**UNITED STATES**

**SECURITIES AND EXCHANGECOMMISSION**

**Washington,D.C.  20549**

** **

**FORM 10-K/A**

 

**AmendmentNo. 1**

 

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**Annual Report Pursuant to Section13 or 15(d) ofthe Securities Exchange Act of 1934**

** **

**For thecalendar year ended:**

** **

**December31, 2002**

** **

**CommissionFile Number:  2-95114**

** **

**LOGAN COUNTY BANCSHARES, INC.******(Exact name of Registrant asspecified in its Charter)

** **
| **West  Virginia**                                         | ** ** | **55-0660015**                   |
|-----------------------------------------------------------------|------------|---------------------------------------|
| (State  or other jurisdiction of Incorporation or organization) | ** ** | (I.R.S.  Employer Identification No.) |
|                                                            | ** ** |                                  |
| **P. O.  Box 597, Logan, West Virginia**                   | ** ** | **25601**                        |
| (Address  of principal executive offices)                       | ** ** | (Zip  Code)                           |

 

**(304) 752-2080**

(Registrant’s telephone number, including area code)

 

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SecuritiesRegistered Pursuant to Section 12(g) of the Securities Exchange Act of 1934:

** **

**NONE**

(Titleof Class)

 

Indicate by check mark whether the registrant (1)has filed all reports required to be filed by Section 13 or 15(d) of theSecurities Exchange Act of 1934 during the preceding 12 months (or for suchshorter period that the registrant was required to file such reports), and (2)has been subject to such filing requirements for the past 90 days. ý Yes  o No.

 

Indicate by check mark if disclosure of delinquentfilers pursuant to Item 405 of Regulation S-K is not contained herein, and willnot be contained, to the best of registrant’s knowledge, in definitive proxy orinformation statements incorporated by reference in Part III of this Form 10-Kor any amendment to this Form 10-K.  ý Yes  o No.

 

Indicate by check mark whether the registrant is anaccelerated filer (as defined in Rule 12b-2 of the Act).   oYes   ý No.

 

Indicate the number of shares outstanding of each ofthe registrant’s classes of common stock as of the latest practicable date:

 

ClassOutstanding at February 28, 2005

 
| Common Stock ($1.67 Par Value) |   | 703,991 Shares |   |
|--------------------------------|--------|----------------|--------|

 

The aggregate market value of the voting stock heldby non-affiliates of registrant as of February 28, 2005, was $12,472,548, whichwas based on the last trade price of $44.00.

 

Documents Incorporated by Reference:  **None**

 

 

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**LOGANCOUNTY BANCSHARES, INC.**

** **

**Table of Contents**

** **
| **EXPLANATORY NOTE** |                                                                                           |
|----------------------|------------------------------------------------------------------------------------------------|
| ** **           |                                                                                           |
| **PART I**           |                                                                                           |
| ** **           |                                                                                           |   |
| **ITEM 1.**          | **BUSINESS**                                                                                   |   |
| ** **           | ** **                                                                                     | ** ** |
| **ITEM 2.**          | **PROPERTIES**                                                                                 |   |
| ** **           | ** **                                                                                     |   |
| **PART II**          |                                                                                           |
| ** **           |                                                                                           |   |
| **ITEM 6.**          | **SELECTED FINANCIAL DATA**                                                                    |   |
| ** **           | ** **                                                                                     | ** ** |
| **ITEM 7.**          | **MANAGEMENT’S DISCUSSION AND ANALYSIS OF  FINANCIAL CONDITION AND RESULTS OF OPERATION** |   |
| ** **           | ** **                                                                                     | ** ** |
| **ITEM 7A.**         | **QUANTITATIVE  AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK**                                |   |
| ** **           | ** **                                                                                     | ** ** |
| **ITEM 8.**          | **FINANCIAL  STATEMENTS AND SUPPLEMENTARY DATA**                                               |   |
| ** **           | ** **                                                                                     | ** ** |
| **ITEM 9A.**         | **CONTROLS AND  PROCEDURES**                                                                   |   |
| ** **           | ** **                                                                                     | ** ** |
| **PART III**         |                                                                                           |
| ** **           | ** **                                                                                     | ** ** |
| **ITEM 10.**         | **DIRECTORS AND EXECUTIVE  OFFICERS OF THE REGISTRANT**                                        |   |
| ** **           | ** **                                                                                     | ** ** |
| **ITEM 11.**         | **EXECUTIVE  COMPENSATION**                                                                    |   |
| ** **           | ** **                                                                                     | ** ** |
| **ITEM 12.**         | **SECURITY  OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT**                            |   |
| ** **           | ** **                                                                                     | ** ** |
| **ITEM 13.**         | **CERTAIN  RELATIONSHIPS AND RELATED TRANSACTIONS**                                            |   |
| ** **           | ** **                                                                                     | ** ** |
| **ITEM 14.**         | **PRINCIPAL  ACCOUNTING FEES AND SERVICES**                                                    |   |
| ** **           | ** **                                                                                     | ** ** |
| **PART  IV**         |                                                                                           |
| ** **           | ** **                                                                                     | ** ** |
| **ITEM 15.**         | **EXHIBITS,  FINANCIAL STATEMENT SCHEDULES**                                                   |   |

 

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** **

**EXPLANATORY NOTE**

 

This Amendment No. 1 on 2002 Form 10-K/A amendsItems 1, 2, 6, 7, 8, 10, 11, 12, 13 and 14, and adds Item 7A and 9A.  As disclosed on Form 8-K filed with theSecurities and Exchange Commission (the “Commission”) on July 23, 2004, LoganCounty BancShares, Inc. (the “Company”), working with its outside auditors andspecially retained securities counsel, learned that it was subject to theSarbanes-Oxley Act of 2002 (“Sarbanes-Oxley”). In addition, the Company has made additional disclosures in Management’sDiscussion and Analysis of Financial Condition and Results of Operation in Item7 to bring the discussion into compliance with Sarbanes-Oxley and to conformthe disclosures to the re-audit performed by S.R. Snodgrass, A.C. discussedbelow.

 

This Amendment No. 1 on 2002 Form 10-K/A alsorevises the consolidated financial statements as of December 31, 2002,including the notes thereto.  Asdisclosed on Form 8-K filed with the Commission on August 4, 2004, the Companywas informed by its independent auditor, McNeal, Williamson & Co. (“McNealWilliamson”) that McNeal Williamson was no longer permitted to issue auditreports for the Company and was no longer permitted to perform interim reviewsin accordance with SAS 100 for the Company as a result of McNeal Williamson’sfailure to register with the Public Company Accounting Oversight Board (“PCAOB”).  McNeal Williamson advised the Company that itshould obtain new independent accountants. Accordingly, the Company retained S. R. Snodgrass, A.C. on August 10,2004, to:  (i) review all interim periodsthat were reviewed by McNeal Williamson after the adoption of Sarbanes-Oxley;(ii) re-audit the financial statements for the period ended December 31, 2003;and (iii) review the audit for the period ended December 31, 2002.  As a result of S. R. Snodgrass, A.C.’sre-audit, adjustments were made to the previously issued financial statements.

 

Significant adjustments or restatements are as follows:

 

•                                          In the Consolidated Statement of Condition asof December 31, 2002, cash and due from banks and non-interest bearing depositswere each reduced by $369,000 to eliminate intercompany account balances.  Federal Reserve Bank Stock was reclassifiedfrom investments to other assets and deferred tax liabilities were nettedagainst deferred tax assets, resulting in a reduction in investment securitiesof $81,000 and an increase in other assets of $81,000.  The aggregate effect of the adjustments andreclassifications was to reduce total assets and total liabilities each in theamount of $369,000.  In addition, federalfunds sold have been included in the Company’s definition of cash and cashequivalents and have been reclassified as such.

 

•                                          No adjustments or restatements have been madeto previously reported net income or net income per share.  The weighted-average shares outstanding foreach of the three years 2002, 2001, and 2000 have been included on theconsolidated statement of income.

 

•                                          Comprehensive income for 2002, 2001, and 2000has been more clearly reflected on the consolidated statement of stockholders’equity by use of a separate column.

 

•                                          The consolidated statement of cash flows for2002, 2001, and 2000 has been restated to reflect federal funds sold as a cashequivalent and to account for the elimination of intercompany deposits.

 

•                                          Significant changes to the notes to theconsolidated financial statements include the following:

 

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•                                          Note 11 - Disclosure of the current anddeferred components of income tax expense; correction of the reconciliation ofthe reported amount of income tax expense and the amount computed at statutoryrates for 2002, 2001 and 2000; and correction of the composition of deferredtax assets and deferred tax liabilities as of December 31, 2002 and 2001.

 

•                                          Note 17 - Correction of the disclosureregarding the limitation on dividend payments by the subsidiary bank.

 

•                                          Note 18 - Correction of fair valueinformation.

 

•                                          Note 19 - Restatement of parent onlystatements of income for 2002, 2001, and 2000 to reflect the receipt ofdividends from the subsidiary bank and to disclose income tax expense.  Restatement of parent only statement of cashflows for 2002, 2001, and 2000 to properly reflect operating and financingactivities and to reflect the purchase of treasury stock in 2001.

 

The adjustments and reclassifications discussedabove are also reflected in the total assets and total deposits reported inItem 6 - Selected Financial Data.  Theshareholders’ equity percentage in the table has also been restated for theadjustment in total assets.

 

The amendments to Items 1, 2, 7A, 9A, 10 (withrespect to information concerning the Company’s Directors, nominees forDirector and Executive Officers), 11, 12, 13, and 14 include information thatwas required to be disclosed on Form 10-K, but was inadvertently not disclosedby the Company.  There were nodisclosures for Items 7A and 9A on Form 10-K. The information contained in the amendments to Items 1 and 2 supplementsthe prior disclosures made on Form 10-K, and the information contained in Items10, 11, 12, 13, and 14 replaces the prior disclosures made on Form 10-K.

 

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**PART I**

 

ITEM1 – BUSINESS

 

Employees

 

As of December 31, 2002, the Company and itssubsidiaries had approximately 64 full-time equivalent employees. None of theseemployees are represented by a collective bargaining unit and managementconsiders employee relations to be excellent.

 

Financial Information

 

The Company’s revenue is derived from interest andfees on loans, interest on investment securities, interest on federal fundssold, service charges and other fees, gains on securities and other sources ofincome.  The breakdown of revenue is setforth in the Management’s Discussion and Analysis of Financial Condition andResults of Operations appearing on pages 5 through 31 herein.

 

ITEM2 – PROPERTIES

 

All of the office buildings and branches of theCompany are owned by the Company.  Theland upon which the branch located at Route 10, South Man, West Virginia issituated, is leased.

 

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**PART II**

 

ITEM6 – SELECTEDFINANCIAL DATA

 

LOGAN BANCSHARES, INC. AND SUBSIDIARY

 

(In Thousands of Dollars)

 
| **YEAR ENDED DECEMBER 31:**                                                | ** ** | **2002** | ** ** | **2001** | ** ** | **2000** | ** ** | **1999** | ** ** | **1998** | ** ** |
|----------------------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|----------|------------|----------|------------|
| Total Interest Revenue                                                     |       | $        | 10,088     |     | $          | 12,090   |       | $        | 11,508     |     | $          | 10,753 |   | $ | 9,964 |   |
| Total Interest Expense                                                     |       | 2,764    |       | 4,801    |       | 4,828    |       | 4,378    |       | 4,260    |       |
|                                                                       |       |     |       |     |       |     |       |     |       |     |       |
| Net Interest Revenue                                                       |       | 7,324    |       | 7,289    |       | 6,680    |       | 6,375    |       | 5,704    |       |
| Provision  for Possible Loan Losses                                        |       | 534      |       | 700      |       | 100      |       | 22       |       | 90       |       |
|                                                                       |       |     |       |     |       |     |       |     |       |     |       |
| Net Interest Revenue After Provision for  Possible Loan Losses             |       | 6,790    |       | 6,589    |       | 6,580    |       | 6,353    |       | 5,614    |       |
| Other Operating Revenue                                                    |       | 805      |       | 707      |       | 769      |       | 699      |       | 989      |       |
| Other Operating Expense                                                    |       | (4,689   | )          | (4,631   | )          | (4,185   | )          | (3,897   | )          | (3,629   | )          |
|                                                                       |       |     |       |     |       |     |       |     |       |     |       |
| Income Before Income Taxes                                                 |       | 2,906    |       | 2,665    |       | 3,164    |       | 3,155    |       | 2,974    |       |
| Income Taxes                                                               |       | 1,064    |       | 909      |       | 1,131    |       | 1,131    |       | 1,083    |       |
|                                                                       |       |     |       |     |       |     |       |     |       |     |       |
| Net Income                                                                 |       | $        | 1,842      |     | $          | 1,756    |       | $        | 2,033      |     | $          | 2,024 |   | $ | 1,083 |   |
| Per Common Share:                                                          |       |     |       |     |       |     |       |     |       |     |       |
| Net Income                                                                 |       | $        | 257        |     | $          | 2.45     |       | $        | 2.84       |     | $          | 2.83 |   | $ | 2.64 |   |
| Cash Dividends Declared                                                    |       | $        | 1.53       |     | $          | 1.50     |       | $        | 1.44       |     | $          | 1.34 |   | $ | 1.18 |   |
|                                                                       |       |     |       |     |       |     |       |     |       |     |       |
| At December 31:                                                            |       |     |       |     |       |     |       |     |       |     |       |
| Total Loans                                                                |       | $        | 107,933    |     | $          | 116,907  |       | $        | 113,641    |     | $          | 109,571 |   | $ | 95,139 |   |
| Total Assets                                                               |       | 169,329  |       | 171,428  |       | 157,480  |       | 152,745  |       | 139,278  |       |
| Total Deposits                                                             |       | 150,074  |       | 152,028  |       | 138,723  |       | 127,619  |       | 124,420  |       |
| Short-Term Debt                                                            |       | 1,000    |       | 2,000    |       | 2,000    |       | 9,840    |       | 0        |       |
| Total Shareholders’ Equity                                            |       | 17,193   |       | 16,800   |       | 16,014   |       | 14,444   |       | 14,060   |       |
| Selected Ratios:                                                           |       |     |       |     |       |     |       |     |       |     |       |
| Rate of Return on Average:                                                 |       |     |       |     |       |     |       |     |       |     |       |
| Total Assets                                                               |       | 1.09     | %          | 1.02     | %          | 1.29     | %          | 1.33     | %          | 0.36     | %          |
| Shareholders’ Equity                                                  |       | 10.71    | %          | 10.45    | %          | 12.70    | %          | 14.01    | %          | 13.45    | %          |
| Tier 1 Capital to Total Assets at Year End                                 |       | 9.58     | %          | 10.31    | %          | 10.25    | %          | 9.92     | %          | 10.09    | %          |
| Average Total Shareholders’ Equity to  Average Total Assets           |       | 9.97     | %          | 9.98     | %          | 9.82     | %          | 11.13    | %          | 10.22    | %          |
| Common Dividend Payout Ratio                                               |       | 59.55    | %          | 61.25    | %          | 50.70    | %          | 47.35    | %          | 44.70    | %          |
| Nonaccrual and Restructured Business Loans  as a Percentage of Total Loans |       | 0.16     | %          | 0.09     | %          | 0. 13    | %          | 0.51     | %          | 0.53     | %          |

 

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ITEM7 – MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION

 

INTRODUCTION

 

Thefollowing discussion and analysis presents the significant changes in financialcondition and the results of operations at Logan County BancShares, Inc. andits subsidiary (the Company).

 

Itshould be read in conjunction with the audited consolidated financialstatements and the accompanying notes, along with the selected financial datapresented elsewhere in this report. Management is not aware of any market or institutional trends, events oruncertainties that will have or are reasonably likely to have a material effecton the liquidity, capital resources or operations of the Company, except asdiscussed herein.  Management is also notaware of any current recommendations by any regulatory authorities, which wouldhave such a material effect if implemented.

 

FORWARD-LOOKINGSTATEMENTS

 

Thisreport may contain certain forward-looking statements, including certain plans,expectations, goals and projections, which are subject to numerous assumptions,risks and uncertainties.  Actual resultscould differ materially from those contained in or implied by such statementsfor a variety of factors including: changes in economic conditions which mayaffect the Company’s primary market area; rapid movements in interest rates;competitive pressures on product pricing and services; success and timing ofbusiness strategies; the nature and extent of governmental actions and reforms;and rapidly changing technology and evolving financial industry standards.

 

CORPORATESTRUCTURE AND ACQUISITIONS

 

LoganCounty Bancshares, Inc. is a bank holding company, which was organized underthe laws of the State of West Virginia in 1985. On May 17, 1985, the Company acquired all the outstanding capital stockof Logan Bank & Trust Company (LB&T) and also all of the outstandingstock of Bank of Chapmanville (BC).  Bothof these subsidiaries were banking corporations organized under the laws of theState of West Virginia.  The subsidiarieseach had one business segment, community banking.  On October 7, 1996, the subsidiary bankscombined and Bank of Chapmanville merged into Logan Bank & Trust Company.

 

RECENTACCOUNTING PRONOUNCEMENTS

 

The FASB issued SFAS No. 142, “Goodwill and OtherIntangible Assets,” which addresses financial accounting and reporting foracquired goodwill and other intangible assets and supersedes APB Opinion No.17, “Intangible Assets,” but it does carry forward some guidance from thatstatement.  This statement requires thatan intangible asset that is acquired either individually or with a group ofother assets (but not those acquired in a business combination) shall beinitially recognized and measured based on its fair value.  Under SFAS No. 142, goodwill is not amortizedand intangible assets with a finite useful life are amortized and thoseintangible assets with an infinite life are not amortized.  This statement is generally effective forfiscal years beginning after December 15, 2001, to all goodwill and otherintangible assets recognized in an entity’s statement of financial position atthe beginning of that fiscal year, regardless of when those previouslyrecognized assets were initially recognized. The provisions of this statement shall be initially applied at the beginningof a fiscal year; retroactive application is not permitted.  The adoption of SFAS No. 142 did not have amaterial impact on the Company.

 

The FASB issued SFAS No. 143, “Accounting for AssetRetirement Obligations,” which addresses financial accounting and reporting forobligations associated with the retirement of tangible long-lived assets andthe associated asset retirement costs. This statement requires an entity to recognize the fair

 

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value of a liability for an asset retirement obligationin the period in which it is incurred if a reasonable estimate of fair valuecan be made.  This statement is effectivefor financial statements issued for fiscal years beginning after June 15, 2002.  Initial application of this statement is asof the beginning of an entity’s fiscal year. Management does not believe the adoption of SFAS No. 143 will have amaterial impact on the Company.

 

The FASB issued SFAS No. 144, “Accounting for theImpairment or Disposal of Long-Lived Assets.” SFAS No. 144 supercedes SFAS No. 121, “Accounting for the Impairment ofLong-Lived Assets and for Long-Lived Assets to be Disposed,” and the AccountingPrinciples Board Opinion No. 30, “Reporting the Results of Operations-Reportingthe Effects of Disposal of a Segment of a Business, and Extraordinary, Unusualand Infrequently Occurring Events and Transactions,” and amends AccountingResearch Bulletin No. 51, “Consolidated Financial Statements.”  This statement is generally effective forfinancial statements issued for fiscal years beginning after December 31, 2001,and interim periods within those fiscal years. The adoption of SFAS No. 144 did not have a material impact on theCompany.

 

The FASB also issued SFAS No. 145, “Rescission ofSFAS No. 4, 44, and 64, Amendment of SFAS No. 13, and Technical Corrections.”  This Statement rescinds SFAS No. 4, “ReportingGains and Losses from Extinguishments of Debt,” and an amendment of thatStatement, SFAS No. 64, “Extinguishments of Debt made to Satisfy Sinking-FundRequirements.”  This Statement alsorescinds SFAS No. 44, “Accounting for Intangible Assets of Motor Carriers.”  This Statement amends SFAS No. 13, “Accountingfor Leases,” to eliminate the inconsistency between the required accounting forsale-leaseback transactions and the required accounting for certain leasemodifications that have economic effects that are similar to sale-leasebacktransactions.  This Statement also amendsother existing authoritative pronouncements to make various technicalcorrections, clarify meanings, or describe their applicability under changedconditions.  This statement is generallyeffective for financial statements issued on or after May 15, 2002.  The adoption of SFAS No. 144 did not have amaterial impact on the Company.

 

The FASB issued SFAS No. 146, “Accounting for CostsAssociated with Exit or Disposal Activities.” This Statement requires that a liability for a cost associated with anexit or disposal activity be recognized and measured initially at fair valuewhen the liability is incurred.  Thisstatement nullifies Emerging Issues Task Force Issue No. 94-3, which requiredthe recognition of a liability for an exit cost at the date of an entity’scommitment to an exit plan.  Theeffective date of this Statement is for exit or disposal activities that areinitiated after December 31, 2002, with early application encouraged.  Management believes the adoption of thisStatement will not have a material impact on the Company.

 

The FASB issued SFAS No. 147, “Acquisitions ofCertain Financial Institutions.”  Exceptfor transactions between two or more mutual enterprises, this Statement removesacquisitions of financial institutions from the scope of both SFAS No. 72, “Accountingfor Certain Acquisitions of Banking and Thrift Institutions” and FASB InterpretationNo. 9, “Applying APB Opinions No. 16 and 17 When a Savings and Loan Associationor Similar Institution Is Acquired in a Business Combination Accounted for bythe Purchase Method.”  SFAS No. 147requires that these transactions be accounted for in accordance with FASBStatements No. 141, “Business Combinations” and No. 142, “Goodwill and OtherIntangible Assets.”  This statement alsoamends SFAS No. 144 to include in its scope long-term customer-relationshipintangible assets of financial institutions such as depositor- and borrower-relationship intangible assets and credit cardholder intangible assets.  The effective date of this Statement isgenerally for activities on or after October 1, 2002.  The adoption of SFAS No. 147 did not have amaterial impact on the Company.

 

On December 31, 2002, the FASB issued SFAS No. 148, *Accounting for Stock-Based Compensation - Transition and Disclosure*,which amends SFAS No. 123, *Accounting for Stock-BasedCompensation.*  SFAS No. 148amends the disclosure requirements of SFAS No. 123 to require more prominentand more frequent disclosures in financial statements about the effects ofstock-based compensation.  Under the

 

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provisions of SFAS No. 123, companies that adoptedthe preferable, fair value based method were required to apply that methodprospectively for new stock option awards. This contributed to a “ramp-up” effect on stock-based compensationexpense in the first few years following adoption, which caused concern forcompanies and investors because of the lack of consistency in reportedresults.  To address that concern, SFASNo. 148 provides two additional methods of transition that reflect an entity’sfull complement of stock-based compensation expense immediately upon adoption,thereby eliminating the ramp-up effect. SFAS No. 148 also improves the clarity and prominence of disclosuresabout the pro forma effects of using the fair value based method of accountingfor stock-based compensation for all companies—regardless of the accountingmethod used—by requiring that the data be presented more prominently and in amore user-friendly format in the footnotes to the financial statements.  In addition, the statement improves thetimeliness of those disclosures by requiring that this information be includedin interim as well as annual financial statements.  The transition guidance and annual disclosureprovisions of SFAS No. 148 are effective for fiscal years ending after December15, 2002, with earlier application permitted in certain circumstances.  The interim disclosure provisions areeffective for financial reports containing financial statements for interimperiods beginning after December 15, 2002.

 

In November 2002, the FASB issued Interpretation No.45, *Guarantor’s Accounting and Disclosure Requirementsfor Guarantees, Including Indirect Guarantees of Indebtedness of Others.*  This interpretation elaborates on thedisclosures to be made by a guarantor in its interim and annual financialstatements about its obligations under certain guarantees that it hasissued.  This interpretation clarifiesthat a guarantor is required to disclose (a) the nature of the guarantee,including the approximate term of the guarantee, how the guarantee arose, andthe events or circumstances that would require the guarantor to perform underthe guarantee; (b) the maximum potential amount of future payments under theguarantee; (c) the carrying amount of the liability, if any, for the guarantor’sobligations under the guarantee; and (d) the nature and extent of any recourseprovisions or available collateral that would enable the guarantor to recoverthe amounts paid under the guarantee. This interpretation also clarifies that a guarantor is required torecognize, at the inception of a guarantee, a liability for the obligations ithas undertaken in issuing the guarantee, including its ongoing obligation tostand ready to perform over the term of the guarantee in the event that thespecified triggering events or conditions occur.  The objective of the initial measurement ofthat liability is the fair value of the guarantee at its inception.  The initial recognition and initialmeasurement provisions of this interpretation are applicable on a prospectivebasis to guarantees issued or modified after December 31, 2002, irrespective ofthe guarantor’s fiscal year end.  Thedisclosure requirements in this interpretation are effective for financialstatements of interim or annual periods ending after December 15, 2002.  Adoption did not have a material impact onthe Company.

 

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INCOME STATEMENT ANALYSIS

 

EARNINGSOVERVIEW

 

Net income for 2002, was$1,842,000 or $2.57 per share, an increase of $86,000 or 4.9% from the$1,756,000 or $2.45 per share earned in 2001 and $191,000 less than the$2,033,000 or $2.84 per share earned in 2000. These earnings reflect an increase in net interest income of $35,000 or0.5%.  Management’s ongoing efforts toenhance asset quality and increase income from other sources partially offsetthe reduction in net interest income for the year ended December 31, 2002,through a decrease in the provision for loan losses of $166,000 and an increaseof other income of $98,000.

 

EARNINGSPER SHARE

 

TheEarnings Per Share Table summarizes the principal sources of changes inearnings per share for 2002.

 
| Net income per share – 2001      |   | $      | 2.45   |   |
|---------------------------------------|--------|--------|--------|--------|
|                                  |   |   |   |
| Increase (decrease) due to change in: |   |   |   |
| Net interest income                   |   | 0.05   |   |
| Provision for loan losses             |   | 0.23   |   |
| Other operating income                |   | 0.14   |   |
| Operating expense                     |   | (0.08  | )      |
| Tax expense                           |   | (0.22  | )      |
|                                  |   |   |   |
| Net income per share – 2002      |   | $      | 2.57   |   |

 

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**CONDENSEDSTATEMENTS OF FINANCIAL CONDITIONStatistical Summary 2002 – 1998 (In thousands)**

** **
| ** **                       | ** ** | **December  31,** | ** ** |
|----------------------------------|------------|-------------------|------------|
| ** **                       | ** ** | **2002**          | ** ** | **%** | ** ** | **2001** | ** ** | **%** | ** ** | **2000** | ** ** | **%** | ** ** | **1999** | ** ** | **%** | ** ** | **1998** | ** ** | **%** | ** ** |
| Loans                            |       | $                 | 107,933    |   | 63 |   | $ | 116,907 |   | 69 |   | $ | 113,641 |   | 72 |   | $ | 109,571 |   | 72 |   | $ | 95,104 |   | 68 |   |
| Investments                      |       | 41,224            |       | 25 |   | 36,355 |   | 21 |   | 29,618 |   | 19 |   | 30,028 |   | 19 |   | 27,794 |   | 20 |   |
| Federal Funds Sold               |       | 11,370            |       | 7 |   | 7,150 |   | 4 |   | 4,280 |   | 3 |   | — |   | 0 |   | 7,520 |   | 5 |   |
|                             |       |              |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest-Earning  Assets         |       | 160,527           |       | 95 |   | 160,412 |   | 94 |   | 147,239 |   | 93 |   | 139,599 |   | 91 |   | 130,418 |   | 94 |   |
|                             |       |              |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Cash and Due from  Banks         |       | 5,598             |       | 3 |   | 6,651 |   | 4 |   | 4,687 |   | 3 |   | 7,184 |   | 5 |   | 5,727 |   | 4 |   |
| Premises and  Equipment          |       | 3,217             |       | 2 |   | 3,384 |   | 2 |   | 3,594 |   | 2 |   | 3,774 |   | 2 |   | 2,085 |   | 2 |   |
| Other Assets                     |       | 1,606             |       | 1 |   | 1,883 |   | 1 |   | 2,363 |   | 2 |   | 2,889 |   | 27 |   | 1,749 |   | 1 |   |
| Reserve for Loan  Losses         |       | (1,619            | )          | -1 |   | (1,153 | ) | -1 |   | (702 | ) | 0 |   | (701 | ) | 0 |   | (701 | ) | 0 |   |
| Total Assets                     |       | $                 | 169,329    |   | 100 |   | $ | 171,177 |   | 100 |   | $ | 157,480 |   | 100 |   | $ | 152,746 |   | 10 |   | $ | 139,278 |   | 100 |   |
|                             |       |              |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Savings &  Interest DDA      |       | $                 | 66,716     |   | 39 |   | $ | 61,174 |   | 36 |   | $ | 51,723 |   | 33 |   | $ | 50,023 |   | 33 |   | $ | 50,461 |   | 36 |   |
| Time Deposits                    |       | 58,651            |       | 34 |   | 63,282 |   | 37 |   | 63,657 |   | 41 |   | 58,265 |   | 38 |   | 55,667 |   | 40 |   |
| Short-Term Debt                  |       | 1,000             |       | 1 |   | 2,000 |   | 1 |   | 2,000 |   | 1 |   | 9,840 |   | 6 |   | — |   | 0 |   |
|                             |       |              |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest-Bearing  Liabilities    |       | 126,367           |       | 74 |   | 126,456 |   | 74 |   | 117,380 |   | 75 |   | 118,128 |   | 77 |   | 106,128 |   | 76 |   |
|                             |       |              |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Demand Deposits                  |       | 24,707            |       | 15 |   | 27,150 |   | 16 |   | 23,343 |   | 15 |   | 19,332 |   | 13 |   | 18,292 |   | 13 |   |
| Other Liabilities                |       | 1,063             |       | 1 |   | 772 |   | 0 |   | 743 |   | 0 |   | 842 |   | 0 |   | 799 |   | 1 |   |
|                             |       |              |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Total Liabilities                |       | 152,137           |       | 90 |   | 154,378 |   | 90 |   | 141,466 |   | 90 |   | 138,302 |   | 90 |   | 125,219 |   | 90 |   |
|                             |       |              |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Total  Shareholders’ Equity |       | 17,192            |       | 10 |   | 16,799 |   | 10 |   | 16,014 |   | 10 |   | 14,444 |   | 10 |   | 14,059 |   | 10 |   |
|                             |       |              |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Total Liabilities  & Equity  |       | $                 | 169,329    |   | 100 |   | $ | 171,177 |   | 100 |   | $ | 157,480 |   | 100 |   | $ | 152,746 |   | 10 |   | $ | 139,278 |   | 100 |   |
|                             |       |              |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Total Deposits                   |       | $                 | 150,074    |   |   |   | $ | 151,607 |   |   |   | $ | 138,723 |   |   |   | $ | 127,620 |   |   |   | $ | 124,420 |   |   |   |
|                             |       |              |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Book Value per  Share            |       | $                 | 24.42      |   |   |   | $ | 23.43 |   |   |   | $ | 22.75 |   |   |   | $ | 20.52 |   |   |   | $ | 29.41 |   |   |   |

 

9

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**SUMMARYOF OPERATIONSStatistical Summary 2002 – 1998 (In thousands)**

** **
| ** **                                                     | ** ** | **2002** | ** ** | **2001** | ** ** | **2000** | ** ** | **1999** | ** ** | **1998** | ** ** |
|----------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|----------|------------|----------|------------|
| Total Interest Revenue                                         |       | $        | 10,088     |     | $          | 12,090   |       | $        | 11,508     |     | $          | 10,753 |   | $ | 9,964 |   |
| Total Interest Expense                                         |       | 2,764    |       | 4,801    |       | 4,828    |       | 4,378    |       | 4,260    |       |
|                                                           |       |     |       |     |       |     |       |     |       |     |       |
| Net Interest Revenue                                           |       | 7,324    |       | 7,289    |       | 6,680    |       | 6,375    |       | 5,704    |       |
| Provision for Possible Loan Losses                             |       | 534      |       | 700      |       | 100      |       | 22       |       | 90       |       |
|                                                           |       |     |       |     |       |     |       |     |       |     |       |
| Net Interest Revenue After Provision for  Possible Loan Losses |       | 6,790    |       | 6,589    |       | 6,580    |       | 6,353    |       | 5,614    |       |
| Other Operating Revenue                                        |       | 805      |       | 707      |       | 769      |       | 699      |       | 989      |       |
| Other Operating Expense                                        |       | (4,689   | )          | (4,631   | )          | (4,185   | )          | (3,897   | )          | 3,629    |       |
|                                                           |       |     |       |     |       |     |       |     |       |     |       |
| Income Before Income Taxes                                     |       | 2,906    |       | 2,665    |       | 3,164    |       | 3,155    |       | 2,974    |       |
| Income Taxes                                                   |       | 1,064    |       | 909      |       | 1,131    |       | 1,131    |       | 1,082    |       |
|                                                           |       |     |       |     |       |     |       |     |       |     |       |
| Net Income                                                     |       | $        | 1,842      |     | $          | 1,756    |       | $        | 2,033      |     | $          | 2,024 |   | $ | 1,891 |   |
| Per Common Shares:                                             |       |     |       |     |       |     |       |     |       |     |       |   |   |   |   |   |
| Net Income                                                     |       | $        | 2.57       |     | $          | 2.45     |       | $        | 2.84       |     | $          | 2.83 |   | $ | 2.64 |   |
| Cash Dividends Declared                                        |       | $        | 1.53       |     | $          | 1.50     |       | $        | 1.44       |     | $          | 1.34 |   | $ | 1.18 |   |
|                                                           |       |     |       |     |       |     |       |     |       |     |       |
| Common Dividend Payout                                         |       | 60       | %          | 61       | %          | 51       | %          | 47       | %          | 45       | %          |

 

10

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BALANCESHEET ANALYSIS

 

LOANS

 

TheCompany’s primary goal is to maximize the return to shareholders.  An important factor in accomplishing thisgoal is meeting the credit needs of the retail and commercial customers in theCompany’s primary markets in southern West Virginia.  Total loans decreased approximately$8,975,000 or 7.7% in 2002, following a 2.8% increase of $3,266,000 in2001.  Competition in the Company’smarket is very aggressive for originating new loans.  Loan demand was relatively strong during mostof 2002, as interest rates remained at historically low levels. However,management continued to adhere to its philosophy of not offering long-termfixed-rate loans in this low interest rate cycle causing loan volume todecline.  At December 31, 2002, the loanportfolio comprised 63.0% of total interest-earning assets as compared to 69.0%of total interest-earning assets at December 31, 2001, and contributed 84.4% oftotal interest income in 2002 and 82.6% in 2001 and 82.7% in 2000.  See Note 4 to the Consolidated FinancialStatement for additional information on loans.

 

During2002, the Company’s strong emphasis continued to be on lending to localcompanies with known local management and excellent financial stability.  Most of the commercial loans in the portfoliowere made at variable rates of interest. Additionally, the Company continued to make loans available in anexpanding retail marketplace.  Consistentwith management’s philosophy of relationship banking, most borrowers are alsodepositors and utilize other banking services. The average yield of the loan portfolio decreased to an average rate of7.58% in 2002 compared to 8.66% in 2001. This reflected the historically low interest rate environment during2002, high rates of refinancing and the continued repricing of loans at lowerinterest rates.

 

Thecommercial loan portfolio is generally diversified and geographically dispersedwithin the Company’s market.  There areno concentrations, lines of business or industry that represent greater than30% of the Company’s equity.  Within eachspecific industry, borrowers are diversified as to specialty, service or otherunique feature of the overall industry. A substantial portion of the customer’s ability to honor theircontractual commitment is largely dependent upon the economic conditions of theborrowers’ respective industries and overall economic conditions of southernWest Virginia, which is somewhat less volatile than many areas of the country.

 

Theconsumer portion of the loan portfolio consists of both secured and unsecuredloans made to individuals and families for various reasons including thepurchase of automobiles, home improvements, educational expenses and otherpurposes.  The Company continues tocarefully monitor the consumer sector during this period of economicweakness.  As recessionary pressuresresult in higher levels of unemployment, the likelihood for increasedvolatility arises in the consumer sector.

 

Commitmentsto extend credit are agreements to lend to a customer provided there is noviolation of any condition established in the contract.  See Note 14 to the Consolidated FinancialStatements for additional information on Commitments and Contingencies.  Commitments generally have fixed expirationdates or other termination clause and may require the payment of a fee.  Since many of the commitments are expected toexpire without being drawn upon, the total amount of commitments does notnecessarily represent future cash requirements. Logan Bank and Trust Company had outstanding commitments to extendcredit of approximately $11,863,000 at December 31, 2002, and $11,271,000 atDecember 31, 2001.  These commitmentsincluded unfunded loan commitments and unused lines of credit totaling$10,801,000 at December 31, 2002 and $10,281,000 at December 31, 2001.  Additionally, standby letters of credittotaled $1,062,000 at December 31, 2002, and $990,000 at December 31,2001.  Financial standby letters ofcredit are conditional commitments issued by Logan Bank & Trust Company toguarantee the financial performance of a customer to a third party.  Those guarantees are primarily used tosupport public and private borrowing arrangements.

 

11

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Atable follows in this discussion and analysis which details the amount andexpected maturities of significant commitments of as December 31, 2002.

 

Nonperformingassets, including nonaccrual loans, loans past-due 90 days or more,restructured loans and other real estate owned, decreased $380,000 orapproximately 13%, from December 31, 2001 to December 31, 2002, following adecrease of $1,153,000, or approximately 28% in 2001.  These decreases reflect management’s ongoingefforts to enhance the quality of the loan portfolio.  This improvement was further enhanced by theCompany’s adhering to a stricter set of criteria in the determination ofgranting renewals and extensions.  TheCompany’s policy is to discontinue the accrual of interest on loans that arepast due more than 90 days, unless such loans are well collateralized and inprocess of collection.  Loans that are ona current payment status or past due less those 90 days may also be classifiedas nonaccrual if repayment of principal or interest is in doubt.  The Company’s holdings of other real estateowned decreased approximately 14%, or $31,000 in 2002, following an increase ofapproximately $27,000 in 2001.  See thefollowing schedule in this discussion and analysis titled Nonperforming Assetsand Loan Loss Analysis.

 

TheCompany maintains, through its provision, an allowance for loan losses believedby management to be adequate to absorb probable credit losses inherent in theportfolio.  Management is committed tothe early recognition of problem loans, and to an appropriate and adequatelevel of allowance.  The allowance forloan losses was 1.50% of year-end loans at December 31, 2002 and 0.99% atDecember 31, 2001.  The estimation of theadequacy of the allowance for loan losses is the most significant estimatedetermined by management.  Differentamounts could result under different conditions or assumptions.  The allowance for loan losses is alsoreviewed by banking regulators and the Company’s independent auditors.

 

TheCompany uses an outsourcing arrangement for its loan review function with anindependent third-party firm.  Thisprocess includes a through evaluation of the credit administration systems andpersonnel. The objective is to have an effective loan review system thatprovides management with information that will produce a more focused andeffective approach in managing credit risk inherent in the loan portfolio.  As a part of this process, a system of loangrades is utilized to further support the adequacy of the loan loss allowance.

 

Inaddition to the review of credit quality through the credit review process, theCompany constructs a comprehensive analysis of the allowance for loan lossesfor its loan portfolio at least quarterly. The procedures that are utilized entail preparation of a loan “watch”list and assigning each loan a classification. For those individually significant loans where it is determined that itis not probable that the borrower will make all payments in accordance with theoriginal loan agreement, management performs an impairment analysis as requiredby SFAS Nos. 114 and 118.  Specificreserves are recorded on impaired loans of $505,000 and $518,000 at December31, 2002 and 2001, respectively.  Otherclassified loans are categorized and allocated appropriate reserves.  Other loans more than 90 days past due thathave not been considered in the aforementioned procedures are assigned aclassification of Substandard and are reserved for accordingly.  The remaining portfolio is segregated intoconsumer, commercial, and residential real estate loans, and the historical netcharge off percentage of each category is applied to the current amountoutstanding in that category.  Also, areview of concentrations of credit, classes of loans and pledged collateral isperformed to determine the existence of any deterioration.  In addition, volume and trends indelinquencies and nonaccural loans, off-balance sheet credit risks, the loanportfolio composition, loan volume and maturity of the portfolio, national andlocal economic conditions and the experience, ability and depth of lendingmanagement and staff are given consideration. See Notes 4, 5, and 15 to the Consolidated Financial Statements foradditional information on loan quality, the allowance for loan losses andconcentration of credit risk.

 

12

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ALLOWANCE FOR LOAN LOSSES

 

TheCompany maintains, through its provision, an allowance for loan losses believedby management to be adequate to absorb probable credit losses inherent in theportfolio.  Management continues toenhance the methodology and procedures for determining the adequacy of theallowance for loan losses.  Thisallowance is also reviewed by banking regulators and the Company’s independentauditors.  The procedures that areutilized entail preparation of a loan watch list and assigning each loan aclassification.  For those individuallysignificant loans where it is determined that it is not probable that theborrower will make all payments in accordance with the original loan agreement,management performs an impairment analysis. The measurement of impaired loans is based on either the fair value ofthe underlying collateral, the present value of the future cash flowsdiscounted at the historical effective interest rate stipulated in the loanagreement, or the estimated market value of the collateral.

 

Otherclassified loans are categorized and allocated appropriate reserves.  Loans are designated as nonaccrual when, inthe opinion of management, the collection of principal or interest isdoubtful.  This generally occurs when aloan becomes 90 days past due as to principal or interest unless the loan isboth well secured and in the process of collection.  Other loans more than 90 days past due, whichhave not been considered in the aforementioned procedures, are reserved foraccordingly.  The remaining portfolio issegregated into consumer, commercial and residential real estate loans, and thehistorical net charge off percentage of each category is applied to the currentamount outstanding in those categories. Additionally, concentrations of credit, collateral deficient loans,volume and trends in delinquencies, off-balance sheet credit risks, loanportfolio composition, loan volume and maturity of the portfolio, national andlocal economic conditions and the experience, ability and depth of lendingmanagement and staff are given consideration. (See Notes 4, 5, and 15 to the Consolidated Financial Statements foradditional information on loan quality, the allowance for loan losses andconcentration of credit risk.

 

13

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** **

**NONPERFORMINGASSETS AND LOAN LOSS ANALYSIS**

** **
| ** **                                       | ** ** | **Year Ended December 31** | ** ** |
|--------------------------------------------------|------------|----------------------------|------------|
| ** **                                       | ** ** | **2002**                   | ** ** | **2001** | ** ** | **2000** | ** ** | **1999** | ** ** | **1998** | ** ** |
| ** **                                       | ** ** | **(Dollars in Thousands)** | ** ** |
| Amount of Loans Outstanding at End of  Period    |       | $                          | 107,933    |   | $ | 116,907 |   | $ | 112,938 |   | $ | 108,870 |   | $ | 95,139 |   |
| Average Amount of Loans                          |       | $                          | 110,174    |   | $ | 110,289 |   | $ | 109,447 |   | $ | 101,197 |   | $ | 90,019 |   |
| Balance of Allowance for Possible Loan  Losses:  |       |                       |       |   |   |   |   |   |   |   |   |
| Balance at Beginning of Year                     |       | $                          | 1,153      |   | $ | 702 |   | $ | 700 |   | $ | 701 |   | $ | 673 |   |
| Loans Charged Off:                               |       |                       |       |   |   |   |   |   |   |   |   |
| Commercial                                       |       | $                          | 9          |   | $ | 32 |   | $ | 0 |   | $ | 0 |   | $ | 14 |   |
| Real Estate                                      |       | 16                         |       | 30 |   | 7 |   | 0 |   | 0 |   |
| Consumer                                         |       | 73                         |       | 205 |   | 99 |   | 29 |   | 51 |   |
|                                             |       | 98                         |       | 257 |   | 106 |   | 29 |   | 65 |   |
| Recovers of Loans Previously Charged Off:        |       |                       |       |   |   |   |   |   |   |   |   |
| Commercial                                       |       | 1                          |       | 1 |   | 0 |   | 1 |   | 1 |   |
| Real Estate                                      |       | 1                          |       | 1 |   | 3 |   | 0 |   | 0 |   |
| Consumer                                         |       | 28                         |       | 6 |   | 5 |   | 4 |   | 2 |   |
| Total Recoveries                                 |       | 30                         |       | 8 |   | 8 |   | 5 |   | 3 |   |
| Net Loans Charged Off:                           |       | 68                         |       | 249 |   | 98 |   | 24 |   | 62 |   |
| Provision for Loan Losses                        |       | 534                        |       | 700 |   | 100 |   | 23 |   | 90 |   |
| Balance at End of Period                         |       | $                          | 1,619      |   | $ | 1,153 |   | $ | 702 |   | $ | 700 |   | $ | 701 |   |
| Ratio of net Charge-Offs to Average Loans        |       | 0.062                      | %          | 0.226 | % | 0.090 | % | 0.024 | % | 0.070 | % |
| Allowance at year end as a% of Loans             |       | 1.523                      | %          | 0.996 | % | 0.622 | % | 0.643 | % | 0.740 | % |
| Provisions for loan losses as a% of Loans        |       | 0.490                      | %          | 0.605 | % | 0.089 | % | 0.021 | % | 0.09 | % |
| Nonperforming assets (at year end)               |       |                       |       |   |   |   |   |   |   |   |   |
| Nonaccrual                                       |       | 1,706                      |       | 864 |   | 426 |   | 555 |   | 509 |   |
| Past-due ninety days or more and still  accruing |       | 617                        |       | 1,761 |   | 3,338 |   | 3,287 |   | 3,310 |   |
| Troubled debt restructurings                     |       | 0                          |       | 0 |   | 0 |   | 0 |   | 0 |   |
| Other real estate owned                          |       | 196                        |       | 227 |   | 200 |   | 358 |   | 94 |   |
| Total Nonperforming Assets                       |       | 2,519                      |       | 2,852 |   | 3,964 |   | 4, 200 |   | 3,913 |   |
| Nonperforming assets/total loans                 |       | 2.33                       | %          | 2.44 | % | 3.51 | % | 3.86 | % | 4.11 | % |
| Nonperforming assets/total assets                |       | 1.49                       | %          | 1.66 | % | 2.53 | % | 2.75 | % | 2.81 | % |

 

14

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**TABLEVI - ALLOCATION OF ALLOWANCE FOR LOAN LOSSES**

 
| ** **  | ** ** | **December  31, 2002** | ** ** | **December  31, 2001** | ** ** | **December  31, 2000** | ** ** | **December  31, 1999** | ** ** | **December  31, 1998** | ** ** |
|-------------|------------|------------------------|------------|------------------------|------------|------------------------|------------|------------------------|------------|------------------------|------------|
|        |       | ** **             | ** ** | **% of**               | ** ** | ** **             | ** ** | **% of**               | ** ** | ** **             | ** ** | **% of** | ** ** | ** ** | ** ** | **% of** | ** ** | ** ** | ** ** | **% of** |   |
| ** **  | ** ** | ** **             | ** ** | **Outstanding**        | ** ** | ** **             | ** ** | **Outstanding**        | ** ** | ** **             | ** ** | **Outstanding** | ** ** | ** ** | ** ** | **Outstanding** | ** ** | ** ** | ** ** | **Outstanding** | ** ** |
|        |       | ** **             | ** ** | **Loan**               | ** ** | ** **             | ** ** | **Loan**               | ** ** | ** **             | ** ** | **Loan** | ** ** | ** ** | ** ** | **Loan** | ** ** | ** ** | ** ** | **Loan** |   |
| ** **  | ** ** | **Allowance**          | ** ** | **Balance**            | ** ** | **Allowance**          | ** ** | **Balance**            | ** ** | **Allowance**          | ** ** | **Balance** | ** ** | **Allowance** | ** ** | **Balance** | ** ** | **Allowance** | ** ** | **Balance** | ** ** |
|        |       |                   |       |                   |       |                   |       |                   |       |                   |       |   |   |   |   |   |   |   |   |   |   |
| Commercial  |       | $                      | 854        |                   | 1.94       | %                      | $          | 749                    |       | 1.52                   | %          | $ | 464 |   | 0.98 | % | $ | 464 |   | 1.03 | % | $ | 463 |   | 1.22 |   |
|        |       |                   |       |                   |       |                   |       |                   |       |                   |       |   |   |   |   |   |   |   |   |   |   |
| Real Estate |       | 623                    |       | 1.19                   | %          | 288                    |       | 0.54                   | %          | 163                    |       | 0.31 | % | 163 |   | 0.32 | % | 163 |   | 0.35 |   |
|        |       |                   |       |                   |       |                   |       |                   |       |                   |       |   |   |   |   |   |   |   |   |   |   |
| Consumer    |       | 142                    |       | 1.24                   | %          | 116                    |       | 0.83                   | %          | 75                     |       | 5.50 | % | 73 |   | 5.50 | % | 75 |   | 0.67 |   |
|        |       |                   |       |                   |       |                   |       |                   |       |                   |       |   |   |   |   |   |   |   |   |   |   |
| Total       |       | $                      | 1,619      |                   | 1.50       | %                      | $          | 1,153                  |       | 0.99                   | %          | $ | 702 |   | 0.62 | % | $ | 700 |   | 0.64 | % | $ | 701 |   | 0.74 |   |

 

15

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SECURITIES

 

Securities,the second largest asset of the Company, increased by $15,021,000 or 58% during2002.  This increase resulted from thedecrease in the loan portfolio.  AtDecember 31, 2002, securities comprised 24.9% of total interest-earning assetscompared to 16.3% of total interest-earning assets at December 31, 2001.  The composition of the Company’s securitiesportfolio reflects management’s investment strategy of maximizing theappropriate level of asset liquidity and providing management a tool to assistin controlling and managing the Company’s interest rate risk while at the sametime producing appropriate levels of interest income.  Management of the maturity of the securitiesportfolio is necessary to ensure adequate liquidity and manage interest raterisk.  During 2002, in order to maintainliquidity and flexibility, management continued categorizing all investments inthe available for sale portfolio. Management believes that the potential for increased loan demandrequires maintaining the liquidity of the securities portfolio.  See the following schedules in thisdiscussion and analysis for more information on the securities portfolio.  In addition, see Note 2 to the ConsolidatedFinancial Statements for additional information.

 

Thefollowing table shows the carrying values of securities at the respectiveperiods, which is market value for available for sale securities.  For additional information see Note 2 to theConsolidated Financial Statements.  Thereare no securities held to maturity.

 
| ** **                          | ** ** | **December 31,**          | ** ** |
|-------------------------------------|------------|---------------------------|------------|
| ** **                          | ** ** | **2002**                  | ** ** | **2001** | ** ** | **2000** | ** ** |
| ** **                          | ** ** | **(Dollar in Thousands)** | ** ** |
| Securities available for  sale      | ** ** | ** **                | ** ** | ** ** | ** ** | ** ** | ** ** |
| U. S. Government securities         |       | $                         | 4,075      |   | $ | 3,489 |   | $ | 1,993 |   |
| U. S. Government agency securities  |       | 36,817                    |       | 32,616 |   | 27,375 |   |
| Other securities                    |       | 332                       |       | 250 |   | 250 |   |
|                                |       |                      |       |   |   |   |   |
| TOTAL SECURITIES AVAILABLE FOR SALE |       | $                         | 41,224     |   | $ | 36,355 |   | $ | 29,618 |   |

 

16

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The following table showsthe maturity periods for Investment Securities as of December 31, 2002.  There were no securities held to maturity.

 

 
| **December 31, 2002**             | ** ** | **One Year  or Less**      | ** ** | **Over One   Year  Through  Five Years** | ** ** | **Over Five  Years  Through  Ten Years** | ** ** | **Over Ten  Years** | ** ** | **Total**     | ** ** | **Market  Value** | ** ** |
|-----------------------------------|------------|----------------------------|------------|------------------------------------------|------------|------------------------------------------|------------|---------------------|------------|---------------|------------|-------------------|------------|
| **(Dollars in**                   | ** ** | **(Dollars in Thousands)** | ** ** |
| **thousands)**                    | ** ** | **Amt.Yield**              | ** ** | **Amt.Yield**                            | ** ** | **Amt.Yield**                            | ** ** | **Amt.Yield**       | ** ** | **Amt.Yield** | ** ** | **Amt.Yield**     | ** ** |
| U. S. Government                  |       |                       |       |                                     |       |                                     |       |                |       |          |       |              |       |
| Available for sale                |       | $                          | 0          |                                     | $          | 3,972                                    |       |                |       | $             | 0          |              | $          | 3,972 |   | $ | 4,075 |   |
|                              |       |                       |       |                                     |       |                                     |       |                |       |          |       |              |       |
| U. S. Federal Agency/and Equities |       |                       |       |                                     |       |                                     |       |                |       |          |       |              |       |
| Available for sale                |       | 14,033                     |       | 22,499                                   |       |                                     |       | 182                 |       | 36,714        |       | 37,149            |       |
|                              |       |                       |       |                                     |       |                                     |       |                |       |          |       |              |       |
| Total Securities                  |       |                       |       |                                     |       |                                     |       |                |       |          |       |              |       |
| Available for sale                |       | 14,033                     |       | 26,471                                   |       |                                     |       | 182                 |       | 40,686        |       | 41,224            |       |
|                              |       |                       |       |                                     |       |                                     |       |                |       |          |       |              |       |
| TOTAL                             |       | $                          | 14,033     |                                     | $          | 26,471                                   |       |                |       | $             | 182        |              | $          | 40,686 |   | $ | 41,224 |   |
|                              |       |                       |       |                                     |       |                                     |       |                |       |          |       |              |       |
| Percent of Total                  |       | 34.49                      | %          | 65.06                                    | %          |                                     |       | 0.45                | %          | 100           | %          | 100               | %          |
|                              |       |                       |       |                                     |       |                                     |       |                |       |          |       |              |       |
| Weighted average yield            |       | 2.73                       | %          | 3.35                                     | %          |                                     |       | 3.25                | %          | 3.32          | %          | 3.28              | %          |

 

NET INTEREST INCOME

 

The major portion of the Company’s earningsis derived from net interest income, which is the interest income oninterest-earning assets less the interest expense on interest-bearingliabilities.  During 2002 net interestincome increased $36,000 or 0.4%.  Thisfollowed a 9.0% increase in 2001, and a 5.0% increase in 2000.  For the year ended December 31, 2002,interest income decreased $2,002,000, or approximately 17%, compared to anincrease of $582,000 or 5.0% for 2001, and an increase of $755,000 or 7.0% for2000.  The net interest margin increasedfrom 3.63% in 2001 to 4.10% in 2002. This follows a decrease in 2001 from 3.99% in 2000.  A detailed analysis of the net interestmargin for each of these three years follows in this MD&A.  Interest on loans, which decreased $1,463,000or 14.6%, contributed to the decrease for 2002. Interest on securities increased $10,000 or 0.7%.  The decrease in interest income wasaccompanied by a decrease in interest expense of $2,037,000 or 42.4% for 2002.  This followed a decrease in interest expenseof $27,000 or 0.6% for 2001, and an increase of $450,000 or 10.28% for2000.  The decline in interest income andinterest expense in 2002 followed the decrease in market interest rates.

 

Net interest income is affected by prevailingmarket interest rates.  Two otherimportant factors are the changes in the balances (volume) of the earningsassets and interest bearing liabilities and the spread between the varioussources and uses of funds.  Theperformance for 2002 is indicative of the historically low interest rateenvironment that was endured throughout 2002. This is reflected in the following volume/rate analysis that shows howboth interest rates and the volumes of interest earning assets and interestbearing liabilities combine to change the net interest income.

 

17

----

 

TABLE XII - ANALYSIS OF EARNING ASSETS AND INTEREST BEARING LIABILITIES

(In Thousands of Dollars)

 
| ** **                | ** ** | **Year  Ended 12/31/02** | ** ** | **Year  Ended 12/31/01** | ** ** | **Year  Ended 12/31/00** | ** ** |
|---------------------------|------------|--------------------------|------------|--------------------------|------------|--------------------------|------------|
| ** **                | ** ** | **Average**              | ** ** | ** **               | ** ** | **Yield/**               | ** ** | **Average** | ** ** | ** ** | ** ** | **Yield/** | ** ** | **Average** | ** ** | ** ** | ** ** | **Yield/** | ** ** |
| ** **                | ** ** | **Balance**              | ** ** | **Interest**             | ** ** | **Rate**                 | ** ** | **Balance** | ** ** | **Interest** | ** ** | **Rate** | ** ** | **Balance** | ** ** | **Interest** | ** ** | **Rate** | ** ** |
| ASSETS                    |       |                     |       |                     |       |                     |       |   |   |   |   |   |   |   |   |   |   |   |   |
| EARNING ASSETS:           |       |                     |       |                     |       |                     |       |   |   |   |   |   |   |   |   |   |   |   |   |
| LOANS:                    |       |                     |       |                     |       |                     |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Commercial                |       | $                        | 44,680     |                     | $          | 3,103                    |       | 6.94 | % | $ | 46,696 |   | $ | 4,209 |   | 9.01 | % | $ | 43,232 |   | $ | 3,955 |   | 9.15 | % |
| Real Estate               |       | 53,180                   |       | 4,262                    |       | 8.01                     | %          | 52,514 |   | 4,376 |   | 8.33 | % | 52,215 |   | 4,302 |   | 8.24 | % |
| Consumer                  |       | 12,564                   |       | 1,154                    |       | 9.18                     | %          | 14,079 |   | 1,397 |   | 9.92 | % | 13,348 |   | 1,257 |   | 9.42 | % |
|                      |       |                     |       |                     |       |                     |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Total Loans               |       | $                        | 110,424    |                     | $          | 8,519                    |       | 7.71 | % | $ | 113,289 |   | $ | 9,982 |   | 8.81 | % | $ | 108,795 |   | $ | 9,514 |   | 8.74 | % |
|                      |       |                     |       |                     |       |                     |       |   |   |   |   |   |   |   |   |   |   |   |   |
| INVESTMENT  SECURITIES    |       |                     |       |                     |       |                     |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Held-to-Maturity          |       | 0                        |       | 0                        |       | 0.00                     | %          | 0 |   | 0 |   | 0.00 | % | 0 |   | 0 |   | 0.00 | % |
| Available-for-Sale        |       | 40,988                   |       | 1,364                    |       | 3.32                     | %          | 25,967 |   | 1,354 |   | 5.21 | % | 28,887 |   | 1,886 |   | 6.53 | % |
|                      |       |                     |       |                     |       |                     |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Toal Securities           |       | 40,988                   |       | 1,364                    |       | 3.32                     | %          | 25,967 |   | 1,354 |   | 5.21 | % | 28,887 |   | 1,886 |   | 6.53 | % |
|                      |       |                     |       |                     |       |                     |       |   |   |   |   |   |   |   |   |   |   |   |   |
| FEDERAL FUNDS  SOLD       |       | 13,106                   |       | 206                      |       | 1.57                     | %          | 20,540 |   | 754 |   | 3.67 | % | 1,728 |   | 108 |   | 6.25 | % |
|                      |       |                     |       |                     |       |                     |       |   |   |   |   |   |   |   |   |   |   |   |   |
| TOTAL EARNING  ASSETS     |       | $                        | 164,518    |                     | $          | 10,089                   |       | 6.13 | % | $ | 159,796 |   | $ | 12,090 |   | 7.57 | % | $ | 139,410 |   | $ | 11,508 |   | 8.25 | % |
|                      |       |                     |       |                     |       |                     |       |   |   |   |   |   |   |   |   |   |   |   |   |
| NON-EARNING  ASSETS:      |       |                     |       |                     |       |                     |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Cash and Due From  Banks  |       | 5,187                    |       |                     |       |                     |       | 5,027 |   |   |   |   |   | 4,467 |   |   |   |   |   |
| Bank Premises             |       | 3,337                    |       |                     |       |                     |       | 3,561 |   |   |   |   |   | 3,765 |   |   |   |   |   |
| Other Assets              |       | 408                      |       |                     |       |                     |       | 1,997 |   |   |   |   |   | 2,373 |   |   |   |   |   |
|                      |       |                     |       |                     |       |                     |       |   |   |   |   |   |   |   |   |   |   |   |   |
| TOTAL NON-EARNING  ASSETS |       | 8,932                    |       |                     |       |                     |       | 10,585 |   |   |   |   |   | 10,605 |   |   |   |   |   |
|                      |       |                     |       |                     |       |                     |       |   |   |   |   |   |   |   |   |   |   |   |   |
| TOTAL ASSETS              |       | $                        | 173,450    |                     |       |                     |       |   | $ | 170,381 |   |   |   |   |   | $ | 150,015 |   |   |   |   |   |

 

18

----

 
| ** **                                          | ** ** | **Year  Ended 12/31/02** | ** ** | **Year  Ended 12/31/01** | ** ** | **Year  Ended 12/31/00** | ** ** |
|-----------------------------------------------------|------------|--------------------------|------------|--------------------------|------------|--------------------------|------------|
| ** **                                          | ** ** | **Average**              | ** ** | ** **               | ** ** | **Yield/**               | ** ** | **Average** | ** ** | ** ** | ** ** | **Yield/** | ** ** | **Average** | ** ** | ** ** | ** ** | **Yield/** | ** ** |
|                                                |       | **Balance**              | ** ** | **Interest**             | ** ** | **Rate**                 | ** ** | **Balance** | ** ** | **Interest** | ** ** | **Rate** | ** ** | **Balance** | ** ** | **Interest** | ** ** | **Rate** |   |
|                                                |       |                     |       |                     |       |                     |       |   |   |   |   |   |   |   |   |   |   |   |   |
| INTEREST-BEARING  LIABILITIES:                      |       |                     |       |                     |       |                     |       |   |   |   |   |   |   |   |   |   |   |   |   |
| DDA                                                 |       | $                        | 65,384     |                     | $          | 584                      |       | 0.89 | % | $ | 57,807 |   | $ | 1,139 |   | 1.97 | % | $ | 55,169 |   | $ | 1,329 |   | 2.41 | % |
| Time Deposits                                       |       | 60,861                   |       | 2,024                    |       | 3.33                     | %          | 64,549 |   | 3,522 |   | 5.46 | % | 59,505 |   | 3,430 |   | 5.76 | % |
| Federal Funds  Purchased                            |       | 2,910                    |       | 157                      |       | 5.39                     | %          | 2,000 |   | 140 |   | 7.00 | % | 1,052 |   | 69 |   | 6.56 | % |
|                                                |       |                     |       |                     |       |                     |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Total Interest  Bearing Liabilities                 |       | $                        | 129,155    |                     | $          | 2,765                    |       | 2.14 | % | $ | 124,356 |   | $ | 4,801 |   | 3.86 | % | $ | 115,726 |   | $ | 4,828 |   | 4.17 | % |
|                                                |       |                     |       |                     |       |                     |       |   |   |   |   |   |   |   |   |   |   |   |   |
| NON-INTEREST  BEARING                               |       |                     |       |                     |       |                     |       |   |   |   |   |   |   |   |   |   |   |   |   |
| LIABILITIES AND  CAPITAL                            |       |                     |       |                     |       |                     |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Demand Deposits                                     |       | 25,559                   |       |                     |       |                     |       | 28,052 |   |   |   |   |   | 18,587 |   |   |   |   |   |
| Accrued Expenses                                    |       | 966                      |       |                     |       |                     |       | 1,023 |   |   |   |   |   | 470 |   |   |   |   |   |
| Capital                                             |       | 17,770                   |       |                     |       |                     |       | 16,950 |   |   |   |   |   | 15,232 |   |   |   |   |   |
|                                                |       |                     |       |                     |       |                     |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Total  Non-Interest Bearing Liabilities and Capital |       | 44,295                   |       |                     |       |                     |       | 46,025 |   |   |   |   |   | 34,289 |   |   |   |   |   |
|                                                |       |                     |       |                     |       |                     |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Total Liabilities  and Stockholders’ Equity    |       | $                        | 173,450    |                     |       |                     |       |   | $ | 170,381 |   |   |   |   |   | $ | 150,015 |   |   |   |   |   |
|                                                |       |                     |       |                     |       |                     |       |   |   |   |   |   |   |   |   |   |   |   |   |
| NET INTEREST  MARGIN                                |       | $                        | 164,518    |                     | $          | 7,324                    |       | 4.45 | % | $ | 159,796 |   | $ | 7,289 |   | 4.56 | % | $ | 134,410 |   | $ | 6,680 |   | 4.97 | % |

 

19

----

 

**THE FOLLOWING TABLE IS AN ANALYSIS OF THE CHANGES IN INTEREST INCOME AND INTEREST EXPENSE FOR THE DATES SHOWN.**

 
| ** **                     | ** ** | **2002 vs 2001**                           | ** ** | ** **                                         | ** ** | ** **                                       | ** ** |
|--------------------------------|------------|--------------------------------------------|------------|----------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                     | ** ** | **Increase  (Decrease)   Due to   Volume** | ** ** | **Increase  (Decrease)  Due to  Change in   Rate** | ** ** | **Increase  (Decrease)   Due to   Account  Mix** | ** ** | **Total** | ** ** |
| INTEREST INCOME ON LOANS:      |       |                                       |       |                                               |       |                                             |       |   |   |
| Commercial                     |       | $                                          | (68        | )                                                  | $          | (1,038                                           | )          | $ | 0 |   | $ | (1,106 | ) |
| Real Estate                    |       | (4                                         | )          | (112                                               | )          | 2                                                |       | (114 | ) |
| Consumer                       |       | (193                                       | )          | (50                                                | )          | 0                                                |       | (243 | ) |
|                           |       |                                       |       |                                               |       |                                             |       |   |   |
| TOTAL LOANS                    |       | (265                                       | )          | (1,200                                             | )          | 2                                                |       | (1,463 | ) |
|                           |       |                                       |       |                                               |       |                                             |       |   |   |
| SECURITIES                     |       |                                       |       |                                               |       |                                             |       |   |   |
|                           |       |                                       |       |                                               |       |                                             |       |   |   |
| Available for Sale             |       | 240                                        |       | (241                                               | )          | 10                                               |       | 9 |   |
|                           |       |                                       |       |                                               |       |                                             |       |   |   |
| TOTAL SECURITIES               |       | 240                                        |       | (241                                               | )          | 10                                               |       | 9 |   |
|                           |       |                                       |       |                                               |       |                                             |       |   |   |
| FEDERAL FUNDS SOLD             |       |                                       |       |                                               |       |                                             |       |   |   |
|                           |       |                                       |       |                                               |       |                                             |       |   |   |
| Federal Funds Sold             |       | (273                                       | )          | (275                                               | )          | 0                                                |       | (548 | ) |
|                           |       |                                       |       |                                               |       |                                             |       |   |   |
| TOTAL INTEREST INCOME          |       | (298                                       | )          | (1,716                                             | )          | 12                                               |       | (2,002 | ) |
|                           |       |                                       |       |                                               |       |                                             |       |   |   |
| INTEREST EXPENSE ON:           |       |                                       |       |                                               |       |                                             |       |   |   |
| Savings & Interest Bearing |       |                                       |       |                                               |       |                                             |       |   |   |
| Demand Deposits                |       | 151                                        |       | (710                                               | )          | 4                                                |       | (555 | ) |
| Time Deposits                  |       | (139                                       | )          | (1,360                                             | )          | 0                                                |       | (1,499 | ) |
|                           |       |                                       |       |                                               |       |                                             |       |   |   |
| Repurchase Agreements          |       | (35                                        | )          | 52                                                 |       | 0                                                |       | 17 |   |
|                           |       |                                       |       |                                               |       |                                             |       |   |   |
| TOTAL INTEREST EXPENSE         |       | (23                                        | )          | (2,018                                             | )          | 4                                                |       | (2,037 | ) |
|                           |       |                                       |       |                                               |       |                                             |       |   |   |
| NET INTEREST INCOME            |       | $                                          | (275       | )                                                  | $          | 302                                              |       | $ | 8 |   | $ | 35 |   |

 

20

----

** **
| ** **                     | ** ** | **2001 vs 2000**                         | ** ** | ** **                                       | ** ** |
|--------------------------------|------------|------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                     | ** ** | **Increase  (Decrease)  Due to  Volume** | ** ** | **Increase  (Decrease)  Due to  Change in Rate** | ** ** | **Total** | ** ** |
| INTEREST INCOME ON LOANS:      |       |                                     |       |                                             |       |   |   |
| Commercial                     |       | $                                        | 424        |                                             | (170       | ) | 254 |   |
| Real Estate                    |       | 319                                      |       | (245                                             | )          | 74 |   |
| Consumer                       |       | (297                                     | )          | 437                                              |       | 140 |   |
|                           |       |                                     |       |                                             |       |   |   |
| TOTAL LOANS                    |       | 446                                      |       | 22                                               |       | 468 |   |
|                           |       |                                     |       |                                             |       |   |   |
| SECURITIES                     |       |                                     |       |                                             |       |   |   |
|                           |       |                                     |       |                                             |       |   |   |
| Available for Sale             |       | 200                                      |       | (732                                             | )          | (532 | ) |
|                           |       |                                     |       |                                             |       |   |   |
| TOTAL SECURITIES               |       | 200                                      |       | (732                                             | )          | (532 | ) |
|                           |       |                                     |       |                                             |       |   |   |
| FEDERAL FUNDS SOLD             |       |                                     |       |                                             |       |   |   |
|                           |       |                                     |       |                                             |       |   |   |
| Federal Funds Sold             |       | 181                                      |       | 465                                              |       | 646 |   |
|                           |       |                                     |       |                                             |       |   |   |
| TOTAL INTEREST INCOME          |       | 827                                      |       | (245                                             | )          | 582 |   |
|                           |       |                                     |       |                                             |       |   |   |
| INTEREST EXPENSE ON:           |       |                                     |       |                                             |       |   |   |
| Savings & Interest Bearing |       |                                     |       |                                             |       |   |   |
| Demand Deposits                |       | 148                                      |       | (339                                             | )          | (191 | ) |
| Time Deposits                  |       | 138                                      |       | (46                                              | )          | 92 |   |
|                           |       |                                     |       |                                             |       |   |   |
| Purchased Agreements           |       | (45                                      | )          | 117                                              |       | 72 |   |
|                           |       |                                     |       |                                             |       |   |   |
| TOTAL INTEREST EXPENSE         |       | 241                                      |       | (268                                             | )          | (27 | ) |
|                           |       |                                     |       |                                             |       |   |   |
| NET INTEREST INCOME            |       | $                                        | 586        |                                             | $          | 23 |   | $ | 609 |   |
|                                |            |                                          |            |                                                  |            |  |  |  |  |  |

 

Changesdue to a combination of volume and rate have been allocated proportionately tovolume and rate.

 

21

----

 

**THE FOLLOWING TABLE IS AN ANALYSIS OF THE CHANGES IN INTEREST INCOMEAND INTEREST EXPENSE FOR THE DATES SHOWN.**

** **
| ** **                                      | ** ** | **2000 vs 1999**                         | ** ** | ** **                                       | ** ** |
|-------------------------------------------------|------------|------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                      | ** ** | **Increase  (Decrease)  Due to  Volume** | ** ** | **Increase  (Decrease)  Due to  Change in Rate** | ** ** | **Total** | ** ** |
| INTEREST INCOME ON LOANS:                       |       |                                     |       |                                             |       |   |   |
| Commercial                                      |       | $                                        | 252        |                                             | $          | 227 |   | $ | 479 |   |
| Real Estate                                     |       | 245                                      |       | 20                                               |       | 265 |   |
| Consumer                                        |       | 107                                      |       | 50                                               |       | 157 |   |
|                                            |       |                                     |       |                                             |       |   |   |
| TOTAL LOANS                                     |       | 604                                      |       | 297                                              |       | 901 |   |
|                                            |       |                                     |       |                                             |       |   |   |
| SECURITIES                                      |       |                                     |       |                                             |       |   |   |
|                                            |       |                                     |       |                                             |       |   |   |
| Available for Sale                              |       | (80                                      | )          | 58                                               |       | (22 | ) |
|                                            |       |                                     |       |                                             |       |   |   |
| TOTAL SECURITIES                                |       | (80                                      | )          | 58                                               |       | (22 | ) |
|                                            |       |                                     |       |                                             |       |   |   |
| FEDERAL FUNDS SOLD                              |       |                                     |       |                                             |       |   |   |
|                                            |       |                                     |       |                                             |       |   |   |
| Federal Funds Sold                              |       | (56                                      | )          | (68                                              | )          | (124 | ) |
|                                            |       |                                     |       |                                             |       |   |   |
| TOTAL INTEREST INCOME                           |       | 468                                      |       | 287                                              |       | 755 |   |
|                                            |       |                                     |       |                                             |       |   |   |
| INTEREST EXPENSE ON:                            |       |                                     |       |                                             |       |   |   |
| Savings & Interest Bearing Demand  Deposits |       | 49                                       |       | (80                                              | )          | (31 | ) |
| Time Deposits                                   |       | 82                                       |       | 384                                              |       | 466 |   |
|                                            |       |                                     |       |                                             |       |   |   |
| Purchased Agreements                            |       | $                                        | 14         |                                             | 1          |   | 15 |   |
|                                            |       |                                     |       |                                             |       |   |   |
| TOTAL INTEREST EXPENSE                          |       | 145                                      |       | 305                                              |       | 450 |   |
|                                            |       |                                     |       |                                             |       |   |   |
| NET INTEREST INCOME                             |       | $                                        | 323        |                                             | $          | (18 | ) | 305 |   |
|                                                 |            |                                          |            |                                                  |            |  |  |  |  |  |

 

Changesdue to a combination of volume and rate have been allocated proportionately tovolume and rate.

 

22

----

 

PROVISIONFOR LOAN LOSSES

 

TheCompany experienced a significant decrease in the provision for loan lossesduring 2002.  The provision for loanlosses was $534,000 for 2002, compared to $700,000 for 2001 and $100,000 for2000.  Factors contributing to thedecreased provision in 2002 included decreased charge-offs in certaincommercial mortgage loans, along with fewer charge-offsin the retail sector.  In evaluating theloan portfolio at December 31, 2002, with the improved level of nonaccrual andpast-due loans, it is anticipated that loan losses will remain stable in 2003.

 

NONINTERESTINCOME AND EXPENSE

 

Noninterestincome increased $97,000 or 13.7% in 2002, following a $62,000 or 8.0% decreasein 2001, and a $70,000 or 10.01% decrease in 2000.  The largest component of non-interest incomeis service charges on deposit accounts. These fees increased approximately $28,000 or 4.4% in 2002, after adecrease of approximately $41,000 or 6.1% in 2001, and an increase ofapproximately $31,000 or 4.9% in 2000.

 

Noninterestexpense increased 1.3% in 2002, following 10.6% increase in 2001 and a 7.4%increase in 2000.  Personnel expense isthe largest component of noninterest expense. Personnel expense increased 4.7% in 2002, following an increase of 3.2%in 2001, and 6.3% in 2000.  In the yearspresented management has been able to control noninterest expense by utilizingnew technology and reassignment of personnel.

 

DEPOSITS

 

Deposits,the Company’s major source of funds, decreased approximately $1,533,000 or 1.0%in 2002, following an increase of $13,305,000 or 9.6% in 2001.  These increases occurred primarily in demandand savings deposits as management placed emphasis on attracting these types ofaccounts and providing superior service for these customers. The average ratepaid on interest-bearing deposits in 2002 was 2.14% and 3.86% in 2001.  Strong competition for deposits exists in theCompany’s primary markets among commercial banks, savings banks, thriftinstitutions, credit unions, mutual funds, brokerage houses, insurancecompanies, and certain national retailers. Despite this intense competition, management continues to evaluatepricing strategies that will ensure the Company’s long-term goal of maintainingmarket share without sacrificing profitability.

 

23

----

 

AVERAGE DEPOSITS

 

The following table showsaverage deposits and rates paid for the years indicated:

 
| ** **                            | ** ** | **2002  Average** | ** ** | **2001  Average** | ** ** | **2000  Average** | ** ** |
|---------------------------------------|------------|-------------------|------------|-------------------|------------|-------------------|------------|
| ** **                            | ** ** | **Balance**       | ** ** | **Rates  Paid**   | ** ** | **Balance**       | ** ** | **Rates  Paid** | ** ** | **Balance** | ** ** | **Rates  Paid** | ** ** |
|                                  |       |              |       |              |       |              |       |   |   |   |   |   |   |
| Non-interest bearing demand deposits  |       | $                 | 25,559     |              | N/A        |              | $          | 28,052 |   | N/A |   | $ | 19,332 |   | N/A |   |
| Interest bearing Demand & Savings |       | 65,384            |       | 0.89              | %          | 57,807            |       | 1.97 | % | 50,814 |   | 2.62 | % |
| Time Deposits                         |       | 60,861            |       | 3.33              | %          | 64,549            |       | 5.46 | % | 61,019 |   | 5.62 | % |
| Repurchased Agreements                |       | 2,910             |       | 5.39              | %          | 2,000             |       | 7.00 | % | 5,920 |   | 1.16 | % |
| TOTAL INTEREST-BEARING DEPOSITS       |       | $                 | 129,155    |              | 2.14       | %                 | $          | 124,356 |   | 3.86 | % | $ | 117,753 |   | 4.10 | % |

 

There are no foreignoffices.  Average balances are computedon daily balances.

 

MATURITIESOF TIME CERTIFCATES OF DEPOSITS OF $ 100,000 OR MORE

 

Thefollowing table shows the maturities of certificates of deposits of $100,000 ormore at December 31, 2002:

 
| ** **                                         | ** ** | **December 31, 2003**      | ** ** |
|----------------------------------------------------|------------|----------------------------|------------|
| ** **                                         | ** ** | **(Dollars in Thousands)** | ** ** |
|                                               |       |                       |       |
| Under 3 months                                     |       | $                          | —     |   |
| 3 to 6 months                                      |       | 842,136                    |       |
| 6 to 12 months                                     |       | 3,004,194                  |       |
| Over 12 months                                     |       | 13,020,657                 |       |
|                                               |       |                       |       |
| TOTAL CERTIFICATES OF DEPOSIT OF $100,000  OR MORE |       | $                          | 16,866,987 |   |

 

24

----

 

SHORT-TERMBORROWED FUNDS

 

Thefollowing table shows the Company’s short-term borrowings for 2002, 2001 and2000:

 
| ** **                                     | ** ** | **December,31**            | ** ** |
|------------------------------------------------|------------|----------------------------|------------|
| ** **                                     | ** ** | **2002**                   | ** ** | **2001** | ** ** |
| ** **                                     | ** ** | **(Dollars in Thousands)** | ** ** |
|                                           |       |                       |       |   |   |
| Securities sold under agreement to  repurchase |       | $                          | 1,000      |   | $ | 2,000 |   |
|                                           |       |                       |       |   |   |
| TOTAL BORROWED FUNDS                           |       | $                          | 1,000      |   | $ | 2,000 |   |

 

The approximate averageinterest rates, average amounts outstanding, andmaximum amounts outstanding at any month-end for securities sold underagreements to repurchase are as follows:

 
| ** **                                    | ** ** | **2002** | ** ** | **2001** | ** ** |
|-----------------------------------------------|------------|----------|------------|----------|------------|
| Average interest rates at December 31         |       | 6.00     | %          | 7.00     | %          |
| Maximum amounts outstanding at any  month-end |       | $        | 3,000      |     | $          | 2,000 |   |
| Average daily amount outstanding              |       | $        | 2,910      |     | $          | 2,000 |   |
| Weighted average interest rates               |       | 5.39     | %          | 7.00     | %          |

 

25

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INCOME TAXES

 

Applicableincome taxes for 2002 increased $154,000 or 17%.  This followed a $222,000 or 19.6% decreasefor 2001, and a $1,000 or 0.09% increase for 2000.  Income taxes computed at the statutory ratedo not differ materially from income tax expense reported on the Company’sfinancial statements.  For a completediscussion of the Company’s tax position, refer to Note 11 of the Notes toConsolidated Financial Statements, presented elsewhere in this report.

 

RETURNON EQUITY AND ASSETS

 

Thefollowing chart shows various percentages relating to equity and assets:

 
| ** **                                                                        | ** ** | **December 31,** | ** ** |
|-----------------------------------------------------------------------------------|------------|------------------|------------|
| ** **                                                                        | ** ** | **2002**         | ** ** | **2001** | ** ** | **2000** | ** ** |
|                                                                              |       |             |       |   |   |   |   |
| Percentage of net income to:                                                      |       |             |       |   |   |   |   |
|                                                                              |       |             |       |   |   |   |   |
| Average stockholders’ equity                                                 |       | 10.37            | %          | 10.36 | % | 13.35 | % |
|                                                                              |       |             |       |   |   |   |   |
| Average total assets                                                              |       | 1.06             | %          | 1.03 | % | 1.36 | % |
|                                                                              |       |             |       |   |   |   |   |
| Percentage of dividends declared per common  share to net income per common share |       | 59.56            | %          | 61.12 | % | 50.79 | % |
|                                                                              |       |             |       |   |   |   |   |
| Percentage of average stockholders’ equity  to average total assets          |       | 10.24            | %          | 9.95 | % | 10.15 | % |

 

26

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CAPITALRESOURCES

 

Cashdividends paid to stockholders during 2002 totaled $1,097,000 following$1,075,000 in 2001 and $1,032,000 for 2000. This represents a dividend pay-out ratio (dividends divided by netincome) of 60% in 2002, 61% in 2001 and 51% in 2000.  Cash dividends per share equaled $1.53 pershare in 2002, $1.50 per share in 2001 and $1.44 per share in 2000.  The Company is dependent upon dividends paidby its subsidiary bank to fund dividends to the stockholders and to cover otherHolding Company operating costs.  TheCompany’s board of directors considers historical financial performance, futureprospects, and anticipated needs for capital in formulating the dividendpayment policy.  Future dividends aredependent upon the Company’s financial results, future prospects, capitalrequirements and general economic conditions.

 

Oneof management’s primary objectives is to maintain a strong capitalposition.  Stockholders’ equity increased$392,000 or 2.33% in 2002.  This increaseresulted primarily from a net increase in retained earnings of $713,000 (netincome less dividends paid to shareholders) and accumulated other comprehensiveincome of $225,000, which was offset by purchases of Treasury Stock in theamount of $546,000.

 

Thepercentage of earnings reinvested in the Company (net income less dividends asa percentage of net income) for the years 2002, 2001 and 2000 was 40%, 39%, and49%, respectively.  The internal capitalformation rate (net income less dividends as a percentage of averagestockholders’ equity) indicates the rate at which assets can grow whilemaintaining the current ratio of stockholders’ equity to assets.  The internal capital information rate was4.1% in 2002, 4.0% in 2001, and 6.5% in 2000.

 

REGULATORYCAPITAL

 

Asof December 31, 2002, the Company and its subsidiary bank were considered wellcapitalized by the Federal Reserve. Management is not aware of any changes which would affect thisclassification.  For more information,see Note 16 to the Consolidated Financial Statements.

 

Risk-basedcapital regulations require all banks and bank holding companies to have aminimum total risk-based capital ratio of 8% with half of the capital composedof core capital.  Conceptually,risk-based capital requirements assess the risk of a financial institution’sbalance sheet and off-balance sheet commitments in relation to its capital.  Under the guidelines capital strength is measuredin two tiers, which are used in conjunction with risk-adjusted assets indetermining the risk-based capital ratios. The Company’s Tier I capital, which consists of stockholders’ equity,adjusted for certain intangible assets, amounted to $16,943,000 at December 31,2002, or 17.4% of total risk-weighted assets, compared to $16,147,000 atDecember 31, 2001, or 15.04% of total risk-weighted assets.  Tier II capital, or supplementary capital,includes capital components such as qualifying allowance for loan losses, andcan equal up to 100% of an institution’s Tier I capital with certainlimitations.  The Company’s Tier IIcapital amounted to $1,207,000 at December 31, 2002, or 1.26% of totalrisk-weighted assets, compared to $1,153,000 at December 31, 2001, or 1.11% oftotal risk-weighted assets.

 

TheCompany’s total consolidated risk-based capital was $17,831,000,atDecember 31, 2002, or 18.54% of total risk-weighted assets, compared to$17,662,000, or 17.04% of total risk-weighted assets as of December 31,2001.  Additionally, risk-based capitalguidelines require a minimum leverage ratio (Tier I capital divided by averageadjusted total consolidated assets) of 4% which may be increased forinstitutions with higher levels of risk or that are experiencing oranticipating significant growth.  TheCompany has not been advised by any regulatory agency of a higher leverageratio applicable to it.  As of December31, 2002 and 2001, the Company’s leverage ratio was 10.31% and 9.63%,respectively; therefore, the Company exceeded all current minimum capitalrequirements.

 

27

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COMMITMENTS

 

Asof December 31, 2002, this table shows off-balance-sheet commitments classifiedby expiration date:

 
| ** **                          | ** ** | **1 Year**                 | ** ** | **1 to 3** | ** ** | **3 to 5** | ** ** | **Over 5** | ** ** | ** ** | ** ** |
|-------------------------------------|------------|----------------------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|
| ** **                          | ** ** | **or Less**                | ** ** | **Years**  | ** ** | **Years**  | ** ** | **Years**  | ** ** | **Total**  | ** ** |
| ** **                          | ** ** | **(Dollars in Thousands)** | ** ** |
|                                |       |                       |       |       |       |       |       |       |       |       |       |
| Unused Lines of Credits             |       |                       |       |       |       |       |       |       |       |       |       |
| Home equity lines                   |       | $                          | —     |       | $          | —     |       | $          | —     |       | $          | — |   | $ | — |   |
| Commercial and financial            |       | —                     |       | —     |       | —     |       | —     |       | —     |       |
| Other unused commitments            |       | —                     |       | —     |       | —     |       | —     |       | —     |       |
| Financial standby letters of credit |       | —                     |       | —     |       | —     |       | —     |       | —     |       |
|                                     |            |                            |            |            |            |            |            |            |            |            |            |  |  |  |  |  |

 

AMOUNTOF LOANS OUTSTANDING

 

The following table reflectsa summary of loans outstanding by classification at December 31 for the yearsindicated:

 
| ** **                             | ** ** | **December 31,**           | ** ** |
|----------------------------------------|------------|----------------------------|------------|
| ** **                             | ** ** | **2002**                   | ** ** | **2001** | ** ** | **2000** | ** ** | **1999** | ** ** | **1998** | ** ** |
| ** **                             | ** ** | **(Dollars in Thousands)** | ** ** |
| Commercial, Financial and Agricultural |       | $                          | 43,980     |   | $ | 39,706 |   | $ | 36,582 |   | $ | 32,936 |   | $ | 37,938 |   |
| Real Estate Mortgage                   |       | 52,503                     |       | 55,532 |   | 56,282 |   | 55,437 |   | 46,088 |   |
| Installment loans to Individuals       |       | 11,450                     |       | 21,669 |   | 20,776 |   | 21,198 |   | 11,114 |   |
|                                   |       |                       |       |   |   |   |   |   |   |   |   |
| TOTAL LOANS OUTSTANDING                |       | $                          | 107,933    |   | $ | 116,907 |   | $ | 113,640 |   | $ | 109,571 |   | $ | 95,140 |   |

 

Thefollowing is a summary of loans outstanding as a percent of total loans as ofDecember 31:

 
| ** **                             | ** ** | **December 31,** | ** ** |
|----------------------------------------|------------|------------------|------------|
| ** **                             | ** ** | **2002**         | ** ** | **2001** | ** ** | **2000** | ** ** | **1999** | ** ** | **1998** | ** ** |
| Commercial, Financial and Agricultural |       | 40.75            | %          | 33.96 | % | 32.19 | % | 30.06 | % | 39.88 | % |
| Real Estate Mortgage                   |       | 48.64            | %          | 47.50 | % | 49.53 | % | 50.59 | % | 48.44 | % |
| Installment Loans to Individuals       |       | 10.61            | %          | 18.54 | % | 18.28 | % | 19.35 | % | 11.68 | % |
|                                   |       | 100.00           | %          | 100.00 | % | 100.00 | % | 100.00 | % | 100.00 | % |

 

28

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Thefollowing table shows the maturity of 1-4 family residential loans, commercialand all other loans outstanding as of December 31, 2002:

 
| ** **                     | ** ** | **Less Than  One Year** | ** ** | **One Year to  Five Years** | ** ** | **Greater  Than Five  Years** | ** ** | **Total** | ** ** |
|--------------------------------|------------|-------------------------|------------|-----------------------------|------------|-------------------------------|------------|-----------|------------|
| One to Four Family Residential |       | 12,169                  |       | 12,784                      |       | 27,550                        |       | 52,503    |       |
| Commercial and Other           |       | 21,263                  |       | 19,861                      |       | 14,306                        |       | 55,430    |       |
| Total                          |       | 33,432                  |       | 32,645                      |       | 41,856                        |       | 107,933   |       |

 

Note: Schedule does not include loans innonaccrual status.

 

29

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LIQUIDITYMANAGEMENT

 

Liquiditymanagement involves the ability to meet the cash flow requirements ofdepositors wanting to withdraw funds, to have sufficient funds available tomeet borrowers’ credit needs and provide for all other cash needs of theCompany.  In the opinion of management,the Company maintains sufficient liquidity to satisfy the needs of itscustomers.  To ensure the Company ispositioned to meet immediate and future cash demands, management relies onliquidity analysis, knowledge of business trends over past economic cycles andforecasts of future conditions.

 

Liquiditycan best be demonstrated by an analysis of the Company’s cash flows.  The primary source of cash flows for theCompany is operating activities. Operating activities provided $3,164,000 of liquidity for the year endedDecember 31, 2002, compared to providing $2,929,000 and $2,356,000 in 2001 and2000, respectively.  The principal elementsof these operating flows are net income, increased for significant non-cashexpenses for the provision for loan losses and depreciation andamortization.  In 2002, 2001 and 2000,these funds were utilized primarily to fund increasing investments aggregating$24,612,000, $55,583,000 and $5,944,000, respectively.

 

Asecondary source of liquidity for the Company comes from investing activities,principally the maturities or sales of investment securities.  During 2002, due to the continued lowinterest rate environment, maturities, calls, and sales of investmentsecurities amounted to $19,925,000, compared to $49,006,000 in 2001 and$7,400,000 in 2000.  As of December 31,2002, the Company had approximately $13,036,000 of investment securities thatmature within 12 months.  It isanticipated that as interest rates begin to stabilize, the rapidity of calls ininvestment securities will decline.  Forthe year ended December 31, 2002, $24,612,000 of cash was redeployed ininvestment securities.

 

THEEFFECTS OF INFLATION AND CHANGING PRICES

 

Inflationaffects the Company in several ways, but not to the same extent that it does acompany that makes large capital expenditures or has a large investment ininventory.  The Company’s asset andliability structure is primarily monetary in nature and, therefore, itsfinancial results are more affected by changes in interest rates than byinflation.  However, the actions of theFederal Reserve Board indicate that interest rate management will continue tobe the primary tool used to curtail inflationary pressures.  Inflation does affect noninterest expense,such as personnel expense and the cost of services and supplies.  To the extent these higher costs cannot berecovered by pricing of loans and deposits, these increases must be offset tothe extent possible, by increases in noninterest income and by control ofnoninterest expense.

 

30

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PERSHARE DATA BY QUARTER

 

The shares of Logan County BancShares, Inc. areinfrequently traded in the local over-the counter market and are not listed onany exchange or national association. Management is not aware of any security dealer, which makes a market inthe stock; therefore, no active trading market should be deemed to exist.

 

The sales price for Logan County BancShares, Inc.stock is determined by negotiations between individual buyers and sellers.  Although the Company keeps no records of saleprices paid for the Company stock, and has no direct knowledge of such prices,for purposes of presentation and based on the information available, Company’smanagement estimates the approximate market value ranges for 2002 and 2001 tobe as shown in the following table.  Thenumber of stockholders at December 31, 2002, was 401 and outstanding sharestotaled 703,991, net of 76,000 treasury shares.

 

PER SHARE DATA BY QUARTER

 
| ** **     | ** ** | ** **    | ** ** | ** ** | ** ** | **Estimated Sales Prices** | ** ** |
|----------------|------------|---------------|------------|------------|------------|----------------------------|------------|
| ** **     | ** ** | **Dividends** | ** ** | **2002**   | ** ** | **2001**                   | ** ** |
| ** **     | ** ** | **2002**      | ** ** | **2001**   | ** ** | **High**                   | ** ** | **Low** | ** ** | **High** | ** ** | **Low** | ** ** |
| **Quarter**    |       |          |       |       |       |                       |       |   |   |   |   |   |   |
| First Quarter  |       | $             | 0.34       |       | $          | 0.33                       |       | $ | 42.00 |   | $ | 42.00 |   | $ | 42.00 |   | $ | 42.00 |   |
| Second Quarter |       | 0.34          |       | 0.34       |       | 42.00                      |       | 42.00 |   | 42.00 |   | 42.00 |   |
| Third Quarter  |       | 0.34          |       | 0.34       |       | 42.00                      |       | 42.00 |   | 42.00 |   | 42.00 |   |
| Fourth Quarter |       | 0.50          |       | 0.49       |       | 42.00                      |       | 42.00 |   | 42.00 |   | 42.00 |   |
| Total          |       | $             | 1.53       |       | $          | 1.50                       |       |   |   |   |   |   |   |   |   |
|                |            |               |            |            |            |                            |            |  |  |  |  |  |  |  |  |  |  |  |  |

 

31

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ITEM 7A –QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

ASSET AND LIABILITYMANAGEMENT AND INTEREST RATE SENSITIVITY

 

Theincome stream of the Company is subject to risk resulting from interest rate fluctuationsto the extent there is a difference between the amount earned on the Company’sinterest-earning assets and the amount paid for interest-bearingliabilities.  Another important factor isthe timing of the maturity of these assets and liabilities including when theyare prepaid, withdrawn, mature or reprice in specified periods.  The goal of asset and liability management isto maintain high quality and consistent growth of net interest income withacceptable levels of risk to changes in market interest rates.

 

Interestrate sensitivity varies with different types of interest-earning assets andinterest-bearing liabilities.  The ratesearned on overnight federal funds, on which rates change daily, and loans whichare tied to a prime interest rate, differ considerably from long-termsecurities and fixed rate loans. Similarly, time deposits of $100,000 and over, NOW accounts and moneymarket deposit accounts are much more interest sensitive than passbook savingsaccounts and other interest-bearing liabilities.  The Company uses a number of tools to measureinterest rate risk, including simulating net interest income under various ratescenarios, monitoring the change in present value of the asset and liability portfoliosunder the same rate scenarios and monitoring the difference or gap between ratesensitive assets and rate sensitive liabilities over various time periods.

 

Managementcontinues its efforts to generate variable rate loans.  However, with strong competition for loans,and in an historically low interest rate environment,customers are seeking more fixed rate loans. The results of management’s efforts to balance interest-earning assetsagainst interest-bearing liabilities can be seen in the Analysis of InterestRate Sensitivity table which follows this discussion.

 

Managementcontinues to monitor the Company’s asset/liability gap positions, whileincorporating more sophisticated risk measurement tools, including simulationmodeling which calculates expected net interest income based on projectedinterest-earning assets, interest-bearing liabilities and interest rates.  Utilizing simulation modeling allows theCompany to evaluate earnings and capital risk due to significant changes ininterest rates.

 

32

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Thefollowing table presents the Company’s Interest Rate Sensitivity position atDecember 31, 2002:

 

INTERESTRATE SENSITIVE ANALYSIS TABLE

 

(InThousands of Dollars)

 
| **As of December 31, 2002**                                               | ** ** | **0-90** | ** ** | **91-180** | ** ** | **181-365** | ** ** | **Total  One  Year** | ** ** | **Over  One  Year** | ** ** | **Total** | ** ** |
|---------------------------------------------------------------------------|------------|----------|------------|------------|------------|-------------|------------|----------------------|------------|---------------------|------------|-----------|------------|
| Earning Assets                                                            |       |     |       |       |       |        |       |                 |       |                |       |      |       |
| Loans                                                                     |       | $        | 6,557      |       | $          | 5,576       |       | $                    | 21,299     |                | $          | 33,432    |       | $ | 74,501 |   | $ | 107,933 |   |
| Investments                                                               |       | 4,003    |       | 2,021      |       | 8,009       |       | 14,033               |       | 26,734              |       | 40,767    |       |
| Federal Funds Sold                                                        |       | 11,370   |       | 0          |       | 0           |       | 11,370               |       | 0                   |       | 11,370    |       |
|                                                                      |       |     |       |       |       |        |       |                 |       |                |       |      |       |
| Total Earning Assets                                                      |       | 21,930   |       | 7,597      |       | 29,308      |       | 58,835               |       | 101,235             |       | 160,070   |       |
|                                                                      |       |     |       |       |       |        |       |                 |       |                |       |      |       |
| Interest Bearing Liabilities                                              |       |     |       |       |       |        |       |                 |       |                |       |      |       |
| Demand Deposits                                                           |       | 21,851   |       | 0          |       | 0           |       | 21,851               |       | 0                   |       | 21,851    |       |
| Savings                                                                   |       | 12,653   |       | 10,062     |       | 22,149      |       | 44,864               |       | 0                   |       | 44,864    |       |
| CD’s of $100,000 and Over                                            |       | 2,730    |       | 2,604      |       | 4,251       |       | 9,585                |       | 7,282               |       | 16,867    |       |
| Other                                                                     |       | 5,413    |       | 6,338      |       | 11,093      |       | 22,844               |       | 13,537              |       | 36,381    |       |
|                                                                      |       |     |       |       |       |        |       |                 |       |                |       |      |       |
| Total Interest Bearing Liability                                          |       | 42,647   |       | 19,004     |       | 37,493      |       | 99,144               |       | 20,819              |       | 119,963   |       |
|                                                                      |       |     |       |       |       |        |       |                 |       |                |       |      |       |
| Interest Sensitivity Gap                                                  |       | $        | (20,717    | )          | $          | (11,407     | )          | $                    | (8,185     | )                   | $          | (40,309   | )          | $ | 80,416 |   | $ | 40,107 |   |
|                                                                      |       |     |       |       |       |        |       |                 |       |                |       |      |       |
| Cumulative Gap                                                            |       | $        | (20,717    | )          | $          | 32,124      |       | $                    | (40,309    | )                   | $          | (40,309   | )          | $ | 40,107 |   | $ | 40,107 |   |
|                                                                      |       |     |       |       |       |        |       |                 |       |                |       |      |       |
| Rate Sensitive Assets/Rate Sensitive  Liabilities (Cumulative Percentage) |       | 51.14    | %          | 47.89      | %          | 59.34       | %          | 59.34                | %          | 133.43              | %          | 133.43    | %          |

 

33

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ITEM8 – FINANCIALSTATEMENTS AND SUPPLEMENTARY DATA

 

[LETTERHEADOF McNEAL, WILLIAMSON & CO.]

 

INDEPENDENT AUDITOR’S REPORT

 

 

To the Board of Directors and Stockholders

of Logan CountyBancShares, Inc. and Subsidiary

 

Wehave audited the accompanying consolidated statements of condition of Logan County BancShares, Inc. and Subsidiaryas of December 31, 2002, and 2001, and the related consolidated statements ofincome, changes in stockholders’ equity and cash flows for each of the threeyears in the period ended December 31, 2002. These consolidated financial statements are the responsibility of theCompany’s management.  Our responsibilityis to express an opinion on these financial statements based on our audit.

 

Weconducted our audit in accordance with standards generally accepted in theUnited States of America. Those standards require that we plan and perform theaudit to obtain reasonable assurance about whether theconsolidate financial statements are free of material misstatement.  An audit includes examining, on a test basis,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 statement presentation.  We believe that our audit provides areasonable basis for our opinion.

 

Inour opinion, the financial statements referred to above present fairly, in allmaterial respects, the consolidated financial position of Logan CountyBancShares, Inc. and Subsidiary as of December 31, 2002, and 2001, and theconsolidated results of its operations and cash flows for each of the threeyears in the period ended December 31, 2002, in conformity with accountingprinciples generally accepted in the United States of America.

 
| /s/  McNeal, Williamson & Co. |   |
|-----------------------------------|--------|
| Logan,  West Virginia             |
| February  26, 2003                |

 

34

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**Logan County BancShares, Inc. and SubsidiaryCONSOLIDATED BALANCE SHEETS**

 
| ** **                                                                                                      | ** ** | **December 31,** | ** **  |
|-----------------------------------------------------------------------------------------------------------------|------------|------------------|-------------|
| ** **                                                                                                      | ** ** | **2002**         | ** **  | **2001** | ** ** |
|                                                                                                            |       |             |        |   |   |
| **ASSETS**                                                                                                      |       |             |        |   |   |
| Cash and cash equivalents:                                                                                      |       |             |        |   |   |
| Cash and due from banks                                                                                         |       | $                | 5,598,423   |   | $ | 6,651,322 |   |
| Federal funds sold                                                                                              |       | 11,370,000       |        | 7,150,000 |   |
| Total cash and cash equivalents                                                                                 |       | 16,968,423       |        | 13,801,322 |   |
|                                                                                                            |       |             |        |   |   |
| Investment securities:                                                                                          |       |             |        |   |   |
| Available-for-sale (at fair value)                                                                              |       | 41,224,138       |        | 36,355,332 |   |
|                                                                                                            |       |             |        |   |   |
| Loans                                                                                                           |       | 107,932,591      |        | 116,907,413 |   |
| Less allowance for loan losses                                                                                  |       | (1,618,632       | )           | (1,152,777 | ) |
| Net loans                                                                                                       |       | 106,313,959      |        | 115,754,636 |   |
|                                                                                                            |       |             |        |   |   |
| Premises and equipment, net                                                                                     |       | 3,217,324        |        | 3,383,539 |   |
| Accrued income receivable                                                                                       |       | 811,373          |        | 973,167 |   |
| Other assets                                                                                                    |       | 794,556          |        | 738,933 |   |
|                                                                                                            |       |             |        |   |   |
| Total assets                                                                                                    |       | $                | 169,329,773 |   | $ | 171,006,929 |   |
|                                                                                                            |       |             |        |   |   |
| **LIABILITIES**                                                                                                 |       |             |        |   |   |
|                                                                                                            |       |             |        |   |   |
| Noninterest bearing deposits:                                                                                   |       |             |        |   |   |
| Demand                                                                                                          |       | $                | 24,707,180  |   | $ | 27,150,351 |   |
| Interest bearing deposits:                                                                                      |       |             |        |   |   |
| Demand                                                                                                          |       | 21,851,348       |        | 21,370,908 |   |
| Savings                                                                                                         |       | 44,864,222       |        | 39,803,797 |   |
| Time                                                                                                            |       | 58,651,287       |        | 63,282,186 |   |
| Total deposits                                                                                                  |       | 150,074,037      |        | 151,607,242 |   |
| Repurchase agreements                                                                                           |       | 1,000,000        |        | 2,000,000 |   |
| Other liabilities                                                                                               |       | 1,063,135        |        | 599,557 |   |
| Total liabilities                                                                                               |       | 152,137,172      |        | 154,206,799 |   |
|                                                                                                            |       |             |        |   |   |
| **STOCKHOLDERS’  EQUITY**                                                                                  |       |             |        |   |   |
|                                                                                                            |       |             |        |   |   |
| Common stock - 780,000 shares authorized at  $1.67 par value: 703,991 shares issued in 2002 and 716,991 in 2001 |       | 1,300,000        |        | 1,300,000 |   |
| Treasury Stock- 76,000 shares in 2002 and  63,000 in 2001, at co                                                |       | (1,406,198       | )           | (860,198 | ) |
| Surplus                                                                                                         |       | 2,408,426        |        | 2,408,426 |   |
| Retained earnings                                                                                               |       | 14,630,049       |        | 13,916,868 |   |
| Accumulated other comprehensive income                                                                          |       | 260,324          |        | 35,034 |   |
| Total stockholders’ equity                                                                                 |       | 17,192,601       |        | 16,800,130 |   |
|                                                                                                            |       |             |        |   |   |
| Total liabilities and stockholders’ equity                                                                 |       | $                | 169,329,773 |   | $ | 171,006,929 |   |

 

Theaccompanying notes are an integral part of the consolidated financialstatements.

 

35

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**Logan County BancShares, Inc. and Subsidiary**

**CONSOLIDATED STATEMENTS OF INCOME**

 
| ** **                                                    | ** ** | **Year Ended December 31,** | ** ** |
|---------------------------------------------------------------|------------|-----------------------------|------------|
| ** **                                                    | ** ** | **2002**                    | ** ** | **2001** | ** ** | **2000** | ** ** |
| **INTEREST INCOME**                                           |       |                        |       |   |   |   |   |
| Interest and fees on loans                                    |       |                        |       |   |   |   |   |
| Taxable                                                       |       | $                           | 8,518,297  |   | $ | 9,981,814 |   | $ | 9,513,879 |   |
| Investment securities:                                        |       |                        |       |   |   |   |   |
| Available-for-sale                                            |       | 1,363,725                   |       | 1,354,163 |   | 1,885,787 |   |
| Interest on federal funds sold                                |       | 205,786                     |       | 753,745 |   | 108,011 |   |
| Total interest income                                         |       | 10,087,808                  |       | 12,089,722 |   | 11,507,677 |   |
|                                                          |       |                        |       |   |   |   |   |
| **INTEREST EXPENSE**                                          |       |                        |       |   |   |   |   |
| Deposits                                                      |       | 2,607,604                   |       | 4,661,023 |   | 4,758,575 |   |
| Other borrowings                                              |       | 156,508                     |       | 140,000 |   | 68,950 |   |
| Total interest expense                                        |       | 2,764,112                   |       | 4,801,023 |   | 4,827,525 |   |
|                                                          |       |                        |       |   |   |   |   |
| Net interest income                                           |       | 7,323,696                   |       | 7,288,699 |   | 6,680,152 |   |
|                                                          |       |                        |       |   |   |   |   |
| **PROVISION FOR POSSIBLE LOAN LOSSES**                        |       | 533,819                     |       | 700,000 |   | 100,000 |   |
|                                                          |       |                        |       |   |   |   |   |
| Net interest income after provision for  possible loan losses |       | 6,789,877                   |       | 6,588,699 |   | 6,580,152 |   |
|                                                          |       |                        |       |   |   |   |   |
| **NONINTEREST INCOME**                                        |       |                        |       |   |   |   |   |
| Service charges and other fees                                |       | 656,160                     |       | 628,220 |   | 668,719 |   |
| Securities gains, net                                         |       | —                      |       | 6,248 |   | — |   |
| Other operating income                                        |       | 148,407                     |       | 72,694 |   | 100,516 |   |
| Total noninterest income                                      |       | 804,567                     |       | 707,162 |   | 769,235 |   |
|                                                          |       |                        |       |   |   |   |   |
| **NONINTEREST EXPENSE**                                       |       |                        |       |   |   |   |   |
| Salary and employee benefits                                  |       | 2,321,908                   |       | 2,216,849 |   | 2,147,995 |   |
| Occupancy and equipment expense                               |       | 546,772                     |       | 534,074 |   | 493,435 |   |
| Other operating expenses                                      |       | 1,820,155                   |       | 1,879,727 |   | 1,543,968 |   |
| Total noninterest expense                                     |       | 4,688,835                   |       | 4,630,650 |   | 4,185,398 |   |
|                                                          |       |                        |       |   |   |   |   |
| Income before income taxes                                    |       | 2,905,609                   |       | 2,665,211 |   | 3,163,989 |   |
|                                                          |       |                        |       |   |   |   |   |
| **INCOME TAXES**                                              |       | 1,063,777                   |       | 909,590 |   | 1,131,268 |   |
|                                                          |       |                        |       |   |   |   |   |
| Net income                                                    |       | $                           | 1,841,832  |   | $ | 1,755,621 |   | $ | 2,032,721 |   |
|                                                          |       |                        |       |   |   |   |   |
| **WEIGHTED AVERAGE SHARES OUTSTANDING**                       |       | 716,991                     |       | 716,991 |   | 716,991 |   |
|                                                          |       |                        |       |   |   |   |   |
| **EARNINGS PER COMMON SHARE**                                 |       | $                           | 2.57       |   | $ | 2.45 |   | $ | 2.84 |   |

 

The accompanying notes are an integral partof the consolidated financial statements.

 

36

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**Logan County BancShares, Inc. and Subsidiary**

**CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY**

 
| ** **                                                                            | ** ** | ** ** | ** ** | ** **  | ** ** | ** **   | ** ** | ** **   | ** ** | **Accumulated**     | ** ** | ** **        | ** ** | ** ** | ** ** |
|---------------------------------------------------------------------------------------|------------|------------|------------|-------------|------------|--------------|------------|--------------|------------|---------------------|------------|-------------------|------------|------------|------------|
| ** **                                                                            | ** ** | ** ** | ** ** | ** **  | ** ** | ** **   | ** ** | ** **   | ** ** | **Other**           | ** ** | ** **        | ** ** | ** ** | ** ** |
| ** **                                                                            | ** ** | **Common** | ** ** | ** **  | ** ** | **Retained** | ** ** | **Treasury** | ** ** | **Compre  hensive** | ** ** | **Comprehensive** | ** ** | ** ** | ** ** |
| ** **                                                                            | ** ** | **Stock**  | ** ** | **Surplus** | ** ** | **Earnings** | ** ** | **Stock**    | ** ** | **Income  (Loss)**  | ** ** | **Income**        | ** ** | **Total**  | ** ** |
| **BALANCE,  DECEMBER 31, 1999**                                                       |       | $          | 1,300,000  |        | $          | 2,408,426    |       | $            | 12,236,479 |                | $          | (860,198          | )          | $          | (641,014   | ) |   |   | $ | 14,443,693 |   |
|                                                                                  |       |       |       |        |       |         |       |         |       |                |       |              |       |       |       |
| Comprehensive  income:                                                                |       |       |       |        |       |         |       |         |       |                |       |              |       |       |       |
| Net income - 2000                                                                     |       | —     |       | —      |       | 2,032,721    |       | —       |       | —              |       | $                 | 2,032,721  |       | 2,032,721  |   |
| Other  comprehensive income, net of tax                                               |       |       |       |        |       |         |       |         |       |                |       |              |       |       |       |   |
| Unrealized gains on  securities available-for-sale                                    |       | —     |       | —      |       | —       |       | —       |       | 570,269             |       | 570,269           |       | 570,269    |       |
| Comprehensive income                                                                  |       |       |       |        |       |         |       |         |       |                |       | $                 | 2,602,990  |       |       |   |
|                                                                                  |       |       |       |        |       |         |       |         |       |                |       |              |       |       |       |
| Cash dividend ($1.44  per share)                                                      |       | —     |       | —      |       | (1,032,467   | )          | —       |       | —              |       |              |       | (1,032,467 | )          |
|                                                                                  |       |       |       |        |       |         |       |         |       |                |       |              |       |       |       |
| **BALANCE,  DECEMBER 31, 2000**                                                       |       | 1,300,000  |       | 2,408,426   |       | 13,236,733   |       | (860,198     | )          | (70,745             | )          |              |       | 16,014,216 |       |
|                                                                                  |       |       |       |        |       |         |       |         |       |                |       |              |       |       |       |
| Comprehensive  income:                                                                |       |       |       |        |       |         |       |         |       |                |       |              |       |       |       |
| Net income -2001                                                                      |       | —     |       | —      |       | 1,755,621    |       | —       |       | —              |       | $                 | 1,755,621  |       | 1,755,621  |   |
| Other  comprehensive income, net of tax                                               |       |       |       |        |       |         |       |         |       |                |       |              |       |       |       |   |
| Unrealized gains on  securities available-for-sale                                    |       | —     |       | —      |       | —       |       | —       |       | 105,779             |       | 105,779           |       | 105,779    |       |
| Comprehensive income                                                                  |       |       |       |        |       |         |       |         |       |                |       | $                 | 1,861,400  |       |       |   |
|                                                                                  |       |       |       |        |       |         |       |         |       |                |       |              |       |       |       |
| Cash dividend ($1.34  per share)                                                      |       | —     |       | —      |       | (1,075,487   | )          | —       |       | —              |       |              |       | (1,075,487 | )          |
|                                                                                  |       |       |       |        |       |         |       |         |       |                |       |              |       |       |       |
| **BALANCE,  DECEMBER 31, 2001**                                                       |       | 1,300,000  |       | 2,408,426   |       | 13,916,867   |       | (860,198     | )          | 35,034              |       |              |       | 16,800,129 |       |
|                                                                                  |       |       |       |        |       |         |       |         |       |                |       |              |       |       |       |
| **Correction  of error**                                                              |       |       |       |        |       | (31,655      | )          |         |       |                |       |              |       | (31,655    | )          |
|                                                                                  |       |       |       |        |       |         |       |         |       |                |       |              |       |       |       |
| Comprehensive income:                                                                 |       |       |       |        |       |         |       |         |       |                |       |              |       |       |       |
| Net income - 2002                                                                     |       | —     |       | —      |       | 1,841,833    |       |         |       | —              |       | $                 | 1,841,833  |       | 1,841,833  |   |
| Other  comprehensive income, net of tax                                               |       |       |       |        |       |         |       |         |       |                |       |              |       |       |       |   |
| Unrealized gains  on securities net of reclassification adjustment available-for-sale |       | —     |       | —      |       | —       |       |         |       | 225,290             |       | 225,290           |       | 225,290    |       |
| Comprehensive income                                                                  |       |       |       |        |       |         |       |         |       |                |       | $                 | 2,067,123  |       |       |   |
|                                                                                  |       |       |       |        |       |         |       |         |       |                |       |              |       |       |       |
| Purchase of  13,000 shares of common stock @ $42 per share                            |       |       |       |        |       |         |       | (546,000     | )          |                |       |              |       | (546,000   | )          |
|                                                                                  |       |       |       |        |       |         |       |         |       |                |       |              |       |       |       |
| Cash dividend ($1.53  per share)                                                      |       | —     |       | —      |       | (1,096,996   | )          | —       |       | —              |       |              |       | (1,096,996 | )          |
|                                                                                  |       |       |       |        |       |         |       |         |       |                |       |              |       |       |       |
| **BALANCE,  DECEMBER 31, 2002**                                                       |       | $          | 1,300,000  |        | $          | 2,408,426    |       | $            | 14,630,049 |                | $          | (1,406,198        | )          | $          | 260,324    |   |   |   | $ | 17,192,601 |   |

 

The accompanying notes are anintegral part of the consolidated financial statements.

 

37

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**Logan County BancShares, Inc. and Subsidiary**

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

 
| ** **                                                                         | ** ** | **Year Ended December 31,** | ** ** |
|------------------------------------------------------------------------------------|------------|-----------------------------|------------|
| ** **                                                                         | ** ** | **2002**                    | ** ** | **2001** | ** ** | **2000** | ** ** |
| **CASH FLOWS FROM OPERATING ACTIVITIES**                                           |       |                        |       |   |   |   |   |
| Net income                                                                         |       | $                           | 1,841,833  |   | $ | 1,755,621 |   | $ | 2,032,271 |   |
| Adjustments to reconcile net income to net  cash provided by operating activities: |       |                        |       |   |   |   |   |
| Allowance for loan losses                                                          |       | 533,819                     |       | 700,000 |   | 100,000 |   |
| Depreciation and amortization                                                      |       | 273,928                     |       | 269,956 |   | 277,506 |   |
| Provision for deferred taxes                                                       |       | (130,620                    | )          | (213,669 | ) | (1,247 | ) |
| Gain on sale of securities                                                         |       | —                      |       | (6,248 | ) | — |   |
| Premium amortization and accretion on  investment securities                       |       | 66,565                      |       | (3,356 | ) | (5,060 | ) |
| Net change in accrued income and other  assets                                     |       | 196,970                     |       | 503,222 |   | 32,608 |   |
| Net change in other liabilities                                                    |       | 381,009                     |       | (80,276 | ) | (83,776 | ) |
| Other, net                                                                         |       | —                      |       | 4,028 |   | 4,028 |   |
| Net cash provided by operating activities                                          |       | 3,163,504                   |       | 2,929,278 |   | 2,356,330 |   |
|                                                                               |       |                        |       |   |   |   |   |
| **CASH FLOWS FROM INVESTING ACTIVITIES**                                           |       |                        |       |   |   |   |   |
| Proceeds from sales/calls of securities  available-for-sale                        |       | 19,925,000                  |       | 8,006,248 |   | — |   |
| Proceeds from maturities of securities  available-for-sale                         |       | —                      |       | 41,000,000 |   | 7,400,000 |   |
| Purchases of securities available-for-sale                                         |       | (24,612,311                 | )          | (55,583,423 | ) | (5,943,619 | ) |
| Purchase of bank owned life insurance                                              |       | —                      |       | — |   | — |   |
| Net change in loans                                                                |       | 8,974,822                   |       | (3,266,801 | ) | (4,167,860 | ) |
| Purchase of bank premises and equipment                                            |       | (107,713                    | )          | (59,493 | ) | (93,479 | ) |
| Net cash provided by (used in) investing  activities                               |       | 4,179,798                   |       | (9,903,469 | ) | (2,804,958 | ) |
|                                                                               |       |                        |       |   |   |   |   |
| **CASH FLOWS FROM FINANCING ACTIVITIES**                                           |       |                        |       |   |   |   |   |
| Net change in deposits                                                             |       | (1,533,205                  | )          | 12,884,453 |   | 11,104,088 |   |
| Net change in repurchase agreements                                                |       | (1,000,000                  | )          | — |   | (7,840,000 | ) |
| Purchase of Treasury Stock, at cost                                                |       | (546,000                    | )          | — |   | — |   |
| Dividends paid                                                                     |       | (1,096,996                  | )          | (1,075,487 | ) | (1,032,437 | ) |
| Net cash provided by (used in) financing  activities                               |       | (4,176,201                  | )          | 11,808,966 |   | 2,231,651 |   |
|                                                                               |       |                        |       |   |   |   |   |
| **INCREASE (DECREASE) IN CASH AND CASH  EQUIVALENTS**                              |       | 3,167,101                   |       | 4,834,775 |   | 1,783,023 |   |
|                                                                               |       |                        |       |   |   |   |   |
| **CASH AND CASH EQUIVALENTS, BEGINNING OF  YEAR**                                  |       | 13,801,322                  |       | 8,966,547 |   | 7,183,524 |   |
|                                                                               |       |                        |       |   |   |   |   |
| **CASH AND CASH EQUIVALENTS, END OF YEAR**                                         |       | $                           | 16,968,423 |   | $ | 13,801,322 |   | $ | 8,966,547 |   |
|                                                                               |       |                        |       |   |   |   |   |
| **Supplemental Disclosures:**                                                      |       |                        |       |   |   |   |   |
| Cash paid for interest                                                             |       | $                           | 2,836,084  |   | $ | 4,876,027 |   | $ | 4,762,739 |   |
| Cash paid for income taxes                                                         |       | $                           | 1,186,510  |   | $ | 1,118,983 |   | $ | 1,117,740 |   |

 

The accompanying notes are an integral partof the consolidated financial statements.

 

38

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**Logan County BancShares, Inc. and Subsidiary**

**NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS**

**DECEMBER 31, 2002, 2001, AND 2000**

 

**NOTE 1 –SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES**

 

Nature of Operations – Logan County BancShares, Inc. (the “Company”) is a West Virginiacorporation.  The Company provides avariety of banking services to individuals and businesses through the branchnetwork of its subsidiary, Logan Bank and Trust (the “Bank”).  The Bank operates four full service locationsin Logan County, West Virginia and one in Lincoln County, West Virginia.  Primary deposit products consist of checkingaccounts, savings accounts, and certificates of deposit.  Primary lending products consist ofcommercial and residential real estate loans, consumer loans, and businessloans.

 

Principles of Consolidation – The consolidated financial statements of the Company include thefinancial statements of the parent and its wholly-owned subsidiary. Allsignificant intercompany transactions and balances 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, disclosures of contingent assets and liabilities atthe date of the financial statements, and the reported amounts of revenues andexpenses during the reporting period. Actual results could differ from those estimates.  Material estimates that are particularlysusceptible to material change in the near term relate to the determination ofthe allowance for loan losses and the valuation of deferred tax assets.

 

Cash and Cash Equivalents – Cash and cash equivalents consist of cash on hand, amounts due frombanks, and federal funds sold.

 

Investment Securities – The Bank’s investment securities are classified in two categoriesand accounted for as follows:

 

*Securities Available-for-Sale*:  Securities available-for-sale consist of bonds, notes, debentures, and certain equitysecurities not classified as securities held-to-maturity.  These securities are carried at their fairvalue.  Unrealized gains and losses, netof tax, are reported as a net amount in a separate component of stockholders’equity until realized.

 

*Securities Held-to-Maturity:*  Bonds, notes, and debenturesfor which the Bank has the positive intent and ability to hold to maturity arereported at cost, adjusted for amortization of premiums and accretion ofdiscounts, which are recognized in interest income using the Constant YieldMethod over the period to maturity.

 

Gainsand losses on the sale of securities are determined using theSpecific-Identification Method.

 

Commonstock of the Federal Reserve Bank represents ownership interest in aninstitution that is wholly owned by other financial institutions.  This equity security is accounted for at costand is classified with other assets.

 

39

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** **

Loans – Loansare reported at the amount of unpaid principal, net of deferred loan fees andcosts and an allowance for loan losses. Interest income on loans is recognized on the accrual basis except forthose loans in a nonaccrual status.  Theaccrual of interest on impaired loans is discontinued when management believes,after consideration of economic and business conditions and collection efforts, that the borrowers’ financial condition is suchthat collection of interest is doubtful. When interest accrual is discontinued, interest income is subsequentlyrecognized only to the extent cash payments are received.

 

Certainloan origination fees and direct origination costs are capitalized andrecognized as an adjustment of the yield on the related loan.  The total of such fees and costs are recordedas a reduction to Loan.

 

Allowance for Loan Losses – The allowance for possible loan losses represents the amount whichmanagement estimates is adequate to provide for probable losses inherent in itsloan portfolio. The allowance method is used in providing for loan losses.Accordingly, all loan losses are charged to the allowance, and all recoveriesare credited to it. The allowance for loan losses is established through aprovision for loan losses which is charged to operations. The provision isbased upon management’s periodic evaluation of individual loans, the overallrisk characteristics of the various portfolio segments, past experience withlosses, the impact of economic conditions on borrowers, and other relevantfactors. The estimates used in determining the adequacy of the allowance forloan losses including the amounts and timing of future cash flows expected onimpaired loans, are particularly susceptible to significant change in the nearterm.  This is due to the variability ofkey variables.

 

Impairedloans are commercial and commercial real estate loans for which it is probablethat the Company will not be able to collect all amounts due according to thecontractual terms of the loan agreement. The Company individually evaluatessuch loans for impairment and does not aggregate loans by major riskclassifications. The definition of “impaired loans” is not the same as thedefinition of “nonaccrual loans,” although the two categories overlap. The Companymay choose to place a loan on nonaccrual status due to payment delinquency oruncertain collectibility, while not classifying the loan as impaired, providedthe loan is not a commercial or commercial real estate classification. Factorsconsidered by management in determining impairment include payment status andcollateral value. The amount of impairment for these types of loans isdetermined by the difference between the present value of the expected cashflows related to the loan, using the original interest rate, and its recordedvalue, or as a practical expedient in the case of collateralized loans, thedifference between the fair value of the collateral and the recorded amount ofthe loans. When foreclosure is probable, impairment is measured based on thefair value of the collateral.

 

Mortgageloans secured by one-to-four family properties and all consumer loans are twolarge groups of smaller balance homogeneous loans and are measured forimpairment collectively by type. Loans that experience insignificant paymentdelays, which are defined as 90 days or less, generally are not classified asimpaired. Management determines the significance of payment delays on acase-by-case basis, taking into consideration all of the circumstancesconcerning the loan, the credit worthiness and payment history of the borrower,any collateral, the length of the payment delay, and the amount of shortfall inrelation to the principal and interest owed.

 

40

----

 

Bank Premises and Equipment – Bank premises and equipment are stated at cost, less accumulateddepreciation.  Repairs and maintenanceexpenditures are charged to operating expenses as incurred.  Major improvements and additions to premisesand equipment are capitalized.  Depreciation is provided on the straight-linemethod over the estimated useful lives of the assets as indicated inNote 7.

 

### Marketing and Advertising Costs –Marketing and advertising costs are expensed as incurred.

 

Real Estate Acquired Through Foreclosure – Real estate acquired through foreclosureis carried at the lower of the recorded investment in the property or its fairvalue.  The value of the underlying loanis written down to the fair value of the real estate to be acquired by a chargeto the allowance for loan losses, if necessary. Any subsequent write-downs are charged to operating expenses.

 

Income Taxes –The Company accounts for income taxes under the asset and liabilitymethod.  Income tax expense is reportedas the total of current income taxes payable and the net change in deferredincome taxes provided for temporary differences.  Deferred income taxes reflect the net taxeffects of temporary differences between the carrying values of assets and liabilitiesfor financial reporting purposes and the values used for income taxpurposes.  Deferred income taxes arerecorded at the statutory Federal and state tax rates in effect at the timethat the temporary differences are expected to reverse.

 

The Company files a consolidated Federal income tax return whichincludes its subsidiary.  Income taxexpense is allocated among the parent company and its subsidiary as if each hadfiled a separate return.

 

Earnings Per Common Share – Earnings per common share are calculated by dividing net income bythe weighted-average number of common stock outstanding during the year.  The Company had no securities which would beconsidered potential common stock.

 

Equity – InDecember 2002, the Company purchased 13,000 shares of Treasury Stock, bringingthe total shares held in Treasury to 76,000. After the purchase, 703,991 shares of the Company’s stock remainedoutstanding, net of treasury shares.

 

Comprehensive Income – Comprehensive income consists of net income and other comprehensiveincome.  Other comprehensive incomeincludes unrealized gains and losses on securities available-for-sale, whichare also recognized as a separate component of equity.

 

Reclassifications – Certain amounts in 2001 have beenreclassified to conform to the 2002 presentation.

 

41

----

 

**NOTE 2 – INVESTMENT SECURITIES**

 

The carrying amounts of investment in securities as shown in theconsolidated balance sheets of the Bank and their approximate fair values atDecember 31, are as follows:

 
| ** **                     | ** ** | **December 31, 2002** | ** ** |
|--------------------------------|------------|-----------------------|------------|
| ** **                     | ** ** | ** **            | ** ** | **Gross** | ** ** | **Gross** | ** ** | **Estimated** | ** ** |
| ** **                     | ** ** | **Amortized**         | ** ** | **Unrealized** | ** ** | **Unrealized** | ** ** | **Fair** | ** ** |
| ** **                     | ** ** | **Cost**              | ** ** | **Gains** | ** ** | **Losses** | ** ** | **Value** | ** ** |
| Securities available-for-sale: |       |                  |       |   |   |   |   |   |   |
| Federal agency securities      |       | $                     | 36,532,502 |   | $ | 284,636 |   | $ | — |   | $ | 36,817,120 |   |
| U.S. Treasury securities       |       | 3,971,774             |       | 103,226 |   | 18 |   | 4,075,000 |   |
| Equity securities              |       | 263,152               |       | 68,866 |   | — |   | 332,018 |   |
|                           |       |                  |       |   |   |   |   |   |   |
| Total                          |       | $                     | 40,767,428 |   | $ | 456,728 |   | $ | 18 |   | $ | 41,224,138 |   |

 
| ** **                     | ** ** | **December 31, 2001** | ** ** |
|--------------------------------|------------|-----------------------|------------|
| ** **                     | ** ** | ** **            | ** ** | **Gross** | ** ** | **Gross** | ** ** | **Estimated** | ** ** |
| ** **                     | ** ** | **Amortized**         | ** ** | **Unrealized** | ** ** | **Unrealized** | ** ** | **Fair** | ** ** |
| ** **                     | ** ** | **Cost**              | ** ** | **Gains** | ** ** | **Losses** | ** ** | **Value** | ** ** |
| Securities available-for-sale: |       |                  |       |   |   |   |   |   |   |
| Federal agency securities      |       | $                     | 32,553,208 |   | $ | 62,594 |   | $ | — |   | $ | 32,615,802 |   |
| U.S. Treasury securities       |       | 3,490,661             |       | — |   | 1,131 |   | 3,489,530 |   |
| Equity securities              |       | 250,000               |       | — |   | — |   | 250,000 |   |
|                           |       |                  |       |   |   |   |   |   |   |
| Total                          |       | $                     | 36,293,864 |   | $ | 62,594 |   | $ | 1,131 |   | $ | 36,355,332 |   |

 

The Company’s investment securities portfolio contains unrealizedlosses on U.S. Government agency securities, which are generally viewed as havingthe implied guarantee of the U.S. government. None of the individual securities have been in an unrealized lossposition for more than twelve months as of December 31, 2002.

 

On a monthly basis, the Company evaluates the severity and duration ofimpairment for its investment securities portfolio unless the Company has theability to hold the security to maturity without incurring a loss.  Generally, impairment is considered otherthan temporary when an investment security has sustained a decline in marketvalue of ten percent or more for a period of six months.

 

The Company has concluded that any impairment of its investmentsecurities portfolio is not other than temporary but is the result of interestrate changes, sector rating changes, or company-specific rating changes thatare not expected to result in the noncollection of principal and interest,during the period.

 

The amortized cost and estimated market value of investment in debtsecurities at December 31, 2002, by contractual maturity, are shown below.  Expected maturities will differ fromcontractual maturities because borrowers may have the right to call or prepayobligations with or without call as prepayment penalties.

 

42

----

 

 
| ** **                   | ** ** | **Securities  Available-for-Sale** | ** ** |
|------------------------------|------------|------------------------------------|------------|
|                         |       | ** **                         | ** ** | **Estimated** |   |
|                         |       | **Amortized**                      | ** ** | **Fair** |   |
|                         |       | **Cost**                           | ** ** | **Value** |   |
|                         |       |                               |       |   |   |
| Due in 1 year or less        |       | $                                  | 12,951,878 |   | $ | 13,035,620 |   |
| Due from 1 year to 5 years   |       | 27,471,398                         |       | 27,775,500 |   |
| Due from 5 years to 10 years |       | —                             |       | — |   |
| Due after 10 years           |       | —                             |       | — |   |
| Equity securities            |       | 344,152                            |       | 413,018 |   |
|                         |       |                               |       |   |   |
| Total                        |       | $                                  | 40,767,428 |   | $ | 41,224,138 |   |

 

No securities were sold in 2001 or 2000.  Gross gains of $6,248 were realized in 2001as the result of securities called prior to maturity.

 

The par value of securities pledged to secure public deposits and forother purposes amounted to $26,056,196 in 2002 and $14,598,233 in 2001.

 

**NOTE 3 – RESTRICTION ON CASH, DUE FROM BANKS, AND CONTINGENTLIABILITIES**

 

As a condition of membership, the Bank is required to maintain averagebalances with the Federal Reserve Bank. The average required reserve balances were $1,131,000 and $1,383,000 for2002 and 2001, respectively.  The Bankhas various claims and actions pending at December 31, 2002, arising in theordinary course of business.  It is theopinion of management and legal counsel that such litigation will notmaterially affect the Bank’s financial position or earnings.

 

**NOTE 4 – LOANS**

 

Major classifications of loans at December 31, 2002 and 2001, are asfollows:

 
| ** **                     | ** ** | **2002**    | ** **  | **2001**    | ** ** |
|--------------------------------|------------|-------------|-------------|-------------|------------|
|                           |       |        |        |        |       |
| Mortgage loans                 |       | $           | 52,502,944  |        | $          | 53,718,980 |   |
| Installment loans              |       | 11,449,826  |        | 13,977,895  |       |
| Commercial and other loans     |       | 43,979,821  |        | 49,210,538  |       |
| Total                          |       | 107,932,591 |        | 116,907,413 |       |
| Less allowance for loan losses |       | 1,618,632   |        | 1,152,777   |       |
|                           |       |        |        |        |       |
| Net loans                      |       | $           | 106,313,959 |        | $          | 115,754,636 |   |

 

43

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The following is a summary of information pertaining to impaired andnon-accrual loans:

 
| ** **                                     | ** ** | **December 31,** | ** ** |
|------------------------------------------------|------------|------------------|------------|
| ** **                                     | ** ** | **2002**         | ** ** | **2001** | ** ** |
|                                           |       |             |       |   |   |
| Impaired loans without a valuation  allowance  |       | $                | 203,589    |   | $ | 918,325 |   |
| Impaired loans with a valuation allowance      |       | 854,889          |       | 646,002 |   |
|                                           |       |             |       |   |   |
| Total impaired loans                           |       | $                | 1,058,478  |   | $ | 1,564,327 |   |
|                                           |       |             |       |   |   |
| Valuation allowance related to impaired  loans |       | $                | 504,554    |   | $ | 518,385 |   |
|                                           |       |             |       |   |   |
| Total non-accrual loans                        |       | $                | 1,705,845  |   | $ | 796,477 |   |

 
| ** **                                    | ** ** | **December 31,** | ** ** |
|-----------------------------------------------|------------|------------------|------------|
| ** **                                    | ** ** | **2002**         | ** ** | **2001** | ** ** | **2000** | ** ** |
|                                          |       |             |       |   |   |   |   |
| Average investment in impaired loans          |       | $                | 992,980    |   | $ | 1,250,972 |   | $ | 997,116 |   |
|                                          |       |             |       |   |   |   |   |
| Interest income recognized on impaired  loans |       | $                | 50,741     |   | $ | 45,357 |   | $ | 54,252 |   |

 

No additional funds are committed to be advanced in connection withimpaired loans.

 

Had the above loans not been placed on a non-accrual status, income forthe Company would have increased approximately $89,407 and $55,753 for 2002 and2001, respectively.

 

**NOTE 5 – ALLOWANCE FOR LOAN LOSSES**

 

Activity in the allowance for loan losses is summarized as follows:

 
| ** **                             | ** ** | **December 31,** | ** ** |
|----------------------------------------|------------|------------------|------------|
| ** **                             | ** ** | **2002**         | ** ** | **2001** | ** ** | **2000** | ** ** |
|                                   |       |             |       |   |   |   |   |
| Balance at beginning of year           |       | $                | 1,152,777  |   | $ | 702,008 |   | $ | 700,553 |   |
| Additions charged to operating expense |       | 533,818          |       | 700,000 |   | 100,000 |   |
| Recoveries                             |       | 29,565           |       | 7,890 |   | 7,125 |   |
| Total                                  |       | 1,716,160        |       | 1,409,898 |   | 807,678 |   |
| Less loans charged-off                 |       | 97,528           |       | 257,121 |   | 105,670 |   |
|                                   |       |             |       |   |   |   |   |
| Balance at end of year                 |       | $                | 1,618,632  |   | $ | 1,152,777 |   | $ | 702,008 |   |

 

44

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**NOTE 6 –****BANK PREMISES AND EQUIPMENT**

 

Premises and equipment are stated at cost, less accumulateddepreciation, as follows:

 
| ** **                         | ** ** | ** **       | ** ** | ** **      | ** ** | **Original** | ** ** |
|------------------------------------|------------|------------------|------------|-----------------|------------|--------------|------------|
| ** **                         | ** ** | **December 31,** | ** ** | **Useful Life** | ** ** |
| ** **                         | ** ** | **2002**         | ** ** | **2001**        | ** ** | **Years**    | ** ** |
|                               |       |             |       |            |       |         |       |
| Land                               |       | $                | 949,972    |            | $          | 949,972      |       |   |   |
| Banking house                      |       | 3,277,794        |       | 3,183,011       |       | 10 – 40 |       |
| Furniture, fixtures, and equipment |       | 2,445,398        |       | 2,432,565       |       | 3 – 20  |       |
| Total                              |       | 6,673,164        |       | 6,565,548       |       |         |       |
| Less accumulated depreciation      |       | 3,455,840        |       | 3,182,009       |       |         |       |
|                               |       |             |       |            |       |         |       |
| Net bank premises and equipment    |       | $                | 3,217,324  |            | $          | 3,383,539    |       |   |   |

 

Charges to operations for depreciation amounted to $273,928, $269,956,and $277,506 in 2002, 2001, and 2000, respectively.  Expenditures for maintenance and repairs werecharged against operations as incurred.

 

**NOTE 7 – OPERATING LEASE COMMITMENTS**

 

The Company has entered into lease agreements for certain premises atthree of its facility locations.  Futureminimum lease payments under the leases amount to $21,400 per year for each ofthe 5 years subsequent to December 31, 2002.

 

**NOTE 8 – DEPOSITS**

 

The following is a summary of interest-bearing deposits, by type, as ofDecember 31:

 
| ** **                                              | ** ** | **2002**   | ** **  | **2001**   | ** ** |
|---------------------------------------------------------|------------|------------|-------------|------------|------------|
|                                                    |       |       |        |       |       |
| NOW and Super NOW accounts                              |       | $          | 17,356,352  |       | $          | 16,976,091 |   |
| Money market accounts                                   |       | 4,494,996  |        | 4,394,817  |       |
| Savings accounts                                        |       | 44,864,222 |        | 39,803,796 |       |
| Regular certificates of deposit                         |       | 53,256,894 |        | 58,197,285 |       |
| Individual retirement accounts and other  time deposits |       | 5,394,393  |        | 5,084,901  |       |
|                                                    |       |       |        |       |       |
| Total                                                   |       | $          | 125,366,857 |       | $          | 124,456,890 |   |

 

Certificates of deposit in denominations of $100,000 or more totaled$16,886,987 and $19,815,003 at December 31, 2002 and 2001, respectively.  Interest paid on all time deposits totaled$2,024,089, $3,662,286, and $3,429,508 for the years ended December 31,2002, 2001, and 2000, respectively.

 

45

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A maturity distribution of time certificates of deposit of $100,000 ormore at December 31, 2002, follows:

 
| ** **                | ** ** | **Amount** | ** ** | **Percent** | ** ** |
|---------------------------|------------|------------|------------|-------------|------------|
|                      |       |       |       |        |       |
| Three months or less      |       | $          | —     |        | $          | 0.00 |   |
| Three through six months  |       | 842,136    |       | 4.99        |       |
| Six through twelve months |       | 3,004,194  |       | 17.81       |       |
| Over twelve months        |       | 13,020,657 |       | 72.20       |       |
|                      |       |       |       |        |       |
| Total                     |       | $          | 16,866,987 |        | 100.00     |   |
|                           |            |            |            |             |            |  |  |

 

At December 31, 2002, the scheduled maturities of time deposits are asfollows:

 
| 2003          |   | $          | 17,304,535 |   |
|---------------|--------|------------|------------|--------|
| 2004          |   | 16,786,257 |       |
| 2005          |   | 6,813,298  |       |
| 2006          |   | 6,473,589  |       |
| 2007 and over |   | 5,879,215  |       |
|          |   |       |       |
| Total         |   | $          | 53,256,894 |   |

 

**NOTE 9 – REPURCHASE AGREEMENTS**

 

Repurchase agreements represent financing arrangements whereby theCompany sells securities and agrees to repurchase the identical securities atthe maturity date of the agreement for a specified price.  The securities underlying the agreementsremain under the Company’s control. Information related to repurchase agreements is summarized below:

 
| ** **                            | ** ** | **2002**  | ** ** | **2001**  | ** ** |
|---------------------------------------|------------|-----------|------------|-----------|------------|
|                                  |       |      |       |      |       |
| Balance at end of year                |       | $         | 1,000,000  |      | $          | 2,000,000 |   |
| Average balance during the year       |       | 2,910,324 |       | 2,000,000 |       |
| Maximum month-end balance             |       | 3,000,000 |       | 2,000,000 |       |
| Weighted-average rate during the year |       | 5.377     | %          | 7.000     | %          |
| Weighted-average rate at December 31  |       | 2.250     | %          | 7.000     | %          |
|                                       |            |           |            |           |            |  |  |

 

46

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**NOTE 10 – INCOME TAX**

 

The provisions for federal income taxes for the years ended December31, 2002, 2001, and 2000 were less than the respective amounts that wouldresult from applying the statutory federal and state income tax rates dueprimarily to the Bank’s investment income and expense accruals.

 

The provisions for income taxes at December 31 consist of:

 
| ** **         | ** ** | **2002** | ** ** | **2001** | ** ** | **2000**  | ** ** |
|--------------------|------------|----------|------------|----------|------------|-----------|------------|
|               |       |     |       |     |       |      |       |
| Current            |       | $        | 1,194,397  |     | $          | 1,123,259 |       | $ | 1,132,515 |   |
| Deferred           |       | (130,620 | )          | (213,669 | )          | (1,247    | )          |
|               |       |     |       |     |       |      |       |
| Income tax expense |       | $        | 1,063,777  |     | $          | 909,590   |       | $ | 1,131,268 |   |

 

Deferred tax assets and deferred tax liabilities are comprised of thefollowing:

 
| ** **                                          | ** ** | **2002** | ** ** | **2001** | ** ** |
|-----------------------------------------------------|------------|----------|------------|----------|------------|
|                                                |       |     |       |     |       |
| Items giving rise to deferred tax assets:           |       |     |       |     |       |
| Allowance for loan losses in excess of tax  reserve |       | $        | 588,240    |     | $          | 374,553 |   |
| Deferred compensation                               |       | —   |       | —   |       |
| Other                                               |       | —   |       | 24,897   |       |
| Total deferred tax assets                           |       | 588,240  |       | 399,450  |       |
| Items giving rise to deferred tax  liabilities:     |       |     |       |     |       |
| Property and equipment                              |       | (175,141 | )          | (116,971 | )          |
| Investment accretion                                |       | (14,830  | )          | (54,492  | )          |
| Other                                               |       | (25,476  | )          | —   |       |
| Unrealized loss on securities available for  sale   |       | (196,385 | )          | —   |       |
| Total deferred tax liabilities                      |       | 411,832  | )          | 171,463  |       |
|                                                |       |     |       |     |       |
| Net deferred tax asset                              |       | $        | 176,408    |     | $          | 227,987 |   |

 

A reconciliation between the amount of reported income tax expense andthe amount computed by applying the statutory federal income tax rate to incomebefore income taxes for the year ended December 31 is as follows:

 
| ** **                                           | ** ** | **2002**   | ** ** | **2001**    | ** ** | **2000**   | ** ** |
|------------------------------------------------------|------------|------------|------------|-------------|------------|------------|------------|
| ** **                                           | ** ** | **Amount** | ** ** | **Percent** | ** ** | **Amount** | ** ** | **Percent** | ** ** | **Amount** | ** ** | **Percent** | ** ** |
|                                                 |       |       |       |        |       |       |       |   |   |   |   |   |   |
| Computed tax at statutory federal rate               |       | $          | 987,907    |        | 34.0       | %          | $          | 906,172 |   | 34.0 | % | $ | 1,044,203 |   | 34.0 | % |
| Plus state income taxes net of federal tax  benefits |       | 74,346     |       | 2.6         |       | 56,716     |       | 2.1 |   | 92,802 |   | 3.0 |   |
|                                                 |       | 1,062,253  |       | 36.6        |       | 962,888    |       | 36.1 |   | 1,137,005 |   | 37.0 |   |
| Effect of:                                           |       |       |       |        |       |       |       |   |   |   |   |   |   |
| Dividends received deduction                         |       | (2,193     | )          | (0.1        | )          | (1,953     | )          | (0.1 | ) | — |   | 0.0 |   |
| Life insurance earnings                              |       | —     |       | 0.0         |       | —     |       | 0.0 |   | — |   | 0.0 |   |
| Travel and dues                                      |       | 1,593      |       | 0.0         |       | 1,578      |       | 0.1 |   | — |   | 0.0 |   |
| Others - net                                         |       | 2,124      |       | 0.1         |       | (52,923    | )          | (2.0 | ) | (5,737 | ) | (0.1 | ) |
|                                                 |       |       |       |        |       |       |       |   |   |   |   |   |   |
| Actual tax expense                                   |       | $          | 1,063,777  |        | 36.6       | %          | $          | 909,590 |   | 34.1 | % | $ | 1,131,268 |   | 36.9 | % |

 

47

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**NOTE 11 – EMPLOYEE BENEFIT PLANS**

 

The Company’s subsidiary has a qualified profit sharing and 401(k)employee benefit plan covering substantially all employees.  The contributions to the plans are at thediscretion of the plan’s advisory board and amounted to $121,121, $125,165, and$114,358 in 2002, 2001, and 2000, respectively.

 

**NOTE 12 – COMMITMENTS AND CONTINGENCIES**

 

The Bank is a party to financial instruments with off-balance-sheetrisk in the normal course of business to meet the financing needs of itscustomers.  These financial instrumentsinclude loan commitments and standby letters of credit.  The instruments involve, to varying degrees,elements of credit and interest rate risk in excess of the amount recognized inthe financial statements.

 

The Company’s exposure to credit loss in the event of nonperformance bythe other party to the financial instrument for loan commitments and standbyletters of credit is represented by the contractual amount of thoseinstruments.  The Bank uses the samecredit policies in making commitments and conditional obligations as it doesfor on-balance-sheet instruments.

 

The total amount of off-balance-sheet financial instruments with creditrisk are as follows:

 
| ** **                | ** ** | **December 31,** | ** ** |
|---------------------------|------------|------------------|------------|
| ** **                | ** ** | **2002**         | ** ** | **2001** | ** ** |
|                      |       |             |       |   |   |
| Loan commitments          |       | $                | 11,061,000 |   | $ | 10,281,000 |   |
| Standby letters of credit |       | 802,000          |       | 990,000 |   |
|                           |            |                  |            |  |  |  |  |

 

Commitments to extend credit are agreements to lend to a customer aslong as there is no violation of any condition established in thecontract.  Commitments generally havefixed expiration dates or other termination clauses and may require payment ofa fee.  Since many of the commitments areexpected to expire without being drawn upon, the total commitment amounts donot necessarily represent future cash requirements.  The Bank evaluates each customer’screditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Bank uponextension of credit, is based on management’s credit evaluation of thecounterparty.  Collateral held varies,but may include accounts receivable, inventory, property, plant, and equipment,and income-producing commercial properties.

 

Standby letters of credit are conditional commitments issued by theCompany to guarantee the performance of a customer to a third party.  These guarantees are primarily issued tosupport public and private borrowing arrangements.  All of the standby letters of credit expirein 2003.  The credit risk involved inissuing letters of credit is essentially the same as that involved in extendingloans to customers.

 

Most of the Bank’s loans and commitments have been granted to customersin the Bank’s primary market area of Logan and Lincoln Counties in WestVirginia.  In the normal course ofbusiness, however, the Bank has originated loans outside of its primary marketarea.  The aggregate loan balancesoutstanding in any one geographic area, other than the Bank’s primary lendingareas, do not exceed 10 percent of total loans. No specific industry concentrations exceeded 10 percent of totalexposure.  The concentrations of creditby type of loan are set forth in Note 4.

 

48

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**NOTE 13 -****REGULATORY MATTERS**

 

The Bank is subject to various regulatory capital requirementsadministered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certainmandatory, and possibly additional discretionary, actions by regulators that,if undertaken, could have a direct material effect on the Bank’s financialstatements.  Under capital adequacyguidelines and the regulatory framework for prompt corrective action, the Bankmust meet specific capital guidelines that involve quantitative measures of theBank’s assets, liabilities, and certain off-balance-sheet items as calculatedunder regulatory accounting practices. The Bank’s capital amounts and classifications are also subject toqualitative judgments by the regulators about components, risk, weighting, andother factors.

 

Quantitative measures established by regulation to ensure capitaladequacy require the banks to maintain minimum amounts and ratios (set forth inthe table below and as defined by regulation) of total and Tier I capital (asdefined in the regulations) to risk-weighted assets, and of Tier I capitalto average assets.  Management believes,as of December 31, 2002, that the Bank meets all capital adequacy requirementsto which it is subject.

 

As of December 31, 2002, the most recent notification from the FederalReserve Bank categorized the Bank as “well capitalized” under the regulatoryframework.  To be categorized as wellcapitalized, the Bank must maintain minimum total risk-based capital, Tier Irisk-based capital, and Tier I capital leverage ratios as set forth in the table.  There are no conditions or events since thosenotifications that management believes have changed the institution’s category.

 
| ** **                            | ** ** | ** ** | ** ** | ** **            | ** ** | ** **              | ** ** | ** **            | ** ** | **To Be Well** | ** ** |
|---------------------------------------|------------|------------|------------|-----------------------|------------|-------------------------|------------|-----------------------|------------|----------------|------------|
| ** **                            | ** ** | ** ** | ** ** | ** **            | ** ** | **For Capital**         | ** ** | **Capitalized Under** | ** ** |
| ** **                            | ** ** | **Actual** | ** ** | **Adequacy Purposes** | ** ** | **Federal Regulations** | ** ** |
| **(Amounts Expressed in  Thousands)** | ** ** | **Amount** | ** ** | **Ratio**             | ** ** | **Amount**              | ** ** | **Ratio**             | ** ** | **Amount**     | ** ** | **Ratio** | ** ** |
|                                  |       |       |       |                  |       |                    |       |                  |       |           |       |   |   |
| As of December 31, 2002:              |       |       |       |                  |       |                    |       |                  |       |           |       |   |   |
| Total Capital                         |       | $          | 17,193     |                  | 17.6       | %                       | $          | 7,809                 |       | 8.0            | %          | $ | 9,761 |   | 10.0 | % |
|   (to Risk Weighted Assets) |       |       |       |                  |       |                    |       |                  |       |           |       |   |   |
| Tier I Capital                        |       | $          | 16,943     |                  | 17.4       | %                       | $          | 3,904                 |       | 4.0            | %          | $ | 5,857 |   | 6.0 | % |
|   (to Risk Weighted Assets) |       |       |       |                  |       |                    |       |                  |       |           |       |   |   |
| Tier I Capital                        |       | $          | 16,948     |                  | 9.8        | %                       | $          | 6,924                 |       | 4.0            | %          | $ | 4,881 |   | 5.0 | % |
|   (to Average Assets)       |       |       |       |                  |       |                    |       |                  |       |           |       |   |   |
|                                  |       |       |       |                  |       |                    |       |                  |       |           |       |   |   |
| As of December 31, 2001:              |       |       |       |                  |       |                    |       |                  |       |           |       |   |   |
| Total Capital                         |       | $          | 16,800     |                  | 16.2       | %                       | $          | 8,290                 |       | 8.0            | %          | $ | 10,362 |   | 10.0 | % |
|   (to Risk Weighted Assets) |       |       |       |                  |       |                    |       |                  |       |           |       |   |   |
| Tier I Capital                        |       | $          | 16,147     |                  | 15.0       | %                       | 4,295      |                  | 4.0        | %              | 6,442      |   | 6.0 | % |
|   (to Risk Weighted Assets) |       |       |       |                  |       |                    |       |                  |       |           |       |   |   |
| Tier I Capital                        |       | $          | 16,147     |                  | 10.3       | %                       | 6,265      |                  | 4.0        | %              | 7,831      |   | 5.0 | % |
|   (to Average Assets)       |       |       |       |                  |       |                    |       |                  |       |           |       |   |   |

 

The Company’s principal source of funds for dividend payments isdividends received from the subsidiary Bank. Banking regulations limit theamount of dividends that may be paid without prior approval of regulatoryagencies.  Under these regulations, theamount of dividends that may be paid in any calendar year is limited to thecurrent year’s net profits, as defined, combined with the retained net profitsof the preceding two years, subject to the capital requirements definedabove.  During 2003, the Bank could,without prior approval, declare dividends of approximately $1,891,306 plus any2003 net profits returned to the date of the dividend declaration.

 

49

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**NOTE 14 - DISCLOSURES ABOUT FAIR VALUE OF FINANCIALINSTRUMENTS**

 

The reported fair values of financial instruments are based on avariety of factors.  Where possible, fairvalues represent quoted market prices for identical or comparableinstruments.  In other cases, fair valueshave been estimated based on assumptions concerning the amount and timing ofestimated future cash flows and assumed discount rates reflecting varyingdegrees of risk.  Intangible valuesassigned to customer relationships are not reflected in the reported fairvalues.  Accordingly, the fair values maynot represent actual values of the financial instruments that could have beenrealized as of year end or that will be realized in the future.

 

The following methods and assumptions were used by the Company inestimating the fair value disclosures for financial instruments:

 

Cash and Cash Equivalents:  For these short-terminstruments, the carrying amount is a reasonable estimate of fair value.

 

Investment Securities:  Fair values for investmentsecurities are based on quoted market prices or dealer quotes.

 

Loans:  Fair value is estimated by discounting thefuture cash flows using the current rates at which similar loans would be madeto borrowers with similar credit ratings and for the same remaining maturities.

 

Deposit Liabilities:  The fair value of demanddeposits, savings accounts, and certain money market deposits is the amountpayable on demand at the reporting date. The fair value of fixed-maturity certificates of deposit is estimated bydiscounting future cash flows using the rates currently offered for deposits ofsimilar remaining maturities.

 

Repurchase Agreements:  For these short-terminstruments, the carrying amount is a reasonable estimate of fair value.

 

Off-Balance-Sheet Instruments:  Commitments to extend creditand standby letters of credit represent agreements to lend to a customer at themarket rate when the loan is extended, thus the commitments and letters ofcredit are not considered to have a fair value.

 

The estimates of fair values of financial instruments are summarized asfollows at December 31:

 
| ** **                  | ** ** | **2002**     | ** ** | **2001**    | ** ** |
|-----------------------------|------------|--------------|------------|-------------|------------|
| ** **                  | ** ** | **Carrying** | ** ** | **Fair**    | ** ** | **Carrying** | ** ** | **Fair** | ** ** |
| ** **                  | ** ** | **Amount**   | ** ** | **Value**   | ** ** | **Amount** | ** ** | **Value** | ** ** |
|                        |       |         |       |        |       |   |   |   |   |
| Financial assets:           |       |         |       |        |       |   |   |   |   |
| Cash and cash equivalents   |       | $            | 5,597,679  |        | $          | 5,597,679 |   | $ | 6,651,322 |   | $ | 6,651,322 |   |
| Federal funds sold          |       | 11,370,000   |       | 11,370,000  |       | 7,150,000 |   | 7,150,000 |   |
| Investment securities       |       | 41,305,138   |       | 41,305,138  |       | 36,292,869 |   | 36,355,332 |   |
| Loans                       |       | 107,932,591  |       | 109,106,568 |       | 115,754,636 |   | 115,754,636 |   |
| Accrued interest receivable |       | 811,373      |       | 811,373     |       | 973,167 |   | 973,167 |   |
|                        |       |         |       |        |       |   |   |   |   |
| Financial liabilities:      |       |         |       |        |       |   |   |   |   |
| Deposits                    |       | 150,073,293  |       | 150,823,589 |       | 151,607,242 |   | 151,896,920 |   |
| Repurchase agreements       |       | 1,000,000    |       | 1,000,000   |       | 2,000,000 |   | 2,000,000 |   |
| Accrued interest payable    |       | 93,142       |       | 93,142      |       | 165,114 |   | 165,114 |   |
|                             |            |              |            |             |            |  |  |  |  |  |  |  |  |

 

50

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**NOTE 15 – CONDENSED PARENT COMPANY ONLY FINANCIALSTATEMENTS**

 

Presented below are the condensed balance sheets, statements of income,and statements of cash flows for Logan County BancShares, Inc.:

 

**BALANCE SHEETS**

 
| ** **                                      | ** ** | ** ** | ** ** | **December 31,** | ** ** |
|-------------------------------------------------|------------|------------|------------|------------------|------------|
| ** **                                      | ** ** | ** ** | ** ** | **2002**         | ** ** | **2001** | ** ** |
| **ASSETS**                                      |       |       |       |             |       |   |   |
| Cash                                            |       |       |       | $                | 369,744    |   | $ | 420,887 |   |
| Securities available for sale, at fair  value   |       |       |       | 332,018          |       | 250,000 |   |
| Other assets                                    |       |       |       | 46,868           |       | 18,295 |   |
| Investment in subsidiary                        |       |       |       | 16,869,078       |       | 16,510,065 |   |
|                                            |       |       |       |             |       |   |   |
| Total assets                                    |       |       |       | $                | 17,617,708 |   | $ | 17,199,247 |   |
|                                            |       |       |       |             |       |   |   |
| **LIABILITIES**                                 |       |       |       |             |       |   |   |
| Other                                           |       |       |       | $                | 425,107    |   | $ | 399,117 |   |
|                                            |       |       |       |             |       |   |   |
| **STOCKHOLDERS’ EQUITY**                   |       |       |       | 17,192,601       |       | 16,800,130 |   |
|                                            |       |       |       |             |       |   |   |
| Total liabilities and stockholders’ equity |       |       |       | $                | 17,617,708 |   | $ | 17,199,247 |   |

 

**STATEMENTS OF INCOME**

 
| ** **                                                                       |       | **Year  Ended December 31,** |       |
|----------------------------------------------------------------------------------|------------|------------------------------|------------|
| ** **                                                                       | ** ** | **2002**                     | ** ** | **2001** |   | **2000** |   |
| **OPERATING INCOME**                                                             |       |                         |       |   |   |   |   |
| Other income                                                                     |       | $                            | 67,285     |   | $ | 8,208 |   | $ | 7,203 |   |
| Dividends from subsidiary                                                        |       | 1,706,148                    |       | 1,075,486 |   | 1,032,467 |   |
| Total operating income                                                           |       | 1,773,433                    |       | 1,083,694 |   | 1,039,670 |   |
|                                                                             |       |                         |       |   |   |   |   |
| **OPERATING EXPENSES**                                                           |       | 121,459                      |       | 60,846 |   | 57,791 |   |
|                                                                             |       |                         |       |   |   |   |   |
| Income before income tax and equity in  undistributed earnings of subsidiary     |       | 1,651,974                    |       | 1,022,848 |   | 981,879 |   |
|                                                                             |       |                         |       |   |   |   |   |
| **INCOME TAX BENEFIT**                                                           |       | 43,127                       |       | 20,900 |   | 20,628 |   |
|                                                                             |       |                         |       |   |   |   |   |
| Income before equity in undistributed  earnings of subsidiary                    |       | 1,695,101                    |       | 1,043,748 |   | 1,002,507 |   |
|                                                                             |       |                         |       |   |   |   |   |
| **EQUITY IN UNDISTRIBUTED (DISTRIBUTIONS IN  EXCESS OF) EARNINGS OF SUBSIDIARY** |       | 146,732                      |       | 711,873 |   | 1,030,214 |   |
|                                                                             |       |                         |       |   |   |   |   |
| Net income                                                                       |       | $                            | 1,841,833  |   | $ | 1,755,621 |   | $ | 2,032,721 |   |

 

51

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**STATEMENTS OF CASH FLOWS**

 
| ** **                                                                         | ** ** | **Year Ended December 31,** | ** ** |
|------------------------------------------------------------------------------------|------------|-----------------------------|------------|
| ** **                                                                         | ** ** | **2002**                    | ** ** | **2001** | ** ** | **2000** | ** ** |
| **CASH FLOWS FROM OPERATING ACTIVITIES**                                           |       |                        |       |   |   |   |   |
| Net income                                                                         |       | $                           | 1,841,833  |   | $ | 1,755,621 |   | $ | 2,032,721 |   |
| Adjustments to reconcile net income to net  cash provided by operating activities: |       |                        |       |   |   |   |   |
| Equity in undistributed (distribution in  excess of) earnings of subsidiary        |       | (146,732                    | )          | (711,873 | ) | (1,030,214 | ) |
| Net change in other assets                                                         |       | (110,591                    | )          | (13,420 | ) | 9,799 |   |
| Net change in accrued expenses                                                     |       | 7,343                       |       | 105,580 |   | 5,131 |   |
| Net cash provided by operating activities                                          |       | 1,591,853                   |       | 1,135,908 |   | 1,017,437 |   |
|                                                                               |       |                        |       |   |   |   |   |
| **CASH FLOWS FROM FINANCING ACTIVITIES**                                           |       |                        |       |   |   |   |   |
| Purchase of Treasury Stock                                                         |       | (546,000                    | )          | — |   | — |   |
| Dividends paid                                                                     |       | (1,104,726                  | )          | (1,075,487 | ) | (1,032,467 | ) |
| Net cash used in Financing activities                                              |       | (1,642,996                  | )          | (1,075,487 | ) | (1,032,467 | ) |
|                                                                               |       |                        |       |   |   |   |   |
| Change in cash and cash equivalents                                                |       | (51,143                     | )          | 60,421 |   | (15,030 | ) |
|                                                                               |       |                        |       |   |   |   |   |
| **CASH AND CASH EQUIVALENTS, BEGINNING OF  YEAR**                                  |       | 420,887                     |       | 360,466 |   | 375,496 |   |
|                                                                               |       |                        |       |   |   |   |   |
| **CASH AND CASH EQUIVALENTS, END OF YEAR**                                         |       | $                           | 369,744    |   | $ | 420,887 |   | $ | 360,466 |   |
|                                                                                    |            |                             |            |  |  |  |  |  |  |  |  |

 

52

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ITEM9A – CONTROLS ANDPROCEDURES

 

Evaluation of Disclosure Controls and Procedures

 

As of the end of the periodcovered by this report, the Company’s Chief Executive Officer and ChiefFinancial Officer evaluated the effectiveness of the Company’s disclosurecontrols and procedures (as defined in Exchange Act Rules 13a-15(e) and15d-15(e)).  Based on their evaluation,the Chief Executive Officer and Chief Financial Officer concluded that theCompany’s disclosure controls and procedures (i) enable the Company to record,process, summarize and report in a timely manner the information that theCompany is required to disclose in its Exchange Act reports, and (ii) are designedwith the objective of ensuring that such information is accumulated andcommunicated to management, including the Chief Executive Officer and ChiefFinancial Officer, as appropriate, to allow timely decisions regardingdisclosure.

 

Changes in Internal ControlOver Financial Reporting

 

There were no changes in theCompany’s internal control over financial reporting identified in theevaluation performed by the Company's Chief Executive Officer and ChiefFinancial Officer that materially affected, or are reasonably likely tomaterially affect, the Company's internal control over financial reporting.

 

53

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**PART III**

 

ITEM10 – DIRECTORS ANDEXECUTIVE OFFICERS OF THE REGISTRANT

 

Setforth below is information concerning the Company’s Directors, Nominees forDirector and Executive Officers.

 
| **Name**           | ** ** | **Age as of  December 31, 2002** | ** ** | **Positions with the Company  and Logan Bank & Trust  Company (“LB&T”)**                                                                                                         | ** ** | **Business Experience  During Last Five Years  and Directorships**                                                                                                                                         |
|--------------------|------------|----------------------------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| Harvey Oakley      |       | 82                               |       | Director of the Company  since 1985 and Director of LB&T since 1964; President and Chairman of the  Board of Directors of Company since 1985 and Chairman of the Board of  LB&T since 1964 |       | Attorney at Law; President  of the Company                                                                                                                                                                 |
|               |       |                             |       |                                                                                                                                                                                               |       |                                                                                                                                                                                                       |
| Clell  Peyton      |       | 66                               |       | Director  of the Company since 1985 and Director of LB&T since 1996                                                                                                                            |       | Retired,  Nationwide Insurance Company.                                                                                                                                                                    |
|               |       |                             |       |                                                                                                                                                                                               |       |                                                                                                                                                                                                       |
| Earle  B. Queen    |       | 75                               |       | Director  of the Company since 1985 and Director of LB&T since 1964                                                                                                                            |       | President,  James Funeral Home; Director of West Logan Water Co., Queen Brothers, Inc.  and Funeral Services, Inc.                                                                                         |
|               |       |                             |       |                                                                                                                                                                                               |       |                                                                                                                                                                                                       |
| LaVeta  Jean Ray   |       | 71                               |       | Director  of the Company since 1985                                                                                                                                                                |       | Retired;  Counselor, Chapmanville High School.                                                                                                                                                             |
|               |       |                             |       |                                                                                                                                                                                               |       |                                                                                                                                                                                                       |
| William  W. Wagner |       | 70                               |       | Director  of the Company since 1985 and Director of LB&T since 1976                                                                                                                            |       | Retired;  Former Director and Executive Comm. Of United Bankshares, Inc.; Former  Chairman of Eagle Bancorp. Inc.                                                                                          |
|               |       |                             |       |                                                                                                                                                                                               |       |                                                                                                                                                                                                       |
| Eddie  Canterbury  |       | 54                               |       | Director  and Executive Vice-President and CEO of the Company since 1985; Director of  LB&T since 1980; CEO of LB&T since 1982 and President of LB&T  since 2000                       |       | Executive  Vice President and CEO of the Company and President and CEO of LB&T;  Director of KY/WV Cable, Inc., Greentree Cable of KY, Inc., Louisa Cable  & TV, Inc. and Logan County Cable, Inc. |
|               |       |                             |       |                                                                                                                                                                                               |       |                                                                                                                                                                                                       |
| Walter  D. Vance   |       | 52                               |       | Director  and Vice President of the Company since 1985                                                                                                                                             |       | Vice  President of the Company; Pharmacist; and Vice President and Director of  Aracoma Drug Company.                                                                                                      |
|               |       |                             |       |                                                                                                                                                                                               |       |                                                                                                                                                                                                       |
| Glenn  T. Yost     |       | 45                               |       | Director  of the Company and LB&T since 1994                                                                                                                                                   |       | President,  W.W. McDonald Land Co.; President,                                                                                                                                                             |
|               |       |                             |       |                                                                                                                                                                                               |       | Triadelphia  Land Co.; President, Bruce McDonald Holding Co.                                                                                                                                               |
|               |       |                             |       |                                                                                                                                                                                               |       |                                                                                                                                                                                                       |
| David  McCormick   |       | 55                               |       | Director  of the Company and LB&T since 1994                                                                                                                                                   |       | President,  McCormick’s, Inc.; President, Bodaco, Co.                                                                                                                                                 |

54

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FAMILY RELATIONSHIPS

 

Harvey Oakley is William W.Wagner’s uncle.

 

AUDIT COMMITTEE

 

The Company has a standing Audit Committeeestablished in accordance with Section 3(a)(58)(A) of the Exchange Act.  The members of the standing Audit Committeeare: Glenn T. Yost, Chairman, Earle B. Queen, and Clell Peyton.

 

55

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ITEM11 – EXECUTIVECOMPENSATION

 

**EXECUTIVE COMPENSATION**

 

**Cash Compensation**

 

The table below sets forth the cash compensation ofthe Company’s CEO.  No other executiveofficer of the Company earned $100,000 or more in salary and bonus for theyears ended December 31, 2002, 2001 and 2000.

 

**SummaryCompensation Table**

 
| ** **                                                                                                                                                                                | ** ** | **Annual Compensation** | ** ** | **Long Term  Compensation** | ** **                        | ** ** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|-----------------------------|-----------------------------------|------------|------------|
| **Name and Principal Position**                                                                                                                                                           | ** ** | **Year**                | ** ** | **Salary**                  | ** **                        | **Bonus**  | ** ** | **Other  Compensation  (1)** | ** ** | **Securities  Underlying  Options** | ** ** | **All  Other(2)** | ** ** |
| Eddie Canterbury Executive Vice President  and Chief Executive Officer of the Company and President and Chief Executive  Officer of Logan Bank & Trust Company (“LB&T”) |       | 2002

2001

2000        |       | $

$

$                     | 120,000

115,000

 

115,000 |       | $  $  $    | 20,000

20,000

 

20,000

  |   | —

—

 

— |   | 0

0

 

0 |   | $  $  $ | 11,200

10,800

 

10,800

  |   |
|                                                                                                                                                                                           |            |                         |            |                             |                                   |            |            |  |  |  |  |  |  |  |  |  |

 

----

(1)       The CEO did not receive perquisites or otherpersonal benefits, securities or property during 2002 which, in the aggregatecost the Company an amount that equaled or exceeded the lesser of $50,000 or10% of the CEO’s salary and bonus earned during the year.

 

(2)       Includes payments made to the Company’s401(K) Profit Sharing Plan.

 

**EMPLOYMENT AGREEMENT ANDSUPPLEMENTAL EXECUTIVE RETIREMENT PLAN**

 

Employment Agreement

 

Effective October 1, 1998, Logan County BancShares,Inc. and Logan Bank & Trust Company (collectively referred to as the “Employers”)entered into an employment agreement with Eddie Canterbury (the “Agreement”).  Pursuant to the Agreement, the Employersagreed to employ Mr. Canterbury as the Executive Vice President and ChiefExecutive Officer and Mr. Canterbury agreed to perform such executive servicesfor the Employers as consistent with his title and as may be assigned to him bythe Employers’ Boards of Directors.  TheAgreement provides for a three (3) year term commencing on October 1,1998.  The Agreement is automaticallyrenewed for additional one (1) year periods unless the Employers’ Boards ofDirectors or the Employee provides contrary written notice to the other notless than forty-five (45) days in advance of each October 1.  The Agreement will not extend beyond thecalendar month in which Mr. Canterbury turns 65 years of age.

 

56

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The Agreement provides that Mr. Canterbury willreceive a base salary, which may be increased from time to time, in suchamounts as may be determined by the Employers’ Boards of Directors.  Mr. Canterbury’s 2002 salary is shown inthe salary column of the Summary Compensation Table.  The Agreement also provides Mr. Canterburywith the same fringe benefits that Mr. Canterbury received prior to enteringinto the Agreement.

 

The Agreement restricts Mr. Canterbury from directlyor indirectly engaging in or making any financial investment in, any firm,corporation, business entity or business enterprise which is competitive withor to any business of the Employers. This restriction does not prohibit Mr. Canterbury from owning passiveinvestments, including investments in the securities of other financialinstitutions of not more than two percent (2.0%) of each financial institution’soutstanding capital stock, as long as such ownership does not require Mr.Canterbury to devote substantial time to management or control of the businessor activities in which he has invested.

 

Pursuant to the Agreement, the Employers mayterminate Mr. Canterbury upon prior written notice, including termination for “justcause” and termination because Mr. Canterbury becomes subject to total andpermanent disability.  “Just cause”includes: personal dishonesty, incompetence, willful misconduct, breach offiduciary duty, willful failure to perform lawful duties assigned andprescribed by the Employers’ Boards of Directors, willful violation of any law,rule or regulation (other than traffic violations or similar offenses) or finalcease-and-desist order, or material breach of any provision of the Agreement.

 

Mr. Canterbury has the right to terminate theAgreement upon prior written notice to the Employers.  If the Agreement is terminated by Mr.Canterbury for any reason other than “good reason”, then Mr. Canterbury is notentitled to compensation or other benefits after the date of termination.  “Good reason” is defined as:

 

A.            A failure by Employers to comply with anymaterial provision of the Agreement, which failure is not cured within 25 daysafter notice of such noncompliance;

 

B.            Any of the following subsequent to a “changein control” and without Mr. Canterbury’s express written consent:

 

(i)            the assignment of duties inconsistent withMr. Canterbury’s positions, duties, responsibilities and status with theEmployers immediately prior to a “change in control” or a change in Mr.Canterbury’s reporting responsibilities, titles, or officer as in effectimmediately prior to a change in control;

 

(ii)           any removal of Mr. Canterbury from, or anyfailure to re-elect Mr. Canterbury to, any of the positions held by Mr.Canterbury, except in connection with a termination of employment for “justcause”, disability, death, retirement or upon termination for any other reasonupon prior written notice;

 

(iii)          a reduction in Mr. Canterbury’s base salaryas in effect immediately prior to a “change in control” or as may be increasedfrom time to time;

 

(iv)          a requirement that Mr. Canterbury berelocated to an office which is more than 100 miles from the current principalexecutive offices of Logan Bank & Trust Company;

 

(v)           the taking of any action by the Employerswhich would adversely affect Mr. Canterbury’s benefits which Mr. Canterbury hasat the time of a “change in control”; or

 

(vi)          any purported termination of Mr. Canterbury’semployment which is not effected pursuant to proper written notice.

 

57

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C.            Any purported termination of Mr. Canterbury’semployment which is not effected pursuant to proper written notice.

 

For purposes of the Agreement a “change in control”means a change in control of a nature that would be required to be reported inresponse to Item 6(e) of Schedule 14A of Regulation 14A promulgated by theSecurities Exchange Act of 1934 (the “Exchange Act”); provided that, withoutlimitation, such a change in control shall be deemed to have occurred if: (i)any person other than the Employers is or becomes the beneficial owner,directly or indirectly, of securities of the Employers representing 25% or moreof the combined voting power of the Company’s or Logan Bank & Trust Company’sthen outstanding securities; or (ii) during any period of two (2) consecutiveyears during the term of this Agreement, individuals who at the beginning ofsuch period constitute the Boards of Directors of the Employers cease for anyreason to constitute at least a majority thereof, unless the election of eachDirector who was not a Director at the beginning of such period has beenapproved in advance by Directors representing at least 2/3 of the Directorsthen in office who were Directors at the beginning of the period.  A change in control is not deemed to occur ifsuch change of stock ownership results from the death of a shareholder or hisdistributes or legatees succeed to such ownership by way of such shareholder’sLast Will and Testament or by intestate succession.

 

If Mr. Canterbury is terminated by Employers for “justcause” or total and permanent disability, then Mr. Canterbury has no right tocompensation or other benefits for any period after the date oftermination.  If Mr. Canterbury isterminated by Employers for any reason other than “just cause” or total andpermanent disability or if Mr. Canterbury terminates this Agreement for “goodreason” as defined in subparagraphs (A) and (C) above, then in lieu of anyfurther salary payments to Mr. Canterbury for periods subsequent to the date oftermination, the Employers must pay Mr. Canterbury severance equal to theproduct of:

 

(i)            Mr. Canterbury’s base salary in effect as ofthe date of termination and

 

(ii)           the number of years (including partial years)remaining in the term of employment of the Agreement or 2.99, whichever isgreater.

 

At the discretion of theEmployers, the severance amount must be paid in a lump sum within 15 days ofthe date of termination or in monthly installments during the 24 monthsfollowing termination.

 

If Mr. Canterbury terminates the Agreement for “goodreason” as defined in subparagraph (B) above, then in lieu of any furthersalary payments to Mr. Canterbury for periods subsequent to the date of termination,the Employers must pay Mr. Canterbury severance equal to three (3) times theaverage annual salary paid to Mr. Canterbury, as reflected in Internal RevenueService Form W-2, for the three (3) years immediately preceding Mr. Canterbury’stermination.  At the discretion of theEmployers, the severance amount must be paid in a lump sum within 15 days ofthe date of termination or in monthly installments during the 24 monthsfollowing termination.

 

Fees for Directors

 

                Directorsof Logan County BancShares, Inc. received $300 per month in 2002.  In addition, members of the Audit Committeereceived $75 for each meeting attended in 2002. Directors of Logan Bank & Trust Company received $250 per month in2002, and members of the Loan and Discount Committee received $150 per meetingattended in 2002.

58

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ITEM 12 – SECURITY OWNERSHIP OF CERTAIN BENEFICIALOWNERS AND MANAGEMENT

 

**PRINCIPAL SHAREHOLDERS**

 

Thefollowing table lists each shareholder of Logan County BancShares, Inc. who isthe beneficial owner of more than 5% of Logan County BancShares Inc.’s commonstock as of February 28, 2005.

 
| **Title of Class** | ** ** | **Name and Address of  Beneficial Owner**                                                 | ** ** | **Amount and  Nature of Beneficial  Ownership** | ** ** | **% of Class** | ** ** |
|--------------------|------------|-------------------------------------------------------------------------------------------|------------|-------------------------------------------------|------------|----------------|------------|
| Common Stock       |       | David  McCormick  Post Office Box 627  Logan, West Virginia 25601                         |       | 38,058                                          | (1)        | 5.40           | %          |
|               |       |                                                                                      |       |                                            |       |           |       |
| Common Stock       |       | Harvey  Oakley  509 Main Street  Logan, West Virginia 25601                               |       | 56,538                                          | (2)        | 8.03           | %          |
|               |       |                                                                                      |       |                                            |       |           |       |
| Common Stock       |       | Sarah  Matteson Irrevocable  Trust 11125 Harbour Estates Circle  Ft. Myers, Florida 33908 |       | 93,182                                          |       | 13.24          | %          |
|               |       |                                                                                      |       |                                            |       |           |       |
| Common Stock       |       | Paul Clinton  Winter  Post Office Box 386  Logan, West Virginia 25601                     |       | 116,619                                         | (3)        | 16.57          | %          |

 

----

(1)       Includes 37,908 shares owned by Bodaco Company.

 

(2)       Includes 7,537 shares jointly owned with spouse.

 

(3)          Includes: 18,000 shares held by Bray &Oakley Insurance Agency; 1,063 held by Mary O. Winter Trust for Michael P.Winter of which Paul Clinter Winter is the Trustee; and 1,063 held by Mary O.Winter Trust for Angela L. Winter of which Paul Clinton Winter is the Trustee.

 

59

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**SECURITY OWNERSHIP OF MANAGEMENT**

 

As of February 28, 2005, the nominees, Directors of the Company andLogan Bank & Trust Company (“LB&T”) and executive officers of theCompany owned beneficially, directly or indirectly, the number of shares ofcommon stock indicated on the following table. The number of shares shown as beneficially owned by each nominee,director and executive officer is determined under the rules of the Securitiesand Exchange Commission and the information is not necessarily indicative ofbeneficial ownership for any other purposes. All Directors and executive officers of the Company as a group owned194,183 shares or 27.58% of the Company’s common stock as of February 28, 2005.

 
| **Title of Class** | ** ** | **Position**                                                                                                                             | ** ** | **Name of  Beneficial Owner** | ** ** | **Amount and  Nature of Beneficial  Ownership** | ** ** | **% of  Class** | ** ** |
|--------------------|------------|------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------------|------------|-------------------------------------------------|------------|-----------------|------------|
| Common Stock       |       | Director of  Company and LB&T and President and Chairman of the Board of Directors of  Company and Chairman of the Board of LB&T |       | Harvey Oakley                 |       | 56,538                                          | (1)        | 8.03            | %          |
|               |       |                                                                                                                                     |       |                          |       |                                            |       |            |       |
| Common Stock       |       | Director of  LB&T                                                                                                                    |       | Clell Peyton                  |       | 10,733                                          |       | 1.52            | %          |
|               |       |                                                                                                                                     |       |                          |       |                                            |       |            |       |
| Common Stock       |       | Director of  LB&T                                                                                                                    |       | Earle B. Queen                |       | 19,813                                          | (2)        | 2.81            | %          |
|               |       |                                                                                                                                     |       |                          |       |                                            |       |            |       |
| Common Stock       |       | Director of  Company                                                                                                                     |       | LaVeta Jean Ray               |       | 7,110                                           |       | 1.01            | %          |
|               |       |                                                                                                                                     |       |                          |       |                                            |       |            |       |
| Common Stock       |       | Director of  LB&T                                                                                                                    |       | William W. Wagner             |       | 18,000                                          | (3)        | 2.56            | %          |
|               |       |                                                                                                                                     |       |                          |       |                                            |       |            |       |
| Common Stock       |       | Director and  Executive Vice-President and CEO of the Company; Director and President and  CEO of LB&T                               |       | Eddie Canterbury              |       | 8,200                                           | (4)        | 1.16            | %          |
|               |       |                                                                                                                                     |       |                          |       |                                            |       |            |       |
| Common Stock       |       | Director of  Company; Vice President of the Company                                                                                      |       | Walter D. Vance               |       | 4,569                                           | (5)        | 0.65            | %          |
|               |       |                                                                                                                                     |       |                          |       |                                            |       |            |       |
| Common Stock       |       | Director of  LB&T                                                                                                                    |       | Glenn T. Yost                 |       | 30,762                                          | (6)        | 4.37            | %          |
|               |       |                                                                                                                                     |       |                          |       |                                            |       |            |       |
| Common Stock       |       | Director of  LB&T                                                                                                                    |       | David McCormick               |       | 38,058                                          | (7)        | 5.40            | %          |
|               |       |                                                                                                                                     |       |                          |       |                                            |       |            |       |
| Common Stock       |       | Elected as  Director of Company and LB&T at Annual Meeting held on May 25, 2004                                                      |       | Michael Winter                |       | 400                                             |       | .06             | %          |

 

60

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----

(1)           Includes 7,537 shares jointly owned withspouse.

 

(2)           Includes: 18,000 shares owned by Earle B.Queen, Trust; 355 shares owned by Funeral Services, Inc.; and 400 shares ownedby Queen Brothers, Inc.

 

(3)           Includes 654 shares jointly owned withspouse.

 

 

(4)           Includes: 800 shares owned in IRA; and 100shares as custodian for Alexis Jo Canterbury.

 

(5)           Includes 849 shares owned by Aracoma DrugCompany.

 

(6)           Includes: 1,225 shares jointly owned withspouse; 28,762 shares for which voting and investment powers are held by GlennT. Yost; 22,224 shares owned by W.W. McDonald Land Company; 5,863 shares ownedby Bruce McDonald Holding Company; and 675 shares owned by Tridelphia LandCompany.

 

(7)           Includes 37,908 shares owned by Bodaco, Co.

 

61

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ITEM13 – CERTAINRELATIONSHIPS AND RELATED TRANSACTIONS.

 

Directors and executive officers of the Company andits subsidiaries, members of their immediate families, and businessorganizations and individuals associated with them have been customers of, andhave had normal banking transactions with Logan Bank & Trust Company, asubsidiary of the Company.  All suchtransactions were made in the ordinary course of business, were made onsubstantially the same terms, including interest rate and collateral, as thoseprevailing at the time for comparable transactions with other persons and didnot involve more than the normal risk of collectibility or present otherunfavorable features.

 

ITEM14 – PRINCIPALACCOUNTING FEES AND SERVICES.

 

Audit and Audit-Related Fees.

 

The following table presents fees for professionalservices rendered by McNeal, Williamson & Co. to perform an audit of theCorporation’s annual financial statements for the years ended December 31,2002, and 2001, and fees for other services rendered by McNeal, Williamson& Co. during those periods:

 
| ** **            | ** ** | **2002** | ** ** | **2001** | ** ** |
|-----------------------|------------|----------|------------|----------|------------|
| Audit Fees(1)         |       | $        | 32,000     |     | $          | 32,000 |   |
| Audit-Related Fees(2) |       | —   |       | —   |       |
| Tax Fees(3)           |       | 8,235    |       | 8,837    |       |
| All Other Fees(4)     |       | 1,650    |       | 2,500    |       |
| Total Fees            |       | $        | 41,885     |     | $          | 43,337 |   |

 

----

(1)           Audit Fees – These are fees for professionalservices performed by McNeal, Williamson & Co. for the audit of theCorporation’s annual financial statements and review of the quarterly financialstatements.

 

(2)           Audit-Related Fees – These are for assurance andrelated services performed by McNeal, Williamson & Co. that are reasonablyrelated to the performance of the audit or review of the Corporation’sfinancial statements.

 

(3)           Tax Fees – These are fees for professionalservices performed by McNeal, Williamson & Co. with respect to taxcompliance, tax advice and tax planning. This includes: the preparation and the filing of federal and stateincome taxes and property taxes.

 

(4)           All Other Fees – These are fees for otherpermissible work performed by McNeal, Williamson & Co. that does not meetthe above category descriptions.  Thefees for services incurred in 2001 and 2002 include the filing of theCorporation’s Form 10-Q for the quarters ending September 30, 2001 and2002.  All services rendered by McNeal,Williamson & Co. are permissible under applicable laws and regulations, andpre-approved by the Audit Committee.

 

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Pre-Approval Policies and Procedures

 

Prior to July 23, 2004, the Audit Committee did nothave formal pre-approval policies and procedures for audit and non-auditservices.  Prior to July 23, 2004, theAudit Committee met and considered each audit and non-audit service to berendered by McNeal, Williamson & Co. During 2002 and 2001, all of fees paid to McNeal, Williamson & Co.were approved by the Audit Committee.

 

On July 23, 2004, the Audit Committee adopted apolicy that requires pre-approval of all audit, audit-related, tax services andother services performed by the independent auditor.  The policy provides for pre-approval by theAudit Committee of specifically defined audit and non-audit services.  Unless the specific service has beenpreviously pre-approved with respect to that year, the Audit Committee mustapprove the permitted service before the independent auditor is engaged toperform it.  The Audit Committee maydelegate pre-approval authority to one or more of its members who shall reportany pre-approval decisions to the Audit Committee at its next scheduledmeeting.

 

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ITEM15 – EXHIBITS,FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K

 

(a)           1.             Financial Statements.

 

Reportof Independent Registered Public Accounting Firm

ConsolidatedBalance Sheets

ConsolidatedStatements of Income

ConsolidatedStatements of Changes in Stockholders’ Equity

ConsolidatedStatements of Cash Flow

Notesto the Consolidated Financial Statements

 

2.             Financial Statement Schedules.

 

Allschedules are omitted, as the required information is inapplicable or theinformation is presented in the Consolidated Financial Statements or relatednotes.

 

3.             Exhibits

 

11.           Statement regarding computation of per shareearnings.

 

(Thesestatements are included in the notes to the Consolidated Financial Statementsand the Management’s Discussion and Analysis of Financial Condition and Resultsof Operation, which are incorporated herein by reference.)

 

21.          Subsidiaries of the Company

 

23.           Consent of McNeal Williamson & Co.

 

31.1         Certification Pursuant to Rule 13a-14(a)/15d-14(a)

 

31.2         Certification Pursuant to Rule13a-14(a)/15d-14(a)

 

32.1         Certification Pursuant to 18 U.S.C. Section1350

 

32.2         Certification Pursuant to 18 U.S.C. Section1350

 

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SIGNATURES

 

Pursuant to the requirements of Section 13 or 15(d)of the Securities Exchange Act of 1934, the registrant has duly caused thisreport to be signed on its behalf by the undersigned, thereunto dulyauthorized.

 
|   | LOGAN  COUNTY BANCSHARES, INC. |                     |
|--------|--------------------------------|--------------------------|
|   | (Registrant)                   |                     |
|   |                           |                     |
|   | By:                            | /s/ Eddie Canterbury     |   |
|   |                           | Eddie  Canterbury        |   |
|   | Its:                           | Chief  Executive Officer |   |
|   |                           |                     |
|   | February  28, 2005             |                     |

 

Pursuant to the requirements of the SecuritiesExchange Act of 1934, this report has been signed below by the followingpersons on behalf of the registrant and in the capacities and on the datesindicated.

 

 
| By:    | /s/  Harvey Oakley                                                                 |   | Date:  | February  28, 2005 |   |
|--------|------------------------------------------------------------------------------------|--------|--------|--------------------|--------|
|   | Harvey  Oakley, Director and Chairman of the Board of Directors                    |   |   |               |   |
|   |                                                                               |   |   |               |   |
| By     | /s/  Clell Peyton                                                                  |   | Date:  | February  28, 2005 |   |
|   | Clell  Peyton, Director                                                            |   |   |               |   |
|   |                                                                               |   |   |               |   |
| By     | /s/  Earle B. Queen                                                                |   | Date:  | February  28, 2005 |   |
|   | Earle  B. Queen, Director                                                          |   |   |               |   |
|   |                                                                               |   |   |               |   |
| By     | /s/  LaVeta Jean Ray                                                               |   | Date:  | February  28, 2005 |   |
|   | LaVeta  Jean Ray, Director                                                         |   |   |               |   |
|   |                                                                               |   |   |               |   |
| By:    | /s/  William W. Wagner                                                             |   | Date:  | February  28, 2005 |   |
|   | William  W. Wagner, Director                                                       |   |   |               |   |
|   |                                                                               |   |   |               |   |
| By     | /s/  Eddie Canterbury                                                              |   | Date:  | February  28, 2005 |   |
|   | Eddie Canterbury, Director, Executive  Vice-President and  Chief Executive Officer |   |   |               |   |
|   |                                                                               |   |   |               |   |
| By     | /s/  Walter D. Vance                                                               |   | Date:  | February  28, 2005 |   |
|   | Walter  D. Vance Director                                                          |   |   |               |   |
|   |                                                                               |   |   |               |   |
| By     | /s/  Glenn T. Yost                                                                 |   | Date:  | February  28, 2005 |   |
|   | Glenn  T. Yost, Director                                                           |   |   |               |   |
|   |                                                                               |   |   |               |   |
| By     | /s/  David McCormick                                                               |   | Date:  | February  28, 2005 |   |
|   | David  McCormick, Director                                                         |   |   |               |   |

 

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