2003 Annual Report


                          Cooperative Bankshares, Inc.
<PAGE>

Table of Contents
                                    Selected Financial and Other Data
                                    President's Message
                                    Management's Discussion & Analysis
                                    Independent Auditors' Report
                                    Consolidated Statements of Financial
                                     Condition
                                    Consolidated Statements of Operations
                                    Consolidated Statements of Comprehensive
                                     Income
                                    Consolidated Statements of Stockholders'
                                     Equity
                                    Consolidated Statements of Cash Flows
                                    Notes to Consolidated Financial Statements
                                    Directors, Officers, and Financial
                                    Center Locations
                                    Corporate Information


Profile

                                    Cooperative Bankshares, Inc. (the "Company")
                                    is a registered bank holding company
                                    incorporated in North Carolina in 1994. The
                                    Company was formed for the purpose of
                                    serving as the holding company for
                                    Cooperative Bank (the "Bank"); a North
                                    Carolina chartered commercial bank. The
                                    Company's primary activities consist of
                                    holding the stock of Cooperative Bank and
                                    operating the business of the Bank and its
                                    subsidiaries. Accordingly, the information
                                    set forth in this report, including
                                    financial statements and related data,
                                    relates primarily to Cooperative Bank and
                                    its subsidiaries.

                                    Cooperative Bank was chartered in 1898. The
                                    Bank's headquarters are located in
                                    Wilmington, North Carolina. Cooperative Bank
                                    operates 21 offices throughout the coastal
                                    and inland communities of eastern North
                                    Carolina. These centers extend from Corolla,
                                    located on the Outer Banks of North
                                    Carolina, to Tabor City, located on the
                                    South Carolina border. In addition, the Bank
                                    operates a subsidiary, Lumina Mortgage
                                    Company, Inc. ("Lumina") a mortgage banking
                                    firm. Lumina has offices in Wilmington,
                                    North Carolina, North Myrtle Beach, South
                                    Carolina, and Virginia Beach, Virginia. The
                                    Bank's other subsidiary, CS&L Holdings, Inc.
                                    ("Holdings") is a Virginia Corporation and a
                                    holding company for CS&L Real Estate Trust,
                                    Inc. (the "REIT"), which is a real estate
                                    investment trust. The Federal Deposit
                                    Insurance Corporation ("FDIC") insures the
                                    Bank's deposit accounts up to applicable
                                    limits.

                                    Through its offices, the Bank provides a
                                    wide range of banking products, including
                                    interest-bearing and noninterest-bearing
                                    checking accounts, certificates of deposit
                                    and individual retirement accounts. It
                                    offers an array of loan products: overdraft
                                    protection, commercial, consumer,
                                    agricultural, real estate, residential
                                    mortgage and home equity loans. Also offered
                                    are safe deposit boxes and automated banking
                                    services through ATMs and Access24 Phone
                                    Banking. The Bank began offering Online
                                    Banking and Bill Payment on July 1, 2003. In
                                    addition, the Bank offers discount brokerage
                                    services, annuity sales and mutual funds
                                    through a third party arrangement with UVEST
                                    Investment Services.

                                    The common stock of the Company is traded on
                                    the NASDAQ National Market under the symbol
                                    "COOP".
Mission
                                    It is the mission of Cooperative to provide
                                    the maximum in safety and security for our
                                    depositors, an equitable rate of return for
                                    our stockholders, and excellent service for
                                    our customers, and to do so while operating
                                    in a fiscally sound and conservative manner,
                                    with fair pricing of our products and
                                    services, good working conditions,
                                    outstanding training and opportunities for
                                    our staff, along with a high level of
                                    corporate citizenship.


<PAGE>
                        SELECTED FINANCIAL AND OTHER DATA
<TABLE>
<CAPTION>

At December 31,                                          2003         2002         2001         2000         1999
------------------------------------------------------------------------------------------------------------------
<S>                                                     <C>           <C>         <C>          <C>            <C>
                                                                       Dollars in Thousands
Selected Financial Condition Data:
  Assets                                            $ 502,306    $ 504,210    $ 458,114    $ 414,961    $ 410,146
  Loans, net                                          401,242      390,876      373,458      347,486      334,744
  Securities                                           47,419       49,935       47,970       35,027       45,261
  FHLB stock                                            4,154        4,055        4,155        3,755        3,755
  Deposits                                            367,072      357,254      339,830      327,312      304,834
  Borrowed funds                                       89,505      104,678       83,097       55,101       75,106
  Stockholders' equity                                 43,143       38,448       33,618       30,812       29,343

</TABLE>
<TABLE>
<CAPTION>

Year Ended December 31,                                  2003         2002         2001         2000         1999
------------------------------------------------------------------------------------------------------------------
<S>                                                      <C>          <C>         <C>          <C>            <C>
                                                                       Dollars in Thousands
Selected Operations Data:
  Interest income                                    $ 27,827     $ 29,496     $ 31,117     $ 31,709     $ 28,449
  Interest expense                                     10,686       13,875       18,916       19,305       16,422
  Net interest income                                  17,141       15,621       12,201       12,404       12,027
  Provision for loan losses                               740          740          460          970          210
  Noninterest income                                    6,634        4,754        2,040        1,670        1,228
  Noninterest expenses                                 15,041       11,888        9,303       10,193        8,885
  Income before income taxes                            7,994        7,747        4,478        2,911        4,160
  Net income                                            5,404        4,944        2,889        1,932        2,680

------------------------------------------------------------------------------------------------------------------

Selected Financial Ratios and Other Data:
  Return on average assets                              1.07%        1.05%        0.67%        0.47%        0.69%
  Return on average equity                             13.16%       13.70%        8.91%        6.35%        8.88%
  Average stockholders' equity to average assets        8.17%        7.64%        7.57%        7.38%        7.74%
  Non-performing assets to total assets                 0.05%        0.24%        0.84%        0.22%        0.35%
  Allowance for loan losses to total loans              0.84%        0.70%        0.67%        0.62%        0.39%
  Dividend payout ratio                                10.54%       11.47%       19.49%       28.09%          --
Per Share Data:
  Earnings per:
     Common share - basic                              $ 1.90       $ 1.74       $ 1.03       $ 0.71       $ 0.95
     Common share - diluted                            $ 1.86       $ 1.73       $ 1.02       $ 0.69       $ 0.90
  Cash dividends declared                              $ 0.20       $ 0.20       $ 0.20       $ 0.20           --
  Book value                                           $15.14       $13.56       $11.86       $11.35       $10.92
  Number of common shares outstanding               2,849,447    2,835,947    2,835,447    2,714,610    2,687,919
</TABLE>


<PAGE>


President's Message


     The year 2003 was a record  setter  for our  company.  The Bank  originated
1,833 loans totaling $250.5 million while the bank's subsidiary, Lumina Mortgage
Company, originated 1,486 loans for $205.5 million, giving total originations of
$456.0  million,  which is a record that far exceeds  any  previous  year in the
history of the company.

     Enhancements  were made to many of our products  including "Online Banking"
which was made available to our customers in July, where customers can now enjoy
the convenience of viewing  deposits and loan  information,  transferring  funds
from one account to another,  and getting stock quote information.  "Online Bill
Pay" allows the customer to schedule bill payments  through a personal  computer
rather than having to write and mail checks.

     In April, 2003, we introduced "Better Than Free Checking".  This account is
truly a free checking  account,  and we have had excellent  response to this new
product.  We also  introduced  "Over Draft  Privilege",  a new service that will
protect  customers  from the  embarrassment  and  inconvenience  of "bouncing" a
check.

     Perhaps the biggest  record that was set during the year was the opening of
four new financial centers, beginning with the opening in May of a new center at
Monkey  Junction  in  Wilmington.  On July 1, our  second  financial  center  in
Morehead  City  opened on Highway  24, and the year ended with a bang during the
month of December  when a center was opened in the Landfall  Shopping  Center in
Wilmington,  and our first entry into the rapidly growing Brunswick County area,
when a new facility in Southport was also added.

     Net income for the year ended  December 31, 2003 was  $5,404,226,  or $1.86
per diluted share, a 9.3% increase in net income over the same period last year.
Net income for the twelve  months  ended  December 31, 2002 was  $4,944,497,  or
$1.73 per diluted share.  Total assets at December 31, 2003 were $502.3 million.
Stockholders'  equity  was  $43.1  million  and  represented  8.59%  of  assets.
Stockholders  were handsomely  rewarded during the year for this  performance as
the price of a share of stock rose from $15.94 on December 31,  2002,  to $25.62
on the same day in 2003, or a 60.7% increase during the year.

     In summary, the past year has been one of the most exciting in the 105 year
history of the Company.  We have experienced  dramatic  improvements in earnings
and efficiencies  while growing our retail and commercial  loans, and making our
balance  sheet more bank  like.  The record  setting  pace of loan  originations
favorably  affected  earnings,  and the  opening of four new  branches,  and the
introduction  of several new bank products bodes well for the future.  Thank you
for your continued support.

                                Sincerely yours,

                                /s/ Frederick Willetts, III

                                Frederick Willetts, III
                                President




<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS

General

     Cooperative  Bankshares,  Inc. (the "Company") is a registered bank holding
company  incorporated  in North  Carolina  in 1994.  The  Company  is the parent
company of Cooperative Bank (the "Bank"), a North Carolina chartered  commercial
bank.  Cooperative  Bank,  headquartered  in  Wilmington,   North  Carolina  was
chartered in 1898. The Bank provides  financial  services  through 21 offices in
Eastern North Carolina.  The Bank's  subsidiary,  Lumina Mortgage Company,  Inc.
("Lumina")  is a mortgage  banking  firm  originating  and  selling  residential
mortgage  loans through  offices in  Wilmington,  North  Carolina,  North Myrtle
Beach,  South  Carolina,   and  Virginia  Beach,   Virginia.  The  Bank's  other
subsidiary, CS&L Holdings, Inc. ("Holdings"),  is a holding company incorporated
in Virginia  for CS&L Real Estate  Trust,  Inc.  (the  "REIT"),  which is a real
estate investment trust. Accordingly,  the information set forth in this report,
including  financial  statements and related data, relates primarily to the Bank
and its subsidiaries.

     The following is Management's  Discussion and Analysis  presented to assist
in understanding  the Company's  financial  condition and results of operations.
This discussion  should be read in conjunction with the  consolidated  financial
statements and accompanying notes presented in this Annual Report.

Critical Accounting Policy

     The preparation of our audited  consolidated  financial  statements and the
information  included in  management's  discussion  and  analysis is governed by
policies  that are based on  accounting  principles  generally  accepted  in the
United  States of America and  general  practices  within the banking  industry.
Among the more significant  policies are those that govern  accounting for loans
and allowance for loan losses and goodwill. These policies are discussed in Note
1 of the "Notes to Consolidated  Financial  Statements"  included in this Annual
Report.

     A  critical  accounting  policy is one that is both very  important  to the
portrayal of the  Company's  financial  condition  and  results,  and requires a
difficult,  subjective  or complex  judgment  by  management.  What makes  these
judgments  difficult,  subjective  and/or  complex is the need to make estimates
about the  effects of  matters  that are  inherently  uncertain.  Estimates  and
judgments are integral to our accounting for certain items,  and those estimates
and  judgments  affect the reported  amounts of assets,  liabilities,  revenues,
expenses  and related  disclosure  of  contingent  assets and  liabilities.  The
Company  periodically  evaluates its estimates,  including  those related to the
reserve for loan losses and goodwill.  While we base our estimates on historical
experience  and on various  other  assumptions  that we believe to be reasonable
under the  circumstances,  actual results may differ from these  estimates under
different   assumptions  or  conditions.   Further  information   regarding  the
accounting policies that we consider to be critical is provided below.

     Allowance  for  loan  losses.  The  Company's  most  significant   critical
accounting  policy is the  determination  of its allowance for loan losses.  The
allowance for loan losses  reflects the  estimated  losses that will result from
the inability of our customers to make required payments. The allowance for loan
losses results from management's  evaluation of the risk  characteristics of the
loan portfolio under current  economic  conditions and considers such factors as
the  financial  condition of the borrower,  fair market value of collateral  and
other items that,  in our opinion,  deserve  current  recognition  in estimating
possible credit losses. Our evaluation  process is based on historical  evidence
and current trends among delinquencies,  defaults and nonperforming  assets. Our
estimate of the  allowance for loan losses does not include the impact of events
that might occur in the future.

     Management  considers the established  allowance  adequate to absorb losses
that relate to loans outstanding at December 31, 2003, although future additions
to the allowance may be necessary  based on changes in economic  conditions  and
other factors. In addition,  various regulatory agencies, as an integral part of
their examination  process,  periodically  review the allowance for loan losses.
Such agencies may require  adjustments to the allowance based on their judgments
of  information  available  to them at the  time of  their  examination.  If the
financial  condition  of our  borrowers  was  to  deteriorate,  resulting  in an
impairment of their ability to make  payments,  our estimates  would be updated,
and  additional  provisions  may be  required.  For further  information  on the
allowance for loan losses, see "Financial Condition" in Management's  Discussion
and  Analysis  and Note 3 of the "Notes to  Consolidated  Financial  Statements"
included in this Annual Report.
<PAGE>

     Goodwill.  Goodwill, which represents the excess of the purchase price over
the fair value of net assets  acquired in a business  combination,  is tested at
least annually for impairment.  The impairment  test is a two-step  process that
begins  with a  comparison  of  book  value  and  stock  price.  If the  initial
evaluation  suggests that an  impairment  of the asset value exists,  the second
step would determine the amount of the impairment, if any. If the tests conclude
that  goodwill  is  impaired,  the  carrying  value  would be  adjusted,  and an
impairment loss would be recorded.

Management Strategy

     The  Bank's  lending  activities  have  traditionally  concentrated  on the
origination of loans for the purpose of  constructing,  financing or refinancing
residential  properties.  In  recent  years,  however,  the Bank has  emphasized
origination of  nonresidential  real estate loans,  equity lines of credit,  and
secured and  unsecured  consumer  and  business  loans.  As of December 31, 2003
approximately $267 million, or 66%, of the Bank's loan portfolio, which excludes
loans held for sale, consisted of loans secured by residential properties.  This
amount  includes  $32  million  of loans  classified  as  construction  and land
development.  This was down from approximately $268 million,  or 68% at December
31,  2002.  The Bank  originates  adjustable  rate and fixed rate  loans.  As of
December 31, 2003,  adjustable  rate and fixed rate loans totaled  approximately
69% and 31%, respectively, of the Bank's total loan portfolio.

     The Bank has chosen to sell a large  percentage  of its fixed rate mortgage
loan  originations in the secondary  market and through  brokered  arrangements.
This enables the Bank to invest its funds in commercial loans,  while increasing
fee income.  This is part of the continuing  effort to  restructure  the balance
sheet and operations to be more reflective of a commercial bank.

     In 2003,  the Bank sold $19 million in loans in the secondary  market where
the Bank retained the servicing of the loans and receives a fee payable  monthly
of up to 1/4% per annum of the unpaid  balance of each loan.  In  addition,  the
Bank sold $25 million in the secondary market and $14 million through a brokered
arrangement where the Bank released the servicing of the loans. Lumina sold $228
million in the secondary market during 2003.

     The growth in the loan  portfolio was  concentrated  in real  estate-backed
commercial loans,  including construction loans. These loans generally involve a
higher level of credit risk than one-to-four family  residential  lending due to
the  concentration of principal in a limited number of loans and borrowers,  the
effects of general  economic  conditions and the  volatility of the  collateral.
This increased risk also causes the allowance for loan losses to increase, which
is the  primary  reason for the  increase in the  allowance  over the past three
years.

     The Bank opened four financial  centers in 2003. The Monkey Junction center
located at 5102 South  College Road in  Wilmington,  North  Carolina  opened May
2003,  and the Morehead City,  North Carolina  center located at 137 Highway 24,
opened  July  2003.  The  Landfall  Center  at  1313  Military  Cutoff  Road  in
Wilmington,  North  Carolina  and  the  5210  Southport-Supply  Road  center  in
Southport,  North Carolina  opened  December  2003. The Southport  office is the
Bank's first financial center in Brunswick County.

Interest Rate Sensitivity Analysis

     Interest rate sensitivity refers to the change in interest spread resulting
from changes in interest  rates. To the extent that interest income and interest
expense do not respond  equally to changes in interest  rates, or that all rates
do not change uniformly,  earnings will be affected.  Interest rate sensitivity,
at a point in time,  can be analyzed  using a static gap analysis  that measures
the match in balances subject to repricing between  interest-earning  assets and
interest-bearing  liabilities.  Gap is  considered  positive  when interest rate
sensitive assets exceed interest rate sensitive  liabilities.  Gap is considered
negative when interest rate sensitive liabilities exceed interest rate sensitive
assets.  At December 31, 2003, the Company had a one-year  positive gap position
of 0.3%.  During a period of rising interest rates, a positive gap would tend to
result in an increase in net interest income, while a negative gap would tend to
adversely affect net interest income. During a period of falling interest rates,
a  positive  gap would tend to  adversely  affect net  interest  income  while a
negative gap would tend to result in an increase in net interest  income.  It is
important to note that certain shortcomings are inherent in static gap analysis.
Although  certain assets and liabilities may have similar  maturities or periods
of repricing,  they may react in different degrees to changes in market interest
rates.  For example,  part of the Company's  adjustable-rate  mortgage  loans is
indexed  to  the  National   Monthly  Median  Cost  of  Funds  to   SAIF-insured
institutions.  This  index is  considered  a lagging  index  that may lag behind
changes in market rates. The one-year or less interest-bearing  liabilities also
include checking,  savings,  and money market deposit  accounts.

<PAGE>
Experience has shown that the Company sees relatively  modest repricing of these
accounts.  Management takes this into  consideration  in determining  acceptable
levels of interest rate risk.

     When  Lumina  gives  a rate  lock  commitment  to a  customer,  there  is a
concurrent  "lock-in" for the loan with a secondary market investor under a best
efforts delivery mechanism.  Therefore,  interest rate risk is mitigated because
any commitments to fund a loan available for sale are  concurrently  hedged by a
commitment from an investor to purchase the loan under the same terms. Loans are
usually sold within 60 days after closing.

     The following  table  indicates the time periods in which  interest-earning
assets and  interest-bearing  liabilities  will mature or reprice in  accordance
with their  contractual  terms.  The table  assumes  prepayments  and  scheduled
principal amortization of fixed-rate loans and mortgage-backed  securities,  and
assumes  that  adjustable  rate loans  will  reprice  at  contractual  repricing
intervals.

<TABLE>
<CAPTION>
-----------------------------------------------------------------------------------------------------------------------
INTEREST RATE SENSITIVITY ANALYSIS
                                                                 Over One      Over Five
                                                 One Year        Through        Through      Over Ten
December 31, 2003                                or Less        Five Years     Ten Years       Years          Total
-----------------------------------------------------------------------------------------------------------------------
<S>                                             <C>              <C>               <C>          <C>              <C>
                                                                        (Dollars in thousands)
Interest-earning assets:
     Securities                               $     17,454   $     21,362   $      3,887   $      4,716   $     47,419
     Interest-bearing bank balances                  3,993             --             --             --          3,993
     Federal Home Loan Bank stock                    4,154             --             --             --          4,154
     All Loans                                     288,183        112,909          7,880          2,092        411,064
                                              -------------  -------------  -------------  -------------  -------------
        Total                                 $    313,784   $    134,271   $     11,767   $      6,808   $    466,630
                                              =============  =============  =============  =============  =============

Interest-bearing liabilities:
     Deposits                                 $    265,966   $     65,031   $      9,467   $         --   $    340,464
     Borrowed funds                                 46,417         25,009         18,014             65         89,505
                                              -------------  -------------  -------------  -------------  -------------
        Total                                 $    312,383   $     90,040   $     27,481   $         65   $    429,969
                                              =============  =============  =============  =============  =============

Interest rate sensitivity gap                 $      1,401   $     44,231   $    (15,714)  $      6,743   $     36,661
                                              =============  =============  =============  =============  =============

Cumulative interest rate sensitivity gap      $      1,401   $     45,632   $     29,918   $     36,661
                                              =============  =============  =============  =============

Cumulative ratio of interest-earning
    assets to interest-bearing liabilities          100.4%         111.3%         107.0%         108.5%
                                              =============  =============  =============  =============

Ratio of cumulative gap to total assets               0.3%           9.1%           6.0%           7.3%
                                              =============  =============  =============  =============

-----------------------------------------------------------------------------------------------------------------------
</TABLE>

Market Risk

     The Company's primary market risk is interest rate risk. Interest rate risk
is the result of differing maturities or repricing intervals of interest-earning
assets  and  interest-bearing  liabilities  and the  fact  that  rates  on these
financial  instruments do not change uniformly.  These conditions may impact the
earnings generated by the Company's  interest-earning  assets or the cost of its
interest-bearing  liabilities,  thus directly  impacting  the Company's  overall
earnings.  The Company's  management actively monitors and manages interest rate
risk. One way this is  accomplished is through the development of, and adherence
to, the Company's  asset/liability  policy.  This policy sets forth management's
strategy for matching the risk characteristics of the Company's interest-earning
assets and interest-bearing  liabilities so as to mitigate the effect of changes
in the rate environment.
<PAGE>

     One way to measure the Company's  potential  exposure to interest rate risk
is to estimate the effect of a change in rates on the Company's  Economic  Value
of Equity  ("EVE").  At December 31, 2003, the percentage of negative  estimated
change in EVE  increased  in the rising  rate  environments  as  compared to the
estimated  change  at  December  31,  2002.  Changes  to EVE in  declining  rate
environments  from  December  31,  2002 to  December  31,  2003  are  positively
impacted.  The following table sets forth information  relating to the Company's
EVE and the estimated changes under various interest rate change scenarios as of
December 31, 2003 (in thousands).

--------------------------------------------------------------------------------
Market Risk Table
December 31, 2003

     Change in               Economic                Estimated        Estimated
  Interest Rates         Value of Equity             $ Change         % Change
--------------------------------------------------------------------------------

400 basis point rise       $   34,430              (17,751)            (34%)
300 basis point rise           38,721              (13,460)            (26%)
200 basis point rise           42,643               (9,538)            (18%)
100 basis point rise           46,834               (5,347)            (10%)
Base Scenario                  52,181                   --
100 basis point decline        53,386                1,205               2%
200 basis point decline        55,321                3,140               6%
300 basis point decline        57,178                4,997              10%
400 basis point decline        59,609                7,428              14%
--------------------------------------------------------------------------------

     Computation of prospective  effects of hypothetical  interest rate changes,
such as the above  computations,  are based on numerous  assumptions,  including
relative levels of market interest  rates,  loan  prepayments and deposit decay,
and should not be relied upon as  indicative  of actual  results.  Further,  the
computations  do not  contemplate  any actions  management  could  undertake  in
response to sudden changes in interest rates.

Liquidity

     The  Company's  goal is to maintain  adequate  liquidity to meet  potential
funding needs of loan and deposit customers,  pay operating  expenses   and meet
regulatory liquidity requirements.  Maturing securities, principal repayments of
loans and  securities,  selling  loans  held for  sale,  deposits,  income  from
operations and  borrowings are the main sources of liquidity.  The Bank has been
granted a line of credit by the Federal Home Loan Bank of Atlanta ("FHLB") in an
amount of up to 25% of the Bank's total assets. At December 31, 2003, the Bank's
borrowed  funds from the FHLB equaled 17% of its total  assets.  Scheduled  loan
repayments are a relatively  predictable  source of funds,  unlike  deposits and
loan  prepayments that are  significantly  influenced by general interest rates,
economic conditions and competition.

     At December 31, 2003,  the  estimated  market value of liquid assets (cash,
cash   equivalents,   marketable   securities  and  loans  held  for  sale)  was
approximately  $72 million,  representing  16% of deposits and borrowed funds as
compared to $88 million or 19% of deposits  and  borrowed  funds at December 31,
2002.  The decrease in liquid  assets was  primarily  due to a decrease in loans
held  for  sale.  Management  maintains  a  portfolio  generally  consisting  of
mortgage-backed securities and securities with short maturities (within 6 years)
and call  dates,  consistent  with the  Bank's  focus on  liquidity.  Investment
securities  available  for  sale are  recorded  at their  fair  value,  with the
unrealized gain or loss included as a component of stockholders'  equity, net of
deferred taxes.

     The  Company's  securities  portfolio  consists  of  U.S.  Treasury,   U.S.
Government agency,  mortgage-backed and other permissible  securities  including
preferred stock from the Federal Home Loan Mortgage Corporation  ("FHLMC") and a
Household Finance  Corporation  note. The Federal National Mortgage  Association
("FNMA") and FHLMC  guarantee the  mortgage-backed  securities.  Mortgage-backed
securities  entitle the Company to receive a pro rata  portion of the cash flows
from  an  identified  pool of  mortgages.  Although  mortgage-backed  securities
generally offer lesser yields than the loans for which they are exchanged,  they
present  substantially  lower credit risk by virtue of the guarantees  that back
them. Mortgage-backed securities are more liquid than individual mortgage loans,
and may be used to collateralize borrowings or other obligations of the Company.


<PAGE>

     The mortgage-backed and related securities owned by the Company are subject
to repayment by the mortgagors of the underlying  collateral at any time.  These
repayments may be affected by a rising or declining  interest rate  environment.
During a rising or  declining  interest  rate  environment,  repayments  and the
interest  rate  caps may  subject  the  Company's  mortgage-backed  and  related
securities to yield and/or price volatility.

     The  Company's  primary uses of liquidity are to fund loans and to purchase
investments.  At December 31, 2003, outstanding off-balance sheet commitments to
extend credit totaled $41 million,  and the undisbursed  portion of construction
loans was $45 million. Management considers current liquidity levels adequate to
meet the Company's cash flow requirements.

Off-Balance Sheet Arrangements

     The Company does not have any off-balance  sheet  arrangements that have or
are  reasonably  likely to have a  current  or  future  effect of the  Company's
financial  condition,  changes in  financial  condition,  revenues or  expenses,
results of operations, liquidity, capital expenditures or capital resources that
are  material  to  investors  except  as  disclosed  in  Note  3  of  "Notes  to
Consolidated Financial Statements."

Contractual Obligations and Commitments

     The Bank enters into  agreements  that obligate it to make future  payments
under  contracts,  such as debt and  lease  agreements.  In  addition,  the Bank
commits to lend funds in the future such as credit  lines and loan  commitments.
Below is a table of such contractual obligations and commitments at December 31,
2003 (in thousands).
<TABLE>
<CAPTION>

---------------------------------------------------------------------------------------------------------------------------
                                                                                     Payments Due by Period
                                                        -------------------------------------------------------------------
                                                                              Less
                                                                             than 1        1-3          4-5         Over 5
                Contractual Obligations                        Total          year        years        years        years
                                                        -------------------------------------------------------------------
<S>                                                          <C>           <C>          <C>         <C>          <C>
Borrowed Funds                                                $ 89,505     $ 41,417      $20,000      $ 5,000      $23,088
Lease Obligations                                                4,992          487          681          493        3,331
Lumina Mortgage Company Purchase                                   400          400           --           --           --
Deposits                                                       367,072      334,154       32,815           82           21
                                                        -------------------------------------------------------------------
Total Contractual Cash Obligations                           $ 461,969    $ 376,458      $53,496      $ 5,575      $26,440
                                                        ===================================================================
</TABLE>
<TABLE>
<CAPTION>

                                                                            Amount of Commitment Expiration
                                                                                        Per Period
                                                        -------------------------------------------------------------------
                                                               Total          Less
                                                              Amounts        than 1        1-3          4-5         Over 5
                   Other Commitments                         Committed        year        years        years        years
                                                        -------------------------------------------------------------------
 <S>                                                       <C>            <C>          <C>         <C>             <C>
Undisbursed portion of home equity
   collateralized primarily by junior liens
   on 1-4 family properties                                   $ 15,431        $ 220      $ 1,707        $ 549      $12,955
Other commitments and credit lines                              15,275        1,614       10,288          400        2,973
Undisbursed portion of construction loans                       45,311       45,311           --           --           --
Available for sale mortgage loan commitments                     2,954        2,954           --           --           --
Fixed-rate mortgage loan commitments                             1,031        1,031           --           --           --
Adjustable-rate mortgage loan
   commitments                                                   5,815        5,815           --           --           --
                                                        -------------------------------------------------------------------
 Total Commitments                                            $ 85,817     $ 56,945      $11,995        $ 949      $15,928
                                                        ===================================================================

---------------------------------------------------------------------------------------------------------------------------
</TABLE>

<PAGE>

     In the normal  course of  business,  the  Company  may enter into  purchase
agreements for goods or services.  In management's opinion, the dollar amount of
such  agreements at December 31, 2003 is immaterial and has not been included in
the previous table.

Capital

     Stockholders'  equity at December  31,  2003,  was $43.1  million,  up $4.7
million, or 12.2%, from $38.4 million at December 31, 2002. The improved capital
position  during the year 2003 reflects the impact of earnings  retention  after
the  declaration  of cash  dividends  of $570,000,  or $0.20 per share,  and the
exercising of 13,500 stock  options.  Stockholders'  equity at December 31, 2003
and  December  31, 2002  includes  unrealized  gains net of tax of $285,000  and
$636,000, respectively, on securities available for sale.

     Under the capital regulations of the Federal Deposit Insurance  Corporation
("FDIC"),  the  Bank  must  satisfy  minimum  leverage  ratio  requirements  and
risk-based  capital  requirements.  Banks supervised by the FDIC must maintain a
minimum  leverage  ratio of core (Tier I) capital  to  average  adjusted  assets
ranging from 3% to 5%. At December 31, 2003, the Bank's  leverage  capital ratio
was 8.41%. The FDIC's  risk-based  capital rules require banks supervised by the
FDIC to maintain  risk-based capital to risk-weighted  assets of at least 8.00%.
Risk-based capital for the Bank is defined as Tier I capital plus the balance of
allowance  for  loan  losses.  At  December  31,  2003,  the Bank had a ratio of
qualifying total capital to risk-weighted assets of 12.11%.

     The Company,  as a bank holding company, is also subject, on a consolidated
basis,  to the capital  adequacy  guidelines  of the Board of  Governors  of the
Federal Reserve (the "Federal Reserve Board").  The capital  requirements of the
Federal Reserve Board are similar to those of the FDIC governing the Bank.

     The Company currently exceeds all of its capital  requirements.  Management
expects the Company to continue to exceed  these  capital  requirements  without
altering current operations or strategies.  For further information,  see Note 7
of "Notes to Consolidated Financial Statements."

     On December 17, 2003, the Company's Board of Directors approved a quarterly
cash  dividend on its common  stock of $.05 per share.  The dividend was payable
January  17,  2004,  to  shareholders  of record on January 2, 2004.  Any future
payment of dividends is dependent on the  financial  condition and capital needs
of the Company,  requirements of regulatory agencies  and economic conditions in
the marketplace.

Related Party Transactions

     The Bank has had, and expects to have in the future,  banking  transactions
in the ordinary  course of business with several  directors,  officers and their
associates  ("Related  Parties")  on  substantially  the same  terms,  including
interest rates and  collateral,  as those  prevailing at the time for comparable
transactions with others.  Those  transactions  neither involve more than normal
risk of collectibility,  nor present any unfavorable features. The one exception
is officers can  participate in the Bank's  employee loan program which offers a
six month  adjustable  rate that is 1% above the Bank's cost of funds rounded up
to the next 1/4%.  An employee can only have one property at any given time that
qualifies for the employee rate program. The interest rate is the only favorable
term.  Officers do not get  preferential  treatment  in this  program over other
employees.  For  further  information,  see  Note 3 of  "Notes  to  Consolidated
Financial  Statements"  included in this Annual Report and the  Company's  Proxy
Statement for its 2004 Annual Meeting of Stockholders.

FINANCIAL CONDITION

     The Company's total assets decreased 0.4% to $502.3 million at December 31,
2003,  as compared to $504.2  million at December 31, 2002.  The major change in
assets is a decrease of $19.3 million  (75.2%) in loans held for sale due to the
decrease in mortgage  volume caused by a reduction in mortgage loan  refinancing
and an increase in mortgage rates at December 31, 2003.  This reduction  allowed
the Bank to reduce  short-term  borrowings $20.2 million  (32.7%).  In addition,
there is an increase of $6.5 million (55.1%) in cash and cash equivalents, which
was caused by an increase in deposits of $9.8  million  (2.7%).  The increase in
deposits was mainly due to checking  accounts.  The Bank  continues to emphasize
obtaining business accounts,  which is part of the reason for this increase. The
Bank also attracted an additional $6.9 million in internet  deposits because the
rates are  competitive  with the Bank's  local  markets.  Internet  deposits are
usually obtained from other financial  institutions  with terms primarily of one
or two years.  The  increase  in deposits  along with the  maturing of a held to
maturity  bond helped


<PAGE>

fund the increase of $10.9 million (2.8%) in loans. The increase of $1.6 million
(23.5%)  in  premises  and  equipment  was  primarily  due to the  building  and
furnishing of new branches. Other assets increased $1.5 million (12.9 %) largely
due to an increase of $448,000 in  deferred  income  taxes and a  receivable  of
$734,000  for the sale of a building.  The  additional  goodwill of $800,000 was
generated by amending the purchase agreement of Lumina Mortgage Company from two
contingent payments into two payments of $400,000 each, payable on July 31, 2003
and 2004.  A reduction in accounts  payable  caused the decrease of $1.1 million
(33.5%) in accrued expenses and other liabilities.

     The Company's  nonperforming  assets (nonaccrual  loans,  accruing loans 90
days or more delinquent and foreclosed  real estate) were $267,000,  or 0.05% of
assets, at December 31, 2003,  compared to $1.2 million,  or 0.24% of assets, at
December 31, 2002.  The Company  assumes an  aggressive  position in  collecting
delinquent  loans and  disposing of  foreclosed  assets to minimize  balances of
nonperforming  assets  and  continues  to  evaluate  the loan  and  real  estate
portfolios to provide loss reserves as considered necessary.  While there can be
no  guarantee,  in the opinion of  management,  the allowance for loan losses of
$3.4 million at December 31, 2003 is adequate to cover probable  losses inherent
in the loan portfolio.

     Management  considers a variety of factors in establishing  the appropriate
levels for the provision and the  allowance  for loan losses.  Consideration  is
given to, among other things,  the impact of current  economic  conditions,  the
diversification of the loan portfolio, historical loss experience, the review of
loans  by  loan  review  personnel,  the  individual  borrower's  financial  and
managerial strengths  and the adequacy of underlying collateral.

     The process used to allocate the allowance for loan losses considers, among
other  factors,  whether  the  borrower  is a  mortgage,  retail  or  commercial
customer,  whether the loan is secured or unsecured,  and whether the loan is an
open or  closed-end  agreement.  Generally,  loans are  reviewed and risk graded
among groups of loans with similar  characteristics.  An independent third party
annually  reviews  our  risk  grades  for  appropriateness.  The  probable  loss
projections  for  each  risk  grade  group  are  the  basis  for  the  allowance
allocation.  The loss  estimates  are based on prior  experience,  general  risk
associated with each loan group and current economic conditions. The unallocated
allowance for loan losses primarily  represents the impact of certain conditions
that were not considered in allocating the allowance to the specific  components
of the loan portfolio.

     At December 31, 2003 deposits had increased  $9.8 million  (2.7%) to $367.1
million as compared to $357.3  million at December 31,  2002.  With the focus to
restructure  the  balance  sheet to be more  reflective  of a  commercial  bank,
management   took  an   aggressive   position   in   attracting   interest   and
noninterest-bearing  demand deposit accounts.  Interest and  noninterest-bearing
demand accounts  increased $12.1 million (29.9%) to $52.5 million as compared to
$40.4 million at December 31, 2002.

RESULTS OF OPERATION

     The net income of the Company depends  primarily upon net interest  income.
Net interest  income is the  difference  between the  interest  earned on loans,
securities  and  interest-bearing  deposits in other banks offset by the cost of
funds,  consisting  principally of the interest paid on deposits and borrowings.
The Company's operations are materially affected by general economic conditions,
the monetary and fiscal policies of the Federal government   and the policies of
regulatory authorities.

Net Income

     Net income  increased  9.3% to $5.4  million for 2003,  as compared to $4.9
million  for 2002 and  $2.9  million  in 2001.  The  following  analysis  of the
Company's  results of operations  will explain the changes that had an effect on
net income for the three years under review.

Interest Income

     Interest  income  amounted to $27.8  million  during  2003,  a $1.7 million
(5.7%) decrease from 2002 levels,  which decreased $1.6 million (5.2%) from 2001
levels.  Interest  income  reduction  during 2003  resulted from lower yields on
earning assets.  The average balance of  interest-earning  assets increased 6.0%
but was more than offset by the yield  decreasing 73 basis points as compared to
the same  period a year ago.  The yield fell  because of the action the  Federal
Reserve took to reduce  interest  rates hoping to spur the economy.  The Federal
Reserve's actions continue to cause adjustable rate loans to adjust down and new
loans to be made at a lower rate.  During 2002, the decrease in interest  income
was due to the yield on  average  interest-earning  assets  decreasing  93 basis
points   because  of  the   interest   rate  cuts.   The   average   balance  of
interest-earning assets increased 8.1% as compared to 2001. The yield on average

<PAGE>

interest-earning  assets for the year 2003  decreased  to 5.89 % as  compared to
6.62% for 2002 and 7.55% for 2001.

Interest Expense

     Interest  expense  amounted to $10.7  million  during  2003, a $3.2 million
(23.0%)  decrease from 2002 levels,  compared to a $5.0 million (26.7%) decrease
from 2001 to 2002. The decrease in interest  expense during 2003 resulted from a
lower cost of interest-bearing liabilities.  During 2003, the average balance of
interest-bearing liabilities increased 4.4% but was more than offset by the cost
decreasing  87 basis  points as  compared to 2002.  During 2002 the  decrease in
interest  expense  was due to a 164 basis  point drop in the  average  rate paid
against a 9.5% increase in the average balance of  interest-bearing  liabilities
as compared to 2001. The average cost on  interest-bearing  liabilities  for the
year 2003 decreased to 2.46% as compared to 3.33% for 2002 and 4.97% for 2001.

Net Interest Income

     Net interest  income totaled $17.1 million during 2003, an increase of $1.5
million,  or 9.7% over 2002, when net interest income was $15.6 million.  During
2002, net interest income increased $3.4 million or 28.0% over the $12.2 million
recorded  during  2001.  The Average  Yield/Cost  Analysis  table  analyzes  the
interest-earning  assets and  interest-bearing  liabilities  for the three years
ending December 31, 2003. The Rate/Volume  Analysis table  identifies the causes
for  changes in interest  income and  interest  expense  for 2003 and 2002.  The
interest  rate  spread was 3.43% for 2003,  compared to 3.29% for 2002 and 2.58%
for 2001. The increased  interest rate spread can be attributed to the fact that
liabilities  have repriced more than assets during these periods.  The net yield
on  interest-earning  assets was 3.63% for 2003  compared  to 3.51% for 2002 and
2.96% for 2001.



<PAGE>



                           AVERAGE YIELD/COST ANALYSIS

     The following table contains  information relating to the Company's average
balance sheets and reflects the average yield on earning assets and average cost
of interest-bearing liabilities for the periods indicated. Such yields and costs
are derived by dividing  income or expense by the average  balances of assets or
liabilities, respectively, for the periods presented. The average loan portfolio
balances include nonaccrual loans.
<TABLE>
<CAPTION>

----------------------------------------------------------------------------------------------------------------------------
                                                                       For the year ended
                                     ---------------------------------------------------------------------------------------

                                          DECEMBER 31, 2003            DECEMBER 31, 2002            DECEMBER 31, 2001
                                     ---------------------------- ---------------------------- -----------------------------
(Dollars in thousands)                                   Average                      Average                       Average
                                      Average             Yield/    Average            Yield/    Average             Yield/
                                      Balance  Interest    Cost     Balance  Interest   Cost     Balance   Interest   Cost
                                     --------- --------  -------- ---------- -------- -------- ---------- --------  --------
<S>                                     <C>     <C>       <C>        <C>      <C>      <C>      <C>        <C>        <C>
ASSETS
Interest-earning assets:
   Interest-bearing deposits in
    other banks                      $  4,315  $    47     1.09%  $  2,732   $    48    1.76%   $  7,648  $   271     3.54%
   Securities:
        Available for sale             40,658    1,868     4.59%    41,185     2,184    5.30%     36,671    2,212     6.03%
        Held to maturity                6,164      253     4.10%     7,206       433    6.01%      7,452      400     5.37%
   FHLB stock                           3,855      147     3.81%     4,141       220    5.31%      3,761      254     6.75%
   All loans                          417,134   25,512     6.12%   390,210    26,611    6.82%    356,540   27,980     7.85%
                                     --------  -------   ------   --------  --------  ------   ---------  -------   ------
    Total interest-earning assets     472,126  $27,827     5.89%   445,474   $29,496    6.62%    412,072  $31,117     7.55%
                                               -------                      --------                      -------
Non-interest earning assets            30,878                       27,330                        16,676
                                     --------                     --------                     ---------
Total assets                         $503,004                     $472,804                      $428,748
                                     ========                     ========                     =========

LIABILITIES AND
STOCKHOLDERS' EQUITY
Interest-bearing liabilities:
   Deposits                          $343,453  $ 7,291     2.12%  $334,980   $10,146    3.03%   $319,777  $15,353     4.80%
   Borrowed funds                      91,767    3,395     3.70%    81,867     3,729    4.55%     60,943    3,563     5.85%
                                     --------  -------   -------- --------  --------  --------  --------  -------   -------
    Total interest-bearing
     liabilities                      435,220  $10,686     2.46%   416,847   $13,875    3.33%    380,720  $18,916     4.97%
                                               -------                      --------                      -------
Non-interest bearing liabilities       26,714                       19,855                        15,588
                                     --------                     --------                      --------

    Total liabilities                 461,934                      436,702                       396,308
    Stockholders' equity               41,070                       36,102                        32,440
                                     --------                     --------                      --------
Total liabilities and stockholders'
 equity                              $503,004                     $472,804                      $428,748
                                     ========                     ========                      ========

Net interest income                            $17,141                       $15,621                      $12,201
                                               =======                      ========                      =======

Interest rate spread                                       3.43%                        3.29%                         2.58%
                                                         ======                       ======                        ======

Net yield on interest-earning assets                       3.63%                        3.51%                         2.96%
                                                         ======                       ======                        ======

Percentage of average interest-earning
   assets to average interest-bearing
   liabilities                                            108.5%                       106.9%                        108.2%
                                                         ======                       ======                        ======

----------------------------------------------------------------------------------------------------------------------------
</TABLE>
<PAGE>
                              RATE/VOLUME ANALYSIS

     The table below provides  information  regarding changes in interest income
and  interest  expense  for  the  periods   indicated.   For  each  category  of
interest-earning  assets  and  interest-bearing   liabilities,   information  is
provided  on changes  attributable  to (i)  changes in volume  (change in volume
multiplied by old rate) and (ii) changes in rates (change in rate  multiplied by
old  volume).  The  changes  attributable  to changes in  rate-volume  have been
allocated to the other categories based on relative absolute values.

<TABLE>
<CAPTION>

------------------------------------------------------------------------------------------------------------------------------------
                                                          For the year ended                             For the year ended
                                            December 31, 2002 vs. December 31, 2003         December 31, 2001 vs. December 31, 2002
                                                      Increase (Decrease)                             Increase (Decrease)
                                                          Due to                                       Due to
                                         -------------------------------------------- ------------------------------------------
(Dollars in thousands)
                                            Volume           Rate           Total        Volume          Rate           Total
                                         -------------  -------------  -------------- -------------  -------------  ------------
<S>                                             <C>           <C>           <C>                 <C>          <C>            <C>
Interest income:
   Interest-bearing deposits in other
    banks                                  $    21          $ (21)        $    --          $ (126)         $ (97)      $ (223)
   Securities:
        Available for sale                     (28)          (288)           (316)            255           (283)         (28)
        Held to maturity                       (57)          (122)           (179)            (13)            46           33
   FHLB stock                                  (14)           (59)            (73)             24            (58)         (34)
   All loans                                 1,759         (2,860)         (1,101)          2,497         (3,866)      (1,369)
                                           -------   ------------   -------------    ------------   ------------       ------
    Total interest-earning assets            1,681         (3,350)         (1,669)          2,637         (4,258)      (1,621)
                                           -------   ------------   -------------    ------------   ------------       ------


Interest expense:
   Deposits                                    251         (3,106)         (2,855)            699         (5,906)      (5,207)
   Borrowed funds                              418           (752)           (334)          1,058           (892)         166
                                           -------   ------------   -------------    ------------   ------------       ------
    Total interest-bearing liabilities         669         (3,858)         (3,189)          1,757         (6,798)      (5,041)
                                           -------   ------------   -------------    ------------   ------------       ------

Net interest income                        $ 1,012          $ 508         $ 1,520           $ 880        $ 2,540       $3,420
                                           =======   ============   =============    ============   ============       ======

------------------------------------------------------------------------------------------------------------------------------------
</TABLE>


Provision for Loan Losses

     The provision for loan losses  charged to  operations  was $740,000  during
2003 and 2002,  compared to $460,000 during 2001. The commercial loan portfolio,
which contains loans with a higher degree of risk,  continues to expand which is
why the provision for loan losses increased from 2001.  Non-performing assets at
December  31, 2003 were  $267,000  compared to $1.2 million at December 31, 2002
and $3.8 million at December 31, 2001.  Net  charge-offs  for 2003 were $230,000
compared to $326,000  during 2002 and $97,000 during 2001. At December 31, 2003,
the  allowance  for loan  losses was 0.86% of net loans as compared to 0.75% for
2002 and 0.67% for 2001. The allowance for loan losses increased to $3.4 million
at December  31, 2003  compared  to $2.9  million at December  31, 2002 and $2.5
million at December 31, 2001.  Management considers this level to be appropriate
based on lending volume,  the current level and types of delinquencies and other
nonperforming   assets,   historical  charge  off  patterns,   overall  economic
conditions  and  other  factors.  Future  increases  to  the  allowance  may  be
necessary,  however, due to changes in loan composition or loan volume,  changes
in economic or market area conditions and other factors.  Additionally,  various
regulatory  agencies,   as  an  integral  part  of  their  examination  process,
periodically  review the Company's  allowance for loan losses. Such agencies may
require  adjustments  to the allowance  based on their  judgments of information
available to them at the time of their examination.

Noninterest Income

     Total noninterest income increased to $6.6 million during 2003, an increase
of $1.9  million or 39.6% over 2002.  This  compares  to $4.8  million  and $2.0
million  during 2002 and 2001,  respectively.  The major  component that had the
most impact on noninterest income was the gain on sale of loans resulting in net
gains of $4.2 million versus a gain of $1.9 million in 2002 and $11,000 in 2001.
These gains were realized  primarily as a result of the May 31, 2002 purchase of
Lumina  and  the  high  volume  of  refinances  due to  the  low  interest  rate
environment.  The Bank has also started to sell a larger percentage of its fixed
rate  mortgage loan  originations  in the  secondary  market  instead of through
brokered


<PAGE>
arrangements.  This  change  caused an  increase  in gain on sale of loans and a
reduction to service  charges and fees on loans.  Deposit related fees increased
29.1%  primarily due to a new service the Bank offered  beginning in April 2003,
for checking  accounts with  non-sufficient  funds.  During 2002 the Bank sold a
parking  lot for  $500,000,  resulting  in the gain on sale of real  estate.  No
similar  transactions  occurred  during  2003  or  2001  other  than a sale of a
building  in 2003  but the  gain was  deferred.  Net gain on sale of  securities
decreased to $51,000  during 2003, a decrease of $85,000 or 62.5% from 2002.  In
2002,  the Bank sold more bonds to purchase  mortgage-backed  securities to give
the  Bank  greater  cash  flow.  In 2003,  Bank-owned  life  insurance  earnings
decreased  7.2% from 2002 due to the  reduction in interest  rates being paid on
this  investment.  The majority of the  insurance  was purchased in September of
2001, which is the cause for the 298.1% increase in 2002 from 2001. Other income
decreased  to  $197,000  (11.7%)  during the year 2003 as  compared  to $223,000
(111.7%  increase)  during the year 2002 and $105,000 for 2001.  The majority of
the other income  changes can be  attributed  to the change in  commissions  for
annuity sales and mutual  funds,  through  UVEST  Investment  Services sold each
year.

Noninterest Expense

     Total  noninterest  expense  was $15.0  million  during the year  2003,  an
increase of $3.2 million or 26.5% from 2002.  The major  increase in noninterest
expense during the year 2003 can be attributed to compensation and related costs
increasing to $9.3 million  (32.3%) in 2003 as compared to $7.0 million  (36.9%)
in 2002 and $5.1 million in 2001. The increase was due to increases in incentive
based pay,  costs of  benefits,  staffing  levels,  including  the  staffing for
additional  branches   and  normal  increases  in  salaries  as well  as  higher
personnel  costs as a result of the May 31, 2002 purchase of Lumina.  The Bank's
occupancy  and  equipment  expense was $2.7 million  during 2003, an increase of
18.0% as compared to $2.3  million  during  2002 and $2.1  million in 2001.  The
increase  in the  years  2003  and  2002 can be  attributed  to the 2002  Lumina
purchase  and  additional  maintenance  necessary  to  keep  the  buildings  and
equipment in good repair,  increases in property  tax,  increases in the cost of
data processing  services   and normal  increases in utility  expenses.  In 2003
there was also an increase in  depreciation  and other  expenses  due to the new
branches  and  upgrades in  hardware  and  software  systems.  Professional  and
examination  fees decreased to $365,000  (36.1%) in 2003. These fees were higher
in 2002 due to organizing Holdings and the REIT.  Advertising costs for the year
2003 were  $579,000  an  increase  of 61.9% as  compared to $358,000 in 2002 and
$278,000 in 2001.  Other  non-interest  expense was $2.0 million during 2003, an
increase of 22.1% as compared to $1.6 million in 2002 and in 2001.  The increase
in  advertising  and other  expense was mainly due to the purchase of Lumina and
the opening of four new financial  centers.  Real estate owned expense increased
$96,000 in 2003  primarily  due to losses and expenses  incurred in disposing of
foreclosed properties.

Income Taxes

     The effective tax rate for the years ended December 31, 2003, 2002 and 2001
was 32.4%, 36.2% and 35.5%, respectively. The decrease in 2003 resulted from the
formation of Holdings and the REIT in December 2002.

Recent Accounting Pronouncements

     See Note 1 to the "Notes to Consolidated  Financial  Statements" for a full
description  of  recent  accounting   pronouncements  including  the  respective
expected  dates of adoption and effects on results of  operations  and financial
condition.

Note Regarding Forward-Looking Statements

     In addition to historical  information  contained  herein,  the  discussion
contains  forward-looking  statements  that  involve  risks  and  uncertainties.
Economic  circumstances,  the Company's  operations   and the  Company's  actual
results could differ  significantly from those discussed in the  forward-looking
statements.  Some  of the  factors  that  could  cause  or  contribute  to  such
differences  are discussed  herein,  but also include changes in the economy and
interest rates in the nation,  changes in the Company's  regulatory  environment
and the Company's market area generally.
<PAGE>
                             SELECTED QUARTERLY DATA

     The following table contains  selected  financial data for the Company on a
quarterly basis for the previous eight quarters.
<TABLE>
<CAPTION>
                                                        2003                                      2002
                                        Fourth     Third    Second    First        Fourth    Third    Second    First
------------------------------------------------------------------------------    --------------------------------------
<S>                                      <C>        <C>       <C>      <C>          <C>       <C>      <C>       <C>
                                                                   Dollars in Thousands
Selected Quarter-End Balances:
  Assets                                $502,306  $496,387 $522,003  $512,578     $ 504,210 $498,035 $ 479,435  $462,846
  Loans, net                             401,242   388,798  394,546   401,081       390,876  386,940   384,871   375,125
  Securities                              47,419    48,577   42,465    47,819        49,935   51,298    48,438    47,354
  FHLB stock                               4,154     3,905    4,005     3,805         4,055    4,155     4,155     4,155
  Deposits                               367,072   362,967  373,628   375,020       357,254  359,873   360,536   352,083
  Borrowed funds                          89,505    88,099  104,047    94,820       104,678   96,133    80,929    74,295
  Stockholders' equity                    43,143    42,237   41,022    39,816        38,448   37,065    35,776    34,142

------------------------------------------------------------------------------    --------------------------------------

                                                                   Dollars in Thousands
Selected Operations Data:
  Interest income                        $ 6,653   $ 6,873  $ 7,116   $ 7,184      $ 7,374   $ 7,366   $ 7,393   $ 7,362
  Interest expense                         2,322     2,640    2,794     2,930        3,234     3,380     3,502     3,758
  Net interest income                      4,331     4,233    4,322     4,254        4,140     3,986     3,891     3,604
  Provision for loan losses                  180       180      180       200          220       120       120       280
  Noninterest income                       1,363     1,845    1,856     1,572        1,666     1,274       604     1,210
  Noninterest expenses                     3,787     3,756    3,880     3,619        3,450     3,277     2,611     2,550
  Income before income taxes               1,727     2,142    2,118     2,007        2,136     1,863     1,764     1,984
  Net income                               1,163     1,430    1,423     1,388        1,305     1,220     1,131     1,288

------------------------------------------------------------------------------    --------------------------------------

Selected Financial Ratios and Other Data:
  Return on average assets                 0.94%     1.12%     1.13%     1.11%        1.06%     1.02%     0.98%     1.13%
  Return on average equity                10.85%    13.66%    13.99%    14.29%       13.65%    13.29%    12.91%    14.99%
  Average stockholders' equity to average
   assets                                  8.65%     8.22%     8.04%     7.75%        7.74%     7.69%     7.57%     7.53%
Per Share Data:
  Earnings per:
     Common share - basic                 $ 0.41    $ 0.50    $ 0.50    $ 0.49       $ 0.46    $ 0.43    $ 0.40    $ 0.45
     Common share - diluted               $ 0.40    $ 0.49    $ 0.49    $ 0.48       $ 0.46    $ 0.43    $ 0.40    $ 0.45
  Cash dividends declared                 $ 0.05    $ 0.05    $ 0.05    $ 0.05       $ 0.05    $ 0.05    $ 0.05    $ 0.05
  Book value                              $15.14    $14.82    $14.40    $13.98       $13.56    $13.07    $12.62    $11.86
  Number of common shares
   outstanding                            2,849,447 2,849,447 2,847,947 2,847,947    2,835,947 2,835,947 2,835,947 2,835,447
</TABLE>

<PAGE>
                        [LETTERHEAD OF DIXON HUGHES PLLC]




                          INDEPENDENT AUDITORS' REPORT

The Board of Directors
Cooperative Bankshares, Inc.

We have audited the accompanying  consolidated statements of financial condition
of Cooperative  Bankshares,  Inc. and subsidiary  (the "Company") as of December
31, 2003 and the related  consolidated  statement of  operations,  comprehensive
income,  stockholders'  equity,  and cash flows for the year then  ended.  These
consolidated  financial  statements  are  the  responsibility  of the  Company's
management.  Our  responsibility is to express an opinion on these  consolidated
financial  statements based on our audit. The consolidated  financial statements
of Cooperative  Bankshares,  Inc. and subsidiary as of December 31, 2002 and for
the years ended  December 31, 2002 and 2001 were audited by other auditors whose
report  dated  January  24,  2003  expressed  an  unqualified  opinion  on those
statements.

We conducted our audit in accordance with auditing standards  generally accepted
in the  United  States of  America.  Those  standards  require  that we plan and
perform the audit to obtain  reasonable  assurance  about  whether the financial
statements are free of material misstatement.  An audit includes examining, on a
test basis,  evidence  supporting  the amounts and  disclosures in the financial
statements.  An audit also includes assessing the accounting principles used and
significant  estimates  made by  management,  as well as evaluating  the overall
financial  statement  presentation.   We  believe  that  our  audit  provides  a
reasonable basis for our opinion.


In our opinion,  the 2003 consolidated  financial  statements  referred to above
present fairly, in all material respects,  the financial position of Cooperative
Bankshares,  Inc. and  subsidiary  as of December  31, 2003,  and the results of
their  operations  and their cash flows for the year then ended,  in  conformity
with accounting principles generally accepted in the United States of America.


/s/ Dixon Hughes PLLC

Sanford, North Carolina
January 23, 2004

<PAGE>
                              [LETTERHEAD OF KPMG]

                          INDEPENDENT AUDITOR'S REPORT


The Board of Directors
Cooperative Bankshares, Inc.:


We have audited the accompanying  consolidated statements of financial condition
of Cooperative Bankshares,  Inc. and subsidiary as of December 31, 2002, and the
related   consolidated   statements   of   operations,   comprehensive   income,
stockholders'  equity,  and cash flows for the years ended December 31, 2002 and
2001. These  consolidated  financial  statements are the  responsibility  of the
Company's  management.  Our  responsibility  is to  express  an opinion on these
consolidated financial statements based on our audits.

We conducted our audits in accordance with auditing standards generally accepted
in the  United  States of  America.  Those  standards  require  that we plan and
perform the audit to obtain  reasonable  assurance  about  whether the financial
statements are free of material misstatement.  An audit includes examining, on a
test basis,  evidence  supporting  the amounts and  disclosures in the financial
statements.  An audit also includes assessing the accounting principles used and
significant  estimates  made by  management,  as well as evaluating  the overall
financial  statement  presentation.   We  believe  that  our  audits  provide  a
reasonable basis for our opinion.

In our opinion, the consolidated  financial statements referred to above present
fairly,  in  all  material  respects,  the  financial  position  of  Cooperative
Bankshares,  Inc. and  subsidiary  as of December  31, 2002,  and the results of
their  operations and their cash flows for the years ended December 31, 2002 and
2001, in conformity with accounting  principles generally accepted in the United
States of America.


/s/ KPMG LLP

Raleigh, North Carolina
January 24, 2003


<PAGE>

                   COOPERATIVE BANKSHARES, INC. AND SUBSIDIARY

                 Consolidated Statements of Financial Condition

                           December 31, 2003 and 2002
<TABLE>
<CAPTION>

                                                                                    2003                 2002
                                                                              -----------------   -----------------
                <S>                                                                  <C>                <C>
                                       ASSETS

Cash and due from banks, noninterest-bearing                                  $     14,400,034    $      11,858,603
Interest-bearing deposits in other banks                                             3,993,331                   --
                                                                              ----------------    -----------------
              Total cash and cash equivalents                                       18,393,365           11,858,603

Securities:
   Available for sale (amortized cost of $43,180,913 in 2003
     and $41,033,409 in 2002)                                                       43,613,112           42,075,212
   Held to maturity (estimated market value of $3,889,736
     in 2003 and $8,009,087 in 2002)                                                 3,806,376            7,859,955
FHLB stock                                                                           4,154,400            4,054,700
Loans held for sale                                                                  6,375,275           25,659,935

Loans                                                                              404,689,442          393,812,940
   Less allowance for loan losses                                                    3,447,002            2,936,795
                                                                              ----------------    -----------------
              Net loans                                                            401,242,440          390,876,145

Other real estate owned                                                                     --              619,163
Accrued interest receivable                                                          1,852,366            2,239,826
Premises and equipment, net                                                          8,665,698            7,019,219
Goodwill                                                                             1,461,543              661,543
Other assets                                                                        12,741,394           11,285,276
                                                                              ----------------    -----------------
              Total assets                                                    $    502,305,969    $     504,209,577
                                                                              ================    =================

                        LIABILITIES AND STOCKHOLDERS' EQUITY

Deposits                                                                      $    367,071,513    $     357,254,096
Short-term borrowings                                                               41,416,785           61,585,827
Escrow deposits                                                                        199,433              223,604
Accrued interest payable                                                               180,067              284,568
Accrued expenses and other liabilities                                               2,207,003            3,320,629
Long-term obligations                                                               48,087,770           43,092,592
                                                                              ----------------    -----------------
              Total liabilities                                                    459,162,571          465,761,316
                                                                              ----------------    -----------------

Commitments and contingencies

Stockholders' equity:
   Preferred stock, $1 par value: 3,000,000 shares authorized,
     no shares issued and outstanding                                                       --                   --
   Common stock, $1 par value: 7,000,000 shares authorized,
     2,849,447 and 2,835,947 issued and outstanding                                  2,849,447            2,835,947
   Additional paid-in capital                                                        2,638,044            2,440,645
   Accumulated other comprehensive income                                              285,251              635,500
   Retained earnings                                                                37,370,656           32,536,169
                                                                              ----------------    -----------------
              Total stockholders' equity                                            43,143,398           38,448,261
                                                                              ----------------    -----------------

              Total liabilities and stockholders' equity                      $    502,305,969    $     504,209,577
                                                                              ================    =================
</TABLE>


See accompanying notes to consolidated financial statements.


<PAGE>
                   COOPERATIVE BANKSHARES, INC. AND SUBSIDIARY

                      Consolidated Statements of Operations

                  Years Ended December 31, 2003, 2002 and 2001
<TABLE>
<CAPTION>

                                                                    2003              2002               2001
                                                              ---------------    ---------------   ----------------
<S>                                                                  <C>               <C>                <C>
Interest income:
   Loans                                                      $    25,512,026    $    26,611,364   $     27,980,414
   Securities                                                       2,120,292          2,613,110          2,611,299
   Other                                                               47,017             51,633            271,767
   Dividends on FHLB stock                                            147,184            219,730            253,918
                                                              ---------------    ---------------   ----------------
              Total interest income                                27,826,519         29,495,837         31,117,398
                                                              ---------------    ---------------   ----------------

Interest expense:
   Deposits                                                         7,290,985         10,148,866         15,352,845
   Borrowed funds                                                   3,394,792          3,726,021          3,563,469
                                                              ---------------    ---------------   ----------------
              Total interest expense                               10,685,777         13,874,887         18,916,314
                                                              ---------------    ---------------   ----------------

Net interest income                                                17,140,742         15,620,950         12,201,084

Provision for loan losses                                             740,000            740,000            460,000
                                                              ---------------    ---------------   ----------------

              Net interest income after
                provision for loan losses                          16,400,742         14,880,950         11,741,084
                                                              ---------------    ---------------   ----------------

Non-interest income:
   Gain on sale of loans                                            4,248,884          1,852,388             11,150
   Net gain on sale of securities                                      50,663            135,182            125,172
   Service charges and fees on loans                                  437,589            649,074            731,338
   Deposit-related fees                                             1,330,370          1,030,429            967,171
   Gain on sale of real estate                                             --            464,977                 --
   Bank-owned life insurance earnings                                 369,996            398,528            100,104
   Other income, net                                                  196,942            223,008            105,324
                                                              ---------------    ---------------   ----------------
              Total non-interest income                             6,634,444          4,753,586          2,040,259
                                                              ---------------    ---------------   ----------------

Non-interest expenses:
   Compensation and fringe benefits                                 9,284,874          7,016,029          5,124,945
   Occupancy and equipment                                          2,733,861          2,317,141          2,073,635
   Professional and examination fees                                  364,522            570,229            238,681
   Advertising                                                        579,314            357,775            277,758
   Real estate owned                                                  110,209             14,300             22,053
   Other                                                            1,968,061          1,612,495          1,566,080
                                                              ---------------    ---------------   ----------------
              Total non-interest expenses                          15,040,841         11,887,969          9,303,152
                                                              ---------------    ---------------   ----------------

Income before income taxes                                          7,994,345          7,746,567          4,478,191

Income tax expense                                                  2,590,119          2,802,070          1,589,248
                                                              ---------------    ---------------   ----------------
              Net income                                      $     5,404,226    $     4,944,497   $      2,888,943
                                                              ===============    ===============   ================

Net income per share:
   Basic                                                      $          1.90    $          1.74   $           1.03
   Diluted                                                    $          1.86    $          1.73   $           1.02

Weighted average common shares outstanding:
   Basic                                                            2,847,567          2,835,712          2,797,317
   Diluted                                                          2,898,907          2,859,014          2,823,191
</TABLE>



See accompanying notes to consolidated financial statements.

<PAGE>
                   COOPERATIVE BANKSHARES, INC. AND SUBSIDIARY

                 Consolidated Statements of Comprehensive Income

                     Years December 31, 2003, 2002 and 2001
<TABLE>
<CAPTION>

                                                                    2003              2002               2001
                                                              ---------------    ---------------   ----------------
<S>                                                                  <C>              <C>                <C>
Net income                                                    $     5,404,226    $     4,944,497   $      2,888,943
                                                              ---------------    ---------------   ----------------

Other comprehensive income:

   Unrealized gain (loss) arising during the year                    (558,941)           868,332            385,127

   Tax (expense) benefit                                              242,130           (338,649)          (150,201)

   Reclassification to realized gain                                  (50,663)          (135,182)          (125,172)

   Tax expense                                                         17,225             52,721             48,817
                                                              ---------------    ---------------   ----------------

              Other comprehensive income (loss)                      (350,249)           447,222            158,571
                                                              ---------------    ---------------   ----------------

Comprehensive income                                          $     5,053,977    $     5,391,719   $      3,047,514
                                                              ===============    ===============   ================
</TABLE>









See accompanying notes to consolidated financial statements.

<PAGE>
                   COOPERATIVE BANKSHARES, INC. AND SUBSIDIARY

                 Consolidated Statements of Stockholders' Equity

                  Years Ended December 31, 2003, 2002 and 2001
<TABLE>
<CAPTION>

                                                                           Accumulated
                                                            Additional        other                       Total
                                                Common        paid-in     comprehensive   Retained     stockholders'
                                                 stock        capital        income       earnings        equity
                                             ------------  ------------   ------------  ------------   ------------
<S>                                               <C>          <C>           <C>           <C>              <C>
Balance, December 31, 2000                   $  2,714,610  $  2,234,936   $     29,707  $ 25,832,926   $ 30,812,179
  Exercise of stock options                       141,537       392,364              -             -        533,901
  Tax benefit of stock option exercise                  -        60,372              -             -         60,372
  Stock traded to exercise options
    (20,700 shares)                               (20,700)     (251,952)             -             -       (272,652)
  Other comprehensive income, net of taxes              -             -        158,571             -        158,571
  Net income for year                                   -             -              -     2,888,943      2,888,943
  Cash dividends ($.20 per share)                       -             -              -      (563,034)      (563,034)
                                             ------------  ------------   ------------  ------------   ------------

Balance, December 31, 2001                      2,835,447     2,435,720        188,278    28,158,835     33,618,280
  Exercise of stock options                           500         4,925              -             -          5,425
  Other comprehensive income, net of taxes              -             -        447,222             -        447,222
  Net income for year                                   -             -              -     4,944,497      4,944,497
  Cash dividends ($.20 per share)                       -             -              -      (567,163)      (567,163)
                                             ------------  ------------   ------------  ------------   ------------

Balance, December 31, 2002                      2,835,947     2,440,645        635,500    32,536,169     38,448,261
  Exercise of stock options                        13,500       173,590              -             -        187,090
  Tax benefit of stock option exercise                  -        23,809              -             -         23,809
  Other comprehensive loss, net of taxes                -             -       (350,249)            -       (350,249)
  Net income for year                                   -             -              -     5,404,226      5,404,226
  Cash dividends ($.20 per share)                       -             -              -      (569,739)      (569,739)
                                             ------------  ------------   ------------  ------------   ------------

Balance, December 31, 2003                   $  2,849,447  $  2,638,044   $    285,251  $ 37,370,656   $ 43,143,398
                                             ============  ============   ============  ============   ============
</TABLE>


See accompanying notes to consolidated financial statements.

<PAGE>
                   COOPERATIVE BANKSHARES, INC. AND SUBSIDIARY

                      Consolidated Statements of Cash Flows

                  Years Ended December 31, 2003, 2002 and 2001
<TABLE>
<CAPTION>

                                                                    2003              2002               2001
                                                              ---------------    ---------------   ----------------
<S>                                                                  <C>            <C>                    <C>
Net income                                                    $     5,404,226    $     4,944,497   $      2,888,943
Adjustments to reconcile net income to net cash
   provided (used) by operating activities:
     Net accretion and amortization                                   395,330            300,135             45,494
     Depreciation                                                     880,767            801,173            669,842
     Net gain on sale of securities                                   (50,663)          (135,182)          (125,172)
     Gain on sale of loans                                         (4,248,884)        (1,777,314)           (11,150)
     Deferred tax benefit                                            (188,149)            (3,990)          (276,589)
     Loss (gain) on sales of premises and equipment                        --           (464,977)             8,621
     Loss (gain) on sales of foreclosed real estate                    63,890             (6,855)             3,793
     Valuation losses on foreclosed real estate                         8,663                 --              2,807
     Provision for loan losses                                        740,000            740,000            460,000
     Proceeds from sales of loans                                 275,871,442        106,027,979            506,245
     Loan originations held for sale                             (252,499,961)      (129,910,600)                --
     Changes in assets and liabilities:
       Accrued interest receivable                                    387,460            397,541            139,037
       Prepaid expenses and other assets                             (274,672)          (148,324)          (843,020)
       Accrued interest payable                                      (104,501)            20,177            (36,005)
       Accrued expenses and other liabilities                      (1,610,964)         2,225,719            269,985
                                                              ---------------    ---------------   ----------------

          Net cash provided (used) by operating activities         24,773,984        (16,990,021)         3,702,831
                                                              ---------------    ---------------   ----------------

Purchases of securities available for sale                        (26,936,750)       (29,203,805)       (82,123,753)
Purchases of securities held to maturity                           (2,981,945)        (4,165,348)                --
Purchase of Lumina Mortgage Company                                  (400,000)          (773,188)                --
Proceeds from maturity of securities available for sale            13,900,000                 --         16,000,000
Proceeds from sale of securities available for sale                 1,060,000         24,058,015         43,107,351
Proceeds from maturities of securities held to maturity             5,000,000                 --          8,000,000
Repayments of mortgage-backed securities available for sale         9,654,231          6,721,816          2,413,006
Repayments of mortgage-backed securities held to maturity           1,865,872          1,192,533                 --
Loan originations, net of principal repayments                    (11,243,814)       (18,120,668)       (28,044,846)
Proceeds from disposals of foreclosed real estate                     854,428            221,207            643,413
Purchases of premises and equipment                                (3,140,041)        (1,311,187)          (902,513)
Proceeds from sales of premises and equipment                              --            499,071              3,518
Net expenditures on foreclosed real estate                             (8,236)          (111,829)           (35,352)
Purchases of FHLB stock                                            (2,149,900)          (350,000)          (399,600)
Proceeds from sale of FHLB stock                                    2,050,200            450,200                 --
Purchases of life insurance                                                --         (1,000,000)        (8,088,704)
                                                              ---------------    ---------------   ----------------

          Net cash used in investing activities                   (12,475,955)       (21,893,183)       (49,427,480)
                                                              ---------------    ---------------   ----------------

Net increase in deposits                                            9,817,417         17,424,044         12,517,728
Net proceeds (repayments) on short-term borrowings                (35,169,042)         6,585,827          5,000,000
Repayments on long-term obligations                                    (4,822)            (4,564)            (4,321)
Proceeds received on long-term obligations                         20,000,000         15,000,000         23,000,000
Proceeds from issuance of common stock, net                           187,090              5,425            261,249
Dividends paid                                                       (569,739)          (567,163)          (563,034)
Net change in escrow deposits                                         (24,171)             2,660           (339,831)
                                                              ---------------    ---------------   ----------------

          Net cash provided (used) by financing activities         (5,763,267)        38,446,229         39,871,791
                                                              ---------------    ---------------   ----------------

       Increase (decrease) in cash and cash equivalents             6,534,762           (436,975)        (5,852,858)

Cash and cash equivalents:
   Beginning of year                                               11,858,603         12,295,578         18,148,436
                                                              ---------------    ---------------   ----------------

   End of year                                                $    18,393,365    $    11,858,603   $     12,295,578
                                                              ===============    ===============   ================
</TABLE>

See accompanying notes to consolidated financial statements.

<PAGE>
                   COOPERATIVE BANKSHARES, INC. AND SUBSIDIARY

                      Consolidated Statements of Cash Flows
                                   (Continued)

                  Years Ended December 31, 2003, 2002 and 2001
<TABLE>
<CAPTION>

                                                                    2003              2002               2001
                                                              ---------------    ---------------   ----------------
<S>                                                                 <C>               <C>                 <C>
Cash paid for:
   Interest                                                   $    10,790,278    $    13,854,710    $    18,952,319
   Income taxes                                                     3,278,665          2,597,763          1,699,583

Summary of noncash investing and financing activities:
   Transfer from loans to other real estate owned                     479,462            989,602          1,151,318
   Transfer of premises and equipment to other real
     real estate owned                                                     --                 --             21,427
   Loans to facilitate the sale of foreclosed
     real estate                                                       72,000            918,450                 --
   Unrealized gains (losses) on securities available
     for sale, net of taxes                                          (350,249)           447,222            158,571
   Transfer of securities from held to maturity to
     available for sale at fair value                                      --                 --          5,946,000
   Accrual of goodwill for purchase of
     Lumina Mortgage Company                                          400,000                 --                 --
   Long-term obligations reclassified to short-term
     borrowings                                                    15,000,000         20,000,000         15,000,000

Sale and leaseback of premises and equipment:
   Increase in other receivable for proceeds on sale                  733,942                 --                 --
   Deferred gain on sale                                              121,147                 --                 --
</TABLE>



See accompanying notes to consolidated financial statements.

<PAGE>
                   COOPERATIVE BANKSHARES, INC. AND SUBSIDIARY

                   Notes to Consolidated Financial Statements

                           December 31, 2003 and 2002

(1)  Basis of Presentation and Significant Accounting Policies

     Basis of Presentation

     The consolidated financial statements include the accounts and transactions
     of  Cooperative  Bankshares,  Inc. (the  Company),  a bank holding  company
     incorporated under the laws of the State of North Carolina,  and its wholly
     owned subsidiary,  Cooperative Bank (the Bank), and the Bank's wholly owned
     subsidiaries,  Lumina Mortgage  Company,  Inc.  (Lumina) and CS&L Holdings,
     Inc.  (Holdings) and Holdings' majority owned subsidiary,  CS&L Real Estate
     Trust,  Inc. (REIT).  All significant  intercompany  transactions have been
     eliminated.

     Nature of Operations

     The Company  operates 24 offices  (including  20 full service  branches) in
     Eastern North Carolina,  North Myrtle Beach,  South Carolina,  and Virginia
     Beach,  Virginia,  and offers a wide range of  banking  services  including
     deposits,  bankcards,  and alternative  investment products.  The funds are
     used for the  extension  of credit  through home loans,  commercial  loans,
     consumer  loans,  and other  installment  credit such as home equity loans,
     auto and boat loans,  and check reserves.  The Company's  primary source of
     revenue is interest income from its loan and securities portfolios.

     Use of Estimates in the Preparation of Financial Statements

     The  preparation  of financial  statements  in conformity  with  accounting
     principles  generally  accepted  in the United  States of America  requires
     management  to make  estimates  and  assumptions  that affect the  reported
     amounts of assets and liabilities  and disclosure of contingent  assets and
     liabilities in the financial  statements  and  accompanying  notes.  Actual
     results could differ from those estimates.  The most significant  estimates
     made  by the  Company  in the  preparation  of the  consolidated  financial
     statements  are the  determination  of the reserve for loan losses and fair
     value estimates.

     Reclassifications

     Certain items included in prior years'  consolidated  financial  statements
     have been reclassified to conform to the current year  presentation.  These
     reclassifications  have no effect on the net income or stockholders' equity
     as previously reported.

     Significant Accounting Policies

     The significant accounting policies of the Company are summarized below:

     (a)  Cash and Cash Equivalents

          Cash and cash  equivalents  include  demand  and time  deposits  (with
          original maturities of ninety days or less) at other institutions.

          Federal  regulations  require  institutions  to  set  aside  specified
          amounts of cash as reserves against transaction and time deposits.  As
          of December 31, 2003, the daily average gross reserve  requirement was
          $1,107,000.
<PAGE>
                   COOPERATIVE BANKSHARES, INC. AND SUBSIDIARY

                   Notes to Consolidated Financial Statements

                           December 31, 2003 and 2002

(1)  Basis of Presentation and Significant Accounting Policies (Continued)

     Significant Accounting Policies (Continued)

     (b)  Securities

          Investments in certain securities are classified into three categories
          and accounted for as follows:  (1) debt securities that the entity has
          the positive intent and the ability to hold to maturity are classified
          as held to maturity  and  reported  at  amortized  cost;  (2) debt and
          equity securities that are bought and held principally for the purpose
          of selling them in the near term are classified as trading  securities
          and reported at fair value,  with unrealized gains and losses included
          in earnings;  (3) debt and equity  securities not classified as either
          held to maturity  securities or trading  securities  are classified as
          available  for  sale  securities  and  reported  at fair  value,  with
          unrealized  gains and losses  excluded from net income and reported as
          other  comprehensive  income and  included as a separate  component of
          stockholders' equity.

          Premiums are amortized and discounts are accreted  using the effective
          interest  method over the remaining  terms of the related  securities.
          Gains and losses on the sales of securities are  determined  using the
          specific-identification  method and are included in noninterest income
          at the time of sale.

     (c)  FHLB Stock

          The Company,  as a member of the Federal Home Loan Bank (FHLB) System,
          is required to maintain an  investment in capital stock of the FHLB of
          Atlanta in an amount  equal to the  greater  of 1% of its  outstanding
          home loans or 5% of its  outstanding  FHLB  advances.  No ready market
          exists for FHLB stock,  and it has no quoted  market  value.  The FHLB
          stock is carried at cost.

     (d)  Loans Held for Sale

          As a part of its normal business  operations,  the Company  originates
          mortgage  loans that have been  approved by secondary  investors.  The
          Company issues a rate lock  commitment to a customer and  concurrently
          "locks  in" with a  secondary  market  investor  under a best  efforts
          delivery  mechanism.  The  terms of the loan are set by the  secondary
          investors  and are  transferred  within  several  weeks of the Company
          initially funding the loan. The Company receives origination fees from
          borrowers and servicing  release  premiums from the investors that are
          recognized  on the  Statement of  Operations in the line item "gain on
          sale of  loans".  Between  the  initial  funding  of the  loans by the
          Company  and the  subsequent  purchase  by the  investor,  the Company
          carries the loans on its balance sheet at cost.

     (e)  Loans and Allowance for Loan Losses

          Loans are  stated at the  amount of unpaid  principal,  reduced  by an
          allowance  for loan losses,  unearned  discounts and net deferred loan
          origination  fees and costs.  Interest  income on loans is recorded on
          the  accrual  basis  based  upon  the  principal  amount  outstanding.
          Deferred  loan fees and costs and unearned  discounts are amortized to
          interest  income  over  the  contractual  life of the loan  using  the
          interest method.  If a loan is sold, the remaining  deferred loan fees
          and costs are included in gain on sale of loans in the period the loan
          is sold.



<PAGE>
                   COOPERATIVE BANKSHARES, INC. AND SUBSIDIARY

                   Notes to Consolidated Financial Statements

                           December 31, 2003 and 2002

(1)  Basis of Presentation and Significant Accounting Policies (Continued)

     Significant Accounting Policies (Continued)

     (e)  Loans and Allowance for Loan Losses (Continued)

          The Company  evaluates its loan portfolio in accordance with Statement
          of  Financial  Accounting  Standards  (SFAS) No. 114,  "Accounting  by
          Creditors  for  Impairment  of a Loan" as  amended  by SFAS  No.  118,
          "Accounting by Creditors for Impairment of a Loan - Income Recognition
          and Disclosure". Under these standards, a loan is considered impaired,
          based on current  information  and events,  if it is probable that the
          Company will be unable to collect the scheduled  payments of principal
          and interest when due according to the  contractual  terms of the loan
          agreement. Uncollateralized loans are measured for impairment based on
          the present  value of expected  future  cash flows  discounted  at the
          original  contractual  interest rate,  while all  collateral-dependent
          loans  are  measured  for  impairment  based on the fair  value of the
          collateral. As permitted by the Statement, smaller-balance homogeneous
          loans which consist  primarily of  residential  mortgages and consumer
          loans are evaluated collectively and reserves are established based on
          historical loss experience.

          The Company uses several factors in determining if a loan is impaired.
          The internal asset classification procedures include a thorough review
          of significant loans and lending relationships and the accumulation of
          related  data.  This data  includes  loan payment  status,  borrowers'
          financial data and borrowers' operating factors such as cash flows and
          operating income or loss.

          The  allowance  for loan  losses is  established  through a  provision
          charged to income. The allowance is an amount that management believes
          will be adequate to absorb probable losses on existing loans, based on
          the  evaluations  of the  collectibility  of loans and prior loan loss
          experience.  The evaluations take into  consideration  such factors as
          changes in the nature and volume of the loan portfolio quality, review
          of specific problem loans, and current economic  conditions and trends
          that may affect the  borrowers'  ability to pay. It is  possible  that
          such  factors  in  management's  evaluations  of the  adequacy  of the
          allowance for loan losses will change.  Thus,  future additions to the
          allowance may be necessary  based on the impact of changes in economic
          conditions.

          Additionally,  various  regulatory  agencies,  as an integral  part of
          their examination process, periodically review the Company's allowance
          for  loan  losses.  Such  agencies  may  require  adjustments  to  the
          allowance based on their judgments of information available to them at
          the time of their examination.

     (f)  Income Recognition on Impaired and Nonaccrual Loans

          Loans,   including   impaired  loans,  are  generally   classified  as
          nonaccrual if they are past due for a payment of principal or interest
          for a period of more than 90 days,  unless such loans are well-secured
          and in the process of collection.  Loans that are on a current payment
          status  or past  due  less  than 90 days  may  also be  classified  as
          nonaccrual  if repayment in full of  principal  and/or  interest is in
          doubt.  When  interest  accrual is  discontinued,  all unpaid  accrued
          interest is reversed.  Interest income is subsequently recognized only
          to the extent cash payments are received.

          Loans  may be  returned  to  accrual  status  when all  principal  and
          interest  amounts   contractually   due  (including   arrearages)  are
          reasonably  assured of repayment within an acceptable  period of time,
          and there is a sustained period of repayment performance  (generally a
          minimum  of six  months)  by the  borrower,  in  accordance  with  the
          contractual terms of interest and principal.

          When  the  future  collectibility  of the  recorded  loan  balance  is
          expected,  interest  income may be recognized on a cash basis.  In the
          case  where  a  nonaccrual   loan  had  been  partially   charged-off,
          recognition of interest on a cash basis is limited to that which would
          have been  recognized on the recorded loan balance at the  contractual
          interest  rate.  Receipts  in excess of that  amount are  recorded  as
          recoveries to the  allowance  for loan losses until prior  charge-offs
          have been fully recovered.



<PAGE>
                   COOPERATIVE BANKSHARES, INC. AND SUBSIDIARY

                   Notes to Consolidated Financial Statements

                           December 31, 2003 and 2002

(1)  Basis of Presentation and Significant Accounting Policies (Continued)

     (g)  Transfers and Servicing of Financial Assets

          Servicing loans for others generally  consists of collecting  mortgage
          payments,   maintaining  escrow  accounts,   disbursing   payments  to
          investors  and  foreclosure  processing.   Loan  servicing  income  is
          recorded  on the cash basis  less the  amortized  amount for  retained
          servicing  rights  and  includes  servicing  fees from  investors  and
          certain charges collected from borrowers, such as late payment fees.

     (h)  Other Real Estate Owned

          Other real estate owned is recorded initially at the lower of the loan
          balance or estimated fair value of the property less  estimated  costs
          to sell  at the  date  of  foreclosure  and  subsequently  reduced  by
          additional  allowances  which are charged to earnings if the estimated
          fair value  declines  below its  initial  value  plus any  capitalized
          costs.   Costs  related  to  the   improvement  of  the  property  are
          capitalized,  whereas  those  related  to  holding  the  property  are
          expensed.

     (i)  Premises and Equipment

          Premises  and   equipment   are  carried  at  cost  less   accumulated
          depreciation  and  amortization.  The  provision for  depreciation  is
          computed  using the  straight-line  method over the  estimated  useful
          lives of the various classes of assets.  Useful lives range from 15 to
          40 years for buildings and 5 to 10 years for furniture and  equipment.
          The cost of leasehold  improvements is amortized on the  straight-line
          method over the lesser of the lives of the  improvements  or the terms
          of the  leases.  Repairs  and  maintenance  are  charged to expense as
          incurred.

     (j)  Goodwill

          Goodwill  resulting from the acquisition of Lumina Mortgage Company in
          2002 is not  amortized but is tested for  impairment  annually or more
          often if an event or  circumstance  indicates that an impairment  loss
          has been incurred.

     (k)  Income Taxes

          Deferred  tax  asset  and   liability   balances  are   determined  by
          application to temporary differences of the tax rate expected to be in
          effect when taxes become payable or receivable.  Temporary differences
          are  differences  between the tax basis of assets and  liabilities and
          their reported amounts in the consolidated  financial  statements that
          will result in taxable or deductible amounts in future years.

     (l)  Stock-Based Compensation

          On January 1, 1996 the Company  adopted SFAS No. 123,  "Accounting for
          Stock-Based  Compensation".  As permitted by SFAS No. 123, the Company
          has chosen to continue to apply APB  Opinion No. 25,  "Accounting  for
          Stock Issued to  Employees"  and related  interpretations.  The option
          exercise price is the market price of the common stock on the date the
          option  is  granted.   Accordingly,  no  compensation  cost  has  been
          recognized for options granted under the Option Plan. Had compensation
          cost for the Company's  Option Plan been determined  based on the fair
          value at the grant dates for awards  under the Option Plan  consistent
          with the  method of SFAS No.  123,  the  Company's  net income and net
          income  per share  would have been  reduced  to the pro forma  amounts
          indicated below.
<PAGE>
                   COOPERATIVE BANKSHARES, INC. AND SUBSIDIARY

                   Notes to Consolidated Financial Statements

                           December 31, 2003 and 2002

(1)  Basis of Presentation and Significant Accounting Policies (Continued)

     (l)  Stock-Based Compensation (Continued)

<TABLE>
<CAPTION>

                                                                             Year ended December 31,
                                                                    2003              2002               2001
                                                              ---------------    ---------------   ----------------
                <S>                                                <C>               <C>                   <C>
              Net income, as reported                         $     5,404,226    $     4,944,497   $      2,888,943
              Deduct:  Total stock-based employee
                compensation expense determined
                under fair value based method for all
                awards, net of related tax effects                         --            (60,543)           (29,097)
                                                              ---------------    ---------------   ----------------

              Proforma net income                             $     5,404,226    $     4,883,954   $      2,859,846
                                                              ===============    ===============   ================

              Earnings per share:
                Basic - as reported                           $          1.90    $          1.74   $           1.03
                                                              ===============    ===============   ================
                Basic - proforma                              $          1.90    $          1.72   $           1.02
                                                              ===============    ===============   ================
                Diluted- as reported                          $          1.86    $          1.73   $           1.02
                                                              ===============    ===============   ================
                Diluted - proforma                            $          1.86    $          1.71   $           1.01
                                                              ===============    ===============   ================
</TABLE>

               The fair value of each option  grant is  estimated on the date of
               grant  using  the  Black-Scholes  option-pricing  model  with the
               following   weighted-average   assumptions  used for   grants  in
               2002 and 2001.  The  weighted  average  fair  values  of  options
               granted in 2002 and 2001 were $3.60 and $2.65,  respectively.  No
               options were granted in 2003.
<TABLE>
<CAPTION>

                                                                                      2002               2001
                                                                                 ---------------   ----------------
                <S>                                                                     <C>              <C>

              Risk-free interest rate                                                      4.79%              4.86%

              Dividend yield                                                               1.45%              1.85%

              Expected volatility                                                            25%                20%

              Expected lives (in years)                                                      8                  8
</TABLE>
     (m)  Comprehensive Income

          The   Company   reports  as   comprehensive   income  all  changes  in
          stockholders'  equity  during the year from  nonowner  sources.  Other
          comprehensive  income refers to all  components  (revenues,  expenses,
          gains, and losses) of comprehensive  income that are excluded from net
          income.   The   Company's   only   component  of   accumulated   other
          comprehensive  income is  unrealized  gains and  losses on  securities
          available for sale.

     (n)  Segment Information

          SFAS No. 131, "Disclosures about Segments of an Enterprise and Related
          Information", requires that public business enterprises report certain
          information about operating segments. It also requires that the public
          business   enterprises  report  related  disclosures  and  descriptive
          information  about  products  and  services  provided  by  significant
          segments,  geographic areas, and major customers,  differences between
          the  measurements  used in  reporting  segments  and those used in the
          enterprise's  general-purpose financial statements, and changes in the
          measurement of segment amounts from period to period.
<PAGE>
                   COOPERATIVE BANKSHARES, INC. AND SUBSIDIARY

                   Notes to Consolidated Financial Statements

                           December 31, 2003 and 2002

(1)  Basis of Presentation and Significant Accounting Policies (Continued)

     (n)  Segment Information (Continued)

          The Company has determined that it operates primarily in one operating
          segment providing general  commercial  financial services to customers
          located  in the single  geographic  area of  Eastern  North  Carolina,
          Southeastern  Virginia and  Northeastern  South Carolina.  The various
          products  are those  generally  offered by  community  banks,  and the
          allocation  of  resources is based on the overall  performance  of the
          institution, versus the individual branches or products.

     (o)  New Accounting Pronouncements

          On January 1, 2001, the Company adopted SFAS No. 133,  "Accounting for
          Derivative  Instruments  and Hedging  Activities".  The  statement  is
          effective for fiscal years beginning after June 15, 2000, with earlier
          adoption  permitted,  as  amended  by  SFAS  No.  137.  SFAS  No.  133
          establishes   accounting   and  reporting   standards  for  derivative
          instruments  and for hedging  activities.  The  statement  requires an
          entity to recognize all derivatives as either assets or liabilities in
          the statement of financial  position and measure those  instruments at
          fair   value.   On   January   1,  2001,   the   Company   transferred
          held-to-maturity  investment  securities  with  an  amortized  cost of
          approximately  $5,978,000 to the  available-for-sale  category at fair
          value as allowed by SFAS No. 133. The  unrealized  loss at the time of
          transfer was approximately $32,000 before tax. Such transfers from the
          held-to-maturity  category at the date of initial  adoption  shall not
          call into question the Company's  intent to hold other debt securities
          to maturity in the future.

          The Company does not engage in hedging  activities  except for the buy
          and sell  commitments  for  loans  held for  sale,  which  are  deemed
          immaterial due to the fact the Company  issues a rate lock  commitment
          to a customer  and  concurrently  "locks in" the loan with a secondary
          market investor under a best efforts  delivery  mechanism.  Therefore,
          market  risk  is  mitigated  because  any  commitment  to  fund a loan
          available  for sale is  concurrently  hedged by a  commitment  from an
          investor to purchase the loan under the same terms.  Loans are usually
          sold  within 60 days  after  closing.  Other  than the  aforementioned
          transfer of securities,  the adoption of the Statement had no material
          impact on the Company.

          On  July  1,  2001,  the  Company  adopted  SFAS  No.  141,  "Business
          Combinations".   This  Statement  improves  the  transparency  of  the
          accounting and reporting for business  combinations  by requiring that
          all business combinations be accounted for under a single method - the
          purchase method. Use of the  pooling-of-interests  method is no longer
          permitted.  SFAS No. 141 requires that the purchase method be used for
          business  combinations  initiated  after June 30,  2001.  The purchase
          method  was used in  recording  the  acquisition  of  Lumina  Mortgage
          Company.

          On January 1, 2002,  the Company  adopted SFAS No. 142  "Goodwill  and
          Other  Intangible  Assets".  This Statement  requires that goodwill no
          longer  be  amortized  to  earnings,   but  instead  be  reviewed  for
          impairment.  The Company did not have any goodwill  until the purchase
          of Lumina  Mortgage  Company on May 31, 2002.  This  purchase  created
          goodwill in the amount of $1,461,543. In accordance with Statement No.
          142,  this  goodwill  will not be amortized but instead will be tested
          for impairment annually.

          In June 2001,  the FASB  issued SFAS No.  143,  "Accounting  for Asset
          Retirement  Obligations".  SFAS No. 143 requires the Company to record
          the fair value of an asset retirement obligation as a liability in the
          period  in which  it  incurs a legal  obligation  associated  with the
          retirement  of  tangible   long-lived  assets  that  result  from  the
          acquisition,  construction,  development,  and/or  normal  use  of the
          assets.  The  Company  also  records  a  corresponding  asset  that is
          depreciated  over the life of the  asset.  Subsequent  to the  initial
          measurement of the asset retirement obligation, the obligation will be
          adjusted  at the end of each period to reflect the passage of time and
          changes in the estimated  future cash flows underlying the obligation.
          The Company  adopted SFAS No. 143 on January 1, 2003.  The adoption of
          SFAS  No.  143  did  not  have a  material  effect  on  the  Company's
          consolidated financial statements.



<PAGE>

                   COOPERATIVE BANKSHARES, INC. AND SUBSIDIARY

                   Notes to Consolidated Financial Statements

                           December 31, 2003 and 2002

(1)  Basis of Presentation and Significant Accounting Policies (Continued)

     (o)  New Accounting Pronouncements (Continued)

          In August  2001,  the FASB issued SFAS No.  144,  "Accounting  for the
          Impairment or Disposal of Long-Lived  Assets",  which  supersedes SFAS
          No. 121,  "Accounting for the Impairment of Long-Lived  Assets and for
          Long-Lived Assets to Be Disposed Of", and the accounting and reporting
          provisions  of  APB  Opinion  No.  30,   "Reporting   the  Results  of
          Operations--Reporting  the  Effects  of  Disposal  of a  Segment  of a
          Business, and Extraordinary, Unusual and Infrequently Occurring Events
          and Transactions".  SFAS No. 144 establishes a single accounting model
          for long-lived assets to be disposed of by a sale. The Company adopted
          the provisions of SFAS No. 144 on January 1, 2002. The  implementation
          did not have a material impact on the Company's consolidated financial
          statements.

          In April 2003,  the FASB issued SFAS No. 149,  "Amendment of Statement
          No. 133 on Derivative  Instruments and Hedging  Activities."  SFAS No.
          149 improves  financial  reporting by requiring  that  contracts  with
          comparable  characteristics be accounted for similarly. In particular,
          SFAS No. 149  clarifies  under what  circumstances  a contract with an
          initial  net  investment  meets the  characteristic  of a  derivative,
          clarifies when a derivative contains a financing component, amends the
          definition of an "underlying" to conform it to language used in FIN 45
          and amends  certain  other  existing  pronouncements.  SFAS No. 149 is
          effective for contracts  entered into or modified after June 30, 2003,
          and for  hedging  relationships  designated  after June 30,  2003.  In
          addition, with some exceptions,  all provisions of SFAS No. 149 should
          be applied prospectively.  The adoption of SFAS No. 149 did not have a
          material impact on the consolidated financial statements.

          In May 2003,  the FASB issued SFAS No.  150,  "Accounting  for Certain
          Financial  Instruments  with  Characteristics  of both Liabilities and
          Equity."  This  Statement  establishes  standards  for  how an  issuer
          classifies   and   measures   certain   financial   instruments   with
          characteristics  of both  liabilities and equity.  It requires that an
          issuer  classify a financial  instrument that is within its scope as a
          liability  (or an  asset in some  circumstances).  This  Statement  is
          effective  for financial  instruments  entered into or modified by the
          Company  after May 31, 2003,  and is effective at the beginning of the
          first interim period beginning after June 15, 2003. However,  the FASB
          has  deferred   indefinitely   the   classification   and  measurement
          provisions   as  they  related  to  certain   mandatorily   redeemable
          noncontrolling  interests. The adoption of SFAS No. 150 did not have a
          material impact on the consolidated financial statements.

          In  January  2003,  the  FASB  issued  Interpretation  No.  (FIN)  46,
          "Consolidation  of Variable  Interest  Entities." This  interpretation
          addresses  the  consolidation  by  business  enterprises  of  variable
          interest entities as defined in the interpretation.  In December 2003,
          the FASB issued a revision to FIN 46 (FIN 46R) to clarify  some of the
          provisions  of  FIN  46  and  to  exempt  certain  entities  from  its
          requirements.  FIN 46R is  effective  for  public  entities  that have
          interests   in   structures   that  are   commonly   referred   to  as
          special-purpose  entities for periods  ending after December 15, 2003.
          Application by public entities, other than small business issuers, for
          all other types of variable interest entities is required in financial
          statements  for periods  ending after March 15, 2004. The Company does
          not expect that FIN 46 and FIN 46R will have a material  impact on its
          consolidated financial statements.

          In November  2003,  the Emerging  Issues Task Force  (EITF)  reached a
          partial consensus on Issue 03-1, "The Meaning of  Other-Than-Temporary
          Impairment  and Its  Application to Certain  Investments."  Issue 03-1
          requires  certain   quantitative   and  qualitative   disclosures  for
          investments   subject  to  SFAS  No.  115,   "Accounting  for  Certain
          Investments in Debt and Equity  Securities,"  that are impaired at the
          balance  sheet date but for which an  other-than-temporary  impairment
          has not been recognized.  The Company adopted the partial consensus on
          Issue  03-1  during  2003  and has  provided  the new  disclosures  in
          footnote  2. The  EITF is  expected  to  continue  deliberating  other
          aspects    of    Issue    03-1,    including    when   to    recognize
          other-than-temporary impairment.



<PAGE>
                   COOPERATIVE BANKSHARES, INC. AND SUBSIDIARY

                   Notes to Consolidated Financial Statements

                           December 31, 2003 and 2002



(1)  Basis of Presentation and Significant Accounting Policies (Continued)

     (o)  New Accounting Pronouncements (Continued)

          In  December  2003,  the FASB  issued  SFAS No.  132  (Revised  2003),
          Employers'   Disclosures  about  Pensions  and  Other   Postretirement
          Benefits.  This Statement retains the disclosure  requirements in SFAS
          No. 132 and requires  additional  details  about plan assets,  benefit
          obligations,  cash flows,  benefit costs,  assumptions  used and other
          relevant  information  for  companies  with  pension  plans  and other
          postretirement benefit plans. A description of investment policies and
          strategies and target allocation  percentages,  or target ranges,  for
          asset categories also are required in financial statements.  These new
          disclosures are required for years ending after December 15, 2003. The
          Company  adopted  SFAS No.  132  (Revised  2003)  during  2003 and has
          provided  the  new  disclosures  in  Note  9.  Additional  disclosures
          regarding  projections of future benefit payments will be required for
          years ending after June 15, 2004.

(2)  Securities

     Securities as of December 31, 2003 and 2002 are summarized as follows:
<TABLE>
<CAPTION>

                                                                               2003
                                                ----------------------------------------------------------------
                                                                      Gross           Gross           Estimated
                                                 Amortized         Unrealized      Unrealized           Market
                                                   Cost               Gains          Losses             Value
                                                 ---------         -----------     ----------         ---------
          <S>                                     <C>                <C>            <C>                 <C>
       SECURITIES AVAILABLE FOR SALE:
         U.S. Government and
           agency securities                   $   25,148,511    $     358,052     $          --   $    25,506,563
         Mortgage-backed securities                11,584,165          201,541           296,928        11,488,778
         Marketable equity securities               4,975,000           74,625                --         5,049,625
         Corporate bonds                            1,473,237           94,909                --         1,568,146
                                               --------------    -------------     -------------   ---------------

           Total                               $   43,180,913    $     729,127     $     296,928   $    43,613,112
                                               ==============    =============     =============   ===============

       SECURITIES HELD TO MATURITY:
         Mortgage-backed securities            $    3,806,376    $      83,360     $          --   $     3,889,736
                                               --------------    -------------     -------------   ---------------

           Total                               $    3,806,376    $      83,360     $          --   $     3,889,736
                                               ==============    =============     =============   ===============
</TABLE>
<TABLE>
<CAPTION>

                                                                               2002
                                               -------------------------------------------------------------------
                                                                      Gross            Gross          Estimated
                                                 Amortized         Unrealized       Unrealized          Market
                                                   Cost               Gains           Losses            Value
                                                -----------        ----------       ----------        ----------
              <S>                                   <C>                 <C>           <C>                <C>
      SECURITIES AVAILABLE FOR SALE:
         U.S. Government and
           agency securities                   $   19,104,121    $     558,725     $          --   $    19,662,846
         Mortgage-backed securities                14,457,784          348,228                --        14,806,012
         Marketable equity securities               4,975,000           99,500                --         5,074,500
         Corporate bonds                            2,496,504           59,743            24,393         2,531,854
                                               --------------    -------------     -------------   ---------------

           Total                               $   41,033,409    $   1,066,196     $      24,393   $    42,075,212
                                               ==============    =============     =============   ===============

       SECURITIES HELD TO MATURITY:
         U.S. Government and
           agency securities                   $    5,000,000    $     122,600     $          --   $     5,122,600
         Mortgage-backed securities                 2,859,955           26,532                --         2,886,487
                                               --------------    -------------     -------------   ---------------

           Total                               $    7,859,955    $     149,132     $          --   $     8,009,087
                                               ==============    =============     =============   ===============
</TABLE>

<PAGE>
                   COOPERATIVE BANKSHARES, INC. AND SUBSIDIARY

                   Notes to Consolidated Financial Statements

                           December 31, 2003 and 2002

(2)  Securities (Continued)

     The following table shows  investments'  gross  unrealized  losses and fair
     value,  aggregated  by  investment  category  and  length  of time that the
     individual  securities have been in a continuous  unrealized loss position,
     at December 31, 2003.
<TABLE>
<CAPTION>

                                        Less Than 12 Months         12 Months or More                Total
                                     ------------------------   ------------------------  -------------------------
                                        Fair       Unrealized      Fair       Unrealized      Fair       Unrealized
                                        value        losses        value       losses         value       losses
                                     -----------  -----------   ----------   -----------  -----------   -----------
          <S>                             <C>        <C>          <C>          <C>           <C>           <C>

       SECURITIES AVAILABLE FOR SALE:
         Mortgage-backed securities  $ 4,908,602  $   296,928   $       --   $        --  $ 4,908,602   $   296,928
                                     -----------  -----------   ----------   -----------  -----------   -----------

         Total temporarily impaired
           securities                $ 4,908,602  $   296,928   $       --   $        --  $ 4,908,602   $   296,928
                                     ===========  ===========   ==========   ===========  ===========   ===========
</TABLE>

     Temporarily  impaired  securities consist of one security that is an agency
     backed   collateralized   mortgage  obligation.   This  security  has  been
     temporarily impaired for a short-term, is agency backed and does not have a
     premium associated with it. Therefore,  the Company believes the impairment
     is temporary and relates to the current  interest rate  environment  and is
     not a permanent impairment.

     The  maturities  of  securities  at  December  31, 2003 are  summarized  as
     follows:
<TABLE>
<CAPTION>

                                                                                                     Estimated
                                                                                   Amortized          Market
                                                                                      Cost             Value
                                                                                 -------------    -------------
           <S>                                                                      <C>                 <C>
       Held to maturity:
       Within 1 year                                                             $           --   $           --
       Mortgage-backed securities                                                     3,806,376        3,889,736
                                                                                 --------------   --------------

                                                                                 $    3,806,376   $    3,889,736
                                                                                 ==============   ==============
       Available for sale:
       Within 1 year                                                             $      200,371   $      201,812
       After 1 year through 5 years                                                  16,461,437       16,808,796
       After 5 years through 10 years                                                 9,959,940       10,064,101
       Marketable equity securities                                                   4,975,000        5,049,625
       Mortgage-backed securities                                                    11,584,165       11,488,778
                                                                                 --------------   --------------

                                                                                 $   43,180,913   $   43,613,112
                                                                                 ==============   ==============
</TABLE>

     Expected  maturities  for  mortgage-backed   securities  will  differ  from
     contractual   maturities   because  borrowers  have  the  right  to  prepay
     obligations without prepayment penalties.

     For the three years ended December 31, 2003, sales of investment securities
     resulted in gross realized  gains of $50,663 in 2003,  gross realized gains
     of $135,182 in 2002, and gross realized gains of $125,172 in 2001.

     Investment  securities having an aggregate carrying value of $15,214,100 at
     December  31,  2003  were  pledged  to  secure  public  funds  on  deposit.
     Investment  securities  having an aggregate  carrying  value of $201,812 at
     December 31, 2003 were pledged to secure repurchase agreements.  Investment
     securities having an aggregate carrying value of $1,568,146 at December 31,
     2003 were  pledged to secure the  Treasury  tax and loan  account  with the
     Federal Reserve Bank.

<PAGE>
                   COOPERATIVE BANKSHARES, INC. AND SUBSIDIARY

                   Notes to Consolidated Financial Statements

                           December 31, 2003 and 2002
(3)  Loans

     Loans  at  December  31,  2003  and  2002 are  summarized  as  follows  (in
     thousands):
<TABLE>
<CAPTION>
                                                                                      2003              2002
                                                                                 --------------   --------------
            <S>                                                                       <C>                <C>
       Real estate:
         Construction and land development                                       $       57,598   $       51,431
         Mortgage:
           1-4 family residential                                                       206,476          204,395
           Multi-family residential                                                      13,357           17,044
           Commercial                                                                    91,627           87,257
           Equity line                                                                   16,006           14,541
           Other                                                                            359              363
                                                                                 --------------   --------------

           Total real estate loans                                                      385,423          375,031

         Commercial, industrial and agricultural                                         14,599           13,717
         Consumer                                                                         6,069            6,396
                                                                                 --------------   --------------

           Total gross loans                                                            406,091          395,144

         Unamortized net deferred fees                                                   (1,402)          (1,331)
                                                                                 --------------   --------------

           Loans                                                                 $      404,689   $      393,813
                                                                                 ==============   ==============
</TABLE>
       In the normal course of business, the Company originates loans to related
       parties. Related parties include directors, executive officers, principal
       shareholders of equity securities, or any associate of such persons. The
       activity with respect to related party loans is summarized below for the
       year ending December 31, 2003 (in thousands):
<TABLE>
<CAPTION>
                        <S>                                                               <C>
                  Balance at beginning of year                                   $        7,807
                  New loans                                                               2,255
                  Repayments                                                               (838)
                                                                                 --------------

                  Balance at end of year                                         $        9,224
                                                                                 ==============
</TABLE>

       Activity in the allowance for loan losses for the years ended December
       31, 2003, 2002 and 2001 is summarized as follows (in thousands):
<TABLE>
<CAPTION>
                                                                      2003             2002             2001
                                                                 -------------     -------------  ----------------
        <S>                                                           <C>               <C>               <C>
       Balance at beginning of year                              $       2,937     $       2,523   $         2,160
       Provision for loan losses                                           740               740               460
       Loans charged-off                                                  (237)             (360)             (106)
       Recoveries                                                            7                34                 9
                                                                 -------------     -------------   ---------------

       Balance at end of year                                    $       3,447     $       2,937   $         2,523
                                                                 =============     =============   ===============
</TABLE>
<PAGE>

                   COOPERATIVE BANKSHARES, INC. AND SUBSIDIARY

                   Notes to Consolidated Financial Statements

                           December 31, 2003 and 2002

(3)  Loans (Continued)

     The following is a summary of nonperforming assets at December 31, 2003 and
     2002 (in thousands):
<TABLE>
<CAPTION>

                                                                                       2003             2002
                                                                                   -------------  ----------------
                <S>                                                                     <C>              <C>
       Loans 90 days past due and still accruing interest                          $         147   $           249
       Nonaccrual loans                                                                      120               335
       Other real estate owned                                                                --               619
                                                                                   -------------   ---------------

       Total                                                                       $         267   $         1,203
                                                                                   =============   ===============
</TABLE>

     At December  31, 2003,  2002 and 2001,  the  recorded  investment  in loans
     considered  impaired  in  accordance  with SFAS No. 114  totaled  $120,372,
     $334,289  and  $505,378,  respectively,  with  no  corresponding  valuation
     allowances.  For the years ended  December  31,  2003,  2002 and 2001,  the
     average recorded  investment in impaired loans was approximately  $150,000,
     $254,000 and $513,000,  respectively.  The amount of interest recognized on
     impaired  loans during the portion of the year that they were  impaired was
     not material.

     In the normal course of business, the Company enters into off-balance sheet
     commitments  to  extend  credit.  The  Company  maintains  the same  credit
     policies  in  making  off-balance  sheet  commitments  as it  does  for its
     on-balance sheet  instruments.  Commitments to extend credit are agreements
     to lend which generally have fixed  expiration  dates or other  termination
     clauses and may require a fee.

     The following table summarizes the Company's outstanding  off-balance sheet
     commitments to extend credit at December 31, 2003 and 2002 (in thousands):
<TABLE>
<CAPTION>

                                                                                       2003             2002
                                                                                   -------------  ----------------
                <S>                                                                     <C>              <C>
       Undisbursed portion of home equity lines of credit collateralized
          primarily by junior liens on 1-4 family
           properties                                                              $      15,431   $        14,130
       Other commitments and credit lines                                                 15,275            13,843
       Undisbursed portion of construction loans                                          45,311            32,667
       Fixed-rate mortgage loan commitments                                                1,031               879
       Adjustable-rate mortgage loan commitments                                           5,815             5,614
       Available-for-sale mortgage loan commitments                                        2,954             3,729
                                                                                   -------------   ---------------

       Total                                                                       $      85,817   $        70,862
                                                                                   =============   ===============
</TABLE>

     As commitments  may expire  unused,  the total  commitment  amount does not
     necessarily represent future cash requirements.

     The Company, through its normal lending activity,  originates and maintains
     loans which are substantially concentrated in Eastern North Carolina, where
     most of its offices are located.  The Company's policy calls for collateral
     or other forms of repayment  assurance to be received  from the borrower at
     the time of loan  origination.  Such  collateral or other form of repayment
     assurance  is subject to changes in economic  value due to various  factors
     beyond the control of the Company and such changes could be significant.

     Loans serviced for others are not included in the accompanying consolidated
     balance sheets.  The unpaid principal  balances of mortgage and other loans
     serviced  for  others  were  approximately  $44,851,000,   $44,809,000  and
     $56,041,000 at December 31, 2003, 2002 and 2001, respectively. The carrying
     value of capitalized servicing rights is included in other assets.  Changes
     in mortgage  servicing rights  capitalized for the year  ended December 31,
     2003 are as follows:
<PAGE>
                   COOPERATIVE BANKSHARES, INC. AND SUBSIDIARY

                   Notes to Consolidated Financial Statements

                           December 31, 2003 and 2002
(3)    Loans (Continued)
<TABLE>
<CAPTION>

                                                                                       2003
                                                                                   -------------
                <S>                                                                   <C>
       Mortgage servicing rights, beginning of year                                $      73,240
       Mortgage servicing rights, capitalized                                            162,064
                                                                                   -------------
                                                                                         235,304
       Accumulated amortization                                                           33,742
                                                                                   -------------
       Mortgage servicing rights, end of year, net
         of amortization                                                           $     201,562
                                                                                   =============
</TABLE>
     The Company  originates both adjustable and fixed interest rate loans.  The
     adjustable-rate  loans have interest rate  adjustment  limitations  and are
     indexed to various nationally recognized indexes or financial  instruments.
     Future  market  factors may affect the  correlation  of the  interest  rate
     adjustment with rates the Company pays on the short term deposits that have
     been primarily utilized to fund these loans.

(4)  Premises and Equipment

     Premises  and  equipment at December  31, 2003 and 2002 are  summarized  as
     follows (in thousands):
<TABLE>
<CAPTION>
                                                                                       2003             2002
                                                                                   -------------  ----------------
        <S>                                                                             <C>               <C>
       Land                                                                        $       2,239  $          2,526
       Buildings                                                                           6,486             5,539
       Leasehold improvements                                                              1,058               369
       Furniture and equipment                                                             7,523             6,516
                                                                                   -------------   ---------------

                                                                                          17,306            14,950
       Less accumulated depreciation and amortization                                     (8,640)           (7,931)
                                                                                   -------------   ---------------

       Premises and equipment, net                                                 $       8,666   $         7,019
                                                                                   =============   ===============
</TABLE>

(5)  Deposits

     Deposits  at  December  31,  2003 and 2002 are  summarized  as follows  (in
     thousands):
<TABLE>
<CAPTION>
                                                                                       2003             2002
                                                                                   -------------  ----------------
         <S>                                                                           <C>                 <C>
       Demand                                                                      $      26,608   $        19,800
       Checking with interest                                                             25,891            20,630
       Money market accounts                                                              26,630            24,213
       Savings                                                                            21,417            20,345
       Time deposits of $100 or more                                                      91,834            85,831
       Other time deposits                                                               174,692           186,435
                                                                                   -------------   ---------------

       Total                                                                       $     367,072   $       357,254
                                                                                   =============   ===============
</TABLE>
<PAGE>
                   COOPERATIVE BANKSHARES, INC. AND SUBSIDIARY

                   Notes to Consolidated Financial Statements

                           December 31, 2003 and 2002
(5)  Deposits (Continued)

     At December 31, 2003,  the  scheduled  maturities of time deposits were (in
     thousands):
<TABLE>
<CAPTION>
           <S>                                                                             <C>
           2004                                                                    $     233,608
           2005                                                                           29,350
           2006                                                                            3,465
           2007                                                                               82
           2008                                                                                -
           Thereafter                                                                         21
                                                                                   -------------

                Total time deposits                                                $     266,526
                                                                                   =============
</TABLE>

(6)  Borrowed Funds

     Borrowed  funds  and the  corresponding  weighted  average  rates  (WAR) at
     December 31, 2003 and 2002 are summarized as follows:
<TABLE>
<CAPTION>

                                                   2003                WAR             2002              WAR
                                             ----------------   --------------    --------------  ----------------
                <S>                                  <C>             <C>                 <C>               <C>
           Advances from FHLB                $     83,000,000            3.06%    $   81,000,000             3.84%
           Affordable Housing Program
                advances from FHLB                     87,770            3.50%            92,592             3.50%
           Advances for loans held
                for sale                            6,251,087            3.86%        23,485,233             4.09%
           Repurchase agreements                      165,698            0.37%           100,594             0.70%
                                             ----------------                     --------------

                      Total                  $     89,504,555                     $  104,678,419
                                             ================                     ==============
</TABLE>

     Pursuant  to  a   collateral   agreement   with  the  FHLB,   advances  are
     collateralized  by all  the  Company's  FHLB  stock  and  qualifying  first
     mortgage  loans.  The  balance of  qualifying  first  mortgage  loans as of
     December 31, 2003 was approximately  $145,667,000.  This agreement with the
     FHLB  provides  for a line of credit up to 25% of the  Bank's  assets.  The
     maximum  month end balances  were $83 million,  $83 million and $83 million
     during the years ended  December  31,  2003,  2002 and 2001,  respectively.
     Annual  principal  maturities  of Federal Home Bank  advances for the years
     subsequent to December 31, 2003 are as follows (in thousands):
<TABLE>
<CAPTION>
           <S>                                                                           <C>
           2004                                                                    $      35,000
           2005                                                                           10,000
           2006                                                                           10,000
           2008                                                                            5,000
           2010                                                                           10,000
           2011                                                                           13,000
                                                                                   -------------
                                                                                   $      83,000
                                                                                   =============
</TABLE>

     The Affordable  Housing Program advances are funds advanced by the FHLB for
     the Company to lend to borrowers who might not otherwise qualify for a home
     mortgage.  These  advances  have an  interest  rate of 3.50% and  mature at
     various times between November 2015 and January 2016.
<PAGE>
                   COOPERATIVE BANKSHARES, INC. AND SUBSIDIARY

                   Notes to Consolidated Financial Statements

                           December 31, 2003 and 2002

(6)  Borrowed Funds (Continued)

     Lumina  borrows  money  on a  short-term  basis  principally  from  another
     financial institution to fund its loans that are held for sale. The balance
     of this  borrowing  was $6.3 million and $23.5 million at December 31, 2003
     and 2002,  respectively.  Borrowings  for loans that were  funded from this
     line of credit  within 60 days were at a rate of 3.37% and  borrowings  for
     loans  that  were  funded  more than 60 days  ($668,000)  were at a rate of
     8.00%.  This borrowing is  collateralized  by mortgage loans held for sale.
     When a loan is sold,  the proceeds are used to repay the  borrowing.  Loans
     are usually  sold within 60 days.  This  borrowing  agreement  is currently
     being  renegotiated,  but the  financial  institution  continues  to supply
     sufficient funds for loans originated by Lumina.

     Cooperative  enters into agreements with customers to transfer excess funds
     in a demand  account  into a  repurchase  agreement.  Under the  repurchase
     agreement,  the Bank sells the customer an interest in securities  that are
     direct obligations of the United States Government. The customer's interest
     in the underlying  security shall be repurchased by the Bank at the opening
     of the next banking day. The rate fluctuates weekly and is tiered, with the
     highest rate being .50% below the 90-day Treasury Bill.

(7)  Regulatory Matters and Capital Requirements

     The  Company  is  subject  to  various  regulatory   capital   requirements
     administered by federal and state banking agencies. Failure to meet minimum
     capital   requirements  can  initiate  certain   mandatory,   and  possibly
     additional  discretionary actions by regulators that, if undertaken,  could
     have a direct  material  effect  on the  Company's  consolidated  financial
     statements.  Quantitative  measures  established  by  regulation  to ensure
     capital  adequacy  require  the  Company to  maintain  minimum  amounts and
     ratios,  as set  forth  in the  table  below.  Management  believes,  as of
     December 31, 2003, that the Company meets all capital adequacy requirements
     to  which  it is  subject.  The  Company's  only  significant  asset is its
     investment in Cooperative Bank.  Consequently,  the information  concerning
     capital ratios is essentially the same for the Company and the Bank.

     As of December  31, 2003 and 2002,  the most recent  notification  from the
     FDIC  categorized  the  Bank  as  well  capitalized  under  the  regulatory
     framework  for  prompt  corrective   action.  To  be  categorized  as  well
     capitalized the Bank must maintain minimum amounts and ratios, as set forth
     in  the  table  below.  There  are  no  conditions  or  events  since  that
     notification that management believes have changed the Bank's category.

     The Bank's  actual  capital  amounts and ratios are also  presented  in the
     table below (dollars in thousands) as of December 31:
<TABLE>
<CAPTION>

                                                                                     Minimum Ratio to Maintain
                                                                                       Well-Capitalized Status
                                                                                  --------------------------------
                                                   2003               2002             2003             2002
                                             ----------------   --------------    --------------  ----------------
             <S>                                     <C>               <C>            <C>                <C>
       Risk-based capital:
         Tier I capital                      $         41,486   $       37,193
         Total capital                                 44,933           40,130
         Risk-adjusted assets                         370,895          364,763
         Quarterly average tangible assets            493,548          494,455

         Tier I capital ratio                          11.19%           10.20%             6.00%             6.00%
         Total capital ratio                           12.11%           11.00%            10.00%            10.00%
         Leverage capital ratio                         8.41%            7.52%             5.00%             5.00%
</TABLE>

<PAGE>
                   COOPERATIVE BANKSHARES, INC. AND SUBSIDIARY

                   Notes to Consolidated Financial Statements

                           December 31, 2003 and 2002

(7)  Regulatory Matters and Capital Requirements (Continued)

     A liquidation  account was established at the time of conversion to a stock
     institution  in an  amount  equal to the  total net worth of the Bank as of
     March 31,  1991.  Each  eligible  deposit  account  holder is entitled to a
     proportionate share of this account in the event of a complete  liquidation
     of the Bank,  and only in such an event.  This share will be reduced if the
     account  holder's  eligible  deposits  fall below the amount on the date of
     record and will cease to exist if the  account is closed.  The  liquidation
     account will never be increased  despite any increase  after the conversion
     in the  related  eligible  deposit of an account  holder.  The  liquidation
     account was approximately $1,954,815 at December 31, 2003.

     The Bank may not declare or pay a cash  dividend,  or repurchase any of its
     capital  stock,  if the effect would cause the  regulatory net worth of the
     Bank to  fall  below  the  amount  required  for  the  liquidation  account
     established  in connection  with the  conversion,  or to an amount which is
     less than the minimum required by the FDIC and the North Carolina Office of
     the Commissioner of Banks.

(8)  Benefit Plans

     The Bank  participates  in a qualified,  noncontributory,  defined-benefit,
     multi-employer retirement plan (the Plan) covering substantially all of its
     employees.  The benefits are based on each employee's  years of service and
     the employee's compensation during the last five years of employment.

     Under the multi-employer plan, the Bank is required to contribute its share
     of  the  Plan's  total   pension   liability  as  determined  by  the  plan
     administrator.  Expenses  related to this Plan were $366,814,  $164,618 and
     $34,537 for the years 2003, 2002 and 2001, respectively.

     The Bank  maintains a  Supplemental  Retirement  401(k) Plan (the  401(k)).
     Employees  are  able  to  contribute  up to 15% of  their  eligible  annual
     compensation to the 401(k) subject to Internal Revenue Service limitations.
     The Bank matches employee  contributions up to a limit determined  annually
     by the Board of Directors. The Board established the match at 50% up to the
     first 6% of the employee contribution for 2003, 2002 and 2001.

     The compensation  expense incurred by the Bank for the 401(k) was $105,027,
     $90,098,  and $78,585 for the years ended December 31, 2003, 2002 and 2001,
     respectively.

     Lumina also  maintains a 401(k) plan for its  employees.  Participants  are
     able to contribute up to 20% of their eligible annual  compensation to this
     plan subject to Internal Revenue Service limitations.  The Company does not
     match employee contributions.

     In 2002, the Bank implemented a non-qualifying  deferred  compensation plan
     for certain key executive  officers.  The Bank has purchased life insurance
     policies on the  participating  officers in order to provide future funding
     of benefit  payments.  Benefits for each officer  participating in the plan
     will accrue and vest during the period of  employment,  and will be paid in
     monthly benefit payments over the participant's life after retirement.  The
     plan also provides for payment of disability or death benefits in the event
     a  participating  officer  becomes  permanently  disabled  or dies prior to
     attainment  of retirement  age. If the Bank has a change in control  before
     the officer reaches age 65, the participating officer will be entitled to a
     benefit.  Provisions of $228,445 in 2003 were expensed for future  benefits
     to be provided  under this plan.  The total  liability  under this plan was
     $351,787 at December 31, 2003 and is included in accrued expenses and other
     liabilities  in  the  accompanying  consolidated  statements  of  financial
     condition.
<PAGE>
                   COOPERATIVE BANKSHARES, INC. AND SUBSIDIARY

                   Notes to Consolidated Financial Statements

                           December 31, 2003 and 2002



(9)  Earnings Per Share

     The following table provides a reconciliation of income available to common
     stockholders  and the average  number of shares  outstanding  for the years
     ended December 31, 2003, 2002 and 2001:
<TABLE>
<CAPTION>

                                                                      2003             2002             2001
                                                                 -------------     -------------  ----------------
            <S>                                                     <C>               <C>                <C>
       Net income (numerator)                                    $   5,404,226     $   4,944,497  $      2,888,943
                                                                 =============     =============  ================

       Shares for basic EPS (denominator)                            2,847,567         2,835,712         2,797,317
       Dilutive effect of stock options                                 51,340            23,302            25,874
                                                                 -------------     -------------  ----------------

       Shares for diluted EPS (denominator)                          2,898,907         2,859,014         2,823,191
                                                                 =============     =============  ================
</TABLE>

     For the years ended December 31, 2003, 2002 and 2001,  there were 0, 14,204
     and 14,204,  respectively,  of options  outstanding that were  antidilutive
     since the  exercise  price  exceeds the average  market price for the year.
     These  options  have been  omitted  from the  calculations  of the dilutive
     effect of stock options.

(10) Income Taxes

     Income tax expense consists of the following components for the years ended
     December 31, 2003, 2002 and 2001:
<TABLE>
<CAPTION>

                                                                      2003             2002             2001
                                                                 -------------     -------------  ----------------
        <S>                                                          <C>                <C>                <C>
       Current tax expense:
         Federal                                                 $   2,664,960     $   2,379,444  $      1,651,815
         State                                                         113,308           426,616           214,022
                                                                 -------------     -------------  ----------------
           Total current tax expense                                 2,778,268         2,806,060         1,865,837
                                                                 -------------     -------------  ----------------

       Deferred tax expense (benefit):
         Federal                                                      (191,112)         (113,579)         (227,083)
         State                                                           2,963           109,589           (49,506)
                                                                 -------------     -------------  ----------------
           Total deferred tax benefit                                 (188,149)           (3,990)         (276,589)
                                                                 -------------     -------------  ----------------

           Total tax expense                                     $   2,590,119     $   2,802,070  $      1,589,248
                                                                 =============     =============  ================
</TABLE>

     The  components of the net deferred tax asset at December 31, 2003 and 2002
     are as follows:
<TABLE>
<CAPTION>

                                                                                      2003               2002
                                                                                 --------------     ---------------
                <S>                                                                     <C>                 <C>
       Deferred tax assets:
          Allowance for loan losses                                              $    1,328,819     $     1,132,134
          Deferred compensation                                                         326,814             226,150
          Other                                                                           3,587                  --
                                                                                 --------------     ---------------

       Total gross deferred tax assets                                                1,659,220           1,358,284

       Valuation allowance                                                             (113,223)            (82,469)
                                                                                 --------------     ---------------

       Total net deferred tax assets                                                  1,545,997           1,275,815
                                                                                 --------------     ---------------
       Deferred tax liabilities:
         Deferred loan fees                                                              77,573             120,264
         FHLB stock                                                                      99,259             169,829
         Premises and equipment                                                         530,853             366,004
         Unrealized gain on securities available for sale                               146,948             406,303
         Goodwill                                                                        33,901               3,456
                                                                                 --------------     ---------------

       Total gross deferred tax liabilities                                             888,534           1,065,856
                                                                                 --------------     ---------------

       Net deferred tax asset                                                    $      657,463     $       209,959
                                                                                 ==============     ===============
</TABLE>
<PAGE>
                   COOPERATIVE BANKSHARES, INC. AND SUBSIDIARY

                   Notes to Consolidated Financial Statements

                           December 31, 2003 and 2002

(10) Income Taxes (Continued)

     The Company has  established  a valuation  allowance  at December  31, 2003
     because management has determined that it is more likely than not that some
     of the  deferred  tax  assets  will not be  realized.  For the  year  ended
     December 31, 2003, the valuation allowance increased $30,754.

     Reconciliations  of income taxes  computed at the statutory  federal income
     tax  rate  (34%) to the  provisions  for  income  tax for the  years  ended
     December 31, 2003, 2002 and 2001 are as follows:
<TABLE>
<CAPTION>
                                                                      2003             2002             2001
                                                                 -------------     -------------  ----------------
        <S>                                                             <C>          <C>               <C>
       Income taxes at federal tax rate                          $  2,718,077      $   2,633,833  $      1,522,585
       Increase (decrease) resulting from:
          State income taxes, net of federal
            income tax benefit                                         76,739            353,895           108,581
          Cash surrender value of bank owned
            life insurance                                           (125,799)          (135,500)          (34,035)
          Tax exempt securities                                       (72,701)           (72,701)          (36,350)
          Other                                                        (6,197)            22,543            28,467
                                                                 ------------      -------------  ----------------

            Total                                                $  2,590,119      $   2,802,070  $      1,589,248
                                                                 ============      =============  ================
</TABLE>
     Retained  earnings at December  31,  2003 and 2002  includes  approximately
     $5,170,000 representing pre-1988 tax bad debt reserve base year amounts for
     which no  deferred  income tax  liability  has been  provided  since  these
     reserves are not expected to reverse and may never  reverse.  Circumstances
     that would  require an accrual of a portion or all of this  unrecorded  tax
     liability are a reduction in qualifying  loan levels relative to the end of
     1987, failure to meet the definition of a bank, dividend payments in excess
     of  accumulated   tax  earnings  and  profits,   or  other   distributions,
     dissolution, liquidation or redemption of the Bank's stock.

(11) Stock Option Plan

     The  Company  has a Stock  Option  Plan  (the  Option  Plan)  for  selected
     employees of the Company and for nonemployee directors.  The purpose of the
     Option  Plan is to  attract  and retain the best  available  personnel  for
     positions of substantial responsibility and to provide additional incentive
     to key employees and directors by  facilitating  their  purchase of a stock
     interest in the Company.

     The Option Plan provides for a term of ten years, after which no awards may
     be made,  unless earlier  terminated by the Board of Directors  pursuant to
     the Option  Plan.  The  option  exercise  price is the market  price of the
     common  stock on the date the option is granted.  Options are fully  vested
     and exercisable upon being granted.



<PAGE>
                   COOPERATIVE BANKSHARES, INC. AND SUBSIDIARY

                   Notes to Consolidated Financial Statements

                           December 31, 2003 and 2002
(11) Stock Option Plan (Continued)

     A summary of the status of the Option Plan as of December  31,  2003,  2002
     and 2001, and changes during the years then ended is presented below:
<TABLE>
<CAPTION>
                                          2003                         2002                          2001
                               -------------------------    --------------------------   --------------------------
                                               Weighted                    Weighted                      Weighted
                                                average                      average                      average
                                                option                       option                       option
                                 Number          price         Number         price         Number         price
                               -----------    ----------    -----------   ------------    ----------   -----------
          <S>                     <C>              <C>         <C>           <C>              <C>           <C>
       Options outstanding,
          beginning of year        141,943    $    11.28        117,943    $     11.37       246,457    $      6.85
       Granted                          --            --         25,500          10.85        18,000          13.38
       Exercised                   (13,500)        13.86           (500)         10.85      (141,537)          3.77
       Forfeited                        --            --         (1,000)         11.00        (4,977)         10.86
                               -----------    ----------    -----------    -----------   -----------    -----------
       Options outstanding,
          end of year              128,443    $    11.01        141,943    $     11.28       117,943    $     11.37
                               ===========    ==========    ===========    ===========   ===========    ===========
</TABLE>
     The following table summarizes additional information about the Option Plan
     at December 31, 2003:
<TABLE>
<CAPTION>
                                                                        Remaining
                                              Number                   Contractual               Number
              Exercise Price                Outstanding                   Life                 Exercisable
             -------------------     -----------------------       ------------------     ----------------------
                  <S>                         <C>                       <C>                       <C>
               $     7.50                      10,000                    .25 years                 10,000
                    10.50                       5,424                   3.25 years                  5,424
                    10.85                      23,000                   8.00 years                 23,000
                    10.94                       9,000                   5.70 years                  9,000
                    11.00                      10,315                   6.00 years                 10,315
                    11.06                      58,500                   5.50 years                 58,500
                    11.50                       8,000                   8.00 years                  8,000
                    19.50                       4,204                   4.00 years                  4,204
                                     -----------------------       ------------------     ----------------------
                                              128,443                   5.60 years                128,443
                                     =======================       ==================     ======================
</TABLE>

(12) Parent Company Financial Information

     Condensed financial information of Cooperative Bankshares, Inc., the parent
     company, at December 31, 2003 and 2002 and for the years ended December 31,
     2003, 2002 and 2001 is presented below:

                            Condensed Statements of Financial Condition
<TABLE>
<CAPTION>

                                                                                      2003               2002
                                                                                 --------------     ---------------
              <S>                                                                    <C>                   <C>
         Assets:
            Cash                                                                 $        2,433     $         1,913
            Equity investment in subsidiary                                          43,233,958          38,490,495
            Other assets                                                                142,472             141,797
                                                                                 --------------     ---------------
                                                                                 $   43,378,863     $    38,634,205
                                                                                 ==============     ===============
         Liabilities and stockholders' equity:
            Other liabilities                                                    $      235,465     $       185,944
            Stockholders' equity                                                     43,143,398          38,448,261
                                                                                 --------------     ---------------
                                                                                 $   43,378,863     $    38,634,205
                                                                                 ==============     ===============
</TABLE>
<PAGE>
                   COOPERATIVE BANKSHARES, INC. AND SUBSIDIARY

                   Notes to Consolidated Financial Statements

                           December 31, 2003 and 2002

(12) Parent Company Financial Information (Continued)

                       Condensed Statements of Operations
<TABLE>
<CAPTION>

                                                                      2003             2002             2001
                                                                 -------------     -------------   ---------------
       <S>                                                           <C>                <C>              <C>
       Dividends from subsidiary                                 $     397,649     $     575,739   $       347,309
       Equity in undistributed net income of subsidiary              5,069,903         4,426,679         2,586,569
       Miscellaneous expenses                                          (63,326)          (57,921)          (44,935)
                                                                 -------------     -------------   ---------------
                                                                 $   5,404,226     $   4,944,497   $     2,888,943
                                                                 =============     =============   ===============
</TABLE>

<TABLE>
<CAPTION>

                       Condensed Statements of Cash Flows

                                                                      2003             2002             2001
                                                                 -------------     -------------   ---------------
        <S>                                                          <C>              <C>               <C>
       Operating activities:
          Net income                                             $   5,404,226     $   4,944,497   $     2,888,943
          Equity in undistributed net income of subsidiary          (5,069,903)       (4,426,680)       (2,586,569)
          Change in other assets                                          (675)              (25)           (6,042)
          Change in other liabilities                                   49,521            44,106             6,036
                                                                 -------------     -------------   ---------------
            Net cash provided by operating activities                  383,169           561,898           302,368
                                                                 -------------     -------------   ---------------

       Financing activities:
          Proceeds from issuance of common stock, net                  187,090             5,425           261,249
          Cash dividends paid                                         (569,739)         (567,163)         (563,034)
                                                                 -------------     -------------   ---------------
            Net cash used in financing activities                    (382,649)          (561,738)         (301,785)
                                                                 -------------     -------------   ---------------

       Increase in cash and cash equivalents                               520               160               583
       Cash and cash equivalents, beginning of year                      1,913             1,753             1,170
                                                                 -------------     -------------   ---------------

       Cash and cash equivalents, end of year                    $       2,433     $       1,913   $         1,753
                                                                 =============     =============   ===============
</TABLE>

(13) Acquisition

     On May 31, 2002, the Bank acquired the operating assets of Wilmington-based
     Lumina  Mortgage  Company.  The combined  resources of these two  companies
     enable the Bank to offer a wider  range of  products  to a larger  customer
     base. Lumina has offices in Wilmington, North Carolina, North Myrtle Beach,
     South Carolina and Virginia Beach,  Virginia.  Their 2001 loan originations
     totaled  $118  million.  The  purchase  price was $740,061 in cash with two
     future  contingent  payments based on loan  origination  volume and meeting
     certain profitability goals of Lumina in the two subsequent years after the
     purchase.  The agreement was subsequently  amended to change the contingent
     payments  into two  payments of $400,000  each payable on July 31, 2003 and
     2004.  These  payments  are  considered   additional  purchase  price  and,
     accordingly,   goodwill  related  to  this  acquisition  was  increased  by
     $800,000.

    Goodwill at December 31, 2002                     $    661,543
    Additions to goodwill                                  800,000
                                                      ------------

    Goodwill at December 31, 2003                     $  1,461,543
                                                      ============
<PAGE>
                   COOPERATIVE BANKSHARES, INC. AND SUBSIDIARY

                   Notes to Consolidated Financial Statements

                           December 31, 2003 and 2002

(13) Acquisition (Continued)


     The following table  summarizes the estimated fair value of assets acquired
     and liabilities assumed at May 31, 2002,  excluding $33,127 of professional
     fees that were included in goodwill as part of this transaction:
<TABLE>
<CAPTION>
                             <S>                                                <C>
                       Property and equipment                            $     71,584
                       Goodwill                                               628,416
                       Other assets                                            51,729
                                                                         ------------
                            Total assets acquired                             751,729
                                                                         ------------

                       Accrued expenses and other liabilities                  11,668
                                                                         ------------
                            Total liabilities assumed                          11,668
                                                                         ------------

                       Net assets acquired                               $    740,061
                                                                         ============
</TABLE>

     Presented  below  are  the  unaudited   proforma   consolidated   condensed
     statements of operations for the Company and Lumina Mortgage  Company,  for
     the years ended December 31, 2002 and 2001,  assuming the  acquisition  was
     completed at the beginning of all periods presented. The unaudited proforma
     information presented below is not necessarily indicative of the results of
     operations  that would have  resulted had the merger been  completed at the
     beginning  of the  applicable  periods  presented,  nor  is it  necessarily
     indicative of the results of operations in future periods.
<TABLE>
<CAPTION>

                                                                                            Years Ended
                                                                                       2002             2001
                                                                                   -------------   ---------------
              <S>                                                                      <C>                  <C>
       Interest income                                                             $  29,648,777   $    31,569,610
       Interest expense                                                               13,973,200        19,334,494
                                                                                   -------------   ---------------
            Net interest income                                                       15,675,577        12,235,116
       Provision for loan losses                                                         740,000           460,000
                                                                                   -------------   ---------------
            Net interest income after provision for loan losses                       14,935,577        11,775,116
                                                                                   -------------   ---------------

       Noninterest income                                                              6,167,688         5,394,986
       Noninterest expense                                                            13,235,876        12,324,831
                                                                                   -------------   ---------------
       Income before income taxes                                                      7,867,389         4,845,271
       Income tax expense                                                              2,849,191         1,732,409
                                                                                   -------------   ---------------
            Net income                                                             $   5,018,198   $     3,112,862
                                                                                   =============   ===============

       Net income per share:
            Basic                                                                  $        1.77   $          1.11
            Diluted                                                                         1.76              1.10
</TABLE>

(14) Fair Value of Financial Instruments

     The  following   disclosure  of  the  estimated  fair  value  of  financial
     instruments is made in accordance  with the  requirements  of SFAS No. 107,
     "Disclosures About Fair Value of Financial Instruments". The estimated fair
     value  amounts have been  determined  by the Company  using the methods and
     assumptions described below. However,  considerable judgment is required to
     interpret market data to develop the estimates of fair value.  Accordingly,
     the  estimates  presented  herein  are not  necessarily  indicative  of the
     amounts the Company could realize in a current market exchange.  The use of
     different market  assumptions  and/or  estimation  methodologies may have a
     material effect on the estimated fair value amounts.
<PAGE>
                   COOPERATIVE BANKSHARES, INC. AND SUBSIDIARY

                   Notes to Consolidated Financial Statements

                           December 31, 2003 and 2002

(14) Fair Value of Financial Instruments (Continued)

     The following  methods and assumptions were used to estimate the fair value
     of each  class of  financial  instruments  for which it is  practicable  to
     estimate that value.

     Cash and Cash Equivalents

     The carrying amount is a reasonable estimate of fair value.

     Securities

     For investments in debt securities,  fair values are based on quoted market
     prices or dealer  quotes.  For other  securities,  fair value equals quoted
     market price, if available. If a quoted market price is not available, fair
     value is estimated using quoted market prices for similar securities.

     FHLB Stock

     The carrying amount is a reasonable estimate of fair value.

     Loans Held for Sale

     The carrying amount is a reasonable  estimate of fair value since they will
     be sold in a short period.

     Loans

     The fair value of loans is estimated by  discounting  the future cash flows
     using the current  rates at which  similar loans would be made to borrowers
     with similar credit ratings and for the same remaining maturities.

     Accrued Interest

     The carrying amount is a reasonable estimate of fair value.

     Deposits

     The fair value of NOW,  savings,  and money market deposit  accounts is the
     amount  payable  on  demand  at the  reporting  date.  The  fair  value  of
     fixed-maturity  certificates  of  deposit  is  estimated  using  the  rates
     currently offered for deposits of similar remaining maturities.

     Borrowed Funds

     Borrowed funds consist of short-term loans and FHLB borrowings with varying
     maturities.  The fair values of these  liabilities  are estimated using the
     discounted  values of the  contractual  cash flows.  The  discount  rate is
     estimated using the rates currently in effect for similar borrowings.

     Off-Balance Sheet Financial Instruments

     The fair value of  off-balance  sheet  financial  instruments is considered
     immaterial.  As  discussed  in Note 3, these  off-balance  sheet  financial
     instruments  are  commitments to extend credit and are either short term in
     nature or subject to immediate repricing.



<PAGE>

                   COOPERATIVE BANKSHARES, INC. AND SUBSIDIARY

                   Notes to Consolidated Financial Statements

                           December 31, 2003 and 2002

(14) Fair Value of Financial Instruments (Continued)

     The carrying  amounts and estimated fair values of the Company's  financial
     instruments at December 31, 2003 and 2002 are as follows (in thousands):
<TABLE>
<CAPTION>

                                                               2003                               2002
                                                 -------------------------------    -------------------------------
                                                    Carrying         Estimated         Carrying         Estimated
                                                     Amount         Fair Value          Amount         Fair Value
                                                  ------------    --------------     ------------    --------------
         <S>                                          <C>              <C>               <C>               <C>
       Financial assets:
          Cash and cash equivalents              $      18,393     $      18,393    $      11,859     $      11,859
       Securities:
          Available for sale                            43,613            43,613           42,075            42,075
          Held to maturity                               3,806             3,890            7,860             8,009
          Loans held for sale                            6,375             6,375           25,660            25,660
          Loans, net                                   401,242           407,076          390,876           397,001
          FHLB stock                                     4,154             4,154            4,055             4,055
          Accrued interest receivable                    1,852             1,852            2,240             2,240
       Financial liabilities:
          Deposits                                     367,072           367,676          357,254           357,915
          Borrowed funds                                89,505            89,468          104,678           106,089
          Accrued interest payable                         180               180              285               285
</TABLE>


(15) Asset Sale

     During  December  2003,  the Company sold the Ogden branch for $800,000.  A
     gain of $121,147  was  deferred  because  the  Company is now leasing  this
     property and another property,  under operating leases,  from the purchases
     of the Ogden branch.  This gain will be recognized as a reduction of rental
     expense over the lives of these leases.

     During  February 2002, the Company sold a parking lot for $500,000.  A gain
     of $464,977 was realized on the sale.

(16) Leases

     The Company has  several  noncancelable  operating  leases,  primarily  for
     office space that expire over the next twenty years. These leases generally
     contain  renewal  options  for periods  ranging  from two to five years and
     require  the Company to pay all  executory  costs such as  maintenance  and
     insurance.  Rental expense for operating leases was approximately $312,000,
     $200,000 and $98,000 during 2003, 2002 and 2001, respectively.

     Future minimum lease payments under  noncancelable  operating  leases as of
     December 31, 2003 are (in thousands):

       Year ending December 31:
       2004                                   $             487
       2005                                                 424
       2006                                                 257
       2007                                                 246
       2008                                                 247
       After 2008                                         3,331
                                              -----------------

       Total minimum lease payments           $           4,992
                                              =================

<PAGE>


                               BOARD OF DIRECTORS
                          Cooperative Bankshares, Inc.
                                Cooperative Bank
<TABLE>
<CAPTION>
<S>                                                                     <C>
Frederick Willetts, III                                           James D. Hundley, M.D.
Chairman, President & Chief Executive Officer                     President, Wilmington Orthopaedic Group P.A.

Paul G. Burton                                                    H. T. King, III
President, Burton Steel Company                                   President, Hanover Iron Works, Inc.

Russell M. Carter                                                 R. Allen Rippy
President, Atlantic Corporation                                   Vice President, Rippy Automotive Company

F. Peter Fensel, Jr.                                              O. Richard Wright, Jr.
President, F. P. Fensel Supply Company                            Attorney, McGougan, Wright, Worley, Harper & Bullard
</TABLE>

                          OFFICERS OF COOPERATIVE BANK
<TABLE>
<CAPTION>

<S>                                                                     <C>
Frederick Willetts, III                                    Chairman, President-Chief Executive Officer
O. C. Burrell, Jr.                                         Executive Vice President-Chief Operating Officer
Dickson B. Bridger                                         Senior Vice President-Mortgage Lending
Todd L. Sammons, CPA                                       Senior Vice President-Chief Financial Officer
Sandra B. Carr                                             Vice President-Retail Banking Operations
George B. Church                                           Vice President-Business Banking
Linda B. Garland                                           Vice President-Marketing/Corporate Secretary
Raymond A. Martin                                          Vice President-Information Services
Donna H. Mitchell                                          Vice President-Mortgage Operations
John P. Payne, CPA                                         General Auditor
Susie K. Register                                          Vice President-Mortgage Servicing/Processing
Dare C. Rhodes                                             Vice President-Human Resources
</TABLE>

                       OFFICERS OF LUMINA MORTGAGE COMPANY

Linda B. Skipper                                           President
Frederick Willetts, III                                    Vice President
Dickson B. Bridger                                         Secretary
Todd L. Sammons                                            Treasurer

                           COOPERATIVE BANK LOCATIONS
Beaufort                                                      Southport
Belhaven                                                      Tabor City
Elizabethtown                                                 Wallace
Jacksonville (2)                                              Washington (2)
Kill Devil Hills                                              Whiteville
Morehead City (2)                                             Wilmington (6)
                         Corolla (Loan Production Office)

                            LUMINA MORTGAGE LOCATIONS
Wilmington, North Carolina; North Myrtle Beach, South Carolina; Virginia Beach,
Virginia



<PAGE>
                             CORPORATE HEADQUARTERS
                          Cooperative Bankshares, Inc.
                                201 Market Street
                                  P.O. Box 600
                        Wilmington, North Carolina 28402
                                 (910) 343-0181
                                www.coop-bank.com
<TABLE>
<CAPTION>
                       <S>                                                              <C>
                     TRANSFER AGENT                                                SPECIAL COUNSEL
                   First Citizens Bank                                   Stradley Ronon Stevens & Young, LLP
            Corporate Trust Department, DAC61                                         Suite 600
                     P.O. Box 29522                                              1220 19th Street, NW
           Raleigh, North Carolina 27626-0522                                    Washington, DC 20036


                     ANNUAL MEETING                                              INDEPENDENT AUDITORS
The Annual Meeting of Stockholders of Cooperative                                 Dixon Hughes PLLC
Bankshares, Inc. will be held:                                                    Post Office Box 70
               HILTON WILMINGTON RIVERSIDE                                Sanford, North Carolina 27331-0070
      301 NORTH WATER STREET, WILMINGTON, NC 28401
              APRIL 30, 2004 AT 11:00 A.M.
</TABLE>



                                    FORM 10-K
              Copies of Form 10-K may be obtained without charge by
                  writing to: Linda B. Garland at the Corporate
              Headquarters address or visit the company website at
                               www.coop-bank.com.

                             ADDITIONAL INFORMATION
                   For additional information, please contact
               Linda B. Garland or Todd Sammons at (910) 343-0181

                           ANNUAL DISCLOSURE STATEMENT
                   "This information has not been reviewed or
                       confirmed for accuracy or relevancy
                          by Federal Deposit Insurance
                              Corporation (FDIC)."


                                  CAPITAL STOCK

Cooperative Bankshares, Inc. stock is traded on the NASDAQ National Market under
the  symbol  "COOP".  As of  December  31,  2003,  there were  2,849,447  shares
outstanding,  which were held by 523  stockholders of record.  A $0.05 per share
dividend was declared each quarter in 2003 and 2002. Stock  performance for 2003
and 2002 is given in the following table


                           Quarterly Common Stock Data
<TABLE>
<CAPTION>
                                                              2003                       2002
     ----------------------------------------------------------------------------------------------
                                                         High         Low          High        Low
             Quarters Ended
     ----------------------------------------------------------------------------------------------
                <S>                                     <C>         <C>          <C>          <C>
             December                                 $26.400     $22.350       $17.000    $13.850
             September                                 26.760      19.000        15.000     13.000
             June                                      20.250      18.470        16.000     12.040
             March                                     19.650      15.950        12.394     10.401
     ----------------------------------------------------------------------------------------------
</TABLE>