or liquidation sale.  Fair valueestimates are made at a specific point in time based on relevant marketinformation and information about the financial instruments.  Because no market value exists for asignificant portion of the financial instruments, fair value estimates arebased on judgments regarding future expected loss experience, current economicconditions, risk characteristics of various financial instruments, and otherfactors. The following methods and assumptions were used to estimate the fairvalue of significant financial instruments:

 

*Cashand Due from Bank and Federal Funds Sold* - The carryingamount is a reasonable estimate of fair value. Federal funds sold are for a term of one day, and the carrying amountapproximates the fair value.

 

*InvestmentSecurities* - The fair values of investment securities arebased on quoted market prices.

 

*Loans*- For certain categories of loans, such as variable rate loans which arerepriced frequently and have no significant change in credit risk, fair valuesare based on the carrying amounts.  Thefair value of other types of loans is estimated by discounting the future cashflows using the current rates at which similar loans would be made to theborrowers with similar credit ratings and for the same remaining maturities.

### ** **

15

----

 

*Deposits*- The fair value of demand deposits, savings, and money market accounts is theamount payable on demand at the reporting date.  The fair values of time deposits are estimated using a discountedcash flow calculation that applies current interest rates to a schedule ofaggregated expected maturities.

 

*Advancesfrom the Federal Home Loan Bank* - The carrying amounts ofvariable rate borrowings are reasonable estimates of fair value because theycan be repriced frequently.  The fairvalues of fixed rate borrowings are estimated using a discounted cash flowcalculation that applies the Company’s current borrowing rate from the FederalHome Loan Bank.

 

*SecuritiesSold under Agreements to Repurchase* - The carrying amount isa reasonable estimate of fair value because these instruments typically haveterms of one day.

 

*AccruedInterest Receivable and Payable* - The carrying value of theseinstruments is a reasonable estimate of fair value.

 

*Off-Balance-SheetFinancial Instruments* - The carrying amount for loancommitments and letters of credit, which are off-balance-sheet financialinstruments, approximates the fair value since the obligations are typicallyissued on a short-term or floating rate basis.

 

The carrying values andestimated fair values of the Company’s financial instruments at December 31,2002 and 2001 are as follows:

 
|                                                                |   | **2002**             |       | **2001**                  |   |
|---------------------------------------------------------------------|--------|----------------------|------------|---------------------------|--------|
|                                                                |   | **Carrying  Amount** |       | **Estimated  Fair Value** |   | **Carrying  Amount** |   | **Estimated  Fair Value** |   |
| **Financial Assets:**                                               |   |                 |       |                      |   |   |   |   |   |
| Cash  and due from banks                                            |   | $                    | 4,409,643  |                      | $      | 4,409,643 |   | $ | 2,769,532 |   | $ | 2,769,532 |   |
| Federal  funds sold                                                 |   | 3,972,000            |       | 3,972,000                 |   | 738,000 |   | 738,000 |   |
| Securities  available for sale                                      |   | 5,546,468            |       | 5,546,468                 |   |   |   |   |   |
| Securities  held to maturity                                        |   | 799,854              |       | 810,500                   |   | 3,749,464 |   | 3,780,078 |   |
| Loans                                                               |   | 51,216,970           |       | 52,862,425                |   | 39,553,284 |   | 39,966,849 |   |
| Accrued  interest receivable                                        |   | 281,245              |       | 281,245                   |   | 312,075 |   | 312,075 |   |
|                                                                |   |                 |       |                      |   |   |   |   |   |
| **Financial Liabilities:**                                          |   |                 |       |                      |   |   |   |   |   |
| Demand  deposit, interest-bearing transaction, and savings accounts |   | $                    | 33,633,064 |                      | $      | 33,633,064 |   | $ | 19,545,152 |   | $ | 19,545,152 |   |
| Time  deposits                                                      |   | 24,295,985           |       | 24,657,385                |   | 20,874,039 |   | 21,011,133 |   |
| Advances  from the Federal Home Loan Bank                           |   | 3,000,000            |       | 3,083,134                 |   | 3,000,000 |   | 2,985,660 |   |
| Securities  sold under agreements to repurchase                     |   | 1,951,169            |       | 1,951,169                 |   | 1,125,204 |   | 1,125,204 |   |
| Accrued  interest payable                                           |   | 47,997               |       | 47,997                    |   | 60,597 |   | 60,597 |   |
|                                                                     |        |                      |            |                           |        |  |  |  |  |  |  |  |  |  |

 
|                                         |   | **Notional  Amount** |      | **Estimated  Fair Value** |   | **Notional  Amount** | ** ** | **Estimated  Fair Value** | ** ** |
|----------------------------------------------|--------|----------------------|-----------|---------------------------|--------|----------------------|------------|---------------------------|------------|
| **Off-Balance-Sheet Financial Instruments:** |   |                 |      |                      |   |                 |       |                      |       |
| Commitments  to extend credit                |   | $                    | 8,587,595 |                      | $      | 8,587,595            |       | $                         | 8,412,920  |   | $ | 8,412,920 |   |
|                                              |        |                      |           |                           |        |                      |            |                           |            |  |  |  |  |

 

16

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### **NOTE16 - COMMITMENTS AND CONTINGENCIES**

 

In the ordinary course ofbusiness, the Company may, from time to time, become a party to legal claimsand disputes.  At December 31, 2002,management and legal counsel are not aware of any pending or threatenedlitigation or unasserted claims or assessments that could result in losses, ifany, that would be material to the financial statements.

 

### **NOTE17 - EARNINGS PER SHARE**

 

Net income per share -basic is computed by dividing net income by the weighted average number ofcommon shares outstanding.  Net incomeper share - diluted is computed by dividing net income by the weighted averagenumber of common shares outstanding and dilutive common share equivalents usingthe treasury stock method.  Dilutivecommon share equivalents include common shares issuable upon exercise ofoutstanding stock options. All average share and per share data have beenretroactively restated to reflect the 5% stock dividends in 2003 and 2002.

 
|                                            |   | **2002** |    | **2001** |   |
|-------------------------------------------------|--------|----------|---------|----------|--------|
| **Net income per share - basic computation:**   |   |     |    |     |   |
|                                            |   |     |    |     |   |
| Net  income available to common shareholders    |   | $        | 532,247 |     | $      | 247,525 |   |
|                                            |   |     |    |     |   |
| Average  common shares outstanding - basic      |   | 679,279  |    | 679,279  |   |
|                                            |   |     |    |     |   |
| Net  income per share - basic                   |   | $        | 0.78    |     | $      | 0.36 |   |
|                                            |   |     |    |     |   |
| **Net income per share - diluted computation:** |   |     |    |     |   |
|                                            |   |     |    |     |   |
| Net  income available to common shareholders    |   | $        | 532,247 |     | $      | 247,525 |   |
|                                            |   |     |    |     |   |
| Average  common shares outstanding - basic      |   | 679,279  |    | 679,279  |   |
|                                            |   |     |    |     |   |
| Incremental  shares from assumed conversions:   |   |     |    |     |   |
| Stock  options                                  |   | 14,580   |    | 10,249   |   |
|                                            |   |     |    |     |   |
| Average  common shares outstanding - diluted    |   | 693,859  |    | 689,528  |   |
|                                            |   |     |    |     |   |
| Net  income per share - diluted                 |   | $        | 0.77    |     | $      | 0.36 |   |

 

17

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### **NOTE18 - REGULATORY MATTERS**

 

The Bank is subject tovarious regulatory capital requirements administered by the federal bankingagencies.  Failure to meet minimumcapital requirements can initiate certain mandatory, and possibly additionaldiscretionary actions by regulators that, if undertaken, could have a directmaterial effect on the Bank’s financial statements.  Under capital adequacy guidelines and the regulatory frameworkfor prompt corrective action, the Bank must meet specific capital guidelinesthat involve quantitative measures of the Bank’s assets, liabilities, andcertain off-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 measuresestablished by regulation to ensure capital adequacy require the Bank tomaintain minimum ratios of Tier 1 and total capital as a percentage of assetsand off-balance-sheet exposures, adjusted for risk weights ranging from 0% to100%.  Tier 1 capital consists of commonshareholders’ equity, excluding the unrealized gain or loss on securitiesavailable for sale, minus certain intangible assets.  Tier 2 capital consists of the allowance for loan losses subjectto certain limitations.  Totalregulatory minimum requirements are 4% for Tier 1 and 8% for total risk-basedcapital.

 

The Bank is also requiredto maintain capital at a minimum level based on average assets, which is knownas the leverage ratio.  Banks are tomaintain capital at the minimum requirement of 3%.

 

As of December 31, 2002,the most recent notification from the Bank’s primary regulator categorized the Bankas well-capitalized under the regulatory framework for prompt correctiveaction.  There are no conditions orevents that management believes have changed the Bank’s category.

 

The following tablesummarizes the capital amounts and ratios of the Bank and the regulatoryminimum requirements at December 31, 2002 and 2001.

 
|                                      |   | **Actual** |      | **For Capital  Adequacy Purposes** |   | **To Be Well-  Capitalized Under  Prompt Corrective  Action Provisions** |   |
|-------------------------------------------|--------|------------|-----------|------------------------------------|--------|--------------------------------------------------------------------------|--------|
|                                      |   | **Amount** |      | **Ratio**                          |   | **Amount**                                                               |   | **Ratio** |   | **Amount** |   | **Ratio** |   |
| **December 31, 2002**                     |   |       |      |                               |   |                                                                     |   |   |   |   |   |   |   |
| Total  capital (to risk-weighted assets)  |   | $          | 6,204,052 |                               | 11.20  | %                                                                        | $      | 4,430,400 |   | 8.00 | % | $ | 5,538,000 |   | 10.00 | % |
| Tier  1 capital (to risk-weighted assets) |   | 5,628,130  |      | 10.16                              | %      | 2,215,200                                                                |   | 4.00 | % | 3,322,800 |   | 6.00 | % |
| Tier  1 capital (to average assets)       |   | 5,628,130  |      | 9.55                               | %      | 2,565,200                                                                |   | 4.00 | % | 3,206,500 |   | 5.00 | % |
|                                      |   |       |      |                               |   |                                                                     |   |   |   |   |   |   |   |
| **December 31, 2001**                     |   |       |      |                               |   |                                                                     |   |   |   |   |   |   |   |
| Total  capital (to risk-weighted assets)  |   | $          | 5,626,270 |                               | 13.26  | %                                                                        | $      | 3,394,480 |   | 8.00 | % | $ | 4,243,100 |   | 10.00 | % |
| Tier  1 capital (to risk-weighted assets) |   | 5,095,883  |      | 12.01                              | %      | 1,697,240                                                                |   | 4.00 | % | 2,545,860 |   | 6.00 | % |
| Tier  1 capital (to average assets)       |   | 5,095,883  |      | 10.44                              | %      | 1,952,720                                                                |   | 4.00 | % | 2,440,900 |   | 5.00 | % |

 

The Federal Reserve Boardhas similar requirements for bank holding companies.  The Company is currently not subject to these requirementsbecause the Federal Reserve guidelines contain an exemption for bank holdingcompanies of less than $150,000,000 in consolidated assets.

 

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**NOTE 19- FNB BANCSHARES, INC. (PARENT COMPANY ONLY)**

 

**BalanceSheets**

## **December31, 2002 and 2001**

 
|                                             |   | **2002**  |      | **2001**  |   |
|--------------------------------------------------|--------|-----------|-----------|-----------|--------|
| **Assets:**                                      |   |      |      |      |   |
| Cash                                             |   | $         | 1,441,092 |      | $      | 1,440,432 |   |
| Investment  in banking subsidiary                |   | 5,688,949 |      | 5,095,883 |   |
| Other  assets                                    |   | —    |      | 196       |   |
|                                             |   |      |      |      |   |
| Total  assets                                    |   | $         | 7,130,041 |      | $      | 6,536,511 |   |
|                                             |   |      |      |      |   |
| **Liabilities**                                  |   |      |      |      |   |
| Other  liabilities                               |   | $         | 832       |      | $      | — |   |
|                                             |   |      |      |      |   |
| **Shareholders’ equity:**                   |   |      |      |      |   |
| Common  stock                                    |   | $         | 6,471     |      | $      | 6,163 |   |
| Capital  surplus                                 |   | 6,450,645 |      | 6,112,318 |   |
| Retained  earnings                               |   | 611,274   |      | 418,030   |   |
| Accumulated  other comprehensive income          |   | 60,819    |      | —    |   |
| Total  shareholders’ equity                 |   | 7,129,209 |      | 6,536,511 |   |
| Total  liabilities and shareholders’ equity |   | $         | 7,130,041 |      | $      | 6,536,511 |   |

 

**Statementsof Income**

**forthe years ended December 31, 2002 and 2001**

 
|                                                                                       |   | **2002** |    | **2001** |   |
|--------------------------------------------------------------------------------------------|--------|----------|---------|----------|--------|
| **Income**                                                                                 |   | $        | —  |     | $      | — |   |
|                                                                                       |   |     |    |     |   |
| **Expenses**                                                                               |   | —   |    | 3,021    |   |
|                                                                                       |   |     |    |     |   |
| **Income before income taxes and equity in undistributed  earnings of banking subsidiary** |   | —   |    | (3,021   | )      |
|                                                                                       |   |     |    |     |   |
| Income  tax benefit                                                                        |   | —   |    | 1,236    |   |
|                                                                                       |   |     |    |     |   |
| Equity  in undistributed earnings of banking subsidiary                                    |   | 532,247  |    | 249,310  |   |
|                                                                                       |   |     |    |     |   |
| **Net income**                                                                             |   | $        | 532,247 |     | $      | 247,525 |   |

 

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**Statementsof Cash Flows**

**forthe years ended December 31, 2002 and 2001**

 
|                                                                               |   | **2002**  |      | **2001**  |   |
|------------------------------------------------------------------------------------|--------|-----------|-----------|-----------|--------|
| **Cash flows from operating activities:**                                          |   |      |      |      |   |
| Net  income                                                                        |   | $         | 532,247   |      | $      | 247,525 |   |
| Adjustments  to reconcile net income to net cash provided by operating activities: |   |      |      |      |   |
| Decrease  in other assets                                                          |   | 196       |      | 5,017     |   |
| Increase  (decrease) in other liabilities                                          |   | 832       |      | —    |   |
| Equity  in undistributed earnings of banking subsidiary                            |   | (532,247  | )         | (249,310  | )      |
| Net  cash provided by operating activities                                         |   | 1,028     |      | 3,232     |   |
|                                                                               |   |      |      |      |   |
| **Cash flows from financing activities:**                                          |   |      |      |      |   |
| Cash  in lieu of fractional shares                                                 |   | (368      | )         | —    |   |
|                                                                               |   |      |      |      |   |
| **Increase in cash**                                                               |   | 660       |      | 3,232     |   |
|                                                                               |   |      |      |      |   |
| **Cash and cash equivalents, beginning of period**                                 |   | 1,440,432 |      | 1,437,200 |   |
|                                                                               |   |      |      |      |   |
| **Cash and cash equivalents, ending of period**                                    |   | $         | 1,441,092 |      | $      | 1,440,432 |   |
|                                                                               |   |      |      |      |   |
| **Supplemental disclosure of non-cash investing activity**                         |   |      |      |      |   |
| Changed  in unrealized gain on securites available for sale, net of income taxes   |   | $         | 60,819    |      | $      | — |   |

 

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