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                                 ANNUAL REPORT

                               _________________
                                  COOPERATIVE
                                BANCSHARES, INC.
                               _________________



                           BUILDING ON A TRADITION OF
                   CUSTOMER SATISFACTION AND TRUST CINE 1898




                               DECEMBER 31, 2002
<PAGE>

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 (or 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.

                    Cooperative   Bank  was   chartered  in  1898.   The  Bank's
                    headquarters  are  located in  Wilmington,  North  Carolina.
                    Cooperative  Bank operates 17 financial  centers  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") as a
                    mortgage  banking  firm.  Lumina has offices in  Wilmington,
                    North  Carolina;  North Myrtle Beach,  South  Carolina;  and
                    Virginia Beach,  Virginia. In October 2002, the Bank changed
                    the name of its  subsidiary  from  CS&L  Services,  Inc.  to
                    Lumina Mortgage  Company,  Inc. The Bank's other subsidiary;
                    CS&L Holdings,  Inc.  ("Holdings")  is a holding company for
                    CS&L Real Estate Trust, Inc. (the "REIT"),  which is a newly
                    formed Real Estate  Investment  Trust.  The Federal  Deposit
                    Insurance  Corporation  ("FDIC")  insures the Bank's deposit
                    accounts up to applicable limits.

                    Through  its  financial  centers,  the Bank  provides a wide
                    range of banking  products,  including  interest bearing and
                    non-interest  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.  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.

TABLE OF CONTENTS
                    Selected  Financial  and Other Data . . . . . . . . . . . .2
                    President's  Message. . . . . . . . . . . . . . . . . . . .3
                    Management's  Discussion & Analysis . . . . . . . . . . . .4
                    Independent  Auditors' Report . . . . . . . . . . . . . . 15
                    Consolidated Statements of Financial Condition. . . . . . 16
                    Consolidated  Statements  of Operations . . . . . . . . . 17
                    Consolidated Statements of Comprehensive Income . . . . . 18
                    Consolidated Statements of Stockholders' Equity . . . . . 19
                    Consolidated  Statements  of Cash Flows . . . . . . . . . 20
                    Notes to Consolidated Financial Statements. . . . . . . . 22
                    Corporate  Information  . . . . . . . . . . . . . . . . . 49
                    Directors, Officers, and Financial Center Locations . . . 50



<PAGE>


                        SELECTED FINANCIAL AND OTHER DATA
<TABLE>
<CAPTION>
AT DECEMBER 31,                                              2002           2001           2000            1999           1998
------------------------------------------------------------------------------------------------------------------------------
                                                                                   Dollars in Thousands
<S>                                                     <C>            <C>            <C>             <C>            <C>
Selected Financial Condition Data:
  Assets                                                $ 504,210      $ 458,114      $ 414,961       $ 410,146      $ 389,773
  Loans, net                                              390,876        373,458        347,486         334,744        321,324
  Securities                                               49,935         47,970         35,027          45,261         44,749
  FHLB stock                                                4,055          4,155          3,755           3,755          2,825
  Deposits                                                357,254        339,830        327,312         304,834        301,656
  Borrowed funds                                          104,678         83,097         55,101          75,106         55,109
  Stockholders' equity                                     38,448         33,618         30,812          29,343         31,613


YEAR ENDED DECEMBER 31,                                      2002           2001           2000            1999           1998
------------------------------------------------------------------------------------------------------------------------------
                                                                                    Dollars in Thousands
Selected Operations Data:
  Interest income                                        $ 29,496       $ 31,117       $ 31,709        $ 28,449       $ 28,411
  Interest expense                                         13,875         18,916         19,305          16,422         17,212
  Net interest income                                      15,621         12,201         12,404          12,027         11,199
  Provision for loan losses                                   740            460            970             210            330
  Noninterest income                                        4,754          2,040          1,670           1,228          1,180
  Noninterest expenses                                     11,888          9,303         10,193           8,885          8,275
  Income before income taxes                                7,747          4,478          2,911           4,160          3,774
  Net income                                                4,944          2,889          1,932           2,680          2,385

------------------------------------------------------------------------------------------------------------------------------
Selected Financial Ratios and Other Data:
  Return on average assets                                  1.05%          0.67%          0.47%           0.69%          0.62%
  Return on average equity                                 13.70%          8.91%          6.35%           8.88%          7.86%
  Average stockholders' equity to average assets            7.64%          7.57%          7.38%           7.74%          7.95%
  Non-performing assets to total assets                     0.24%          0.84%          0.22%           0.35%          1.08%
  Allowance for loan losses to total loans                  0.75%          0.67%          0.62%           0.39%          0.35%
  Dividend payout ratio                                    11.47%         19.49%         28.09%               -              -
Per Share Data:
  Earnings per:
     Common share - basic                                  $ 1.74         $ 1.03         $ 0.71          $ 0.95         $ 0.79
     Common share - diluted                                $ 1.73         $ 1.02         $ 0.69          $ 0.90         $ 0.74
  Cash dividends declared                                  $ 0.20         $ 0.20         $ 0.20               -              -
  Tangible book value                                     $ 13.56        $ 11.86        $ 11.35         $ 10.92        $ 10.38
  Number of common shares outstanding                   2,835,947      2,835,447      2,714,610       2,687,919      3,046,284

</TABLE>

                                       2
<PAGE>

     Net income for the year ended December 31, 2002 was $4,944,497 or $1.73 per
diluted  share,  a 71.2%  increase over last year. Net income for the year ended
December 31, 2001 was  $2,888,943,  or $1.02 per diluted share.  Total assets at
December 31, 2002 were $504.2  million as compared to $458.1 million at December
31, 2001, a 10.1%  increase in assets during the year.  Stockholders'  equity at
December 31, 2002, was $38.4 million, or $13.56 per share, and represented 7.63%
of assets.

     In May 2002,  we  completed  our  purchase of Lumina  Mortgage  Company,  a
Wilmington-based  mortgage  banking  firm with  additional  offices in  Virginia
Beach,  Virginia, and North Myrtle Beach, South Carolina.  This acquisition,  in
addition to placing us in our two adjacent states, also increases  significantly
the fee income that will be generated  going forward as Lumina is a full service
mortgage  banking firm,  selling its entire  product and receiving fee income in
return.

     Also,  in May 2002,  we installed an ATM at  Wrightsville  Beach  providing
additional  bank  services both to the  vacationers  from outside of our area as
well as our customer base who find it convenient to bank at Wrightsville Beach.

     During 2002, the Company continued paying a quarterly cash dividend of $.05
per share to our  stockholders,  and it is our hope and  intention  to  continue
paying such dividends in the future.

     On  December  31,  2002,  the  Bank  completed  its  previously   announced
conversion from a state savings bank to a state commercial bank. This conversion
formalizes  the  transition  that the Bank has been making over the past several
years from a savings  institution to a full service community bank. The official
name of the bank is now, Cooperative Bank.

     In summary, the past year has been an exciting one for our Company. We have
experienced a dramatic improvement in earnings and efficiencies, and significant
growth in retail and  commercial  loans,  making our balance sheet  increasingly
more bank-like. The acquisition of Lumina Mortgage Company will increase the non
interest earnings of the Company as well as provide  additional  outlets for the
origination  of  mortgage  loans in our two  adjacent  states.  As I look to the
future,  I do so with a great deal of  confidence  in our ability to continue to
provide  banking  services to the people of Eastern North  Carolina,  and now to
those in Virginia  and South  Carolina as well.  I thank you for your  continued
support.

                                       Sincerely yours,
                                       Frederick Willetts, III
                                       President

                                       3
<PAGE>
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 17 financial
centers 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. In October 2002, the
Bank  changed  the name of its  subsidiary  from CS&L  Services,  Inc. to Lumina
Mortgage  Company,  Inc.  The  Bank's  other  subsidiary;  CS&L  Holdings,  Inc.
("Holdings") is a holding company for CS&L Real Estate Trust, Inc. (the "REIT"),
which  is  a  newly  formed  real  estate  investment  trust.  Accordingly,  the
information set forth in this report, including financial statements and related
data, relates primarily to Cooperative Bank.

     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 report.

CRITICAL ACCOUNTING POLICY

     The Bank's most significant critical accounting policy is the determination
of its allowance for loan losses.  A critical  accounting  policy is one that is
both very  important to the  portrayal  of the Bank's  financial  condition  and
results,  and  requires  management's  most  difficult,  subjective  or  complex
judgments.  What makes these judgments  difficult,  subjective and/or complex is
the need to make  estimates  about the  effects of matters  that are  inherently
uncertain.  For further  information  on the allowance for loan losses,  see the
"Financial Condition" in Management's  Discussion and Analysis and Note 3 of the
"Notes to Consolidated Financial Statements" included in this Annual Report.

MANAGEMENT STRATEGY

     Cooperative 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, 2002 approximately $268 million, or 69%, 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 $273 million,  or 73% at
December 31, 2001. The Bank originates  adjustable rate and fixed rate loans. As
of December 31, 2002, adjustable rate and fixed rate loans totaled approximately
65% and 35%, 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 2002, the Bank sold $8.8 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 $6.3  million  in the  secondary  market and $24.5  million  through a
brokered  arrangement where the bank released the servicing of the loans. Lumina
sold $90.4 million in the secondary market during 2002.

     The  growth  in  the  loan   portfolio  has  been   concentrated   in  real
estate-backed  construction  and land  development and commercial  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 has begun construction to build additional  branches in Wilmington
and Morehead City, North Carolina.

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

                                       4

<PAGE>

assets.  At December 31, 2002, the Company had a one-year  positive gap position
of 4.9%.  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 are
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.  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.

     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.



INTEREST RATE SENSITIVITY ANALYSIS
<TABLE>
<CAPTION>

                                                            Over One       Over Five
                                             One Year       Through         Through        Over Ten
December 31, 2002                            or Less        Five Years     Ten Years         Years           Total
--------------------------------------------------------------------------------------------------------------------
                                                            (Dollars in thousands)
<S>                                         <C>             <C>            <C>              <C>            <C>
Interest-earning assets:
     Securities                             $  22,453       $  18,801      $   3,699        $  4,982       $  49,935
     Interest-bearing bank balances                 -               -              -               -               -
     Federal Home Loan Bank stock               4,055               -              -               -           4,055
     All Loans                                302,572         108,233          7,631           1,037         419,473
                                            ---------       ---------      ---------        --------       ---------
        Total                               $ 329,080       $ 127,034      $  11,330        $  6,019       $ 473,463
                                            =========       =========      =========        ========       =========
Interest-bearing liabilities:
     Deposits                               $ 237,934       $  91,321      $   8,199        $      -       $ 337,454
     Borrowed funds                            66,589          20,010         18,015              64         104,678
                                            ---------       ---------      ---------        --------       ---------
        Total                               $ 304,523       $ 111,331      $  26,214        $     64       $ 442,132
                                            =========       =========      =========        ========       =========

Interest rate sensitivity gap               $  24,557       $  15,703      $ (14,884)       $  5,955       $  31,331
                                            =========       =========      =========        ========       =========
Cumulative interest rate sensitivity gap    $  24,557       $  40,260      $  25,376        $ 31,331
                                            =========       =========      =========        ========
Cumulative ratio of interest-earning
    assets to interest-bearing liabilities     108.1%           109.7%         105.7%          107.1%
                                            =========       =========      =========        ========
Ratio of cumulative gap to total assets          4.9%             8.0%           5.0%            6.2%
                                            =========       =========      =========        ========
</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  liabilities  so as to  mitigate  the  effect of changes in the rate
environment.

                                       5
<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, 2002, the percentage of negative  estimated
change in EVE is reduced in the rising  rate  environments  as  compared  to the
estimated  change  at  December  31,  2001.  Changes  to EVE in  declining  rate
environments  from  December 31, 2001,  to December  31,  2002,  are  negatively
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, 2002 (in thousands).
<TABLE>
<CAPTION>
-----------------------------------------------------------------------------
Market Risk Table
December 31, 2002

           Change in             Economic            Estimated      Estimated
         Interest Rates       Value of Equity         $ Change      % Change
-----------------------------------------------------------------------------
<S>                              <C>                 <C>               <C>
400 basis point rise             $ 31,946            (10,604)         -25%
300 basis point rise               34,651             (7,899)         -19%
200 basis point rise               37,754             (4,796)         -11%
100 basis point rise               41,277             (1,273)          -3%
Base Scenario                      42,550                  -
100 basis point decline            41,745               (805)          -2%
200 basis point decline            40,570             (1,980)          -5%
300 basis point decline            41,887               (663)          -2%
400 basis point decline            45,011              2,461            6%
---------------------------------------------------------------------------
</TABLE>

     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,  deposits,  income from operations and borrowings are the
main  sources  of  liquidity.   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, 2002,  the  estimated  market value of liquid assets (cash,
cash   equivalents,   marketable   securities  and  loans  held  for  sale)  was
approximately  $87.6 million,  representing 19.0% of deposits and borrowed funds
as compared to $60.5 million or 14.3% of deposits and borrowed funds at December
31,   2001.   Management   maintains  a  portfolio   generally   consisting   of
mortgage-backed securities and securities with short maturities (within 5 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 shareholders'  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"),  a
Household  Finance  Corporation  note and a Ford Motor Credit  Company 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.

     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

                                       6
<PAGE>

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, 2002, outstanding off-balance sheet commitments to
extend credit totaled $38.2 million, and the undisbursed portion of construction
loans was $32.7 million.  Management considers current liquidity levels adequate
to meet the Company's cash flow requirements.

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,
2002 (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                                       $ 104,678    $ 61,585    $ 15,000      $ 5,000    $ 23,093
Lease Obligations                                        2,998         285         471          264       1,978
Deposits                                               357,254     294,339      62,653          181          81

                                                  --------------------------------------------------------------
Total Contractual Cash Obligations                   $ 464,930    $356,209    $ 78,124      $ 5,445    $ 25,152
                                                  ==============================================================
<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                           $ 14,130       $ 633     $ 1,414        $ 411    $ 11,672
Other commitments and credit lines                      13,843       3,144       7,631          295       2,773
Undisbursed portion of construction loans               32,667      32,667           -            -           -
Available for sale mortgage loan commitments             3,729       3,729           -            -           -
Fixed-rate mortgage loan commitments                       879         879           -            -           -
Adjustable-rate mortgage loan
   commitments                                           5,614       5,614           -            -           -

                                                  --------------------------------------------------------------
Total Commitments                                     $ 70,862    $ 46,666     $ 9,045        $ 706    $ 14,445
                                                  ==============================================================
</TABLE>

CAPITAL

     Stockholders'  equity at December  31,  2002,  was $38.4  million,  up $4.8
million, or 14.4%, from $33.6 million at December 31, 2001. The improved capital
position  during the year 2002 reflects the impact of earnings  retention  after
the  declaration  of cash  dividends  of $567,163,  or $0.20 per share,  and the
exercising of 500 stock options.  Stockholders'  equity at December 31, 2002 and
December 31, 2001 includes unrealized gains net of tax of $635,500 and $188,278,
respectively, on securities available for sale.

     Under the capital  regulations of the 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, 2002,
the Bank's leverage capital ratio was 7.52%. The FDIC's risk-based capital rules
require  banks  supervised  by  the  FDIC  to  maintain  risk-

                                       7
<PAGE>

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, 2002, the Bank had a ratio of qualifying  total capital
to risk-weighted assets of 11.00%.

     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 19, 2002, 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,  2003,  to  shareholders  of record on January 2, 2003.  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 2003 Annual Meeting of Stockholders.

                                       8
<PAGE>

                  FINANCIAL CONDITION AND RESULTS OF OPERATIONS

                 DECEMBER 31, 2002 COMPARED TO DECEMBER 31, 2001

FINANCIAL CONDITION

     The Company's  total assets  increased  10.1% to $504.2 million at December
31, 2002, as compared to $458.1  million at December 31, 2001. The major changes
in the assets are as follows:  an increase  of $2.9  million  (57.2%) in held to
maturity  securities,   an  increase  of  $17.4  million  (4.7%)  in  net  loans
receivable,  and a $1.6 million (15.2%)  increase in other assets.  In addition,
primarily due to the Lumina purchase,  loans held for sale were $25.7 million at
December  31,  2002 and there  was not a similar  asset at  December  31,  2001.
Although the Company has historically concentrated its lending activities on the
origination  of loans for the purpose of  financing or  refinancing  residential
properties,  it  is  now  actively  pursuing  construction,   land  development,
consumer,  and business  lending.  The Bank funded the  increase in  securities,
loans and other assets with a $17.4 million (5.1%) increase in retail  deposits,
a $21.6 million (26.0%)  increase in borrowed funds and other  available  liquid
assets.  The increase in deposits was primarily in the seven month  certificates
due to the customer's desire to stay short in the current rate environment.  The
Bank also attracted an additional  $7.2 million in internet  deposits.  Internet
deposits are primarily obtained from other financial  institutions in increments
of $99,000 with terms primarily of one or two years.  The increase in borrowings
was due to a short term loan from another  financial  institution,  used to fund
the loans held for sale. This loan is collateralized by the loans held for sale.
The increase in other assets was due to an increase in cash  surrender  value of
bank owned life  insurance  ("BOLI") of $1.4 million and a $662,000  increase in
Goodwill  due to the  purchase of Lumina  Mortgage  Company.  Other  liabilities
increased $2.2 million  (206.5%)  primarily due to accounts  payable and accrued
expenses.

     The Company's  nonperforming  assets (nonaccrual  loans,  accruing loans 90
days or more delinquent and foreclosed real estate) were $1.2 million,  or 0.24%
of assets, at December 31, 2002, compared to $3.8 million or 0.84% of assets, at
December  31,  2001.  The  Company  usually  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 $2.9  million at  December  31, 2002 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 the 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, 2002 deposits had increased  $17.4 million (5.1%) to $357.3
million as compared to $339.8  million at December 31,  2001.  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  $4.2 million  (11.6%) to $40.4 million as compared to $36.2
million at December 31, 2001.

RESULTS OF OPERATIONS

     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  71.2% to $4.9 million for 2002,  as compared to $2.9
million  in 2001 and  $1.9  million  in  2000.  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.
<
                                       9
<PAGE>

INTEREST INCOME

     Interest  income  amounted to $29.5  million  during  2002,  a $1.6 million
(5.2%) decrease from 2001 levels,  which decreased $592,000 (1.9%) from the 2000
levels.  Interest  income  reduction  during 2002  resulted from lower yields on
earning assets.  The average balance of  interest-earning  assets increased 8.1%
but was more than offset by the yield  decreasing 93 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 2001, the decrease in interest  income
was due to the yield on  average  interest-earning  assets  decreasing  37 basis
points   because  of  the   interest   rate  cuts.   The   average   balance  of
interest-earning assets increased 3.0% as compared to 2000. The yield on average
interest-earning  assets for the year 2002  decreased  to 6.62% as  compared  to
7.55% for 2001 and 7.92% for 2000.

INTEREST EXPENSE

     Interest  expense  amounted to $13.9  million  during  2002, a $5.0 million
(26.7%)  decrease from 2001 levels,  compared to a $388,000 (2.0%) decrease from
2000 to 2001. The decrease in interest expense during 2002 resulted from a lower
cost of  interest-bearing  liabilities.  During  2002,  the  average  balance of
interest-bearing liabilities increased 9.5% but was more than offset by the cost
decreasing  164 basis  points as compared to 2001.  During 2001 the  decrease in
interest  expense  was due to a 26 basis  point  drop in the  average  rate paid
against a 3.2% increase in the average balance of  interest-bearing  liabilities
as compared to 2000. The average cost on  interest-bearing  liabilities  for the
year 2002 decreased to 3.33% as compared to 4.97% for 2001 and 5.23% for 2000.

NET INTEREST INCOME

     Net interest  income totaled $15.6 million during 2002, an increase of $3.4
million or 28.0% over 2001, when net interest  income was $12.2 million.  During
2001,  net interest  income  decreased  $203,000 or 1.6% under the $12.4 million
recorded  during  2000.  The Average  Yield/Cost  Analysis  table  analyzes  the
interest-earning  assets and  interest-bearing  liabilities  for the three years
ending December 31, 2002. The Rate/Volume  Analysis table  identifies the causes
for  changes in interest  income and  interest  expense  for 2002 and 2001.  The
interest  rate  spread was 3.29% for 2002,  compared to 2.58% for 2001 and 2.69%
for 2000. The increased  interest rate spread can be attributed to the fact that
liabilities  have  repriced  more  than  assets  during  2002.  The net yield on
interest-earning  assets was 3.51% for 2002 compared to 2.96% for 2001 and 3.10%
for 2000.

     During  2001,  the Bank  provided  a  retirement  benefit  for its Board of
Directors,  President and Executive Vice President.  In addition,  the Directors
can now defer their Board  compensation.  These  benefits are funded through the
purchase of BOLI, which should enable the Bank to provide these benefits without
a reduction to net income.  This  transaction will have a negative impact on net
interest income of  approximately  $350,000  annually because it was funded with
borrowed   funds.   Noninterest   income  should  be   positively   affected  by
approximately $320,000 annually.

                                       10
<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, 2002                     DECEMBER 31, 2001
                                              ----------------------------------    ----------------------------------
(DOLLARS IN THOUSANDS)                                                   Average                               Average
                                                Average                   Yield/      Average                   Yield/
                                                Balance     Interest       Cost       Balance     Interest       Cost
                                              ------------ ------------  ---------  ------------ ------------  ---------
<S>                                              <C>           <C>          <C>        <C>           <C>          <C>
ASSETS
Interest-earning assets:
   Interest-bearing deposits in other banks      $  2,732      $    48      1.76%      $  7,648      $   271      3.54%
   Securities:
        Available for sale                         41,185        2,184      5.30%        36,671        2,212      6.03%
        Held to maturity                            7,206          433      6.01%         7,452          400      5.37%
   FHLB stock                                       4,141          220      5.31%         3,761          254      6.75%
   All loans                                      390,210       26,611      6.82%       356,540       27,980      7.85%
                                                 --------      -------    ------       --------      --------  -------
    Total interest-earning assets                 445,474      $29,496      6.62%       412,072       31,117      7.55%
                                                               -------                               --------
Non-interest earning assets                        27,330                                16,676
                                                 --------                              --------
Total assets                                     $472,804                              $428,748
                                                 ========                              ========

LIABILITIES AND
STOCKHOLDERS' EQUITY
Interest-bearing liabilities:
   Deposits                                       334,980       10,146      3.03%      $319,777      $15,353      4.80%
   Borrowed funds                                  81,867        3,729      4.55%        60,943        3,563      5.85%
                                                 --------      -------    ------       --------      -------   -------
    Total interest-bearing liabilities            416,847      $13,875      3.33%       380,720       18,916      4.97%
                                                               -------                               -------
Non-interest bearing liabilities                   19,855                                15,588
                                                 --------                              --------

    Total liabilities                             436,702                               396,308
    Stockholders' equity                           36,102                                32,440
                                                 --------                              --------
Total liabilities and stockholders' equity       $472,804                              $428,748
                                                 ========                              ========

Net interest income                                            $15,621                               $12,201
                                                               =======                               =======
Interest rate spread                                                        3.29%                                 2.58%
                                                                         =======                               =======
Net yield on interest-earning assets                                        3.51%                                 2.96%
                                                                         =======                               =======
Percentage of average interest-earning
   assets to average interest-bearing
   liabilities                                                             106.9%                                108.5%
                                                                         =======                               =======
<CAPTION>
                                                    For the year ended
                                              -----------------------------------
                                                       DECEMBER 31, 2000
                                              -----------------------------------
(DOLLARS IN THOUSANDS)                                                  Average
                                              Average                    Yield/
                                              Balance      Interest       Cost
                                              ----------  ------------  ---------
<S>                                            <C>            <C>          <C>
ASSETS
Interest-earning assets:
   Interest-bearing deposits in other banks    $  9,528       $   390      4.09%
   Securities:
        Available for sale                       21,619         1,267      5.86%
        Held to maturity                         18,385         1,066      5.80%
   FHLB stock                                     3,755           291      7.75%
   All loans                                    346,848        28,695      8.27%
                                               --------       -------    ------
    Total interest-earning assets               400,135        31,709      7.92%
                                                              -------
Non-interest earning assets                      11,665
                                               --------
Total assets                                   $411,800
                                               ========

LIABILITIES AND
STOCKHOLDERS' EQUITY
Interest-bearing liabilities:
   Deposits                                    $303,379       $15,062      4.96%
   Borrowed funds                                65,470         4,243      6.48%
                                               --------       -------    ------
    Total interest-bearing liabilities          368,849        19,305      5.23%
                                                              -------
Non-interest bearing liabilities                 12,549
                                               --------

    Total liabilities                           381,398
    Stockholders' equity                         30,402
                                               --------
Total liabilities and stockholders' equity     $411,800
                                               ========

Net interest income                                           $12,404
                                                              =======
Interest rate spread                                                       2.69%
                                                                        =======
Net yield on interest-earning assets                                       3.10%
                                                                        =======
Percentage of average interest-earning
   assets to average interest-bearing
   liabilities                                                            108.5%
                                                                        =======
</TABLE>

                                       11
<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, 2001 vs. December 31, 2002   December 31, 2000 vs. December 31, 2001
                                                         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    $ (126)      $   (97)     $  (223)        $  (72)       $   (47)       $ (119)
   Securities:
        Available for sale                        255          (283)         (28)           906             39           945
        Held to maturity                          (13)           46           33           (593)           (73)         (666)
   FHLB stock                                      24           (58)         (34)             -            (37)          (37)
   All loans                                    2,497        (3,866)      (1,369)           788         (1,503)         (715)
                                               ------       -------      -------         ------        -------        ------
    Total interest-earning assets               2,637        (4,258)      (1,621)         1,029         (1,621)         (592)
                                               ------       -------      -------         ------        -------        ------

Interest expense:
   Deposits                                       699        (5,906)      (5,207)           797           (506)          291
   Borrowed funds                               1,058          (892)         166           (282)          (398)         (680)
                                               ------       -------      -------         ------        -------        ------
    Total interest-bearing liabilities          1,757        (6,798)      (5,041)           515           (904)         (389)
                                               ------       -------      -------         ------        -------        ------
Net interest income                            $  880       $ 2,540      $ 3,420         $  514        $  (717)       $ (203)
                                               ======       =======      =======         ======        =======        ======
</TABLE>

PROVISION FOR LOAN LOSSES

     The provision for loan losses  charged to  operations  was $740,000  during
2002,  compared to $460,000  during 2001 and $970,000 during 2000. The provision
for 2000  included an increase of  approximately  $670,000 made in response to a
detailed review of the Bank's loan portfolio.  Management's decision to increase
the loan loss  reserve was  considered  appropriate  in light of the  successful
expansion  in the  commercial  loan  portfolio  and was not in  response  to any
significant increase in non-performing  assets. While commercial loans typically
earn a higher yield than traditional  residential  mortgage loans,  they pose an
incrementally  higher  level of  credit  risk to the  Company.  A review  of the
portfolio  during  the  first  quarter  of 2000  highlighted  this  trend in the
portfolio and prompted  management to make this  provision.  The commercial loan
portfolio  continues  to  expand  which is why the  provision  for  loan  losses
continued  to increase in 2002 over 2001.  Nonperforming  assets at December 31,
2002 were $1.2  million  compared  to $3.8  million  at  December  31,  2001 and
$925,000 at December 31, 2000. Net charge-offs  for 2002 were $326,000  compared
to $97,000  during 2001 and  $117,000  during 2000.  At December  31, 2002,  the
allowance  for loan  losses was 0.75% of net loans as compared to 0.67% for 2001
and 0.62% for 2000.  The allowance for loan losses  increased to $2.9 million at
December 31, 2002 compared to $2.5 million at December 31, 2001 and $2.2 million
at December 31, 2000. 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 the  recognition of additions to the allowance  based on their judgments
of information available to them at the time of their examination.

                                       12
<PAGE>

NONINTEREST INCOME

     Total noninterest income increased to $4.8 million during 2002, an increase
of $2.7  million or 133.0% over 2001.  This  compares  to $2.0  million and $1.7
million during 2001 and 2000, respectively. The major component in the year 2002
that had the most  impact on  noninterest  income  was the gain on sale of loans
resulting in net gains of $1.9 million  versus a gain of $11,000 in 2001.  These
gains were realized  primarily as a result of the purchase of Lumina.  There was
also a gain  on  sale  of  real  estate  of  $465,000  in  2002  but no  similar
transaction  in 2001.  Service  charges and fees on loans  decreased to $649,000
(11.2%)  during  the year 2002 as  compared  to  $731,000  (63.6%)  for 2001 and
$447,000 in 2000. The decrease in service charges and fees on loans for 2002 was
mainly due to a decrease in loan settlement service fees for loans processed for
others and loans  serviced for others.  The increase in 2001 was due to the fact
that the program for settlement services processed for others began in May 2000.
Bank-owned life insurance  earnings  increased to $399,000 (298.1%) in 2002 from
$100,000 in 2001.  This  insurance  was  purchased in  September of 2001.  Other
income  increased  to  $223,000  (111.7%)  during the year 2002 as  compared  to
$105,000  (5.6%) for 2001 and $100,000 in 2000. The majority of the increase can
be attributed to the increase in commissions for annuity sales and mutual funds,
through UVEST Investment Services sold in 2002.

NONINTEREST EXPENSE

     Total  noninterest  expense  was $11.9  million  during the year  2002,  an
increase of $2.6 million or 27.8% from 2001.  The major  increase in noninterest
expense during the year 2002 can be attributed to compensation and related costs
increasing  to $7.0 million  (36.9%) in 2002 as compared to $5.1 million in 2001
and $6.0 million in 2000.  The increase was due to increases in incentive  based
pay, costs of benefits, staffing levels and normal increases in salaries as well
as higher personnel costs as a result of the purchase of Lumina. The decrease in
2001 of  15.2%  was due to a  modification  of the  defined  benefit  plan and a
onetime early retirement offering to certain employees. The Bank's occupancy and
equipment  expense  was $2.3  million  during  2002,  an  increase  of 11.7 % as
compared to $2.1 million in 2001 and $2.0  million in 2000.  The increase in the
years 2002 and 2001 can be  attributed to  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 as well as the purchase of Lumina in 2002. Advertising cost for
the year 2002 was $358,000, an increase of 28.8% as compared to $278,000 in 2001
and $398,000 in 2000.  The reduction in advertising in 2001 can be attributed to
a more  conservative  advertising  policy that year. Other operating expense was
$1.6  million,  an increase of 3.0% as compared to $1.6 million in 2001 and $1.4
million in 2000.  The  majority  of the  increase in 2001 can be  attributed  to
credits the Bank received in 2000 for phone lines for data  processing.  No such
credits were received in 2002 and 2001.

INCOME TAXES

     The effective tax rate for the years ended December 31, 2002, 2001 and 2000
was 36.2%,  35.5% and 33.6%  respectively.  The lower effective tax rate in 2000
was due to higher relative levels of state tax-exempt income.

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.

                                       13
<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>
                                                                  2002
                                              Fourth       Third        Second       First
----------------------------------------------------------------------------------------------
                                                         Dollars in Thousands
<S>                                           <C>          <C>          <C>         <C>
Selected Quarter-End Balances:
  Assets                                      $ 504,210    $ 498,035    $ 479,435   $ 462,846
  Loans, net                                    390,876      386,940      384,871     375,125
  Securities                                     49,935       51,298       48,438      47,354
  FHLB stock                                      4,055        4,155        4,155       4,155
  Deposits                                      357,254      359,873      360,536     352,083
  Borrowed funds                                104,679       96,133       80,929      74,295
  Stockholders' equity                           38,448       37,065       35,776      34,142

----------------------------------------------------------------------------------------------
                                                         Dollars in Thousands
Selected Operations Data:
  Interest income                               $ 7,374      $ 7,366      $ 7,393     $ 7,362
  Interest expense                                3,234        3,380        3,502       3,758
  Net interest income                             4,140        3,986        3,891       3,604
  Provision for loan losses                         220          120          120         280
  Noninterest income                              1,666        1,274          604       1,210
  Noninterest expenses                            3,450        3,277        2,611       2,550
  Income before income taxes                      2,136        1,863        1,764       1,984
  Net income                                      1,305        1,220        1,131       1,288

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

Selected Financial Ratios and Other Data:
  Return on average assets                        1.06%        1.02%        0.98%       1.13%
  Return on average equity                       13.65%       13.29%       12.91%      14.99%
  Average stockholders' equity to average assets  7.74%        7.69%        7.57%       7.53%
Per Share Data:
  Earnings per:
     Common share - basic                        $ 0.46       $ 0.43       $ 0.40      $ 0.45
     Common share - diluted                      $ 0.46       $ 0.43       $ 0.40      $ 0.45
  Cash dividends declared                        $ 0.05       $ 0.05       $ 0.05      $ 0.05
  Tangible book value                           $ 13.56      $ 13.07      $ 12.62     $ 11.86
  Number of common shares outstanding         2,835,947    2,835,947    2,835,947   2,835,447

<CAPTION>
                                                                      2001
                                                  Fourth       Third       Second       First
--------------------------------------------------------------------------------------------------
                                                             Dollars in Thousands
<S>                                               <C>          <C>         <C>          <C>
Selected Quarter-End Balances:
  Assets                                          $ 458,114    $ 443,781   $ 427,992    $ 417,408
  Loans, net                                        373,458      364,306     351,104      349,136
  Securities                                         47,970       47,441      51,650       42,767
  FHLB stock                                          4,155        3,755       3,755        3,755
  Deposits                                          339,830      340,615     338,985      328,566
  Borrowed funds                                     83,097       68,098      55,099       55,100
  Stockholders' equity                               33,618       33,010      31,873       31,375

--------------------------------------------------------------------------------------------------
                                                             Dollars in Thousands
Selected Operations Data:
  Interest income                                 $   7,505    $   7,870   $   7,825    $   7,918
  Interest expense                                    4,375        4,747       4,823        4,972
  Net interest income                                 3,130        3,123       3,002        2,946
  Provision for loan losses                             160          120          90           90
  Noninterest income                                    630          533         462          415
  Noninterest expenses                                2,362        2,292       2,275        2,374
  Income before income taxes                          1,238        1,244       1,099          897
  Net income                                            806          805         703          574

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

Selected Financial Ratios and Other Data:
  Return on average assets                            0.72%        0.74%       0.67%        0.56%
  Return on average equity                            9.59%        9.87%       8.77%        7.31%
  Average stockholders' equity to average assets      7.52%        7.53%       7.63%        7.59%
Per Share Data:
  Earnings per:
     Common share - basic                         $    0.29    $    0.29   $    0.25    $    0.21
     Common share - diluted                       $    0.28    $    0.28   $    0.25    $    0.20
  Cash dividends declared                         $    0.05    $    0.05   $    0.05    $    0.05
  Tangible book value                             $   11.86    $   11.69   $   11.38    $   11.20
  Number of common shares outstanding             2,835,447    2,823,271   2,800,975    2,800,975

</TABLE>
                                       14

<PAGE>
                               [KPMG LETTERHEAD]





                          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 as of December 31, 2002 and 2001,
and the related  consolidated  statements of operations,  comprehensive  income,
stockholders'  equity,  and cash  flows for each of the years in the  three-year
period ended December 31, 2002. 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 2001,  and the
results  of their  operations  and their cash flows for each of the years in the
three-year  period ended  December  31,  2002,  in  conformity  with  accounting
principles generally accepted in the United States of America.


/s/ KPMG LLP

Raleigh, North Carolina
January 24, 2003

                                       15
<PAGE>
                   COOPERATIVE BANKSHARES, INC. AND SUBSIDIARY

                 Consolidated Statements of Financial Condition
                           December 31, 2002 and 2001
<TABLE>
<CAPTION>
                             ASSETS                                       2002            2001
                                                                      ------------   ------------
<S>                                                                   <C>              <C>
Cash and due from banks, noninterest-bearing                          $ 11,858,603     10,709,799
Interest-bearing deposits in other banks                                        --      1,585,779
                                                                      ------------   ------------
                 Total cash and cash equivalents                        11,858,603     12,295,578
Securities:
     Available for sale (amortized cost of $41,033,409 in 2002
        and $42,661,527 in 2001)                                        42,075,212     42,970,180
     Held to maturity (estimated market value of $8,009,087
        in 2002 and $5,282,815 in 2001)                                  7,859,955      5,000,000
FHLB stock                                                               4,054,700      4,154,900
Loans held for sale                                                     25,659,935             --
Loans                                                                  393,812,940    375,980,628
     Less allowance for loan losses                                      2,936,795      2,522,737
                                                                      ------------   ------------
                 Net loans                                             390,876,145    373,457,891
Other real estate owned                                                    619,163        759,272
Accrued interest receivable                                              2,239,826      2,637,367
Premises and equipment, net                                              7,019,219      6,471,715
Prepaid expenses and other assets                                       11,946,819     10,367,162
                                                                      ------------   ------------
                 Total assets                                         $504,209,577    458,114,065
                                                                      ============   ============
                   LIABILITIES AND STOCKHOLDERS' EQUITY

Deposits                                                              $357,254,096    339,830,052
Short-term borrowings                                                   61,585,827     35,000,000
Escrow deposits                                                            223,604        220,944
Accrued interest payable                                                   284,568        264,391
Accrued expenses and other liabilities                                   3,320,629      1,083,242
Long-term obligations                                                   43,092,592     48,097,156
                                                                      ------------   ------------
                 Total liabilities                                     465,761,316    424,495,785
                                                                      ------------   ------------
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,
        2,835,947 and 2,835,447 issued and outstanding                   2,835,947      2,835,447
     Additional paid-in capital                                          2,440,645      2,435,720
     Accumulated other comprehensive income                                635,500        188,278
     Retained earnings                                                  32,536,169     28,158,835
                                                                      ------------   ------------
                 Total stockholders' equity                             38,448,261     33,618,280
                                                                      ------------   ------------
                 Total liabilities and stockholders' equity           $504,209,577    458,114,065
                                                                      ============   ============
</TABLE>

See accompanying notes to consolidated financial statements.

                                       16
<PAGE>
                   COOPERATIVE BANKSHARES, INC. AND SUBSIDIARY

                      Consolidated Statements of Operations
                  Years ended December 31, 2002, 2001 and 2000
<TABLE>
<CAPTION>
                                                                   2002          2001          2000
                                                               -----------   -----------   -----------
<S>                                                            <C>            <C>           <C>
Interest income:
     Loans                                                     $26,611,364    27,980,414    28,694,889
     Securities                                                  2,613,110     2,611,299     2,332,743
     Other                                                          51,633       271,767       390,285
     Dividends on FHLB stock                                       219,730       253,918       291,036
                                                               -----------   -----------   -----------
                 Total interest income                          29,495,837    31,117,398    31,708,953
                                                               -----------   -----------   -----------
Interest expense:
     Deposits                                                   10,148,866    15,352,845    15,061,870
     Borrowed funds                                              3,726,021     3,563,469     4,242,721
                                                               -----------   -----------   -----------
                 Total interest expense                         13,874,887    18,916,314    19,304,591
                                                               -----------   -----------   -----------
Net interest income                                             15,620,950    12,201,084    12,404,362
Provision for loan losses                                          740,000       460,000       970,000
                                                               -----------   -----------   -----------
                 Net interest income after provision for
                    loan losses                                 14,880,950    11,741,084    11,434,362
                                                               -----------   -----------   -----------
Noninterest income:
     Gain on sale of loans                                       1,852,388        11,150           245
     Net gain (loss) on sale of securities                         135,182       125,172      (287,282)
     Service charges and fees on loans                             649,074       731,338       446,922
     Deposit-related fees                                        1,030,429       967,171       827,432
     Gain on sale of real estate                                   464,977            --       582,583
     Bank-owned life insurance earnings                            398,528       100,104            --
     Other income, net                                             223,008       105,324        99,694
                                                               -----------   -----------   -----------
                 Total noninterest income                        4,753,586     2,040,259     1,669,594
                                                               -----------   -----------   -----------
Noninterest expenses:
     Compensation and fringe benefits                            7,016,029     5,124,945     6,046,774
     Occupancy and equipment                                     2,317,141     2,073,635     1,994,560
     Professional and examination fees                             570,229       238,681       310,363
     Advertising                                                   357,775       277,758       397,662
     Real estate owned                                              14,300        22,053        36,031
     Other                                                       1,612,495     1,566,080     1,407,797
                                                               -----------   -----------   -----------
                 Total other operating expenses                 11,887,969     9,303,152    10,193,187
                                                               -----------   -----------   -----------
Income before income taxes                                       7,746,567     4,478,191     2,910,679
Income tax expense                                               2,802,070     1,589,248       979,004
                                                               -----------   -----------   -----------
                 Net income                                    $ 4,944,497     2,888,943     1,931,675
                                                               ===========   ===========   ===========
Net income per share:
     Basic                                                     $      1.74          1.03           .71
                                                               ===========   ===========   ===========
     Diluted                                                          1.73          1.02           .69
                                                               ===========   ===========   ===========
Weighted average common shares outstanding:
     Basic                                                       2,835,712     2,797,317     2,714,216
                                                               ===========   ===========   ===========
     Diluted                                                     2,859,014     2,823,191     2,805,611
                                                               ===========   ===========   ===========
</TABLE>

See accompanying notes to consolidated financial statements

                                       17
<PAGE>
                   COOPERATIVE BANKSHARES, INC. AND SUBSIDIARY

                 Consolidated Statements of Comprehensive Income
                  Years ended December 31, 2002, 2001 and 2000
<TABLE>
<CAPTION>
                                                    2002           2001           2000
                                                -----------     ----------     ----------
<S>                                             <C>              <C>            <C>
Net income                                      $ 4,944,497      2,888,943      1,931,675
Other comprehensive income:
     Unrealized gain arising during the year        868,332        385,127        286,808
     Tax expense                                   (338,649)      (150,201)      (111,855)
     Reclassification to realized (gain) loss      (135,182)      (125,172)       287,282
     Tax expense (benefit)                           52,721         48,817       (112,040)
                                                -----------     ----------     ----------
                 Other comprehensive income         447,222        158,571        350,195
                                                -----------     ----------     ----------
Comprehensive income                            $ 5,391,719      3,047,514      2,281,870
                                                ===========     ==========     ==========
</TABLE>

See accompanying notes to consolidated financial statements.

                                       18
<PAGE>
                   COOPERATIVE BANKSHARES, INC. AND SUBSIDIARY
                 Consolidated Statements of Stockholders' Equity
                  Years ended December 31, 2002, 2001 and 2000
<TABLE>
<CAPTION>
                                                                                 ACCUMULATED
                                                                                   OTHER
                                                                  ADDITIONAL     COMPREHENSIVE                     TOTAL
                                                     COMMON        PAID-IN       INCOME (LOSS),     RETAINED    STOCKHOLDERS'
                                                     STOCK         CAPITAL           NET            EARNINGS       EQUITY
                                                   ----------    ----------       --------        -----------   -----------
<S>                                                <C>            <C>             <C>              <C>           <C>
Balance, December 31, 1999                         $2,687,919     2,531,998       (320,488)        24,443,871    29,343,300
     Exercise of stock options                         73,076       132,959             --                 --       206,035
     Tax benefit of stock option exercise                  --         4,251             --                 --         4,251
     Repurchase of stock (46,385 shares)              (46,385)     (434,272)            --                 --      (480,657)
     Other comprehensive income, net  of  taxes            --            --        350,195                 --       350,195
     Net income for year                                   --            --             --          1,931,675     1,931,675
     Cash dividends ($.20 per share)                       --            --             --           (542,620)     (542,620)
                                                   ----------    ----------       --------        -----------   -----------
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
                                                   ==========    ==========       ========        ===========   ===========
</TABLE>

See accompanying notes to consolidated financial statements.

                                       19
<PAGE>
                   COOPERATIVE BANKSHARES, INC. AND SUBSIDIARY
                      Consolidated Statements of Cash Flows
                  Years ended December 31, 2002, 2001 and 2000
<TABLE>
<CAPTION>
                                                                          2002             2001             2000
                                                                    -------------      -----------      -----------
<S>                                                                 <C>                  <C>              <C>
Net income                                                          $   4,944,497        2,888,943        1,931,675
Adjustments to reconcile net income to net cash
     provided by operating activities:
        Net accretion and amortization                                    300,135           45,494           15,085
        Depreciation                                                      801,173          669,842          639,291
        Net (gain) loss on sale of securities                            (135,182)        (125,172)         287,282
        Gain on sale of loans                                          (1,777,314)         (11,150)            (245)
        Deferred tax benefit                                               (3,990)        (276,589)        (695,383)
        Loss (gain) on sales of premises and equipment                   (464,977)           8,621             (130)
        Gain on sale of branch office                                          --               --         (582,583)
        Loss (gain) on sales of foreclosed real estate                     (6,855)           3,793           22,681
        Valuation losses on foreclosed real estate                        108,738           36,330               --
        Provision for loan losses                                         740,000          460,000          970,000
        Proceeds from sales of loans                                  106,027,979          506,245           44,560
        Loan originations held for sale                              (129,910,600)              --               --
        Changes in assets and liabilities:
           Accrued interest receivable                                    397,541          139,037         (309,675)
           Prepaid expenses and other assets                             (148,324)        (843,020)         890,265
           Accrued interest payable                                        20,177          (36,005)        (169,702)
           Accrued expenses and other liabilities                       2,225,719          269,985          496,507
                                                                    -------------      -----------      -----------
                 Net cash provided (used) by operating activities     (16,881,283)       3,736,354        3,539,628
                                                                    -------------      -----------      -----------
Purchases of securities available for sale                            (29,203,805)     (82,123,753)     (10,000,000)
Purchases of securities held to maturity                               (4,165,348)              --         (986,604)
Purchase of Lumina Mortgage Company                                      (773,188)              --               --
Proceeds from maturity of securities available for sale                        --       16,000,000        5,000,000
Proceeds from sale of securities available for sale                    24,058,015       43,107,351       16,277,957
Proceeds from maturities of securities held to maturity                        --        8,000,000               --
Repayments of mortgage-backed securities available for sale             6,721,816        2,413,006          213,783
Repayments of mortgage-backed securities held to maturity               1,192,533               --               --
Loan originations, net of principal repayments                        (18,229,406)     (28,078,369)     (15,451,318)
Proceeds from disposals of foreclosed real estate                         221,207          643,413          353,420
Purchases of premises and equipment                                    (1,311,187)        (902,513)        (789,299)
Proceeds from sales of premises and equipment                             499,071            3,518           68,154
Net cash paid related to sale of branch office                                 --               --       (5,156,761)
Net expenditures on foreclosed real estate                               (111,829)         (35,352)         (14,985)
Purchases of FHLB stock                                                  (350,000)        (399,600)              --
Proceeds from sale of FHLB stock                                          450,200               --               --
Purchases of life insurance                                            (1,000,000)      (8,088,704)              --
                                                                    -------------      -----------      -----------
                 Net cash used in investing activities                (22,001,921)     (49,461,003)     (10,485,653)
                                                                    -------------      -----------      -----------
Net increase in deposits                                               17,424,044       12,517,728       29,576,608
Net proceeds (repayments) on short-term borrowings                      6,585,827        5,000,000      (40,000,000)
Repayments on long-term obligations                                        (4,564)          (4,321)          (4,090)
Proceeds received on long-term obligations                             15,000,000       23,000,000       20,000,000
Proceeds from issuance of common stock, net                                 5,425          261,249          206,035
Purchase and retirement of common stock                                        --               --         (480,657)
Dividends paid                                                           (567,163)        (563,034)        (406,890)
Net change in escrow deposits                                               2,660         (339,831)         218,071
                                                                    -------------      -----------      -----------
                 Net cash provided by financing activities             38,446,229       39,871,791        9,109,077
                                                                    -------------      -----------      -----------
                 Increase (decrease) in cash and
                    cash equivalents                                     (436,975)      (5,852,858)       2,163,052
Cash and cash equivalents:
     Beginning of year                                                 12,295,578       18,148,436       15,985,384
                                                                    -------------      -----------      -----------
     End of year                                                    $  11,858,603       12,295,578       18,148,436
                                                                    =============      ===========      ===========

                                                                                                        (Continued)
</TABLE>

                                       20
<PAGE>
                   COOPERATIVE BANKSHARES, INC. AND SUBSIDIARY
                      Consolidated Statements of Cash Flows
                  Years ended December 31, 2002, 2001 and 2000
<TABLE>
<CAPTION>
                                                             2002          2001          2000
                                                         -----------    ----------    ----------
<S>                                                      <C>            <C>           <C>
Cash paid for:
     Interest                                            $13,854,710    18,952,319    19,305,008
     Income taxes                                          2,597,763     1,699,583     1,739,500
Summary of noncash investing and financing activities:
     Transfer from loans to other real estate owned          989,602     1,151,318       351,201
     Transfer of premises and equipment to other real
        real estate owned                                         --        21,427            --
     Loans to facilitate the sale of foreclosed
        real estate                                          918,450            --            --
     Unrealized gains (losses) on securities available
        for sale, net of taxes                               447,222       158,571       350,195
     Transfer of securities from held to maturity to
        available for sale at fair value                          --     5,946,000            --
     Long-term obligations reclassified to short-term
        borrowings                                        20,000,000    15,000,000    15,000,000
</TABLE>


See accompanying notes to consolidated financial statements.

                                       21
<PAGE>
                   COOPERATIVE BANKSHARES, INC. AND SUBSIDIARY

                   Notes to Consolidated Financial Statements

                           December 31, 2002 and 2001



(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'  wholly owned  subsidiary,  CS&L Real Estate
     Trust,  Inc. (REIT).  All significant  intercompany  transactions have been
     eliminated.

     NATURE OF OPERATIONS

     The Company  operates 20 offices  (including  16 full service  branches) in
     Eastern North Carolina and 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, 2002, the daily average gross reserve  requirement was
          $823,000.

                                       22
<PAGE>
                   COOPERATIVE BANKSHARES, INC. AND SUBSIDIARY

                   Notes to Consolidated Financial Statements

                           December 31, 2002 and 2001

     (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.

                                       23
<PAGE>
                   COOPERATIVE BANKSHARES, INC. AND SUBSIDIARY

                   Notes to Consolidated Financial Statements

                           December 31, 2002 and 2001

          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  the  recognition  of
          additions 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.


                                       24
<PAGE>
                   COOPERATIVE BANKSHARES, INC. AND SUBSIDIARY

                   Notes to Consolidated Financial Statements

                           December 31, 2002 and 2001

          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.

     (g)  TRANSFERS AND SERVICING OF FINANCIAL ASSETS

          There were  $8,832,200  and  $470,400  in loans sold in 2002 and 2001,
          respectively,  with retained servicing rights. The recorded balance of
          the  rights to  service  mortgage  loans for  others  was  $73,240  at
          December  31, 2002 as  compared to $3,898 at December  31, 2001 and is
          included  in other  assets.  There  were no loan  sales  in 2000  with
          retained servicing rights.

          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)  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.


                                       25
<PAGE>
                   COOPERATIVE BANKSHARES, INC. AND SUBSIDIARY

                   Notes to Consolidated Financial Statements

                           December 31, 2002 and 2001


     (k)  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.
<TABLE>
<CAPTION>
                                                                                 YEAR ENDED DECEMBER 31,
                                                                   --------------------------------------------
                                                                        2002           2001            2000
                                                                   -------------   ------------     -----------
              <S>                                                  <C>                <C>             <C>
              Net income, as reported                              $   4,944,497      2,888,943       1,931,675
              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)        (46,905)
                                                                   -------------   ------------     -----------
              Proforma net income                                  $   4,883,954      2,859,846       1,884,770
                                                                   =============   ============     ===========
              Earnings per share:
                  Basic - as reported                              $        1.74           1.03            0.71
                                                                   =============   ============     ===========
                  Basic - proforma                                 $        1.72           1.02            0.69
                                                                   =============   ============     ===========
                  Diluted- as reported                             $        1.73           1.02            0.69
                                                                   =============   ============     ===========
                  Diluted - proforma                               $        1.71           1.01            0.67
                                                                   =============   ============     ===========
</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, 2001 and 2000.
          The weighted  average fair values of options granted in 2002, 2001 and
          2000 were $3.60, $2.65 and $1.85, respectively.
<TABLE>
<CAPTION>
                                                2002         2001        2000
                                               -----        ------      ------
<S>                                            <C>           <C>         <C>
     Risk-free interest rate                   4.79%         4.86%       6.00%
     Dividend yield                            1.45%         1.85%       2.00%
     Expected volatility                         25%           20%         20%
     Expected lives (in years)                    8             8           5
</TABLE>

                                                                     (Continued)

                                       26
<PAGE>
                   COOPERATIVE BANKSHARES, INC. AND SUBSIDIARY

                   Notes to Consolidated Financial Statements

                           December 31, 2002 and 2001

     (l)  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 other comprehensive  income is
          unrealized gains and losses on securities available for sale.

     (m)  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.

          The Company has determined that it operates primarily in one operating
          segment,  the providing of 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.

     (n)  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  commitments  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.

                                                                     (Continued)

                                       27
<PAGE>
                   COOPERATIVE BANKSHARES, INC. AND SUBSIDIARY

                   Notes to Consolidated Financial Statements

                           December 31, 2002 and 2001


          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 $661,543.  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 is required to adopt SFAS No. 143 on January 1, 2003.  The
          adoption of SFAS No. 143 is not expected to have a material  effect on
          the Company's consolidated financial statements.

          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.

                                                                     (Continued)

                                       28
<PAGE>
                   COOPERATIVE BANKSHARES, INC. AND SUBSIDIARY

                   Notes to Consolidated Financial Statements

                           December 31, 2002 and 2001


          In April  2002,  the FASB issued  SFAS No.  145,  "Rescission  of FASB
          Statements  No. 4, 44 and 64,  Amendment of FASB Statement No. 13, and
          Technical  Corrections".  SFAS No. 145  amends  existing  guidance  on
          reporting gains and losses on the  extinguishment  of debt to prohibit
          the classification of the gain or loss as extraordinary, as the use of
          such  extinguishments have become part of the risk management strategy
          of many  companies.  SFAS No. 145 also  amends  SFAS No. 13 to require
          sale-leaseback  accounting for certain lease  modifications  that have
          economic   effects  similar  to   sale-leaseback   transactions.   The
          provisions of the Statement related to the rescission of Statement No.
          4 is applied in fiscal years  beginning  after May 15,  2002.  Earlier
          application of these  provisions is encouraged.  The provisions of the
          Statement  related to Statement No. 13 were effective for transactions
          occurring after May 15, 2002, with early application  encouraged.  The
          adoption of SFAS No. 145 is not expected to have a material  effect on
          the Company's consolidated financial statements.

          In June 2002,  the FASB  issued SFAS No.  146,  "Accounting  for Costs
          Associated with Exit or Disposal  Activities".  SFAS No. 146 addresses
          financial  accounting and reporting for costs  associated with exit or
          disposal  activities and nullifies  Emerging  Issues Task Force (EITF)
          Issue 94-3,  "Liability  Recognition for Certain Employee  Termination
          Benefits and Other Costs to Exit an Activity".  The provisions of this
          Statement  are  effective  for exit or  disposal  activities  that are
          initiated after December 31, 2002, with early application  encouraged.
          The adoption of SFAS No. 146 is not expected to have a material effect
          on the Company's consolidated financial statements.

          In October  2002,  the FASB  issued  SFAS No.  147,  "Acquisitions  of
          Certain Financial  Institutions".  This Statement  requires  financial
          institutions  to  subject  all of their  goodwill,  including  amounts
          previously  recorded as intangible assets relating to transactions now
          determined  to be  business  combinations  under SFAS No.  147,  to an
          annual  impairment  test  instead  of  amortizing  the asset  over its
          estimated useful life. The adoption of SFAS No. 147 on October 1, 2002
          did not have a material effect on the Company's consolidated financial
          statements.

          In November 2002, the FASB issued  Interpretation No. 45, "Guarantor's
          Accounting  and  Disclosure  Requirements  for  Guarantees,  Including
          Indirect  Guarantees of Indebtedness to Others,  an  interpretation of
          FASB   Statements  No.  5,  57  and  107  and  a  rescission  of  FASB
          Interpretation  No.  34".  This   Interpretation   elaborates  on  the
          disclosures  to be made  by a  guarantor  in its  interim  and  annual
          financial  statements about its obligations  under guarantees  issued.
          The  Interpretation  also  clarifies  that a guarantor  is required to
          recognize, at inception of a guarantee, a liability for the fair value
          of the obligation undertaken.  The initial recognition and measurement
          provisions of the  Interpretation  are applicable to guarantees issued
          or modified  after  December  31, 2002 and are not  expected to have a
          material effect on the Company's  consolidated  financial  statements.
          The disclosure  requirements are effective for financial statements of
          interim and annual periods ending after December 15, 2002.

          In  December  2002,  the FASB issued  SFAS No.  148,  "Accounting  for
          Stock-Based Compensation - Transition and Disclosure,  an amendment of
          FASB Statement No. 123. This Statement  amends FASB Statement No. 123,
          Accounting  for  Stock-Based  Compensation",  to  provide  alternative
          methods of transition for a voluntary  change to the fair value method
          of accounting for stock-based employee compensation. In addition, this
          Statement  amends the disclosure  requirements of Statement No. 123 to
          require  prominent  disclosures  in both annual and interim  financial
          statements.

                                                                     (Continued)

                                       29
<PAGE>
                   COOPERATIVE BANKSHARES, INC. AND SUBSIDIARY

                   Notes to Consolidated Financial Statements

                           December 31, 2002 and 2001

          Certain of the disclosure  modifications are required for fiscal years
          ending after  December 15, 2002 and are included in the notes to these
          consolidated financial statements.

          In January 2003, the FASB issued Interpretation No. 46, "Consolidation
          of Variable Interest Entities,  an interpretation of ARB No. 51". This
          Interpretation  addresses the consolidation by business enterprises of
          variable  interest  entities  as  defined in the  Interpretation.  The
          Interpretation  applies  immediately to variable interests in variable
          interest  entities  created  after  January 31, 2003,  and to variable
          interests in variable  interest  entities  obtained  after January 31,
          2003. For public  enterprises  with a variable  interest in a variable
          interest  equity created before  February 1, 2003, the  interpretation
          applies to that  enterprise  no later than the  beginning of the first
          interim or annual  reporting period beginning after June 15, 2003. The
          application of this  Interpretation is not expected to have a material
          effect  on  the  Company's  consolidated  financial  statements.   The
          Interpretation  requires certain  disclosures in financial  statements
          issued after  January 31, 2003 if it is  reasonably  possible that the
          Company  will  consolidate  or  disclose  information  about  variable
          interest entities when the Interpretation becomes effective.

(2)  SECURITIES

     Securities as of December 31, 2002 and 2001 are summarized as follows:
<TABLE>
<CAPTION>
                                                                       GROSS         GROSS
                                                                     UNREALIZED     UNREALIZED        ESTIMATED
                                                 AMORTIZED COST        GAINS          LOSSES         MARKET VALUE
                                                 --------------      ----------     ----------       ------------
<S>                                                <C>                   <C>                             <C>
      2002:
          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
                                                   ------------      -----------     ---------         ------------
                                                   $  7,859,955          149,132            --            8,009,087
                                                   ============      ===========     =========         ============

                                                                                                        (Continued)
</TABLE>

                                       30
<PAGE>
                   COOPERATIVE BANKSHARES, INC. AND SUBSIDIARY

                   Notes to Consolidated Financial Statements

                           December 31, 2002 and 2001

<TABLE>
<CAPTION>
                                                                       GROSS         GROSS
                                                                     UNREALIZED     UNREALIZED        ESTIMATED
                                                 AMORTIZED COST        GAINS          LOSSES         MARKET VALUE
                                                 --------------      ----------     ----------       ------------
<S>                                                <C>                   <C>        <C>               <C>
      2001:
          SECURITIES AVAILABLE FOR SALE:
           U.S. Government and agency
             securities                         $    25,600,964          268,987       112,134        25,757,817
            Mortgage-backed securities               11,070,696          120,060        67,456        11,123,300
            Marketable equity securities              4,984,950          114,425            --         5,099,375
            Corporate bonds                           1,004,917               --        15,229           989,688
                                                ---------------      -----------   -----------       -----------

                    Total                       $    42,661,527          503,472       194,819        42,970,180
                                                ===============      ===========   ===========       ===========
          SECURITIES HELD TO MATURITY:
            U.S. Government and agency
              securities                        $     5,000,000          282,815            --         5,282,815
                                                ===============      ===========   ===========       ===========
</TABLE>

       The maturities of securities at December 31, 2002 are summarized as
follows:
<TABLE>
<CAPTION>
                                                                     ESTIMATED
                                                    AMORTIZED          MARKET
                                                      COST             VALUE
                                                   -----------       -----------
<S>                                                <C>                 <C>
Held to maturity:
    Within 1 year                                  $ 5,000,000         5,122,600
    Mortgage-backed securities                       2,859,955         2,886,487
                                                   -----------       -----------

                                                   $ 7,859,955         8,009,087
                                                   ===========       ===========
Available for sale:
    Within 1 year                                  $   300,516           306,000
    After 1 year through 5 years                    12,697,765        12,983,166
    After 5 years through 10 years                   8,602,344         8,905,534
    Marketable equity securities                     4,975,000         5,074,500
    Mortgage-backed securities                      14,457,784        14,806,012
                                                   -----------       -----------

                                                   $41,033,409        42,075,212
                                                   ===========       ===========
</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, 2002, sales of investment securities
     resulted in gross realized gains of $135,182 in 2002,  gross realized gains
     of  $125,172 in 2001,  gross  realized  gains of $4,697 and gross  realized
     losses of $291,979 in 2000.

                                                                     (Continued)

                                       31
<PAGE>
                   COOPERATIVE BANKSHARES, INC. AND SUBSIDIARY

                   Notes to Consolidated Financial Statements

                           December 31, 2002 and 2001

     Investment  securities having an aggregate carrying value of $13,905,534 at
     December  31,  2002  were  pledged  to  secure  public  funds  on  deposit.
     Investment  securities  having an aggregate  carrying  value of $511,312 at
     December 31, 2002 were pledged to secure repurchase agreements.  Investment
     securities  having an aggregate  carrying value of $987,720 at December 31,
     2002 were  pledged to secure the  Treasury  tax and loan  account  with the
     Federal Reserve Bank.

(3)  LOANS

       Loans at December 31, 2002 and 2001 are summarized as follows (in
thousands):
<TABLE>
<CAPTION>
                                                        2002            2001
                                                      ---------       ---------
<S>                                                   <C>                <C>
Real estate:
    Construction and land development                 $  51,431          62,142
    Mortgage:
      1-4 family residential                            204,395         209,622
      Multi-family residential                           17,044          15,626
      Commercial                                         87,257          55,664
      Equity line                                        14,541          13,131
      Other                                                 363             254
                                                      ---------       ---------

Total real estate loans                                 375,031         356,439

Commercial, industrial and agricultural                  13,717          13,430
Consumer                                                  6,396           7,285
                                                      ---------       ---------
Total gross loans                                       395,144         377,154

Unamortized net deferred fees                            (1,331)         (1,173)
                                                      ---------       ---------

Loans                                                 $ 393,813         375,981
                                                      =========       =========
</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, 2002 (in thousands):

                    Balance at beginning of year   $ 6,380
                    New loans                        2,503
                    Repayments                      (1,076)
                                                   -------

                    Balance at end of year         $ 7,807
                                                   =======

                                                                     (Continued)

                                       32
<PAGE>
                   COOPERATIVE BANKSHARES, INC. AND SUBSIDIARY

                   Notes to Consolidated Financial Statements

                           December 31, 2002 and 2001


     Activity in the allowance for loan losses for the years ended  December 31,
     2002, 2001 and 2000 is summarized as follows (in thousands):
<TABLE>
<CAPTION>
                                             2002          2001          2000
                                            -------       -------       -------

<S>                                         <C>             <C>           <C>
Balance at beginning of year                $ 2,523         2,160         1,306
Provision for loan losses                       740           460           970
Loans charged-off                              (360)         (106)         (146)
Recoveries                                       34             9            30
                                            -------       -------       -------

Balance at end of year                      $ 2,937         2,523         2,160
                                            =======       =======       =======
</TABLE>

     The following is a summary of nonperforming assets at December 31, 2002 and
     2001 (in thousands):
<TABLE>
<CAPTION>
                                                                2002       2001
                                                               ------     ------

<S>                                                            <C>         <C>
Loans 90 days past due and still accruing interest             $  249      2,563
Nonaccrual loans                                                  335        505
Other real estate owned                                           619        759
                                                               ------     ------

Total                                                          $1,203      3,827
                                                               ======     ======
</TABLE>

     At December  31, 2002,  2001 and 2000,  the  recorded  investment  in loans
     considered  impaired  in  accordance  with SFAS No. 114  totaled  $334,289,
     $505,378  and  $332,779,  respectively,  with  no  corresponding  valuation
     allowances.  For the years ended  December  31,  2002,  2001 and 2000,  the
     average recorded  investment in impaired loans was approximately  $254,000,
     $513,000 and $204,000,  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, 2002 and 2001 (in thousands):
<TABLE>
<CAPTION>
                                                              2002      2001
                                                             -------   -------
<S>                                                          <C>        <C>
Undisbursed portion of home equity lines of credit
    collateralized primarily by junior liens on 1-4
    family properties                                        $14,130    12,031
Other commitments and credit lines                            13,843    15,755
Undisbursed portion of construction loans                     32,667    33,728
Fixed-rate mortgage loan commitments                             879       618
Adjustable-rate mortgage loan commitments                      5,614     1,881
Available-for-sale mortgage loan commitments                   3,729        --
                                                             -------   -------

Total                                                        $70,862    64,013
                                                             =======   =======
</TABLE>

                                                                     (Continued)

                                       33
<PAGE>
                   COOPERATIVE BANKSHARES, INC. AND SUBSIDIARY

                   Notes to Consolidated Financial Statements

                           December 31, 2002 and 2001


     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
     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.

     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.

     Mortgage loans serviced for others  approximated  $44,809,000,  $56,041,000
     and $74,140,000 at December 31, 2002, 2001 and 2000, respectively.

(4)  PREMISES AND EQUIPMENT

     Premises  and  equipment at December  31, 2002 and 2001 are  summarized  as
     follows (in thousands):
<TABLE>
<CAPTION>
                                                           2002          2001
                                                         --------      --------

<S>                                                      <C>              <C>
Land                                                     $  2,526         1,984
Buildings                                                   5,539         5,524
Leasehold improvements                                        369           308
Furniture and equipment                                     6,516         5,786
                                                         --------      --------

                                                           14,950        13,602
Less accumulated depreciation and amortization             (7,931)       (7,130)
                                                         --------      --------

Premises and equipment, net                              $  7,019         6,472
                                                         ========      ========
</TABLE>

(5)  DEPOSITS

     Deposits  at  December  31, 2002 and 2001,  are  summarized  as follows (in
     thousands):
<TABLE>
<CAPTION>
                                                          2002             2001
                                                       --------         --------
<S>                                                    <C>                <C>
Demand                                                 $ 19,800           17,716
Checking with interest                                   20,630           18,523
Money market accounts                                    24,213           24,862
Savings                                                  20,345           20,175
Time deposits of $100 or more                            85,831           74,610
Other time deposits                                     186,435          183,944
                                                       --------         --------

Total                                                  $357,254          339,830
                                                       ========         ========
</TABLE>

                                                                     (Continued)

                                       34
<PAGE>
                   COOPERATIVE BANKSHARES, INC. AND SUBSIDIARY

                   Notes to Consolidated Financial Statements

                           December 31, 2002 and 2001


     At December 31, 2002,  the  scheduled  maturities of time deposits were (in
     thousands):

                 2003                       $209,351
                 2004                         59,689
                 2005                          2,964
                 2006                            100
                 2007                             81
                 Thereafter                       81
                                            --------

                 Total time deposits        $272,266
                                            ========


(6)  BORROWED FUNDS

     Borrowed  funds  and the  corresponding  weighted  average  rates  (WAR) at
     December 31, 2002 and 2001 are summarized as follows:
<TABLE>
<CAPTION>
                                                      2002              WAR              2001          WAR
                                                  ---------------     -------       ------------    ----------

           <S>                                    <C>                    <C>        <C>                <C>
           Advances from FHLB                     $    81,000,000        3.84%      $ 83,000,000       4.59%
           Affordable Housing Program
               Advances from FHLB                          92,592        3.50%            97,156       3.50%
           Advances for loans held
                for sale                               23,485,233        4.09%                --        --
           Repurchase agreements                          100,594        0.70%                --        --
                                                  ---------------                   ------------

                            Total                 $   104,678,419                   $ 83,097,156
                                                  ===============                   ============
</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, 2002 was approximately  $115,762,000.  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 $75 million
     during the years ended  December  31,  2002,  2001 and 2000,  respectively.
     Annual  principal  maturities  of Federal Home Bank  advances for the years
     subsequent to December 31, 2002 are as follows:


       2003                           $     38,000,000
       2004                                 15,000,000
       2006                                  5,000,000
       2010                                 10,000,000
       2011                                 13,000,000
                                      ----------------

                                      $     81,000,000
                                      ================
                                                                     (Continued)

                                       35
<PAGE>
                   COOPERATIVE BANKSHARES, INC. AND SUBSIDIARY

                   Notes to Consolidated Financial Statements

                           December 31, 2002 and 2001


     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.

     Lumina  borrows  money  on a  short-term  basis  principally  from  another
     financial institution to fund its loans that are held for sale. At December
     31, 2002, the balance of this  borrowing was $23.5 million.  Borrowings for
     loans that were  funded  from this line of credit  within 60 days were at a
     rate of 3.63% and  borrowings  for loans that were funded more than 60 days
     ($2.3 million) were at a rate of 8.25%. 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 provides for a maximum line of credit up to $10 million,  but the
     financial  institution  continues  to  supply  sufficient  funds  for loans
     originated by Lumina during the large volume increase caused by the current
     low interest rate environment.

     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, 2002, 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, 2002 and 2001,  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.

                                                                     (Continued)

                                       36
<PAGE>
                   COOPERATIVE BANKSHARES, INC. AND SUBSIDIARY

                   Notes to Consolidated Financial Statements

                           December 31, 2002 and 2001

     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
                                                                                ------------------------------
                                          2002                 2001               2002                 2001
                                       ----------            ---------          ---------            ---------
<S>                                    <C>                     <C>              <C>                  <C>
      Risk-based capital:
          Tier I capital               $   37,193              33,428
          Total capital                    40,130              35,951
          Risk-adjusted assets            364,763             326,820
          Quarterly average
            tangible assets               494,455             447,214

      Tier I capital ratio                  10.20%              10.23%            6.00%                6.00%
      Total capital ratio                   11.00%              11.00%           10.00%               10.00%
      Leverage capital ratio                 7.52%               7.47%            5.00%                5.00%
</TABLE>

     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 $2,219,170 at December 31, 2002.

     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 Company 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 Company 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  $164,618,  $34,537 and
     $303,803 for the years 2002, 2001 and 2000, respectively.

     During 2000, the Company made certain  changes to its defined benefit plan.
     As a result of these changes,  three  executives of the Company  decided to
     take early retirement. The Company established a deferred compensation plan
     for these  executives,  which resulted in a pre-tax charge of approximately
     $686,000.

                                                                     (Continued)

                                       37
<PAGE>
                   COOPERATIVE BANKSHARES, INC. AND SUBSIDIARY

                   Notes to Consolidated Financial Statements

                           December 31, 2002 and 2001


     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 2002, 2001 and 2000.

     The  compensation  expense  incurred  by the  Company  for the  401(k)  was
     $90,098,  $78,585 and $107,784 for the years ended December 31, 2002,  2001
     and 2000, 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.

(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, 2002, 2001 and 2000:
<TABLE>
<CAPTION>
                                          2002        2001          2000
                                       ----------   ----------   ----------

<S>                                    <C>           <C>          <C>
Net income (numerator)                 $4,944,497    2,888,943    1,931,675
                                       ==========   ==========   ==========

Shares for basic EPS (denominator)      2,835,712    2,797,317    2,714,216
Dilutive effect of stock options           23,302       25,874       91,395
                                       ----------   ----------   ----------

Shares for diluted EPS (denominator)    2,859,014    2,823,191    2,805,611
                                       ==========   ==========   ==========
</TABLE>

     For the years ended  December 31, 2002,  2001 and 2000,  there were 14,204,
     14,204  and  114,043,   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 2002,  2001 and 2000
     calculations of the dilutive effect of stock options.

                                                                     (Continued)

                                       38
<PAGE>
                   COOPERATIVE BANKSHARES, INC. AND SUBSIDIARY

                   Notes to Consolidated Financial Statements

                           December 31, 2002 and 2001


(10) INCOME TAXES

     Income tax expense consists of the following components for the years ended
     December 31, 2002, 2001 and 2000:
<TABLE>
<CAPTION>
                                       2002           2001           2000
                                    -----------    -----------    -----------
<S>                                 <C>              <C>            <C>
Current tax expense:
   Federal                          $ 2,379,444      1,651,815      1,525,540
   State                                426,616        214,022        148,847
                                    -----------    -----------    -----------
       Total current tax expense      2,806,060      1,865,837      1,674,387
                                    -----------    -----------    -----------

Deferred tax expense (benefit):
   Federal                             (113,579)      (227,083)      (570,120)
   State                                109,589        (49,506)      (125,263)
                                    -----------    -----------    -----------
       Total deferred tax benefit        (3,990)      (276,589)      (695,383)
                                    -----------    -----------    -----------

       Total tax expense            $ 2,802,070      1,589,248        979,004
                                    ===========    ===========    ===========
</TABLE>

     The  components of the net deferred tax asset at December 31, 2002 and 2001
     are as follows:
<TABLE>
<CAPTION>
                                                          2002           2001
                                                       -----------    -----------
<S>                                                    <C>                <C>
Deferred tax assets:
    Allowance for loan losses                          $ 1,132,134        972,515
    Deferred compensation                                  226,150        207,118
                                                       -----------    -----------

Total gross deferred tax assets                          1,358,284      1,179,633

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

Total net deferred tax assets                            1,275,815      1,179,633
                                                       -----------    -----------

Deferred tax liabilities:
    Deferred loan fees                                     120,264        167,046
    FHLB stock                                             169,829        190,467
    Excess of book over tax basis of equipment             186,755        204,231
    Unrealized gain on securities available for sale       406,303        120,376
    Like kind exchange of real estate                      179,249             --
    Other                                                    3,456          5,618
                                                       -----------    -----------

Total                                                    1,065,856        687,738
                                                       -----------    -----------

Net deferred tax asset                                 $   209,959        491,895
                                                       ===========    ===========
</TABLE>

     The Company has  established  a valuation  allowance  at December  31, 2002
     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, 2002, the valuation allowance increased $82,469.

                                                                     (Continued)

                                       39
<PAGE>
                   COOPERATIVE BANKSHARES, INC. AND SUBSIDIARY

                   Notes to Consolidated Financial Statements

                           December 31, 2002 and 2001

     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, 2002, 2001 and 2000 are as follows:
<TABLE>
<CAPTION>
                                                   2002           2001            2000
                                                -----------    -----------    -----------

<S>                                             <C>              <C>              <C>
Income taxes at federal tax rate                $ 2,633,833      1,522,585        989,631
Increase (decrease) resulting from:
    State income taxes, net of federal income
      tax benefit                                   353,895        108,581         15,565
    Cash surrender value of bank owned
      life insurance                               (135,500)       (34,035)          --
    Tax exempt securities                           (72,701)       (36,350)          --
    Other                                            22,543         28,467        (26,192)
                                                -----------    -----------    -----------

Total                                           $ 2,802,070      1,589,248        979,004
                                                ===========    ===========    ===========
</TABLE>

     Retained  earnings at December  31,  2002 and 2001  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.

                                                                     (Continued)

                                       40
<PAGE>
                   COOPERATIVE BANKSHARES, INC. AND SUBSIDIARY

                   Notes to Consolidated Financial Statements

                           December 31, 2002 and 2001

     A summary of the status of the Option Plan as of December  31,  2002,  2001
     and 2000, and changes during the years then ended is presented below:
<TABLE>
<CAPTION>
                                        2002                             2001                             2000
                            -----------------------------    -----------------------------    -----------------------------
                                             WEIGHTED                         WEIGHTED                         WEIGHTED
                                              AVERAGE                          AVERAGE                          AVERAGE
                               NUMBER       OPTION PRICE       NUMBER        OPTION PRICE       NUMBER        OPTION PRICE
                            -------------   -------------    -------------   -------------    -------------   -------------
<S>                           <C>           <C>                <C>           <C>                <C>           <C>
      Options
          outstanding,
          beginning of
          year                117,943       $      11.37       246,457       $       6.85       281,118       $       5.03
      Granted                  25,500              10.85        18,000              13.38        38,415              10.58
      Exercised                  (500)             10.85      (141,537)              3.77       (73,076)              2.82
      Forfeited                (1,000)             11.00        (4,977)             10.86            --                 --
                            ---------       ------------     ---------       ------------     ---------       ------------

      Options
          outstanding,
          end of year         141,943       $      11.28       117,943       $      11.37       246,457       $       6.85
                            =========       ============     =========       ============     =========       ============
</TABLE>


     The following table summarizes additional information about the Option Plan
     at December 31, 2002:
<TABLE>
<CAPTION>
                                                          Remaining
        Exercise Price               Number               Contractual       Number
        Exercise Price            Outstanding               Life          Exercisable
        --------------            -----------          --------------     -----------
          <S>                        <C>                   <C>                <C>
          $  7.50                    10,000                1.25 years         10,000
            10.50                     5,424                4.25 years          5,424
            10.85                     2,000                 .90 years          2,000
            10.85                    23,000                9.00 years         23,000
            10.94                     9,000                6.70 years          9,000
            11.00                    10,315                7.00 years         10,315
            11.06                    60,000                6.50 years         60,000
            11.50                     8,000                9.00 years          8,000
            14.88                    10,000                8.10 years         10,000
            19.50                     4,204                5.00 years          4,204
                                  ---------            --------------    -----------

                                    141,943                6.63 years        141,943
                                  =========            ==============    ===========
</TABLE>
                                                                     (Continued)

                                       41
<PAGE>
                   COOPERATIVE BANKSHARES, INC. AND SUBSIDIARY

                   Notes to Consolidated Financial Statements

                           December 31, 2002 and 2001

(12) PARENT COMPANY FINANCIAL INFORMATION

     Condensed financial information of Cooperative Bankshares, Inc., the parent
     company, at December 31, 2002 and 2001 and for the years ended December 31,
     2002, 2001 and 2000 is presented below:
<TABLE>
<CAPTION>
                   CONDENSED STATEMENTS OF FINANCIAL CONDITION

                                                        2002            2001
                                                    -----------      -----------
<S>                                                 <C>              <C>
Assets:
    Cash                                            $     1,913            1,753
    Equity investment in subsidiary                  38,490,495       33,616,593
    Other assets                                        141,797          141,772
                                                    -----------      -----------

                                                    $38,634,205       33,760,118
                                                    ===========      ===========
Liabilities and stockholders' equity:
    Other liabilities                               $   185,944          141,838
    Stockholders' equity                             38,448,261       33,618,280
                                                    -----------      -----------

                                                    $38,634,205       33,760,118
                                                    ===========      ===========
</TABLE>
<TABLE>
<CAPTION>
                       CONDENSED STATEMENTS OF OPERATIONS

                                                       2002          2001           2000
                                                   -----------    -----------    -----------
<S>                                                <C>                <C>            <C>
Dividends from subsidiary                          $   575,739        347,309        825,242
Equity in undistributed net income of subsidiary     4,426,679      2,586,569      1,114,286
Miscellaneous expenses                                 (57,921)       (44,935)        (7,853)
                                                   -----------    -----------    -----------

                                                   $ 4,944,497      2,888,943      1,931,675
                                                   ===========    ===========    ===========
</TABLE>
                                                                     (Continued)

                                       42
<PAGE>
                   COOPERATIVE BANKSHARES, INC. AND SUBSIDIARY

                   Notes to Consolidated Financial Statements

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

                       CONDENSED STATEMENTS OF CASH FLOWS

                                                      2002          2001           2000
                                                  -----------    -----------    -----------
<S>                                               <C>              <C>            <C>
Operating activities:
    Net income                                    $ 4,944,497      2,888,943      1,931,675
    Equity in undistributed net income of
      subsidiary                                   (4,426,680)    (2,586,569)    (1,114,286)
    Change in other assets                                (25)        (6,042)      (135,730)
    Change in other liabilities                        44,106          6,036             72
                                                  -----------    -----------    -----------
        Net cash provided by operating
          activities                                  561,898        302,368        681,731

Financing activities:
    Proceeds from issuance of common stock, net         5,425        261,249        206,035
    Purchase and retirement of common stock                --             --        (480,657)
    Cash dividends paid                              (567,163)      (563,034)      (406,890)
                                                  -----------    -----------    -----------
          Net cash used in financing activities      (561,738)      (301,785)      (681,512)
                                                  -----------    -----------    -----------

Increase in cash and cash equivalents                     160            583            219
Cash and cash equivalents, beginning of year            1,753          1,170            951
                                                  -----------    -----------    -----------

Cash and cash equivalents, end of year            $     1,913          1,753          1,170
                                                  ===========    ===========    ===========
</TABLE>

                                                                     (Continued)

                                       43
<PAGE>
                   COOPERATIVE BANKSHARES, INC. AND SUBSIDIARY

                   Notes to Consolidated Financial Statements

                           December 31, 2002 and 2001

(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.  Due to the  uncertainties  surrounding the  determination of the
     contingent  payments,  such  payments  have  not  been  recorded.  The  two
     contingent payments are estimated to be approximately $650,000 each and, if
     made, will be recorded as additional  purchase price.  The goodwill created
     by this transaction was $661,543.

     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:

               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
                                                        ========

     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.

                                                                     (Continued)

                                       44
<PAGE>
                   COOPERATIVE BANKSHARES, INC. AND SUBSIDIARY

                   Notes to Consolidated Financial Statements

                           December 31, 2002 and 2001
<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.

     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.

                                                                     (Continued)

                                       45
<PAGE>
                   COOPERATIVE BANKSHARES, INC. AND SUBSIDIARY

                   Notes to Consolidated Financial Statements

                           December 31, 2002 and 2001


          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.

                                                                     (Continued)

                                       46
<PAGE>
                   COOPERATIVE BANKSHARES, INC. AND SUBSIDIARY

                   Notes to Consolidated Financial Statements

                           December 31, 2002 and 2001

     The carrying  amounts and estimated fair values of the Company's  financial
     instruments at December 31, 2002 and 2001 are as follows (in thousands):
<TABLE>
<CAPTION>
                                                      2002                            2001
                                         -----------------------------     -----------------------------
                                         CARRYING       ESTIMATED FAIR      CARRYING      ESTIMATED FAIR
                                          AMOUNT            VALUE            AMOUNT            VALUE
                                         ---------      --------------     ----------     --------------
<S>                                       <C>             <C>               <C>            <C>
      Financial assets:
          Cash and cash
            equivalents                   11,859          11,859            12,296         12,296
          Securities:
            Available for sale            42,075          42,075            42,970         42,970
            Held to maturity               7,860           8,009             5,000          5,283
          Loans held
             for sale                     25,660          25,660                --             --
          Loans, net                     390,876         397,001           373,458        376,503
          FHLB stock                       4,055           4,055             4,155          4,155
          Accrued interest
            receivable                     2,240           2,240             2,637          2,637
      Financial liabilities:
          Deposits                       357,254         357,915           339,830        340,320
          Borrowed funds                 104,678         106,089            83,097         86,451
          Accrued interest
            payable                          285             285               264            264
</TABLE>


(15) STOCK REPURCHASE PLAN

     On October  21,  1999 the  Company's  Board of  Directors  approved a Stock
     Repurchase  Program  authorizing  the Company to  repurchase  up to 138,000
     shares, or approximately 5% of the then outstanding shares of common stock.
     The Company did not purchase any shares pursuant to the program during 2002
     and 2001.  During 2000, the Company  purchased  46,385 shares at an average
     cost of $10.36 per share pursuant to the program.

(16) ASSET SALE

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

     During February 2000, the Company sold the Robersonville,  N.C. branch with
     $7.1  million in  deposits  to  Southern  Bank & Trust  Company.  A gain of
     $582,583 was realized on the sale.

                                                                     (Continued)

                                       47
<PAGE>

                   COOPERATIVE BANKSHARES, INC. AND SUBSIDIARY

                   Notes to Consolidated Financial Statements

                           December 31, 2002 and 2001


(17) 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 $200,000,
     $98,000 and $62,000 during 2002, 2001 and 2000, respectively.

     Future minimum lease payments under  noncancelable  operating  leases as of
     December 31, 2002 are (in thousands):

              YEAR ENDING DECEMBER 31:
              -----------------------

              2003                             $     285
              2004                                   263
              2005                                   208
              2006                                   138
              2007                                   126
              After 2007                           1,978
                                               ---------

              Total minimum lease payments     $   2,998
                                               =========


                                       48
<PAGE>
<TABLE>
<CAPTION>
                                                        CORPORATE HEADQUARTERS
                                                     Cooperative Bankshares, Inc.
                                                           201 Market Street
                                                             P.O. Box 600
                                                   Wilmington, North Carolina 28402
                                                            (910) 343-0181
                                                           www.coop-bank.com

<S>                                                                       <C>
                     TRANSFER AGENT                                                SPECIAL COUNSEL
                   First Citizens Bank                                   Stradley Ronon Stevens & Young, LLP
            Corporate Trust Department, DAC61                               1220 19th Street, NW Suite 600
                     P.O. Box 29522                                              Washington, DC 20036
           Raleigh, North Carolina 27626-0522


                     ANNUAL MEETING                                                   FORM 10-K
The Annual Meeting of Stockholders of Cooperative
Bankshares, Inc. will be held:                                       Copies of Form 10-K may be obtained without
               HILTON WILMINGTON RIVERSIDE                           charge by writing to Linda B. Garland at the
      301 NORTH WATER STREET, WILMINGTON, NC 28401                         Corporate Headquarters address.
              APRIL 25, 2003 AT 11:00 A.M.
All stockholders are cordially invited to attend.


                                                        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)."
</TABLE>


Cooperative Bankshares, Inc. stock is traded on the NASDAQ National Market under
the  symbol  "COOP".  As of  December  31,  2002,  there were  2,835,947  shares
outstanding,  which were held by 530  stockholders of record.  A $0.05 per share
dividend was declared each quarter in 2002 and 2001. Stock  performance for 2002
and 2001 is given in the following table
<TABLE>
<CAPTION>

                                                      QUARTERLY COMMON STOCK DATA
                                                              2002                       2001
             --------------------------------------------------------------------------------------
                                                         HIGH         LOW          HIGH        LOW
             QUARTERS ENDED
             --------------------------------------------------------------------------------------
             <S>                                       <C>         <C>           <C>         <C>
             December                                  17.000      13.850        12.400      9.500
             September                                 15.000      13.000        13.500      9.500
             June                                      16.000      12.040        12.500     10.800
             March                                     12.394      10.401        15.750      9.750
             --------------------------------------------------------------------------------------
</TABLE>

                                       49
<PAGE>
<TABLE>
<CAPTION>
                                                          BOARD OF DIRECTORS
                                                     Cooperative Bankshares, Inc.
                                                           Cooperative Bank


<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


                                                     OFFICERS OF COOPERATIVE BANK

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

                                              COOPERATIVE BANK FINANCIAL CENTER LOCATIONS

                        Beaufort                                                      Tabor City
                        Belhaven                                                       Wallace
                      Elizabethtown                                                 Washington (2)
                    Jacksonville (2)                                                  Whiteville
                    Kill Devil Hills                                                Wilmington (4)
                      Morehead City
                                                    Corolla -Loan Production Office

                                                   LUMINA MORTGAGE COMPANY LOCATIONS

                       Wilmington, North Carolina; North Myrtle Beach, South Carolina; Virginia Beach; Virginia

</TABLE>
                                       50