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SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549
   FORM 10-KSB (Mark One) ( X )
    
    ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THESECURITIES EXCHANGE ACT OF 1934For the fiscal year ended September 30, 2004(     )
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)OF THESECURITIES EXCHANGE ACT OF 1934For the transition period from  to
 Commission File Number: 1-13640 SOUTHFIRST BANCSHARES, INC.  A Delaware Corporation
I.R.S. Employer Identification No. 63-1121255
126 North Norton Ave.
Sylacauga, Alabama 35150
(256) 245-4365 Securities Registered Pursuant to Section 12(b)
of the Exchange Act: Title of Each Class
    
    Name of Each Exchange
on Which RegisteredCommon Stock, $.01 par value
    
    American Stock Exchange, Inc.
 Securities Registered Pursuant to Section 12(g)
of the Exchange Act: None Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.Yes [ X ] No [     ] Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-B is not contained herein, and will not be contained, to
the best of the registrants knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-KSB, or any
amendment to this Form 10-KSB. [  ] Issuers Revenues for the fiscal year ended September 30, 2004:
$10,360,454 The aggregate market value of the common equity held by non-affiliates of
the Registrant (594,691 shares), computed using the closing price as reported
on the American Stock Exchange for the Registrants Common Stock on December 9,
2004 was $9,158,241. For the purposes of this response, officers, directors
and holders of 10% or more of the Registrants Common Stock are considered the
affiliates of the Registrant. The number of shares outstanding of the Registrants Common Stock as of
December 9, 2004: 709,406 shares of $.01 par value Common Stock. Transitional Small Business Disclosure Format: Yes [     ] No [ X ] DOCUMENTS INCORPORATED BY REFERENCE: None




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SOUTHFIRST BANCSHARES, INC. FORM 10-KSB FOR THE FISCAL YEAR ENDED SEPTEMBER 30, 2004 Index  
 PART IItem 1.
    
    BusinessItem 2.
    
    PropertyItem 3.
    
    Legal ProceedingsItem 4.
    
    Submission of Matters to a Vote of Security HoldersPART IIItem 5.
    
    Market for Common Equity and Related Stockholder MattersItem 6.
    
    Managements Discussion and Analysis of Financial Condition and Results of OperationsItem 7.
    
    Financial StatementsItem 8.
    
    Changes In and Disagreements with Accountants on Accounting and Financial DisclosureItem 8A.
    
    Controls and ProceduresPART IIIItem 9.
    
    Directors, Executive Officers and Control Persons of the RegistrantItem 10.
    
    Executive CompensationItem 11.
    
    Security Ownership of Certain Beneficial Owners and Management and Related Stockholder MattersItem 12.
    
    Certain Relationships and Related TransactionsItem 13.
    
    Exhibits and Reports on Form 8-KItem 14
    
    Principal Accountant Fees and ServicesEX-11 STATEMENT REGARDING COMPUTATION OF PER SHARE EARNINGSEX-21 SUBSIDIARIES OF THE REGISTRANTEX-23.1 CONSENT OF JONES & KIRKPATRICK, P.C.EX-31.1 SECTION 302 CERTIFICATION OF THE CEOEX-31.2 SECTION 302 CERTIFICATION OF THE CFOEX-32.1 SECTION 906 CERTIFICATION OF THE CEOEX-32.2 SECTION 906 CERTIFICATION OF THE CFO




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Safe Harbor Statement Under the Private Securities Litigation Reform Act of 1995 Management has endeavored in its communications, in its Annual Report and
in this Form 10-KSB to highlight the trends and factors that might have an
impact on SouthFirst Bancshares, Inc. (SouthFirst, or the Company) and the
industry in which SouthFirst competes. Any forward-looking statements within
the meaning of the Private Securities Litigation Reform Act of 1995, which
statements generally can be identified by the use of forward-looking
terminology, such as may, will, expect, estimate, anticipate,
believe, target, plan, project, or continue or the negatives thereof
or other variations thereon or similar terminology, are made on the basis of
managements plans and current analyses of SouthFirst, its business and the
industry as a whole. These forward-looking statements are subject to risks and
uncertainties, including, but not limited to, economic conditions, competition,
interest rate sensitivity and exposure to regulatory and legislative changes.
The above factors, in some cases, have affected, and in the future could
affect, SouthFirsts financial performance and could cause actual results for
fiscal year 2005 and beyond to differ materially from those expressed or
implied in such forward-looking statements. SouthFirst does not undertake to
publicly update or revise its forward-looking statements, even if experience or
future changes make it clear that any projected results expressed or implied
therein will not be realized. 
 PART I 
 ITEM 1. BUSINESS Business of SouthFirst General SouthFirst Bancshares, Inc. (SouthFirst or the Company) was formed in
April of 1994, at the direction of the Board of Directors of First Federal of
the South (First Federal), a federally chartered savings association subject
to the regulatory oversight of the Office of Thrift Supervision (OTS) for the
purpose of becoming a holding company to own all of the outstanding common
stock of First Federal. On February 13, 1995, First Federal was converted from
a mutual to a stock form of ownership (the Conversion), whereupon SouthFirst,
approved by the OTS as a thrift holding company, acquired all of the issued and
outstanding shares of First Federal. SouthFirsts business primarily involves
directing, planning and coordinating the business activities of its
wholly-owned subsidiary, First Federal, along with First Federals two
wholly-owned operating subsidiaries, (i) Pension & Benefit Financial Services,
Inc., d/b/a Pension & Benefit Trust Company (Pension & Benefit), an employee
benefit plan consulting firm and trust company located in Montgomery, Alabama,
and (ii) SouthFirst Mortgage, Inc. (SouthFirst Mortgage), residential
mortgage and construction lending operations located in Hoover and Chelsea,
Alabama. Further, SouthFirst organized, as a wholly-owned subsidiary,
SouthFirst Financial Services, Inc. (SouthFirst Financial), located in
Montgomery and Sylacauga, Alabama, through which SouthFirst provides insurance
products and other financial services to the customers of First Federal. In
the future, SouthFirst may acquire or organize other operating affiliates or
subsidiaries, including other financial institutions. To date, SouthFirst has neither owned nor leased any property, but,
instead, has used the premises, equipment and furniture of First Federal. At
the present time, because SouthFirst does not intend to employ any persons
other than officers, it will continue utilizing the support staff of First
Federal from time to time. Additional employees may be hired as appropriate to
the extent SouthFirst expands in the future. Business of First Federal General First Federal was organized in 1949 as a federally chartered mutual
savings and loan association under the name Sylacauga Federal Savings and Loan
Association. In 1959, First Federal changed its name to First Federal Savings
and Loan Association of Sylacauga. In the conversion, First Federal changed
its name to First Federal of 1




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the South. First Federal is a member of the Federal Home Loan Bank (the
FHLB) System and its deposit accounts are insured up to the maximum amount
allowable by the FDIC. At September 30, 2004, First Federal conducted business from three
full-service locations in Alabama. These locations included its main office
in Sylacauga and branches in Talladega and Clanton. In addition, SouthFirst
Mortgage, the wholly-owned subsidiary of First Federal, operates loan
production offices in the Alabama cities of Hoover and Chelsea (suburbs of
metropolitan Birmingham), primarily to enhance First Federals
construction-lending activities in the growing residential markets of
metropolitan Birmingham. First Federal also pursues other types of loans, such
as consumer and commercial loans, in the Birmingham market area, as demands
dictate. In January 2004, First Federal of the Souths wholly-owned subsidiary,
SouthFirst Mortgage, acquired all of the assets and work in progress of Walton
Mortgage, located in Chelsea, Alabama. In addition to being based in Chelsea,
a rapidly growing area on the outskirts of Birmingham, Walton Mortgage has loan
originators who generate mortgage loans in other locations within Alabama,
including Huntsville, Montgomery, Cullman and Alexander City. These lending
areas will complement the mortgage banking activities of SouthFirst Mortgage
located in Birmingham. First Federals principal business has been, and continues to be,
attracting retail deposits from the general public and investing those
deposits, together with funds generated from operations, primarily in
one-to-four family mortgage loans, residential constructions loans,
mortgage-backed securities, collateralized mortgage obligations (CMOs) and
investment securities. First Federals revenues are derived principally from interest and fees on
loans in its portfolio and from mortgage-backed securities, CMOs, investment
securities portfolios and customer service fees. First Federals primary
sources of funds are deposits and proceeds from principal and interest payments
on loans, mortgage-backed securities, CMOs, FHLB advances and other investment
securities. First Federals primary expense is interest paid on deposits. First Federal markets its one-to-four family residential loans and deposit
accounts primarily to persons in Talladega and Chilton Counties in Alabama.
Mortgage loans are generated from depositors, walk-in customers, referrals from
local real estate brokers and developers and, to a limited extent, local radio
and newspaper advertising. Construction-loan originations are attributable
largely to First Federals lending officers reputations and their
long-standing relationships with builders and developers in the market areas
they serve. See  Construction Lending. First Federal offers its customers fixed-rate and adjustable-rate
residential mortgage loans, residential construction loans, as well as other
consumer loans, including savings account loans. Fixed-rate mortgage loans
are generally sold upon origination to the secondary market. One-year
adjustable-rate loans with 30-year maturities are generally originated for
retention in First Federals loan portfolio. All consumer loans are retained
in First Federals portfolio. To attract deposits, First Federal offers a selection of deposit accounts,
including NOW accounts, money-market accounts, passbook savings accounts and
certificates of deposit. First Federal offers competitive rates and relies
substantially on customer service, advertising and long-standing relationships
with customers to attract and retain deposits. Market Area First Federals primary deposit gathering and lending area covers
Talladega and Chilton Counties in central Alabama. To a lesser extent, First
Federals deposit gathering and lending area covers the adjoining Alabama
counties of Coosa, Shelby, Clay, Cleburne, Calhoun, St. Clair and Jefferson.
Talladega County has a population of approximately 80,000 and Chilton County
had a population of approximately 40,000, based on 2000 census data, as
published by the U.S. Bureau of Vital Statistics. First Federals main office
in Sylacauga is 2




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situated approximately 38 miles southeast of Birmingham, the largest city in
Alabama. First Federals branch office in the city of Talladega is situated
approximately 55 miles east of Birmingham. First Federals Clanton office is
located approximately 55 miles north of Montgomery. The loan production office
of SouthFirst Mortgage, located in the city of Hoover, is situated within the
Birmingham metropolitan area. Walton Mortgage, located south of Hoover in
Chelsea, Alabama, is in Shelby County, which is considered the fastest growing
county in the state of Alabama. First Federal is the largest financial institution headquartered in
Sylacauga and is the second largest in Talladega County. Talladega County has
a diversified economy, based primarily on textile and other manufacturing,
wholesale, retail, mining, service, government, agriculture and tourism.
Manufacturing accounts for approximately one-third of the total employment in
Talladega County. The economy is generally stable, and there has been no
substantial increase or decrease in the population in the last five years. Sylacaugas economy is based primarily on major industrial employers such
as Imerys USA, Inc. American Color Graphics, Inc., Avondale Mills, Blue Bell
Ice Cream, Pursell Industries and Georgia Marble. Bowater, Inc., a paper
manufacturer, is a major employer in Childersburg, Alabama, located 10 miles
from Sylacauga in Talladega County. Teksid, Inc., another major employer in
the region, recently completed construction on a new aluminum casting
manufacturing facility. The new plant, operated by Teksid Automotive
Components, Inc., is located in Sylacauga, and employs approximately 400
skilled workers. Talladegas economy is based largely on major textile manufacturing
employers such as Brecon Knitting Mills and Image Industries, Inc.
Georgia-Pacific Corporation also employs a number of persons in Talladega.
American Honda Motor Co., Inc. (Honda) operates a comprehensive automobile
manufacturing facility near the town of Lincoln, Talladega County, Alabama that
was completed in the Fall of 2001. The plant is located on a 1,350-acre tract,
approximately forty miles east of Birmingham and 20 miles north of the city of
Talladega. Construction was completed in 2004 on a record assembly line that
put employment well over the 4,000 mark. The $70 million expansion nearly
doubles the size of the already impressive 160,000 square foot facility.
Talladega is the home of the Talladega Superspeedway which hosts the EA Sports
500 and other NASCAR events and attracts individuals to Talladega County
primarily from the southeast region of the United States. Although Chilton County is generally a rural area in which the economy is
largely based on the growth and harvesting of peaches, this county has been
experiencing relatively higher growth rates than Talladega County in terms of
population and households. Chilton County employers include GulfStates Paper
Corp., International Paper Corp. and Union Camp Corp. Residential Lending General First Federals primary lending activity consists of the origination of
one-to-four family, owner-occupied, residential mortgage loans, secured by
property located in First Federals market area. Originations for such loans
are generally obtained from existing or past customers, realtors, referrals,
walk-ins, and, to a lesser extent, local newspaper and radio advertising.
Loans are originated by First Federal lending personnel. No loan brokers are
used. Conventional residential loans are priced based on rates offered by the
local competition and in the secondary market. At September 30, 2004, First
Federal had $44.9 million, or 47.5% of its loan portfolio, invested in
one-to-four family residential mortgage loans. Management believes that this
policy of focusing on one-to-four family lending has been effective in
contributing to net interest income, while reducing credit risk by keeping loan
delinquencies and losses to a minimum. First Federal offers conventional fixed-rate, one-to-four family mortgage
loans, with terms of 15 and 30 years. Fixed-rate loans are generally
underwritten according to, either, Federal Home Loan Mortgage Corporation
(FHLMC) or Federal National Mortgage Association (FNMA) guidelines,
utilizing their approved documents so that the loans qualify for sale in the
secondary mortgage market. Generally, First Federal 3




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holds a portion of its fixed-rate mortgage loans, with maturities not exceeding
15 years, in its portfolio as long-term investments. Adjustable-rate-mortgage (ARM) loans originated by First Federal consist
of one, three, five, and seven-year ARMs that are indexed to the comparable
maturity Treasury index or various cost-of-funds indexes. At September 30,
2004, First Federal held approximately $37.7 million ARMs, which represented
approximately 39.4% of First Federals total loan portfolio. First Federals
ARM loans are subject to a limitation of 2.0% per year adjustment for interest
rate increases and decreases. In addition, ARM loans currently originated by
First Federal typically have a lifetime cap of 6.0% on increases in the
interest rate. These limits, based on the initial rate, may reduce the
interest rate sensitivity of such loans during periods of changing interest
rates. The repayment terms of ARM loans may increase the likelihood of
delinquencies during periods of rising interest rates. First Federal offers
teaser rates on ARM loans to remain competitive. Adjustable-rate loans which
provide for teaser rates may be subject to increased risk of delinquency or
default as the higher, fully indexed rate of interest subsequently replaces the
lower, initial rate. Regulations limit the amount which a savings association may lend in
relationship to the appraised value of the real estate securing the loan, as
determined by an appraisal at the time of loan origination. Such regulations
permit a maximum loan-to-value ratio of 100% for residential property and 90%
for all other real estate loans. First Federals lending policies, however,
generally limit the maximum loan-to-value ratio to 95% of the appraised value
of the property, based on an independent appraisal. For Federal Housing
Administration (FHA), Veterans Administration (VA) and Farmers Home
Loans, First Federal generally limits the maximum loan-to-value ratio to 100%
of the appraised value of the property. When First Federal makes a loan in
excess of 80% of the appraised value or purchase price, private mortgage
insurance is required. The loan-to-value ratio, maturity and other provisions of the residential
real estate loans made by First Federal reflect the policy of making loans
generally below the maximum limits permitted under applicable regulations. For
all residential mortgage loans originated by First Federal, upon receipt of a
completed loan application from a prospective borrower, a credit report is
ordered, income, employment and certain other information are verified; and, if
necessary, additional financial information is requested. First Federal
requires an independent appraisal, title insurance (or an attorneys opinion),
flood hazard insurance (if applicable), and fire and casualty insurance on all
properties securing real estate loans made by First Federal. First Federal
reserves the right to approve the selection of which title insurance companies
policies are acceptable to insure the real estate in the loan transactions. Members of the First Federal Board of Directors receive a monthly summary
of all loans which are closed. Construction loans in excess of $350,000
require authorizations by the Loan Committee of the First Federal Board prior
to closing. First Federal issues written, formal commitments as to interest
rates to prospective borrowers upon request on real estate loans at the date of
application. The interest rate commitment remains valid for 30 to 60 days (the
lock-in period) from the date of the application. Upon receipt of loan
approval, the borrower has the balance of the lock-in period to close the loan
at the interest rate committed. Originated mortgage loans held in First Federals portfolio generally
include due-on-sale clauses which provide First Federal with the contractual
right to deem the loan immediately due and payable in the event that the
borrower transfers ownership of the property without First Federals consent.
It is First Federals policy to enforce due-on-sale provisions or to require
that the interest rate be adjusted to the current market rate when ownership is
transferred. First Federal also offers loans secured by second mortgages on real
estate, such as home improvement and home equity loans. At September 30, 2004,
such loans amounted to $16.7 million. Second mortgage loans are extended for up
to 80% of the appraised value of the property, less existing liens, at an
adjustable or fixed interest rate. Home equity loans are extended in amounts
up to 90% of the appraised value of the property. First Federal generally
holds the first mortgage loans on the properties securing the second mortgages. 4




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Residential Lending - Birmingham Market Area Residential Lending in the Birmingham area was particularly strong during
fiscal year 2004. With interest rates dropping to a forty year low refinances
and purchases increased significantly. However, during fiscal 2004, the
refinancing boom in the Birmingham market decreased significantly due primarily
to the bottoming out of refinances in the market. During the first six
months of fiscal 2004, SouthFirst Mortgage experienced significant operational
losses as a result of this market change. In an effort to slow or curtail
these losses, the bank downsized and restructured the SouthFirst Mortgage
operation in order to meet the changing market demands associated with
refinances and first mortgages. Additionally, the bank sought economies of
scale in mortgage operations by dove-tailing the operations of SouthFirst
Mortgage in Hoover with the acquisition of Walton Mortgage in Chelsea, Alabama.
For fiscal 2004, SouthFirst Mortgage, both locations, had 177 residential loan
originations, resulting in a pretax gain on sale of loans for approximately
$454,000. For the years ended September 30, 2004 and 2003, First Federals
total residential loan originations (including the originations by SouthFirst
Mortgage) resulted in a pretax gain on sale of loans of approximately $719,000
and $1,170,000, respectively. Construction Lending SouthFirst Mortgage, Inc. The majority of the residential construction lending of First Federal is
conducted in the Birmingham metropolitan area, through its wholly-owned
subsidiary, SouthFirst Mortgage, located in Hoover, Alabama, a suburb of
Birmingham. At September 30, 2004, committed construction loans secured by
single-family residential property totaled $22.9 million; of this amount,
approximately $6.8 million was not disbursed. SouthFirst Mortgage makes
construction loans primarily to builders for the construction of single-family
residences, on both a pre-sold and speculative basis. SouthFirst Mortgage also
makes construction loans on single-family residences to individuals who will
ultimately be the owner-occupant of the house. Construction loan proceeds are disbursed in increments as construction
progresses. Disbursements are scheduled by contract, with SouthFirst Mortgage
reviewing the progress of the underlying construction project prior to each
disbursement. The construction loan agreements of SouthFirst Mortgage with
builders generally provide that principal repayments are required as individual
units are sold to third parties. Construction loans are principally made to builders who have an
established credit history with SouthFirst Mortgage and First Federal, as well
as to builders who are referred by such borrowers. New builders must be
approved by First Federals Loan Committee and, further, must display the same
levels of knowledge and financial strength similar to that of existing
builders. The application process includes a submission to SouthFirst Mortgage
of plans, specifications and costs of the project to be constructed or
developed. SouthFirst Mortgage and the Loan Committee of First Federal also
review the borrowers existing financial condition and total debt outstanding.
All borrower relationships are reviewed annually by the SouthFirst Mortgage and
the Loan Committee. The residential construction loans are originated with
adjustable or fixed rates of interest that are negotiated with the builders,
but typically will be tied to the prime rate plus a spread and have terms of 12
months or less. Construction loans generally have a maximum loan-to-value
ratio of 80% on an as completed basis. SouthFirst Mortgage generally obtains
personal guarantees for all of its construction loans and converts many of its
construction loans to permanent loans upon completion of the construction
phase. Construction loans generally involve a higher level of credit risk than
permanent single-family residential lending, due to the concentration of
principal in a limited number of borrowers and the effects of changing
economic, governmental and weather conditions. The nature of these loans is
such that they require a sophisticated knowledge of building standards,
material costs, union rules, real estate values and housing demand; and, thus,
are more difficult to evaluate and monitor. The risk of loss on a construction
loan is dependent largely upon the accuracy of the initial estimate of the
propertys value upon completion of the project and the estimated cost
(including interest) of the project. If the estimate of construction cost
proves to be inaccurate, SouthFirst Mortgage may be required to advance funds
beyond the amount originally committed in order to permit 5




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completion of the project and will be confronted, at or prior to the maturity
of the loan, with a project having a value which is insufficient to assure full
repayment. During fiscal year ending September 30, 2004, the Construction Loan
Division of SouthFirst Mortgage continued to operate under the supervisory
agreement imposed by the OTS on First Federal in fiscal year 2002 (See,
Construction Lending  Supervisory Agreement and Organizational Restructure
below). Curt Reamer, Vice President of construction lending and mortgage
operations, manages both areas in the Hoover office. Senior management of
First Federal has oversight of both lending groups as set forth by the Board of
Directors. The organizational structure for SouthFirst Mortgage is set forth
below. Supervisory Agreement and Organizational Restructure The construction-lending activity of SouthFirst Mortgage was placed under
certain loan-amount restrictions, and related requirements during all of fiscal
year ended September 30, 2004, as a result of a supervisory agreement imposed
on First Federal (the Supervisory Agreement), in March, 2002, by the OTS. On
December 16, 2004, First Federal received notification from the OTS that First
Federal had complied with the obligations contained in the Supervisory
Agreement and that the Supervisory Agreement was rescinded as of December 14,
2004. See also Item 6. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULT OF OPERATIONS  Supervisory Agreement. Pursuant to the requirements of the Supervisory Agreement, and in light of
the resignation of Ms. Bryant, it was determined by the Board of Directors of
First Federal that Senior Management of First Federal should provide direct
managerial oversight of SouthFirst Mortgage. Thereafter, Joe K. McArthur,
President and Chief Executive Office of First Federal, was appointed as the
Chief Executive Officer of SouthFirst Mortgage, Sandra Stephens, Executive Vice
President and Chief Operating Officer of First Federal, was appointed as
President of SouthFirst Mortgage, and Janice Browning, Vice President and
Controller of First Federal, was appointed as Vice President and Controller of
SouthFirst Mortgage. Further, certain Vice Presidents of First Federal were appointed as
additional Vice Presidents of SouthFirst Mortgage, in order to perform credit
review analysis and assist in certain administrative functions within the
SouthFirst Mortgage construction lending and permanent mortgage lending
operations. Any Vice President of SouthFirst Mortgage with construction
lending authority can originate construction loans up to $350,000 with
co-approval of another Vice President. Any construction loan between $350,000
and $500,000 must be presented to the loan committee of First Federal for
approval. All construction loans greater than $500,000 require approval of the
Board of Directors of First Federal. To further enhance the overall organizational structure of SouthFirst
Mortgage, in, both, the residential lending and construction lending functions,
SouthFirst Mortgage named a Vice President of Billing and Collections who has
many years of experience in the collection function with another financial
institution. First Federal, pursuant to the provisions of the Supervisory Agreement,
has previously instituted a system of internal procedures to help ensure that
construction loan interest, construction loan balances, and other provisions
set forth in the Supervisory Agreement regarding construction lending are met
and fairly stated. Commercial Lending At September 30, 2004, commercial lending totaled $14.0 million, or 14.6%,
of First Federals total loan portfolio. First Federals commercial loans are
secured by real estate or other acceptable collateral. In addition, borrowers
generally must personally guarantee loans secured by commercial real estate.
Commercial loans are mostly made at adjustable rates. Commercial loans generally involve a greater degree of risk than
residential mortgage loans. Because payments on loans are often dependent on
successful operation or management of business, repayment of such loans may be
subject to a greater extent to adverse economic conditions. First Federal
seeks to minimize these 6




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risks by lending to established customers and generally restricting such loans
to its primary market area. Due to the growth in commercial lending in recent
years, First Federal has increased its commercial loan portfolio. Consumer Lending and Other Lending As a community-oriented financial institution, First Federal offers
certain consumer loans, including both unsecured loans and loans secured by
assets such as deposits, vehicles, and heavy equipment. At September 30,
2004, consumer loans totaled $4.0 million, or 4.1% of First Federals total
loan portfolio. This amount includes $0.8 million of loans secured by savings
accounts, $2.1 million of loans secured by vehicles, and $1.1 million in other
secured loans. The underwriting standards employed by First Federal for consumer loans
include a determination of the applicants payment history on other debts and
an assessment of ability to meet existing obligations and payments on the
proposed loan. In addition, the stability of the applicants monthly income
from primary employment is considered during the underwriting process.
Creditworthiness of the applicant is of primary consideration; however, the
underwriting process also includes a comparison of the value of the security,
if any, in relation to the proposed loan amount. Loan Approval All permanent residential mortgage loans, other than residential
construction loans less than $350,000, are underwritten and approved by the
loan committee of First Federal. Any Vice President of SouthFirst Mortgage
with construction lending authority, with the co-approval of another Vice
President, has underwriting and loan approval authority for any construction
loan up to $350,000. Construction loans in amounts greater than $350,000, but
less than $500,000, must be approved by the loan committee of the First Federal
Board of Directors. All permanent residential mortgage loans and residential
construction loans in excess of $500,000 require approval of the Board of
Directors of First Federal. Loan Origination, Commitment and Other Fees and Commissions In addition to interest earned on loans, First Federal charges fees for
originating and making loan commitments, prepayments of non-residential loans,
late payments, changes in property ownership and other miscellaneous services.
The income realized from such fees varies with the volume of loans made or
repaid, and the fees vary from time to time depending upon the supply of funds
and other competitive conditions in the mortgage markets. Loan demand and the
availability of money also affect these conditions. Fees, net of related
origination costs, are deferred as an adjustment to yield. First Federal also
charges commissions on the sale of credit life insurance and fees in connection
with retail banking activities which are reflected in First Federals
non-interest operations income. Competition First Federal has significant competition for its loan products in
Talladega, Jefferson and Chilton Counties and in the Birmingham market area.
The cities of Birmingham, Sylacauga, Talladega and Clanton have a high density
of financial institutions, some of which are larger, have a state-wide or
regional presence and have greater financial resources than First Federal.
First Federal also faces significant competition in attracting deposits in its
relevant market areas. First Federals competition for its loan products comes
principally from savings and loan associations and commercial banks. In
addition, there are a number of mortgage bankers, mortgage brokers, finance
companies and insurance companies that compete with First Federal for loan
customers. Credit unions, securities firms and mutual funds compete with First
Federal in raising deposits. Many of these institutions also seek to provide
the same community-oriented services as First Federal. First Federal competes
for deposit accounts by offering depositors competitive interest rates and a
high level of personal service. First Federal competes for loans primarily
through the interest rates and loan fees it charges and the efficiency and
quality of service it provides borrowers and contractors. Competition in the
financial services industry has increased significantly within the past several
years as a result of federal and state legislation which 7




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has, in several respects, deregulated financial institutions. The full impact
of this legislation and subsequent laws cannot be fully assessed or predicted. First Federal is a community and retail-oriented financial institution
serving its relevant market areas with deposit services and loan services.
Management considers First Federals reputation for financial strength and
quality customer service to be its major competitive advantage in attracting
and retaining customers in its market areas. Data Processing During fiscal 2004, First Federal converted the banks data processing
function to the FISERV Vision system, replacing the data processing services
provided by Kirchman Corp., whose contractual agreement expired during 2004. FISERV provides First Federal a full range of data processing services,
including an automated general ledger, deposit accounting, commercial, real
estate and consumer lending data processing platforms, central information
file, investment portfolio accounting and ATM processing. Employees First Federal presently employs 74 individuals on a full-time basis,
including 21 officers and 4 individuals on a part-time basis. First Federal
will hire additional persons as needed, including additional tellers and
financial service representatives. Business of Subsidiaries SouthFirst Mortgage, Inc. SouthFirst Mortgage was incorporated on July 23, 1999, as a wholly-owned
operating subsidiary of First Federal. Through SouthFirst Mortgage, First
Federal is conducting residential mortgage and construction lending activities
in Birmingham, Alabama, and intends to pursue such activities in other markets.
See Business of First Federal - Construction Lending  SouthFirst Mortgage,
Inc. above. Pension & Benefit Trust Company Pension & Benefit was acquired by SouthFirst in April of 1997, and was,
initially, a wholly-owned subsidiary thereof. On April 27, 1998, SouthFirst
and First Federal submitted an application to the OTS, seeking approval to
exercise limited trust powers through Pension & Benefit and to establish
Pension & Benefit as an operating subsidiary. Upon being granted limited trust
powers from the OTS, SouthFirst transferred the ownership of Pension & Benefit
to First Federal. Upon the transfer, Pension & Benefit became the wholly-owned
subsidiary of First Federal. The primary business of Pension & Benefit is rendering actuarial and
administrative services to employee benefit plans of corporate employers,
including their plan administrators and plan trustees, and, under appropriate
circumstances, serving as an employee benefit plan trustee. These actuarial,
administrative and trust services are rendered to approximately 250 retirement
plans and, generally, are as follows: Actuarial Services The actuarial services include: the computation of retirement benefits,
the determination of plan costs, the projection of benefit payments,
contributions, and non-income, and the analysis of turnover rates and other
contingencies for specific groups of plan participants. 8




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Administrative Services The administrative services include: the preparation of the annual returns
and reports for retirement plans (including Form 5500, or 5500-C/R, and related
schedules and attachments), the preparation of summary plan descriptions,
summary annual reports, statements of accrued benefits and various other
notices and reports required under ERISA, and the preparation of accounting
records for plan trustees, including the preparation and maintenance of
participants accounts. Trust Services The trust services rendered by Pension & Benefit are limited to those
trust services required by self-directed profit sharing plans, 401(k) plans and
Employee Stock Ownership Plans. Magnolia Title Service, Inc. During part of fiscal year 2004 SouthFirst owned a 50% interest in
Magnolia Title Services, Inc. (Magnolia), a company which provides title
insurance and related services to borrowers and lenders. Start-up losses at
Magnolia resulted in a write-off of SouthFirsts investment in the amount of
$245,000. In November 2003, SouthFirst sold its entire interest back to
Magnolia for $25,000. SouthFirst Financial Services, Inc. SouthFirst Financial was incorporated on June 16, 2000, as a wholly-owned
subsidiary of SouthFirst. Through SouthFirst Financial, SouthFirst provides
insurance products and other financial services to the customers of First
Federal and to others. Supervision and Regulation General SouthFirst and First Federal are subject to regulations, supervision and
examination by the OTS, the FDIC and other state and federal regulators. These
regulators have significant discretion in connection with their supervisory and
enforcement activities and examination policies, including policies with
respect to the classification of assets and the establishment of adequate loan
loss reserves for regulatory purposes. The system of regulation and
supervision applicable to SouthFirst and First Federal establishes a
comprehensive framework for the operations of SouthFirst and First Federal, and
is intended primarily for the protection of the FDIC and the depositors of
First Federal. Changes in the regulatory framework could have a material
adverse effect on First Federal and its operations that, in turn, could have a
material adverse effect on SouthFirst. To the extent that the following
information describes certain statutory and regulatory provisions, it is
qualified in its entirety by reference to the particular statutory and
regulatory provisions. Any change in applicable laws or regulations may have a
material effect on the business and prospects of SouthFirst. Regulation of SouthFirst General As the owner of all of the stock of only one federal savings association,
First Federal, SouthFirst is a unitary thrift holding company subject to
regulatory oversight by the OTS and the SEC. As such, SouthFirst is required
to register and file reports with the OTS and the SEC and is subject to
regulation and examination by the OTS. In addition, the OTSs enforcement
authority over SouthFirst and its non-savings association subsidiaries permits
the OTS to restrict or prohibit activities that are determined to be a serious
risk to the subsidiary savings association. This regulation and oversight is
intended primarily for the protection of the depositors of First Federal rather
than for the benefit of stockholders of SouthFirst. 9




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Qualified Thrift Lender Test As a unitary thrift holding company, SouthFirst generally is allowed to
engage and invest in a broad range of business activities not permitted to
commercial bank holding companies or multiple savings and loan holding
companies, provided that First Federal continues to qualify as a qualified
thrift lender (see - Regulation of First Federal  Qualified Thrift Lender
Test below). Although the Gramm-Leach-Bliley Act, enacted in November 1999,
prohibits new unitary thrift holding companies from engaging in nonfinancial
activities or affiliating with nonfinancial entities, such prohibition does not
apply, for a period of 10 years if the non-financial activities constitute no
more than 15% of its business, to companies, such as SouthFirst, which became
unitary thrift holding companies pursuant to applications filed with the OTS
prior to May 4, 1999. Because SouthFirst filed its application prior to this
date, it is considered a grandfathered unitary thrift holding company; as
such, SouthFirst retains the authority to engage in nonfinancial activities,
but SouthFirst cannot be acquired by a nonfinancial company. In the event that
SouthFirst acquires control of another savings association as a separate
subsidiary, it would become a multiple savings and loan holding company and
would thereafter be subject to further restrictions on its activities. Restrictions on Acquisitions SouthFirst must obtain approval from the OTS before acquiring control of
any other SAIF-insured association or savings and loan holding company.
Federal law generally provides that no person, acting directly or indirectly
or through or in concert with one or more other persons, may acquire control,
as that term is defined in OTS regulations, of a federally insured savings
association without giving at least 60 days written notice to the OTS and
providing the OTS an opportunity to disapprove the proposed acquisition. Such
acquisition of control may be disapproved if it is determined, among other
things, that (i) the acquisition would substantially lessen competition; (ii)
the financial condition of the acquiring person might jeopardize the financial
stability of the savings association or prejudice the interests of its
depositors; or (iii) the competency, experience or integrity of the acquiring
person or the proposed management personnel indicates that it would not be in
the interest of the depositors or the public to permit the acquisition of
control by such person. Control of a savings association or a savings and loan
holding company is conclusively presumed to exist if, among other things, a
person or group of persons acting in concert, directly or indirectly, acquires
more than 25.0% of any class of voting stock of the institution or holding
company or controls in any manner the election of a majority of the directors
of the insured institution or the holding company. Control is rebuttably
presumed to exist if, among other things, a person acquires 10.0% or more of
any class of voting stock (or 25.0% of any class of stock) and is subject to
any of certain specified control factors. The Financial Institutions Reform, Recovery and Enforcement Act of 1989
(FIRREA) amended provisions of the Bank Holding Company Act of 1956 (the
BHCA) to specifically authorize the Federal Reserve Board to approve an
application by a bank holding company to acquire control of a savings
association. FIRREA also authorized a bank holding company that controls a
savings association to merge or consolidate the assets and liabilities of the
savings association with, or transfer assets and liabilities to, any subsidiary
bank which is a member of the Bank Insurance Fund (BIF) with the approval of
the appropriate federal banking agency and the Federal Reserve Board. The
Federal Deposit Insurance Corporation Improvement Act of 1991 (FDICIA)
further amended the BHCA to permit federal savings associations to acquire or
be acquired by any insured depository institution. As a result of these
provisions, there have been a number of acquisitions of savings associations by
bank holding companies and other financial institutions in recent years. As discussed above, the Gramm-Leach-Bliley Act has further restricted the
acquisitions of nonfinancial companies by unitary thrift holding companies
formed after May 4, 1999, and has eliminated the acquisition of grandfathered
unitary thrift holding companies, such as SouthFirst, as well as new unitary
thrift holding companies (formed after May 4, 1999) by nonfinancial companies. 10




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Federal Securities Laws Shares of common stock of SouthFirst (Common Stock), held by persons who
are affiliates (generally officers, directors and principal stockholders) of
SouthFirst, may not be resold without registration or unless sold in accordance
with certain resale restrictions. If SouthFirst meets specified current public
information requirements, however, each affiliate of SouthFirst is able to sell
in the public market, without registration, a limited number of shares of
Common Stock in any three-month period. Regulation of First Federal First Federal derives its lending and investing powers, as a federal
savings association, from the Home Owners Loan Act, as amended (HOLA), which
is implemented by regulations adopted and administered by the OTS. As a
federal savings association, First Federal is subject to regulation,
supervision and regular examination by the OTS. Federal banking laws and
regulations control, among other things, First Federals required reserves,
investments, loans, mergers and consolidations, payment of dividends and other
aspects of First Federals operations. First Federals deposits are insured by
the SAIF, which is administered by the FDIC, to the maximum extent provided by
law ($100,000 for each depositor). In addition, the FDIC has certain
regulatory and examination authority over OTS-regulated savings associations
and may recommend enforcement actions against savings associations to the OTS. As a federally insured depository institution, First Federal is subject to
various regulations promulgated by the Federal Reserve Board, including
Regulation B (Equal Credit Opportunity), Regulation D (Reserve Requirements),
Regulation E (Electronic Fund Transfers), Regulation Z (Truth in Lending),
Regulation CC (Availability of Funds and Collection of Checks) and Regulation
DD (Truth in Savings). Insurance of Deposit Accounts First Federals deposit accounts are insured by the SAIF to a maximum of
$100,000 for each insured member (as defined by law and regulation). Insured
institutions are members of either the SAIF or the BIF. Pursuant to FIRREA, an
insured institution may not convert from one insurance fund to the other
without the advance approval of the FDIC. Under FIRREA, the FDIC is given the authority, should it initiate
proceedings to terminate an institutions deposit insurance, to suspend the
insurance of any such institution without tangible capital. However, if a
savings association has positive capital when it includes qualifying intangible
assets, the FDIC cannot suspend deposit insurance unless capital declines
materially or the institution fails to enter into and remain in compliance with
an approved capital plan. Regardless of an institutions capital level, insurance of deposits may be
terminated by the FDIC upon a finding that the institution has engaged in
unsafe or unsound practices, is in an unsafe or unsound condition to continue
operations or has violated any applicable law, regulation, rule, order or
condition imposed by the FDIC or the institutions primary regulator. The
management of First Federal is unaware of any practice, condition or violation
that might lead to termination of its deposit insurance. As an insurer, the FDIC issues regulations, conducts examinations and
generally supervises the operations of its insured members. FDICIA directed
the FDIC to establish a risk-based premium system under which the FDIC is
directed to charge an annual assessment for the insurance of deposits based on
the risk a particular institution poses to its deposit insurance fund. Under
the FDICs risk-related insurance regulations, an institution is classified
according to capital and supervisory factors. Institutions are assigned to one
of three capital groups: well capitalized, adequately capitalized or
undercapitalized. Within each capital group, institutions are assigned to
one of three supervisory subgroups. There are nine combinations of groups and
subgroups (or assessment risk classifications) to which varying assessment
rates are applicable. 11




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As a result of the recapitalization of the SAIF implemented by the
Economic Growth and Regulatory Paperwork Reduction Act of 1996 (the EGRPRA),
SAIF-insured institutions were required, until December 31, 1999, to pay
assessments to the FDIC at an annual rate of between 6.0 and 6.5 basis points
to help fund interest payments on certain bonds issued by the Financing
Corporation (FICO), an agency of the federal government established to
recapitalize the predecessor to the SAIF. During this period, BIF member banks
were assessed for payment of the FICO obligations at one-fifth the annual rate
applicable to SAIF member institutions. After December 31, 1999, BIF and SAIF
members were assessed at the same rate for FICO obligations. The EGRPRA also provides that the FDIC may not assess regular insurance
assessments for the SAIF unless required to maintain or to achieve the
designated reserve ratio of 1.25%, except for such assessments on those
institutions that are not classified as well capitalized or that have been
found to have moderately severe or unsatisfactory financial, operational or
compliance weaknesses. First Federal is classified as well capitalized and
has not been found by the OTS to have such supervisory weaknesses. OTS Supervisory Assessments In addition to federal deposit insurance premiums, savings associations
like First Federal are required by OTS regulations to pay assessments to the
OTS to fund the operations of the OTS. The general assessment is paid on
either a semi-annual or quarterly basis, as determined by the OTS on an annual
basis, and is computed based on total assets of the institution, including
consolidated subsidiaries, as reported in the associations latest quarterly
Thrift Financial Report. Regulations base the assessment for an individual
savings association on three components: the size of the association, on which
the basic assessment is based; the associations supervisory condition, which
results in percentage increases for any savings association with a composite
rating of 3, 4, or 5 in its most recent safety and soundness examination; and
the complexity of the savings associations operations, which results in a
percentage increase for a savings association that manages over $1 billion in
trust assets, provides services for other loans aggregating more than $1
billion, or has certain off-balance sheet assets aggregating more than $1
billion. In order to avoid a disproportionate impact upon smaller savings
institutions, whose total assets never exceeded $100 million, the OTS
regulations provide that the portion of the assessment based on asset size will
be the lesser of the assessment under the amended regulations or the
regulations before the amendment. Regulatory Capital Requirements General. The OTS has adopted capital regulations which establish capital
standards applicable to all savings associations. To meet its regulatory
capital requirements, a savings association must satisfy each of the following
capital requirements: (i) a risk-based capital requirement, where a savings
associations minimum risk-based capital requirement shall be an amount equal
to 8% of its risk-weighted assets; (ii) a leverage ratio requirement, where a
savings associations minimum leverage ratio requirement shall be: (a) for a
savings association assigned a composite rating of 1 on the CAMELS financial
institutions rating system, equal to a ratio of core capital to adjusted total
assets of 3%; (b) for all other savings associations which are assigned a value
lower than 1 on the CAMELS financial institutions rating system, equal to a
ratio of core capital to adjusted total assets of 4%; and (iii) a tangible
capital requirement, where the savings associations minimum tangible capital
requirement shall be an amount equal to at least 1.5% of adjusted total assets. The OTS, also, has established, pursuant to FDICIA, five classifications
for institutions based upon the capital requirements: well capitalized,
adequately capitalized, undercapitalized, significantly undercapitalized and
critically under capitalized. At September 30, 2004, First Federal was well
capitalized. Failure to maintain that status could result in greater
regulatory oversight or restrictions on First Federals activities. Core Capital and Tangible Capital. The OTS requires savings associations
receiving a composite examination rating of 1, the best possible rating under
the CAMELS examination rating system, to maintain a ratio of core capital to
adjusted total assets of 3.0%. All other savings associations are required to
maintain minimum core capital of at least 4.0% of total adjusted assets. Core
capital includes, generally, (i) common stockholders equity (including
retained earnings), (ii) non-cumulative perpetual preferred stock and related 12




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surplus, (iii) non-withdrawable accounts and certain pledged deposits of
mutual savings associations, (iv) minority interests in fully-consolidated
subsidiaries, and (v) the remaining goodwill resulting from certain prior
regulatory accounting practices, less a savings associations (A) investments
in certain non-includable subsidiaries (as determined by regulation) and (B)
intangible assets (with limited exceptions for purchased mortgage servicing
rights, purchased credit card relationships and certain intangible assets
arising from prior regulatory accounting practices). At September 30, 2004,
First Federals ratio of tangible and core capital to total adjusted assets was
8.08%. The tangible capital requirement requires a savings association to
maintain tangible capital in an amount not less than 1.5% of its adjusted total
assets. Tangible capital means (i) common stockholders equity (including
retained earnings), (ii) non-cumulative perpetual preferred stock and related
earnings, (iii) non-withdrawable accounts and pledged deposits that qualify as
core capital, and (iv) minority interests in equity accounts of
fully-consolidated subsidiaries, less (A) any intangible assets (except for
purchased mortgage servicing rights and purchased credit card relationships
included in core capital), and (B) investments, both equity and debt, in
certain subsidiaries that are not includable subsidiaries Risk-Based Capital. The risk-based capital standard for savings
associations requires the maintenance of total regulatory capital (which is
defined as core capital plus supplementary capital) of 8.0% of risk-weighted
assets. The components of supplementary capital include, among other items,
cumulative perpetual preferred stock, perpetual subordinated debt, mandatory
convertible subordinated debt, intermediate-term preferred stock and the
general allowance for credit losses. The portion of the allowance for credit
losses includable in supplementary capital is limited to a maximum of 1.25% of
risk-weighted assets. Overall, supplementary capital is limited to 100.0% of
core capital. Risk-weighted assets equal assets plus consolidated off-balance
sheet items where each asset or item is multiplied by the appropriate risk
weight. The risk weight assigned to a particular asset or on-balance sheet
credit equivalent amount determines the percentage of that asset/credit
equivalent amount that is included in the calculation of risk-weighted assets.
Thus, to determine the ratio of total capital to total risk-weighted asset: (i)
each off-balance sheet item must be converted to an on-balance sheet credit
equivalent amount by multiplying the face amount of such item by a credit
conversion factor ranging from 0.0% to 100.0% (depending upon the nature of the
item); (ii) the credit equivalent amount of each off-balance sheet item and
each on-balance sheet asset must be multiplied by a risk factor ranging from 0%
to 100.0% (again depending on the nature of the item); and (iii) the resulting
amounts are added together and constitute total risk-weighted assets. At
September 30, 2004, First Federals ratio of total capital to total
risk-weighted assets was 13.18%. The OTS and other federal banking regulators adopted, effective October 1,
1998, an amendment to their risk-based capital guidelines that permits insured
depository institutions to include in supplementary capital up to 45% of the
pretax net unrealized holding gains on certain available-for-sale equity
securities, as such gains are computed under the guidelines. The OTS regulations require a savings association with above normal
interest rate risk to deduct a portion of such capital from its total capital
to account for the above normal interest rate risk. A savings associations
interest rate risk is measured by the decline in the net portfolio value of its
assets (i.e. the difference between incoming and outgoing discounted cash flows
from assets, liabilities, and off-balance sheet contracts) that would result
from a hypothetical 200 basis point increase or decrease in market rates of
interest (whichever results in a lower net portfolio value), divided by the
estimated economic value of the savings associations assets, as calculated in
accordance with guidelines set forth by the OTS. A savings associations
interest rate risk exposure is measured by the decline in the net portfolio
value that would result from a 200 basis point increase or decrease in market
interest rates, except when the 3-month Treasury bond equivalent yield falls
below 400 basis points. In that case, the decrease would be equal to one-half
of that Treasury rate. A savings association whose measured interest rate risk exposure exceeds
0.02 (2%) must deduct an interest rate risk component in calculating its total
capital for purposes of determining whether it meets its risk-based capital
requirement. The interest rate risk component is an amount equal to one-half
of the difference between its measured interest rate risk and 0.02, multiplied
by the estimated economic value of its total assets. 13




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Any required deduction for interest rate risk becomes effective on the
last day of the third quarter following the reporting date of the associations
financial data on which the interest rate risk was computed. The OTS has indefinitely deferred the implementation of the interest rate
risk component in the computation of an institutions risk-based capital
requirements. The OTS continues to monitor the interest rate risk of
individual institutions and retains the right to impose additional capital
requirements on individual institutions. See Item 6. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS  Capital Resources for tables setting forth First
Federals compliance with its regulatory capital requirements as of September
30, 2004. Prompt Corrective Action Under the OTS final rule implementing the prompt corrective action
provisions of FDICIA, an institution shall be deemed to be: (i) well
capitalized if it has a total risk-based capital ratio of 10.0% or greater,
has a Tier 1 risk-based capital ratio (ratio of Tier 1 capital (core capital)
to risk-weighted assets) of 6.0% or greater, has a Tier 1 leverage capital
ratio of 5.0% or greater and is not subject to any order or capital directive
to meet and maintain a specific capital level for any capital measure; (ii)
adequately capitalized if it has a total risk-based capital ratio of 8.0% or
greater, a Tier 1 risk-based capital ratio of 4.0% or greater and a Tier 1
leverage ratio of 4.0% or greater (3% under certain circumstances) and does not
meet the definition of well capitalized; (iii) undercapitalized if it has
a total risk-based capital ratio that is less than 8.0%, or has a Tier 1
risk-based capital ratio that is less than 4.0% or a Tier 1 leverage ratio
that is less than 4.0% (3% under certain circumstances); (iv) significantly
undercapitalized if it has a total risk-based capital ratio that is less than
6.0%, or a Tier 1 risk-based capital ratio that is less than 3.0% or a Tier 1
leverage ratio that is less than 3.0%; and (v) critically undercapitalized if
the financial association has a ratio of tangible equity to total assets that
is equal to or less than 2.0%. However, under certain circumstances, a federal
banking agency may reclassify a well capitalized institution as adequately
capitalized and may require an adequately capitalized institution or an
undercapitalized institution to comply with supervisory actions as if it were
in the next lower category (except that the FDIC may not reclassify a
significantly undercapitalized institution as critically undercapitalized).
At September 30, 2004, First Federal was classified as a well capitalized
institution. The severity of the action, authorized or required to be taken under the
prompt corrective action regulations, increases as an associations capital
deteriorates within the three undercapitalized categories. All associations
are prohibited from paying dividends or other capital distributions or paying
management fees to any controlling person, if, following such distribution, the
association would be undercapitalized. An undercapitalized association is
required to file a capital restoration plan within 45 days of the date the
association receives notice that it is within any of the three undercapitalized
categories. The OTS is required to monitor closely the condition of an
undercapitalized association and to restrict the asset growth, acquisitions,
branching, and new lines of business of such an association. Significantly
undercapitalized associations are subject to restrictions on compensation of
senior executive officers; such an association may not, without OTS consent,
pay any bonus or provide compensation to any senior executive officer at a rate
exceeding the officers average rate of compensation during the 12 months
preceding the month when the association became undercapitalized. A
significantly undercapitalized association may also be subject, among other
things, to forced changes in the composition of its board of directors or
senior management, additional restrictions on transactions with affiliates,
restrictions on acceptance of deposits from correspondent associations, further
restrictions on asset growth, restrictions on rates paid on deposits, forced
termination or reduction of activities deemed risky, and any further
operational restrictions deemed necessary by the OTS. When appropriate, the OTS can require corrective action by a savings
association holding company under the prompt corrective action provisions of
FDICIA. 14




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Standards for Safety and Soundness Under FDICIA, as amended by the Riegle Community Development and
Regulatory Improvements Act of 1994, the federal banking agencies were required
to establish safety and soundness standards for institutions under its
authority. The federal banking agencies, including the OTS, have adopted
interagency guidelines establishing standards for safety and soundness and
final rules establishing deadlines for submission and review of safety and
soundness compliance plans. The guidelines require savings associations to
maintain internal controls and information systems and internal audit systems
that are appropriate for the size, nature and scope of the institutions
business. The guidelines also establish certain basic standards for loan
documentation, credit underwriting, interest rate risk exposure, and asset
growth. The guidelines further provide that savings associations should
maintain safeguards to prevent the payment of compensation, fees and benefits
that are excessive or that could lead to material financial loss, and should
take into account factors such as compensation practices at comparable
institutions. Additionally, the OTS guidelines require savings associations to
maintain internal controls over their asset quality and earnings. Under the
guidelines, a savings association should maintain systems, commensurate with
its size and the nature and scope of its operations, to identify problem assets
and prevent deterioration in those assets as well as to evaluate and monitor
earnings and ensure that earnings are sufficient to maintain adequate capital
and reserves. If the OTS determines that a savings association is not in
compliance with the safety and soundness guidelines, it may require the
institution to submit an acceptable plan to achieve compliance with the
guidelines. A savings association must submit an acceptable compliance plan to
the OTS within 30 days of receipt of a request for such a plan. Failure to
submit or implement a compliance plan may subject the institution to regulatory
sanctions. Dividends and Other Capital Distribution Limitations OTS regulations impose limitations upon savings associations capital
distributions, such as cash dividends, payments to repurchase or otherwise
acquire its shares and other distributions charged against capital. Under the
OTS regulations governing capital distributions, certain savings associations
are permitted to pay capital distributions during a calendar year that do not
exceed the associations net income for the year plus its retained net income
for the prior two years, without application or notice to, or the approval of,
the OTS. However, a savings association subsidiary of a savings and loan
holding company, such as the Company, will continue to have to file a notice
and to receive the approval of the OTS. The OTS may disapprove a notice or
deny an application regarding a proposed capital distribution, if the OTS
determines that the proposed distribution by a savings association would
constitute an unsafe or unsound practice or that, after making the
distribution, the savings association would be undercapitalized under the OTS
regulations. Qualified Thrift Lender Test HOLA requires savings associations to meet the Qualified Thrift Lender
(QTL) test, or suffer a number of regulatory sanctions, including
restrictions on business activities and on FHLB advances. To qualify as a QTL,
a savings association must either (i) be deemed a domestic building and loan
association under the Internal Revenue Code, as amended (the Code), by
maintaining at least 60% of its total assets in specified types of assets,
including cash, certain government securities, loans secured by and other
assets related to residential real property, educational loans, and investments
in premises of the institution, or (ii) maintain at least 65% of its portfolio
assets in certain qualified thrift investments in at least nine months of
the most recent twelve-month period. Portfolio assets means, in general, a
savings associations total assets less the sum of (a) certain intangible
assets, including goodwill and credit card and purchased mortgage servicing
rights, (b) the value of property used by a savings association in its
business, and (c) specified liquid assets up to 20% of total assets.
Qualified thrift investments include (i) various types of loans made to
finance, construct, improve or repair domestic residential or manufactured
housing, (ii) home equity loans, (iii) securities backed by or representing
interest in mortgages or domestic residential or manufactured housing, (iv)
obligations issued by the federal deposit insurance agencies, (v) shares of
stock issued by any Federal home loan bank, (vi) loans for educational
purposes, (vii) loans to small business, and (viii) loans made through credit
cards or credit card accounts. In addition, subject to a limit of 20% of
portfolio assets, savings associations are able to treat as Qualified Thrift
Investments 200% of their investments in loans to finance starter homes and
loans for construction, 15




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development or improvement of housing and community service facilities or
for financing small business in credit needy areas. At September 30, 2004,
First Federal was a Qualified Thrift Lender. A savings association that does not maintain its status as a QTL in at
least nine out of every 12 months must either convert to a bank charter to
become one or more banks or comply with the following restrictions on its
operations: (i) the savings association may not engage in any new activity or
make any new investment, directly or indirectly, unless such activity or
investment is permissible for a national bank and for a savings association;
(ii) the branching powers of the savings association are restricted to those of
a national bank in the savings associations home state; (iii) the savings
association is not eligible to obtain any advances from its FHLB; and (iv)
payment of dividends by the savings association are subject to the rules
regarding payment of dividends by a national bank. In addition, within one
year of the date a savings association ceases to meet the QTL test, any company
controlling the association has to register under, and become subject to, the
requirements of the Bank Holding Company Act of 1956, as amended. If the
savings association does not requalify as a QTL within the three-year period
after it fails the QTL test, it is required to cease any activity and not
retain any investment not permissible for a national bank, and immediately
repay any outstanding FHLB advances as promptly as prudently can be done,
consistent with the safe and sound operation of the savings association. A
savings association that has failed the QTL test may requalify as a QTL and be
free of such limitations. Loans to One Borrower Under HOLA, savings associations are subject to the national bank limits
on loans to one borrower. Generally, a savings association may not make a loan
or extend credit to a single or related group of borrowers in excess of 15.0%
of unimpaired capital and surplus. An additional amount, not in excess of
10.0% of unimpaired capital and surplus, may be loaned, if such loan is secured
by readily-marketable collateral, which is defined to include certain debt and
equity securities and bullion, but generally does not include real estate.
Prior to March 2002, First Federal had permission from the OTS to increase its
loans to one borrower limit for single-family, residential builders, as
permitted under applicable federal law and regulations. The increased limit
for these borrowers was 30.0% of unimpaired capital and surplus of First
Federal, with an aggregate limit to all such borrowers equal to 150.0% of First
Federals unimpaired capital and surplus. As a result of the Supervisory
Agreement between First Federal and the OTS, entered into in March 2002, the
30% limit had been revoked during all of fiscal year ended September 30, 2004.
See, also, Item 6. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS  Supervisory Agreement. Lending Guidelines All financial institutions must adopt and maintain comprehensive written
real estate lending policies that are consistent with safe and sound banking
practices. These lending policies must reflect consideration of the
Interagency Guidelines for Real Estate Lending Policies adopted by the federal
banking agencies (the Guidelines). The Guidelines set forth, pursuant to the
mandates of FDICIA, uniform regulations prescribing standards for real estate
lending. Real estate lending is defined as the extension of credit secured
by liens on interests in real estate or made for the purpose of financing the
construction of a building or other improvements to real estate, regardless of
whether a lien has been taken on the property. Such real estate lending policies must address certain lending
considerations set forth in the Guidelines, including loan-to-value (LTV)
limits, loan administration procedures, underwriting standards, portfolio
diversification standards, and documentation, approval and reporting
requirements. These policies must also be appropriate to the size of the
institution and the nature and scope of its operations, and must be reviewed
and approved by the institutions board of directors at least annually. The
LTV ratio framework, with a LTV ratio being the total amount of credit to be
extended, divided by the appraised value of the property securing or being
improved by the extension of credit, plus the amount of readily-marketable
collateral or other acceptable collateral, must be established for each
category of real estate loans. If not a first lien, the lender must combine
all senior liens when calculating this ratio. The Guidelines, among other
things, establish the following supervisory LTV limits: raw land (65.0%); land
development (75.0%); construction (commercial, multifamily and nonresidential)
(80.0%); improved property (85.0%). There is no maximum LTV limit for
one-to-four family 16




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##### Table of Contents



residential (owner occupied); however, any LTV ratio in excess of 90.0%
requires appropriate credit enhancement in the form of either mortgage
insurance or readily marketable collateral. Certain institutions may make real estate loans that do not conform with
established LTV limits, up to 100.0% of the institutions total capital.
Within this aggregate limit, total loans for all commercial, agricultural,
multi-family and other non-one-to-four family residential properties should not
exceed 30.0% of total capital. An institution will come under increased
supervisory scrutiny as the total of such loans approaches these levels.
Certain loans are also exempt from the LTV ratios, such as loans guaranteed by
a government agency, loans to facilitate the sale of real estate owned, and
loans renewed, refinanced or restructured by the original lender(s) to the same
borrower(s) where there is no advancement of new funds. Community Reinvestment Under the Community Reinvestment Act of 1977 (the CRA), as implemented
by OTS regulations, a savings association has a continuing and affirmative
obligation consistent with its safe and sound operation to help meet the credit
needs of its entire community, including low and moderate income neighborhoods.
The CRA does not establish specific lending requirements or programs for
financial institutions, nor does it limit an institutions discretion to
develop the types of products and services that it believes are best suited to
its particular community, consistent with the CRA. The CRA requires the OTS,
in connection with its examination of a savings association, to assess the
institutions record of meeting the credit needs of its community and to take
this record into account in its evaluation of certain applications by the
institution. FIRREA amended the CRA to require public disclosure of an
institutions CRA rating and to require the OTS to provide a written evaluation
of an institutions CRA performance, utilizing a four-tiered descriptive rating
system in lieu of the existing five-tiered numerical rating system. First
Federal received a satisfactory rating as a result of its latest evaluation on
December 31, 2003. Consumer Credit Regulation First Federals mortgage lending activities are subject to the provisions
of various federal and state statutes, including, among others, the Truth in
Lending Act, the Equal Credit Opportunity Act, the Real Estate Settlement
Procedures Act, the Fair Housing Act, and the regulations promulgated
thereunder. These statutes and regulations, among other provisions, prohibit
discrimination, prohibit unfair and deceptive trade practices, require the
disclosure of certain basic information to mortgage borrowers concerning credit
terms and settlement costs, and otherwise regulate terms and conditions of
credit and the procedures by which credit is offered and administered. Many of
the above regulatory requirements are designed to protect the interests of
consumers, while others protect the owners or insurers of mortgage loans.
Failure to comply with these requirements can lead to administrative
enforcement actions, class action lawsuits and demands for restitution or loan
rescission. Transactions with Affiliates Generally, statutory restrictions, promulgated in OTS regulations and by
Section 23A and 23B of the Federal Reserve Act, limit the authority of First
Federal to engage in transactions with affiliates. These restrictions require
that transactions between a savings association, or its subsidiaries, and its
affiliates be on terms as favorable to the institution as comparable
transactions with non-affiliates. In addition, extensions of credit and
certain other transactions with affiliates are restricted to an aggregate
percentage of a savings associations capital, and collateral in specified
amounts must usually be provided by affiliates to receive loans from the
institution. Affiliates of First Federal include, among others, SouthFirst and
any company which would be under common control with First Federal. In
addition, a savings association may not lend to any affiliate engaged in
activities not permissible for a bank holding company or acquire the securities
of any affiliate which is not a subsidiary. Currently, a subsidiary of a
savings association that is not also a depository institution is not treated as
an affiliate of the savings association for purposes of Section 23A and 23B of
the Federal Reserve Act. A savings associations authority to extend credit to its officers,
directors and 10% stockholders, as well as to entities that such persons
control, is governed by Sections 22(g) and 22(h) of the Federal Reserve Act and 17




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##### Table of Contents



Regulation O promulgated by the Federal Reserve Board. Among other
things, these laws and regulations require such loans to be made on terms
substantially similar to those offered to unaffiliated individuals, place
limits on the amount of loans a savings association may make to such persons
based, in part, on the institutions capital position, and require certain
approval procedures to be followed. OTS regulations, with minor variations,
apply Regulation O to savings associations. Branching by Federal Associations Subject to certain limitations, HOLA and the OTS regulations permit
federally chartered savings associations to establish branches in any state of
the United States. The authority to establish such a branch is available (a)
in states that expressly authorize branches of savings associations located in
another state and (b) to an association that either satisfies the QTL test or
qualifies as a domestic building and loan association under the Code, which
imposes qualification requirements similar to those for a qualified thrift
lender under HOLA. The authority for a federal savings association to
establish an interstate branch network would facilitate a geographic
diversification of the associations activities. This authority under HOLA and
the OTS regulations preempts any state law purporting to regulate branching by
federal savings associations. Liquidity Requirements The Asset and Liability Committee (ALCO) of First Federals Board of
Directors monitors and manages the liquidity needs of the Company to ensure
that there is sufficient cash flow to satisfy demand for credit and deposit
withdrawals, to fund operations and to meet other Company obligations and
commitments on a timely and cost effective basis. Under current regulations,
First Federal is required to maintain sufficient liquidity to assure its safe
and sound operation. The requirement to maintain a specific minimum amount of
liquid assets, established by previous regulation, has been eliminated.
Presently, there is no objective standard or guideline regarding the
application of the current regulatory requirement that a savings association
maintain a liquidity sufficient to ensure its safe and sound operation. Under the previous regulation, First Federal was required to maintain an
average daily balance of liquid assets, in each calendar quarter, of not less
than 4% of (i) the amount of its liquidity base at the end of the preceding
calendar quarter, or (ii) the average daily balance of its liquidity base
during the preceding quarter. For purposes of this computation, liquid assets
included specified short-term assets (e.g., cash, certain time deposits,
certain bankers acceptances and short-term U.S. Government, state or federal
agency obligations), and long-term assets (e.g., U. S. Government obligations
of more than one and less than five years and state agency obligations maturing
in two years or less). As of September 30, 2004, First Federals average daily balance of liquid
assets was approximately 11.3% of its June 30, 2004 liquidity base, far
exceeding the 4% requirement set by the previous regulation. These liquid
assets included approximately $5,097,000 in cash and cash equivalents, and
approximately $7,068,000 in other qualifying assets. As of September 30, 2004,
the fair market value of the Companys investment securities portfolio, which
is held for sale, was $14,180,000. The Company uses its investment securities
portfolio to manage liquidity and interest rate risk, whereby liquidity is
available through those securities that are not pledged. Further, cash flows
from operations, resulting primarily from net income adjusted for certain items
such as interest expense and provision for loan losses, are an additional
source of liquidity for the Company. With respect to current funding sources, deposits provide a significant
portion of SouthFirsts cash flow needs and continue to provide a relatively
stable, low cost source of funds. Other sources of funding used by SouthFirst
include commercial lines of credit and advances from the Federal Home Loan
Bank of Atlanta. See MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATION  Liquidity. 18




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##### Table of Contents



Federal Home Loan Bank System General. First Federal is a member of the FHLB System, which consists of
twelve regional FHLBs subject to supervision and regulation by the Federal
Housing Finance Board (the FHFB). The FHLBs maintain central credit
facilities primarily for member institutions. First Federal, as a member of the FHLB of Atlanta, is required to acquire
and hold shares of capital stock in the FHLB of Atlanta in an amount at least
equal to the greater of: (i) one percent of the aggregate outstanding principal
amount of its unpaid home mortgage loans, home purchase contracts and similar
obligations as of the beginning of each year or, (ii) $500. First Federal is
in compliance with this requirement with an investment in stock of the FHLB of
Atlanta, at September 30, 2004, of $1,117,000. Federal Home Loan Bank Advances Each FHLB serves as a reserve or central bank for its members within its
assigned region. Each FHLB is funded from proceeds derived from the sale of
consolidated obligations of the FHLB system. FHLB makes advances (i.e., loans)
to members in accordance with policies and procedures established by the Board
of Directors of the FHLB. Long-term advances may only be made for the purpose
of providing funds for residential housing. On April 15, 2002, First Federal was notified that the amount available
under its credit line with the Federal Home Loan Bank of Atlanta had been
changed from a variable amount, equal to 30% of total assets. or approximately
$42,000,000, to a fixed amount of $22,000,000. This amount was subsequently
changed to an amount equal to 10% of its total assets. At September 30, 2004,
First Federal owed the Federal Home Loan Bank of Atlanta $20,670,000 in
outstanding advances. The Federal Home Loan Bank of Atlanta has notified First
Federal that it will not require First Federals existing borrowings to be
reduced to the new fixed amount prior to the existing advance maturities, but
that it will require that any additional borrowings by First Federal be
approved through application by First Federal to the Federal Home Loan Bank of
Atlantas Credit Committee. Management believes that this reduction in the
amount available under this credit line, because of the existing liquidity and
other funding sources available to SouthFirst and First Federal, will have no
adverse impact on the operations of SouthFirst or First Federal. As a result of FIRREA, the FHLBs are required to provide funds for the
resolution of troubled savings associations and to contribute to affordable
housing programs through direct loans or interest subsidies on advances
targeted for community investment and low and moderate income housing projects.
These contributions have adversely affected the level of dividends paid on
FHLB stock and could continue to do so in the future. For the years ended
September 30, 2004 and 2003, dividends were paid by the FHLB to First Federal
in the amounts of $39,904 and $54,302, respectively. Were these dividends to
be reduced, or were interest subsidies on future FHLB advances were to
increase, First Federals net interest income likely would be reduced. Federal Reserve System The Federal Reserve Board requires all depository institutions to maintain
non-interest bearing reserves at specified levels against their deposit
transaction accounts (e.g., primarily checking, NOW and Super NOW checking
accounts) and non-personal time deposits. Under current Federal Reserve Board
regulations, no reserves are required to be maintained on the first $6.6
million of transaction accounts, while reserves equal to 3% must be maintained
on the next $45.4 million of transaction accounts, plus reserves equal to 10%
of the remainder. Because required reserves must be maintained in the form of
vault cash or in a non-interest bearing account at a Federal Reserve Bank, the
reserve requirement has the effect of reducing the amount of depository
institutions interest-earning assets. At September 30, 2004, First Federal
was in compliance with the reserve requirements of the Federal Reserve Board. 19




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##### Table of Contents



Savings associations have authority to borrow from the Federal Reserve
Banks discount window, but Federal Reserve policy generally requires savings
associations to exhaust all OTS sources before borrowing from the Federal
Reserve System. First Federal did not have any such borrowings at September
30, 2004. 
 ITEM 2. PROPERTIES. First Federal conducts its business through its main office located in
Sylacauga, Alabama, branch offices located in Talladega and Clanton, Alabama,
and loan production offices in Hoover and Chelsea, Alabama. In addition, First
Federal has purchased a parcel of land in Birmingham, Alabama at a total price
of $1,445,000. The following table sets forth information relating to the offices of
SouthFirst, First Federal and Pension & Benefit at September 30, 2004. The
total net book value of these properties at September 30, 2004 was
approximately $3,863,000. Net Book Value
    
    DepositsLeased
    
    
    
    
    
    as of
    
    as ofLocation
    
    or Owned
    
    Date Opened
    
    Sept. 30, 2004
    
    Sept. 30, 2004(In thousands)SouthFirst and First FederalMain Office126 North Norton Avenue
Sylacauga, Alabama 35150
    
    Owned
    
    April 1966
    
    $
    693
    
    
    $
    51,908Office/Storage BuildingNorth Norton Avenue
Sylacauga, Alabama 35150
    
    Owned
    
    November 1995
    
    
    237
    
    
    
    N/AFirst Federal Branch Offices301 West North Street
Talladega, Alabama 35160
    
    Owned
    
    April 1961
    
    
    181
    
    
    
    12,976102 Fifth Street North
Clanton, Alabama 35045
    
    Owned
    
    November 1997
    
    
    1,043
    
    
    
    32,909SouthFirst MortgageLoan Production Offices2159 Rocky Ridge Road
Birmingham, Alabama 35216
    
    Leased
    
    March 1994
    
    
    1,445
    
    
    
    N/A70 Chelsea Corners
Chelsea, AL 35043
    
    Leased
    
    January 2004
    
    
    
    
    
    
    N/APension & Benefit260 Commerce Street
Third Floor
Montgomery, Alabama 36101
    
    Owned
    
    April 1997
    
    
    264
    
    
    
    N/ATotal
    
    
    
    
    
    
    
    
    
    $
    3,863
    
    
    $
    97,793
 20




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##### Table of Contents



ITEM 3. LEGAL PROCEEDINGS In the normal course of business, SouthFirst and First Federal from time
to time are involved in legal proceedings. SouthFirst and First Federal
management believe that there are no pending or threatened legal proceedings
which, upon resolution, are expected to have a material effect upon
SouthFirsts or First Federals financial condition. Nonetheless, descriptions
of certain legal proceedings, including previously-disclosed legal proceedings,
follow: Pending Legal Proceedings First Federal is currently involved in three (3) pending legal
proceedings, descriptions of which are set forth below. All three (3) of these
pending lawsuits have been consolidated before Chilton County Circuit Court
Judge Sibley Reynolds into one proceeding. First Federals insurance carrier
has been notified of the preceedings and has entered an appearance and is
defending the claims made against First Federal. 1. In a lawsuit brought by Mike Burford and his company styled Burford,
d/b/a Burfords Wood Waste and also Burfords Tree Surgeons v. Harry Eugene
Hammock and Janice C. Hammock, in the Circuit Court of Chilton County, CV
03-337, First Federal has now been named as a defendant for allegedly
improperly cashing checks presented by the Hammocks to First Federal, but made
payable to Burford and/or his company. First Federal has turned over copies of
all checks it was able to find that were deposited directly either into the
Hammocks checking and/or savings accounts. Damages could be assessed against
First Federal if it is ultimately held liable for improperly cashing and/or
improperly depositing checks. Mr. Buford has estimated his total damages in
the existing lawsuit to fall in the broad range of between $250,000 and
$650,000. On November 4, 2003, Judge Reynolds issued a Temporary Restraining Order
enjoining the Hammocks from disposing of any assets acquired before that date,
including any funds held in any checking or savings accounts on December 8,
2003. That Order was extended indefinitely by Judge Reynolds. 2. First Federal is a plaintiff in an interpleader action filed by it
originally styled First Federal of the South v. Danny E. Hammock, Janice
Hammock, Burford Tree Surgeons and Mike Burfordin the Circuit Court of Chilton
County, Alabama, CV 03-338. First Federal has interpleaded those funds held in
checking and savings accounts in the names of Janice Hammock and/or her
husband, Danny Hammock into the Circuit Court Clerks Office. Burford Tree
Surgeons and Mike Burford have filed an Answer to First Federals Complaint,
claiming that they are entitled to the funds. 3. In the suit originally styled Danny E. Hammock and Janice Hammock v.
First Federal and Sandra Stephens(CV 03-347), the Hammocks requested that the
Court issue an order directing First Federal to unfreeze the Hammocks
accounts. That request was denied. The Hammocks have also made monetary
claims, for unspecified amounts, against First Federal for negligence,
wantonness, and recklessness in freezing the accounts. First Federal received
the Chilton County District Attorneys subpoena on October 29, 2003, and froze
the Hammocks accounts on that date. Any allegedly improper freezing of
assets took place at most for only six days because the assets were frozen by
Court Order in case number CV 03-337 on November 4, 2003. 
 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matter was submitted during the fourth quarter ended September 30, 2004
to a vote of security holders of SouthFirst. 
 PART II 
  ITEM 5.
    MARKET FOR REGISTRANTS COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS As of Decmeber 21, 2004, SouthFirsts Common Stock was held by
approximately 304 persons. SouthFirsts Common Stock trades on the American
Stock Exchange, under the symbol SZB. The following 21




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##### Table of Contents



data reflects, by fiscal quarter, the high and low sale prices, as well as cash
dividends declared for each quarter from October 1, 2001 through September 30,
2004: CashDividendsHigh Sale
    
    Low Sale
    
    Declared(1)Fiscal Year Ended September 30, 2004First Quarter ended December 31, 2003
    
    
    17 1/3
    
    
    
    15 1/2
    
    
    $
    106,500Second Quarter ended March 31, 2004
    
    
    17 4/5
    
    
    
    16
    
    
    
    106,501Third Quarter ended June 30, 2004
    
    
    18 3/4
    
    
    
    15 5/9
    
    
    
    106,495Fourth Quarter ended September 30, 2004
    
    
    16 3/4
    
    
    
    15 1/7
    
    
    
    106,487Fiscal Year Ended September 30, 2003First Quarter ended December 31, 2002
    
    
    14
    
    
    
    11 3/5
    
    
    $
    121,076Second Quarter ended March 31, 2003
    
    
    15
    
    
    
    13 5/9
    
    
    
    116,876Third Quarter ended June 30, 2003
    
    
    15 1/7
    
    
    
    13 4/9
    
    
    
    107,801Fourth Quarter ended September 30, 2003
    
    
    15 1/3
    
    
    
    14
    
    
    
    107,794
  (1)
    
    Certain cash dividends associated with SouthFirsts Management
Recognition Plans and Employee Stock Option Plan shares are reflected as
compensation expense in the consolidated financial statements. See Item
10. EXECUTIVE COMPENSATION  Management Recognition Plans and 
Employee Stock Ownership Plan. Holders of SouthFirst Common Stock are entitled to receive such dividends
as may be declared by SouthFirsts Board of Directors. The amount and
frequency of cash dividends will be determined in the judgment of SouthFirsts
Board of Directors based upon a number of factors, including the companys
earnings, financial condition, capital requirements, and other relevant
factors. SouthFirst management presently intends to continue its present
dividend policies. See Item 1. BUSINESS  Supervision and Regulation 
Regulation of First Federal  Dividends and Other Capital Distribution
Limitations. The amount of dividends payable by First Federal is limited by law and
regulation. The need for First Federal to maintain adequate capital also
limits dividends that may be paid to SouthFirst. Although Federal Reserve
policy could restrict future dividends on SouthFirst Common Stock, such policy
places no current restrictions on such dividends. See Item 6. MANAGEMENTS
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 
Capital Resources and Item 1. BUSINESS  Supervision and Regulation 
Regulation of First Federal  Dividends and Other Capital Distribution
Limitations. 22




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##### Table of Contents



ITEM 6.
    MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS The following discussion and analysis is designed to provide a better
understanding of the major factors that affected SouthFirsts results of
operations and financial condition for the referenced periods. The purpose of this discussion is to focus on significant changes in the
financial condition and results of SouthFirsts operations during the two-year
period ended September 30, 2004 This discussion and analysis is intended to
supplement and highlight information contained in the accompanying consolidated
financial statements and the selected financial data presented elsewhere
herein. Forward Looking Statements As stated in the opening paragraph to this Annual Report onForm 10-KSB,
entitled Safe Harbor Statement Under the Private Securities Litigation Reform
Act of 1995, this Annual Report onForm 10-KSBcontains certain
forward-looking statements, including managements discussion and analysis of
financial condition and results of operation under this Item 6. While
SouthFirst believes that the statements contained in this Item 6, and
throughout this Annual Report onForm 10-KSB, are accurate, SouthFirsts
business is dependent upon general economic conditions and various conditions
specific to its industry. Future trends and conditions could cause actual
results to differ materially from the forward-looking statements made herein. Results of Operations Net Income For the fiscal year ended September 30, 2004, net income decreased
$643,799 (555.65%) from net income of $115,864 in fiscal 2003.
Earnings/(loss) per common share was ($0.74) and $0.16 for the fiscal years
ended September 30, 2004 and 2003, respectively. The decrease in net income
for fiscal 2004 was due primarily to an increase in loan loss reserves, an
increase in non-interest expense and a decrease in non-interest income. First
Federals net interest income after provision for loan losses decreased
$391,172 (11.7%) during fiscal 2004, from $3,342,849 to $2,951,677. This
decrease was primarily attributable to an increase in the provision for loan
losses of $807,334, from an expense of $549,603 at September 30, 2003 compared
to an expense of $1,356,937 for the fiscal year ended September 30, 2004, the
reasons for which are discussed below under the heading Provision for Loan
Losses. This decrease in net interest income was partially offset by an
increase in net interest income before provision for loan losses in the amount
of $416,162, (10.7%) resulting primarily from the changes in balances and the
effect in the changes in interest rates between interest-earning assets and
interest-bearing liabilities. Fee income received by Pension and Benefit Trust
Company increased $350,435 (28.5%) during fiscal 2004, from $1,231,622 to
$1,582,057. The gain from the sale of loans decreased $451,064 (38.5%) from
$1,170,453 to $719,389. Other expenses increased $144,905 (2.1%) from
$6,897,411 to $7,042,316 during fiscal 2004. For the fiscal year ended September 30, 2003, net income decreased
$554,941 (82.73%) from net income of $670,805 in fiscal 2002. Earnings
(losses) per common share were $0.16 for the fiscal year ended September 30,
2003. The decrease in net income for fiscal 2003 was due primarily to an
increase in the provision for loan losses and an increase in non-interest
expense. The components of net income discussed in the preceding paragraphs are
discussed more fully below. Net Interest Income Net interest income was $4,308,614 for the twelve months ended September
30, 2004, which represents an increase of $416,162 (10.7%) from fiscal 2003.
Net interest income is the difference between the interest earned on loans,
investment securities and other earning assets and the interest cost associated
with deposits and borrowed funds. The increase in 2004 is primarily due to an
increase in the net interest rate spread. The net 23




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##### Table of Contents



interest rate spread increased as rates on interest-earning assets decreased
twenty-nine (29) basis points to 5.80% and the cost of funds also decreased
sixty-one (61) basis points to 2.32%. The combined effect of the changes in
average balances and the changes in rates above resulted in an increase in net
interest income. Net interest income was $3,892,452 for the twelve months ended September
30 2003. The increase of $95,056 (2.5%) over the comparable twelve months of
2002 was primarily the result of an increase in the interest rate spread of
thirty (30) basis points from 2.86% at September 30, 2002 to 3.16% at September
30, 2003. First Federals Asset/Liability Committee (ALCO) conducts a gap analysis
in order to assist in analyzing the yields on earning assets and the rates paid
on interest-bearing liabilities. There can be no assurance, however, that such
analysis will positively affect earnings. Rate/Volume Variance Analysis The following table sets forth information regarding the extent to which
changes in interest rates, changes in volume of interest assets, and changes in
volume of interest related assets and liabilities have affected First Federals
interest income and expense during the periods indicated. For each category of
interest-earning asset and interest-bearing liability, information is provided
for changes attributable to (i) changes in volume (change in volume multiplied
by old rate), (ii) changes in rates (change in rate multiplied by old volume)
and (iii) changes in rate/volume (change in rate multiplied by change in
volume). Changes in rate/volume have been allocated proportionately between
changes in volume and changes in rates. Year Ended September 30,2004 vs. 2003
    
    2003 vs. 2002
    
    2002 vs. 2001Increase (Decrease)
    
    Increase (Decrease)
    
    Increase (Decrease)Due to
    
    Due to
    
    Due toVolume
    
    Rate
    
    Total
    
    Volume
    
    Rate
    
    Total
    
    Volume
    
    Rate
    
    Total(Dollar amounts in thousands)Interest income:Securities
    
    $
    167
    
    
    $
    (30
    )
    
    $
    197
    
    
    $
    (215
    )
    
    $
    4
    
    
    $
    (211
    )
    
    $
    (286
    )
    
    $
    (400
    )
    
    $
    (686
    )Loans receivable
    
    
    (152
    )
    
    
    (301
    )
    
    
    (513
    )
    
    
    (154
    )
    
    
    (726
    )
    
    
    (880
    )
    
    
    (534
    )
    
    
    (1,145
    )
    
    
    (1,679
    )Total interest income
    
    
    15
    
    
    
    (331
    )
    
    
    (316
    )
    
    
    (369
    )
    
    
    (722
    )
    
    
    (1,091
    )
    
    
    (820
    )
    
    
    (1,545
    )
    
    
    (2,365
    )Interest expense:NOW accounts
    
    
    (1
    )
    
    
    (43
    )
    
    
    (44
    )
    
    
    1
    
    
    
    (81
    )
    
    
    (80
    )
    
    
    14
    
    
    
    (31
    )
    
    
    (17
    )Money market demand
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1
    )
    
    
    (1
    )
    
    
    (1
    )
    
    
    
    
    
    
    (1
    )Passbook savings
    
    
    (1
    )
    
    
    (47
    )
    
    
    (48
    )
    
    
    1
    
    
    
    (106
    )
    
    
    (105
    )
    
    
    4
    
    
    
    (41
    )
    
    
    (37
    )CDs other than Jumbos
    
    
    25
    
    
    
    (567
    )
    
    
    (542
    )
    
    
    (57
    )
    
    
    (749
    )
    
    
    (806
    )
    
    
    (314
    )
    
    
    (899
    )
    
    
    (1,213
    )Jumbos
    
    
    (139
    )
    
    
    (13
    )
    
    
    (152
    )
    
    
    68
    
    
    
    (46
    )
    
    
    22
    
    
    
    (10
    )
    
    
    (208
    )
    
    
    (218
    )Borrowed funds
    
    
    148
    
    
    
    (94
    )
    
    
    54
    
    
    
    (194
    )
    
    
    (22
    )
    
    
    (216
    )
    
    
    (185
    )
    
    
    (584
    )
    
    
    (769
    )Total interest expense
    
    
    32
    
    
    
    (764
    )
    
    
    (732
    )
    
    
    (181
    )
    
    
    (1,005
    )
    
    
    (1,186
    )
    
    
    (492
    )
    
    
    (1,763
    )
    
    
    (2,255
    )Change in net interest income
    
    $
    (17
    )
    
    $
    433
    
    
    $
    416
    
    
    $
    (188
    )
    
    $
    283
    
    
    $
    95
    
    
    $
    (328
    )
    
    $
    218
    
    
    $
    (110
    )
 Interest Income Interest income is a function of both the volume of interest earning
assets and their related yields. Interest income was $7,121,000, $7,436,000
and $8,527,000 for the twelve months ended September 30, 2004, 2003 and 2002,
respectively. Average interest earning assets increased $524,000 (.43%) during
2004, decreased $6,472,000 (5.0%) during 2003 and decreased $12,945,000 (9.1%)
during 2002. The yield for 2004, 2003 and 2002 decreased primarily due to
rates on mortgage and residential construction loans decreasing during the
year. Interest and fees on loans were $5,436,000, $5,948,000 and $6,828,000
for the twelve months ended September 30, 2004, 2003 and 2002, respectively.
Although actual loans receivable increased substantially during fiscal 2004,
average loan balances decreased approximately $2,600,000 (2.7%). This decrease
in average balances is attributable to the sale of approximately $6,400,000 in
commercial, residential mortgage and other consumer 24




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##### Table of Contents



loans as the result of the sale of the Centreville branch office in
Centreville, Alabama to First Financial Bank in Bessemer, Alabama occurring
during the last quarter of fiscal 2003. The sale of these loans resulted in
the decrease in average loans receivable in fiscal 2003 of approximately
$2,400,000. Interest income on total securities available-for-sale decreased $95,000
(6.8%) to $1,302,000 in 2004. The average balance outstanding of securities
available-for-sale decreased $3,038,000 (11.2%) to $24,200,000 in 2004,
decreased $3,670,000 (11.9%) to $27,238,000 in 2003, and decreased $5,612,000
(15.4%) to $30,907,000 in 2002. The yields on securities available-for-sale
were 5.38% in 2004 and 5.13% in 2003. Interest income on securities
available-for-sale decreased $203,000 (12.7%) in 2003 from 2002. Interest income on securities held-to-maturity increased approximately
$345,000 in 2004. This increase in interest income is the result of the
re-classification of approximately $16,000,000 from available-for-sale to
held-to-maturity investments during the third quarter of fiscal 2004. The
yield earned on securities held to maturity was 5.50% at September 30, 2004. Interest Expense Total average interest-bearing liabilities were $121,142,000, $120,924,000
and $125,364,000 for fiscal years 2004, 2003, and 2002, respectively. Interest
bearing liabilities increased by $218,000 (0.2%) in 2004, decreased by
$4,439,000 (3.5%) in 2003, and decreased $10,636,000 (7.8%) in 2002. The
rates paid on these liabilities decreased by 61 basis points to 2.32% in 2004,
decreased by 84 basis points to 2.93% in 2003, and increased by 137 basis
points to 3.77% in 2002. Total interest expense was $2,812,000, $3,544,000 and
$4,730,000 for 2004, 2003, and 2002, respectively, which represents a decrease
of $732,000 (20.6%), a decrease of $1,186,000 (25.1%), and a decrease of
$2,254,000 (32.3%), during 2004, 2003, and 2002, respectively. The decrease in
2004 was primarily due to the decrease in interest rates. The decrease in 2003
and 2002 was primarily due to the decrease in interest-bearing liabilities,
along with the reduction in interest rates. Interest on deposits, the primary component of total interest expense
decreased to $1,735,000 in 2004, decreased to $2,521,000 in 2003 and decreased
to $3,491,000 in 2002. The average balance of interest-bearing deposits
decreased to $91,900,000 in 2004 from $95,707,000 in 2003, representing a
decrease of $3,806,000 (4.0%). In 2003, the balance of $95,707,000 represented
an increase of $344,000 (0.4%) from the balance of $95,363,000 in 2002. Interest expense on borrowed funds, including both short-term and other
borrowed funds was $1,077,000, $1,023,000 and $1,239,000 for fiscal 2004, 2003
and 2002, respectively. Interest expense increased in 2004 approximately
$54,000 (5.3%) from fiscal 2003. Although interest rates on borrowed funds
decreased 38 basis points to 3.68% from 4.06%, average balances increased from
$25,218,000 to $29,242,000 in fiscal 2004, representing an increase of
approximately $4,000,000 (16.0). The decrease in 2003 and 2002 was primarily
due to lower interest rates, along with principal reductions in average
borrowings of approximately $4,800,000 and $4,471,000, respectively. The
average balance of FHLB advances outstanding was $22,124,000, $22,340,000 and
$27,044,000 for 2004, 2003, and 2002, respectively. The average balance of
total borrowed funds, including both short-term and other borrowed funds was
$29,242,000, $25,218,000 and $30,001,000 for 2004, 2003 and 2002, respectively. Provision for Loan Losses The provision for loan losses is based on managements current assessment
of the risk in the loan portfolio and is influenced primarily by the amount of
recent loan losses. The provision for loan losses (benefit) was $1,356,937,
$549,603, and ($667,650) for fiscal 2004, 2003 and 2002, respectively. The
amount of the provision for loan losses for fiscal 2004 is primarily the result
of the write down of an acquisition and development loan in Columbiana,
Alabama, which entered into foreclosure in January 2004. At the date of
foreclosure, this loan had a disbursed balance of approximately $1,948,000,
with previously recognized allowances of approximately $525,000. At the time
of foreclosure, the fair value of the property was estimated to be $500,000.
The year to date provision also includes approximately $312,000 of additional
general loan loss 25




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##### Table of Contents



reserves recorded to increase the balance in allowance for loan losses to an
appropriate level, based on continuing reviews of asset quality. The amount of
the provision for loan losses for fiscal 2003 is primarily the result of a
specific reserve for approximately $525,000 relative to the above mentioned
acquisition and development loan. As of September 30, 2003, the disbursed
balance on this loan was approximately $1,790,000. (See Allowance for Loan
Losses and Risk Elements for further discussion.) The amount of the provision
for loan losses for fiscal 2002 is primarily the result of a reversal of an
additional provision for a loan, which defaulted, in the fourth quarter of
fiscal 2001 in the principal amount of $657,000. This loan was made to Vawter
Properties and Resources, LP, an Alabama limited partnership whose general
partner is Charles R. Vawter, Jr., a former director of the Company and the
Bank, and who also personally guaranteed the loan. The total of the loan loss
and the related expenses associated with this loan in the fourth quarter of
2001 was $713,000, including the loss of principal and unpaid interest, as well
as related legal and accounting expenses. The Bank brought suit against Mr.
Vawter, Vawter Properties and Resources, LP, and other related parties to
recover the total amount of the loan loss and related expenses. A settlement
was reached on August 28, 2002, for which the bank received $761,000. First Federals provision for loan losses also reflects managements
current assessment of economic and other factors which management deems
relevant to its risk analysis, including loan concentrations in particular
markets, economic activity in particular markets, certain regulatory
requirements regarding loan loss reserves and related safety and soundness
issues, as well as managements view of the general economic outlook. As previously discussed, the loan portfolio is comprised primarily of
one-to-four family residential mortgage loans and residential construction
loans. The one-to-four family residential mortgage loans are originated in
First Federals primary market area of Talladega and Chilton County, Alabama.
Management believes that the credit risks associated with this type of loan are
significantly lower than other loan types. Although residential construction loans have characteristics of relatively
higher credit risks, such as concentrations of amounts due from a smaller
number of borrowers and dependence on the expertise of the builder, management
believes that its residential construction lending policies and procedures
reduce the credit risks associated with this type of loan, and that its current
provisions for loan losses in the construction loan portfolio (1%) is adequate
in light of these policies and procedures. First Federal entered the
residential construction lending area in 1994 by purchasing the portfolio of
another Alabama thrift. A significant portion of First Federals residential
construction loans were originated in Hoover, Alabama, a suburb of Birmingham
and one of the most affluent areas of the state. Since acquiring the
portfolio, First Federal has not suffered a significant loss on a residential
construction loan. Significant write-offs in fiscal 2004 consisted of the acquisition and
development loan mentioned above, and other charge-offs for various types of
consumer loans of approximately $103,000. Significant write-offs in fiscal
2003 consisted primarily of a commercial real estate loan in Clanton, Alabama,
which was foreclosed and subsequently sold in 2003. There were no significant
charge-offs in 2002. In addition, management has also specifically reserved
approximately $395,000, of which approximately $316,000 is reserved on a
commercial loan to a used automobile dealership, and approximately $79,000 on
other types of consumer loans. Management believes the allowances for loan
losses at September 30, 2004 ($911,964) to be an adequate level relative to the
total loan portfolio and to non-performing loans, and in light of the other
factors, which are relevant to the assessment of risks in the loan portfolio. Future additions to the allowance may be necessary based on changes in
economic conditions and other factors. In addition, various regulatory
agencies periodically review First Federals allowance for loan losses and may
require First Federal to recognize additions to the allowance based upon and
analysis of information available at the time of their review. Other Income Other income decreased $502,000 (13.4%) in 2004 from $3,742,000 in 2003.
Other income increased $708,000 (23.3%) in 2003 from $3,033,000 in 2002. The
decrease in 2004 was due to a decrease in the gain on the sale of mortgage
loans from $1,170,000 to $719,000, a decrease in the gain from the sale of
securities 26




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##### Table of Contents



available-for-sale from $238,000 to $84,000, and a decrease in the profit from
the sale of deposits of $250,000, which was a one-time profit as a result of
the sale of the Centreville branch location in the fourth quarter of fiscal
2003. Service charges and other fees decreased from $569,000 to $546,000,
while other income decreased from $345,000 to $314,000. Off-setting these
decreases in income are increases in fee income generated from Pension &
Benefit Trust Company from $1,232,000 to $1,582,000 and a decrease in the loss
from the sale of foreclosed and other assets from $70,000 to $7,000. The
increase in 2003 was due to an increase in fee income from Pension & Benefit
Trust Company from $1,173,000 to $1,232,000, an increase in the gain from the
sale of mortgage loans from $612,000 to $1,170,000, and a gain from service
charges and other fees from $448,000 to $569,000. The gain on sale of mortgage loans decreased $451,000 (38.5%) in 2004,
increased $558,000 (91.3%) in 2003 and increased $218,000 (55.4%) in 2002. The
restructuring process in the mortgage banking division, along with increased
rates as the refinancing boom of 2003 closed, has resulted in decreased volumes
of originations and sales of mortgage loans in fiscal 2004. During 2003 and
2002, with the addition of mortgage loan originators, along with the decrease
in mortgage loan rates, the volume of originations and sales of mortgage loans
increased. The gain on sale of securities available-for-sale decreased approximately
$155,000 (64.9%) for fiscal year 2004. The gain on sale of securities
available-for-sale remained approximately the same for fiscal 2003 and 2002 at
$238,000 and $236,000, respectively. In 2002, the gain from the sale of
available-for-sale securities increased $232,000. Service charges and other fees were $546,000, $569,000 and $448,000 in
fiscal 2004, 2003 and 2002, respectively. The fluctuations are primarily due
to changes in overdraft and non-sufficient charges. Other Expense Total other expense increased to $7,042,000 in 2004 from $6,897,000 in
2003. Other expense increased in 2002 to $6,407,000. This represented an
increase of $145,000 (2.1%) in 2004, an increase of $490,000 (7.7%) in 2003,
and an increase of $382,000 (6.3%) in 2002. Compensation and benefits totaled $4,331,000, $4,279,000 and $3,636,000
for fiscal 2004, 2003 and 2002, respectively. These levels reflect an increase
of $52,000 (1.2%) in 2004, an increase of $644,000 (17.7%) in 2003 and an
increase of $518,000 (16.6%) in 2002. In 2004, the increase was attributable
to the acquisition of Walton Mortgage in January 2004 and certain severance
payments made in connection with the restructuring of SouthFirst Mortgage and
certain other areas within the company. The increases in 2003 and 2002 was
primarily attributable to new salaries associated with the restructuring
process, along with merit and cost of living raises and the costs of benefits
associated with such increases. Increases in other expenses during fiscal 2004 occurred in occupancy,
furniture and fixtures expense, office supplies and related expenses, and data
processing of approximately $27,000, $54,000, $6,000 and $123,000,
respectively. The increase in data processing costs resulted primarily from
the conversion of the Banks data processing function to FISERV. These
increases in other expenses were partially offset with decreases in expenses
related to deposit insurance premiums, legal and other in the amount of $5,000,
$58,000 and $54,000, respectively. Income Tax Expense Income tax expenses (benefit) were (323,000), 71,000 and $421,000 for
fiscal 2004, 2003 and 2002, respectively. These levels represent an effective
tax rate on pre-tax earnings (losses) of 38% in 2004, 38% in 2003 and 39% in
2002. 27




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Supervisory Agreement On March 29, 2002, SouthFirst announced that First Federal, on March 22,
2002, had entered into a Supervisory Agreement with the OTS that formalized
certain understandings between First Federal and the OTS with respect to
actions that First Federal and its Board of Directors had to undertake to
comply with the requirements of the OTS. On December 16, 2004, First Federal
received notification from the OTS that First Federal had complied with the
obligations contained in the Supervisory Agreement and that the Supervisory
Agreement was rescinded as of December 14, 2004. New Accounting Pronouncements In March 2004, the Securities and Exchange Commission (SEC) issued Staff
Accounting Bulletin (SAB) 105, Application of Accounting Principles to Loan
Commitments,which summarized the views of the staff regarding the application
of generally accepted accounting principles to loan commitments accounted for
as derivative instruments. The SAB requires that the fair value measurement of
a loan commitment that is accounted for as a derivative includes only
differences between the guaranteed interest rate in the loan commitment and a
market interest rate, excluding any expected cash flows related to the customer
relationship or loan servicing. This SAB is effective for loan commitments
entered into after March 31, 2004. The Company adopted SAB 105 on April 1,
2004, and the effect was not material. In March 2004, the FASBs Emerging Issues Task Force reached a consensus
of EITF Issue No. 03-1, The Meaning of Other-Than-Temporary Impairment and Its
Application to Certain Investments.The guidance prescribes a three-step model
for determining whether an investment is other-than-temporarily impaired and
requires disclosures about unrealized losses on investments. The accounting
guidance provided to evaluate whether an impairment is other than temporary has
been delayed by FASB Staff Position EITF Issue 03-1-1, Effective Date of
Paragraphs 10-20 of EITF Issue No. 03-1, The Meaning of Other-Than-Temporary
Impairment and Its Application to Certain Investments, posted September 30,
2004. The delay of the effective date for paragraphs 10-20 will be superseded
concurrent with the final issuance of proposed FSP EITF Issue 03-1-a,
Implementation Guidance for the Application of Paragraph 16 of EITF Issue No.
03-1, The Meaning of Other-Than-Temporary Impairment and Its Application to
Certain Investments,while the disclosure requirements are effective for
annual reporting periods ending after December 15, 2003. The Company has
adopted the disclosure requirements of this EITF, and is currently evaluating
the impact of the adoption of the accounting guidance in the EITF. In December 2004, the FASB issued Statement of Financial Accounting
Standards No. 123 (revised 2004) Share-Based Payment. The Statement is a
revision of FASB Statement No. 123, Accounting for Stock-Based Compensation.
This Statement supersedes APB Opinion No. 25, Accounting for Stock Issued to
Employees, and its related implementation guidance. The Statement establishes
standards for the accounting for transactions in which an entity exchanges its
equity instruments for goods or services. It also addresses transactions in
which an entity incurs liabilities in exchange for goods or services that are
based on the fair value of the entitys equity instruments or that may be
settled by the issuance of those equity instruments. The Statement focuses
primarily on accounting for transactions in which an entity obtains employee
services in share-based payment transactions. The Statement requires a public
entity to measure the cost of employee services received in exchange for an
award of equity instruments based on the grant-date fair value of the award
(with limited exceptions). That cost will be recognized over the period during
which an employee is required to provide service in exchange for the award -
the requisite service period (usually the vesting period). No compensation
cost is recognized for equity instruments for which employees do not render the
requisite service. The Statement eliminates the alternative to use APB Opinion
25s intrinsic value method of accounting that was provided in Statement 123 as
originally issued. Under Opinion 25, issuing stock options to employees
generally resulted in recognition of no compensation cost. This Statement
requires entities to recognize the cost of employee services received in
exchange for awards of equity instruments based on the grant-date fair value of
those awards (with limited exceptions). The Statement is effective for public
entities that do not file as small business issuers as of the beginning of the
first interim or annual reporting period that begins after June 15, 2005, and
for public entities that file as small business issuers as of the beginning of
the first interim or annual reporting period that begins 28




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##### Table of Contents



after December 15, 2005. The Company is currently evaluating the impact
the adoption of this statement will have on its statement of condition and
results of operations. Interest Rate Sensitivity An integral aspect of the funds management of First Federal is the
maintenance of a reasonably balanced position between interest rate sensitive
assets and liabilities. ALCO is charged with the responsibility of managing,
to the degree prudently possible, First Federals exposure to interest rate
risk, while attempting to provide a stable and steadily increasing flow of
depositors and borrowers and to seek earnings enhancement opportunities. An
asset or liability is said to be interest rate sensitive within a specific
period if it will mature or reprice within that period. First Federal measures
its interest rate risk as the ratio of cumulative interest sensitivity gap to
total interest-earning assets (ratio). The ratio is defined as the
difference between the amount of interest-earning assets maturing or repricing
within a specific time period and the amount of interest-bearing liabilities
maturing or repricing within that same time period, divided by the total
interest earning assets. This ratio is positive when the amount of interest
rate sensitive assets exceeds the amount of interest sensitive liabilities, and
is negative when the amount of interest rate sensitive liabilities exceeds the
amount of interest rate sensitive assets. Generally, during a period of rising
interest rates, a negative ratio would adversely affect net interest income,
while a positive ratio would result in an increase in net interest income.
Conversely, during a period of falling interest rates, a negative ratio would
result in an increase in net interest income and a positive ratio would
adversely affect net interest income. Due to the nature of First Federals
balance sheet structure and its use of the market approach to pricing
liabilities, First Federals management and the First Federal Board of
Directors recognize that achieving a perfectly matched gap position in any
given time frame would be extremely rare. At September 30, 2004, First Federal
had a negative one-year cumulative ratio of 7.08% and a five-year cumulative
ratio of 1.39%, as a result of which its net interest income could be
negatively affected by rising interest rates and positively affected by falling
interest rates. At September 30, 2003, First Federal had a positive one-year
cumulative ratio of 8.82% and a positive five-year cumulative ratio of 4.13%.
During the declining interest rate environment for the early months of fiscal
year 2004, and most of fiscal year 2003, First Federals interest rate spread
increased. There are other factors that may affect the interest rate sensitivity of
First Federals assets and liabilities. These factors generally are difficult
to quantify but can have a significant impact on First Federal when interest
rates change. Such factors include features in adjustable rate loans that
limit the changes in interest rates on a short-term basis and over the life of
a loan. First Federals portfolio of one-to-four family residential mortgage
loans included $29.3 million and $22.54 million (30.7% and 26.7% of First
Federals total loan portfolio) of adjustable rate loans at September 30, 2004
and 2003, respectively. These loans have restrictions limiting interest rate
changes to 1.0% or 2.0% per year and 6.0% over the life of the loan. In a
rapidly declining or rising interest rate environment, these restrictions could
have a material effect on interest income by slowing the overall response of
the portfolio to market movements. ALCO utilizes the Asset and Liability
Management Report prepared by Farin & Associates (the Strategic Asset
Liability Management) in order to assist First Federal in determining First
Federals gap and interest rate position. Through use of the Farin &
Associates analysis, ALCO analyzed the effect of an increase or decrease of up

to 300 basis points on the market value of First Federals portfolio equity
(MVPE) at September 30, 2004 and 2003. At a 300 basis point increase, First
Federals MVPE decreased approximately $5,090,000 and $2,288,000 at September
30, 2004 and 2003, respectively, and at a 300 basis point decrease, First
Federals MVPE increased approximately $3,290,000 and $1,377,000 at September
30, 2004 and 2003, respectively. At the 300 basis point increase, the equity
exposure was a negative 44.18%, which represents a negative variance of 4.18%
from the board established limit as outlined in First Federals interest rate
risk policy. The ALCO committee is in the process of analyzing different
strategies to address this variance and reduce the interest rate risk
associated with a sudden change in interest rates. The following table sets forth information regarding the projected
maturities and repricing of the major asset and liability categories of First
Federal, as of September 30, 2004 and 2003. The projected maturity and
repricing dates were arrived at by applying the assumptions set forth below.
Classifications of items in the table are different from those presented in
other tables and the financial statements and accompanying notes included
therein. 29




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##### Table of Contents



Interest Rate Sensitivity Gap At September 30, 2004One year
    
    One to
    
    Three to
    
    Overor less
    
    three years
    
    five years
    
    five years
    
    TotalInterest-earning assets:Mortgage loans
    
    $
    46,690
    
    
    $
    19,994
    
    
    $
    12,337
    
    
    $
    6,766
    
    
    $
    85,796All other loans
    
    
    3,340
    
    
    
    3,087
    
    
    
    1,726
    
    
    
    1,938
    
    
    
    10,091Collateralized mortgage
obligations
    
    
    875
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    875Mortgage-backed
securities
    
    
    1,431
    
    
    
    2,233
    
    
    
    1,585
    
    
    
    3,004
    
    
    
    8,253Other Investments (1)
    
    
    25,235
    
    
    
    100
    
    
    
    
    
    
    
    
    
    
    
    25,335Total interest- earning assets
    
    $
    77,580
    
    
    $
    25,414
    
    
    $
    15,648
    
    
    $
    11,708
    
    
    $
    130,350Interest-bearing liabilities:Deposits
    
    $
    58,621
    
    
    $
    24,634
    
    
    $
    10,123
    
    
    $
    4,477
    
    
    $
    97,855Borrowed funds
    
    
    28,186
    
    
    
    2,500
    
    
    
    
    
    
    
    
    
    
    
    30,686Total interest-bearing liabilities
    
    $
    86,807
    
    
    $
    27,134
    
    
    $
    10,123
    
    
    $
    4,477
    
    
    $
    128,541Interest sensitivity gap
    
    $
    (9,227
    )
    
    $
    (1,720
    )
    
    $
    5,525
    
    
    $
    7,231
    
    
    $
    1,809Cumulative interest sensitivity gap
    
    $
    (9,227
    )
    
    $
    (10,947
    )
    
    $
    (5,422
    )
    
    $
    1,809
    
    
    $
    Ratio of cumulative interest sensitivity
gap to total interest earning assets
    
    
    (7.08
    )%
    
    
    (8.40
    )%
    
    
    (4.16
    )%
    
    
    1.39
    %
    
    
    Ratio of cumulative interest sensitivity
gap to total assets of $140,470
    
    
    (6.57
    )%
    
    
    (7.79
    )%
    
    
    (3.86
    )%
    
    
    1.29
    %
    
    
    
   [Continued from above table, first column(s) repeated] At September 30, 2003One year
    
    One to
    
    Three to
    
    OverOr less
    
    three years
    
    five years
    
    five years
    
    TotalInterest-earning assets:Mortgage loans
    
    $
    51,969
    
    
    $
    13,066
    
    
    $
    8,099
    
    
    $
    3,395
    
    
    $
    76,529All other loans
    
    
    5,080
    
    
    
    2,645
    
    
    
    1,283
    
    
    
    1,173
    
    
    
    10,181Collateralized mortgage
obligations
    
    
    1,440
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,440Mortgage-backed
securities
    
    
    2,578
    
    
    
    2,947
    
    
    
    1,349
    
    
    
    1,043
    
    
    
    7,917Other Investments (1)
    
    
    29,247
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    29,247Total interest- earning assets
    
    $
    90,314
    
    
    $
    18,658
    
    
    $
    10,731
    
    
    $
    5,611
    
    
    $
    125,314Interest-bearing liabilities:Deposits
    
    $
    54,848
    
    
    $
    24,079
    
    
    $
    11,307
    
    
    $
    4,820
    
    
    $
    95,054Borrowed funds
    
    
    24,412
    
    
    
    673
    
    
    
    
    
    
    
    
    
    
    

    25,085Total interest-bearing liabilities
    
    $
    79,260
    
    
    $
    24,752
    
    
    $
    11,307
    
    
    $
    4,820
    
    
    $
    120,139Interest sensitivity gap
    
    $
    11,054
    
    
    $
    (6,094
    )
    
    $
    (576
    )
    
    $
    791
    
    
    $
    5,175Cumulative interest sensitivity gap
    
    $
    11,054
    
    
    $
    4,960
    
    
    $
    4,384
    
    
    $
    5,175
    
    
    $
    Ratio of cumulative interest sensitivity
gap to total interest earning assets
    
    
    8.82
    %
    
    
    3.96
    %
    
    
    3.50
    %
    
    
    4.13
    %
    
    
    Ratio of cumulative interest sensitivity
gap to total assets of $140,470
    
    
    8.25
    %
    
    
    3.70
    %
    
    
    3.27
    %
    
    
    3.86
    %
    
    
    
   (1)
    
    Includes investments in overnight deposits. 30




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##### Table of Contents



Gap Sensitivity The Farin & Associates analysis for 2004 and the preceding table were
based upon the contractual terms of the asset or liability and in consideration
of the following assumptions regarding prepayment of loans, collateralized
mortgage obligations (CMOs) and mortgage-backed securities, and decay rates
of deposits. These prepayment and decay rate assumptions are managements
estimates based on expectations of future interest rates. Fixed rate mortgage
loans are assumed to prepay at approximately 6.3%. Adjustable rate loans, CMOs
and mortgage-backed securities are presented in the period in which they next
reprice. All other loans (principally consumer installment loans) are
presented at their contractual maturities. Fixed rate CMOs are assumed to
prepay at rates ranging from 15% to 20%. The decay rates for money market
demand accounts are assumed to be 50% each year. The decay rates for passbook
accounts are assumed to be 33% each year, and the decay rates for NOW accounts
are assumed to be 25% each year. Certificate accounts and borrowed funds are
presented at their contractual maturities. Certain shortcomings are inherent
in the method of analysis presented in the table above. Although certain
assets and liabilities may have similar maturities or periods of repricing,
they may react in different degrees to changes in the market interest rates.
The interest rates on certain liabilities may lag behind changes in market
interest rates. Certain assets, such as ARMs, generally have features, which
restrict changes in interest rates on a short-term basis and over the life of
the asset. In the event of a change in interest rates, prepayments and early
withdrawal levels would cause significant deviations in the table.
Additionally, an increased credit risk may result if the ability of many
borrowers to service their debt decreases in the event of an interest rate
increase. A majority of the adjustable rate loans in First Federals portfolio
contain conditions, which restrict the periodic change in interest rates. Interest Rate Risk Strategy First Federal has employed various strategies intended to minimize the
adverse effect of interest rate risk on future operations by attempting to
balance the interest rate sensitivities of its assets and liabilities. First
Federals strategies are intended to stabilize long term net interest income by
protecting its interest rate spread against decreases and increases in interest
rates. To offset the interest rate risk associated with holding a substantial
amount of fixed rate loans and having a predominantly short-term certificate of
deposit base, First Federal maintains a portfolio of residential
adjustable-rate mortgage loans that reprice in less than one year. The amount
of loans in this portfolio was equal to $23,890,000 at September 30, 2004 and
$22,392,000 at September 30, 2003. First Federal also sells a significant
portion of its fixed rate loan originations in the secondary markets, and
directs excess cash flow into short-term and adjustable rate investment
securities. Diversification into more interest-sensitive securities directs
excess cash flow into short-term and adjustable rate investment securities.
Diversification into more interest-sensitive mortgage loans and construction
loans in the Birmingham area has also served to reduce First Federals interest
rate risk exposure. Effects of Inflation and Changing Prices Inflation generally increases the costs of funds and operating overhead,
and, to the extent that loans and other assets bear variable rates, the yields
on such assets. Unlike most industrial companies, virtually all of the assets
and liabilities of a financial institution are monetary in nature. As a
result, interest rates generally have a more significant impact on the
performance of a financial institution than the effects of general levels of
inflation. Although interest rates do not necessarily move in the same
direction, or to the same extent, as the prices of goods and services,
increases in inflation generally have resulted in increased interest rates. In
addition, inflation affects a financial institutions cost of goods and
services purchased, the cost of salaries and benefits, occupancy expense, and
similar items. Inflation and related increases in interest rates generally
decrease the market value of investments and loans held and may adversely
affect liquidity, earnings, and stockholders equity. Mortgage originations
and refinancings tend to slow as interest rates increase and would likely
reduce First Federals earnings from such activities. Further, First Federals
income from the sale of residential mortgage loans in the secondary market
likely would decrease if interest rates increased. 31




---



##### Table of Contents



Average Balance, Interest, Yields and Rates The following table sets forth certain information relating to First
Federals average interest-earning assets and interest-bearing liabilities and
reflects the average yield on assets and average cost of liabilities for the
periods indicated. Such yields and costs are derived by dividing income or
expense by the average monthly balance of assets or liabilities, respectively,
for the periods presented. Average balances are derived from month-end
balances. Management does not believe that the use of month-end balances
instead of daily balances has caused any material difference in the information
presented. The following table also presents information for the periods indicated
with respect to the difference between the average yield earned on
interest-earning assets and average rate paid on interest-bearing liabilities,
or interest rate spread, which savings associations have traditionally used
as an indicator of profitability. Another indicator of an institutions net
interest income is its net yield on total interest-earning assets, which is
its net interest income divided by the average balance of interest-earning
assets. Net interest income is affected by the interest rate spread and by the
relative amounts of interest-earning assets and interest-bearing liabilities.
When interest-earning assets reflect or exceed interest-bearing liabilities,
any positive interest rate spread will generate net interest income. 32




---



##### Table of Contents



Average Balance, Interest, Yields and Rates Year Ended September 30,2004
    
    2003Average
    
    
    
    
    
    Yield/
    
    Average
    
    
    
    
    
    Yield/Balance
    
    Interest
    
    Cost
    
    Balance
    
    Interest
    
    CostInterest Earning Assets:Interest earnings deposited
in other financial institutions
    
    $
    602,805
    
    
    $
    37,776
    
    
    
    6.27
    %
    
    $
    761,750
    
    
    $
    91,223
    
    
    
    11.98
    %Total securities
    
    
    30,476,375
    
    
    
    1,647,473
    
    
    
    5.41
    %
    
    
    27,237,544
    
    
    
    1,397,105
    
    
    
    5.13
    %Loans receivable
    
    
    91,610,652
    
    
    
    5,435,692
    
    
    
    5.93
    %
    
    
    94,166,707
    
    
    
    5,948,317
    
    
    
    6.32
    %Total interest earning assets
    
    
    122,689,832
    
    
    
    7,120,941
    
    
    
    5.80
    %
    
    
    122,166,001
    
    
    
    7,436,645
    
    
    
    6.09
    %Allowance for loan losses
    
    
    (980,380
    )
    
    
    
    
    
    
    
    
    
    
    (927,683
    )Cash and amounts due from
depository institutions
    
    
    5,592,476
    
    
    
    
    
    
    
    
    
    
    
    8,364,641Premises and equipment
    
    
    4,568,474
    
    
    
    
    
    
    
    
    
    
    
    4,507,558FHLB stock, at cost
    
    
    1,117,000
    
    
    
    
    
    
    
    
    
    
    
    1,262,833Foreclosed real estate
    
    
    495,330
    
    
    
    
    
    
    
    
    
    
    
    420,213Accrued interest receivable
    
    
    665,166
    
    
    
    
    
    
    
    
    
    
    
    605,552Other assets
    
    
    3,299,720
    
    
    
    
    
    
    
    
    
    
    
    2,650,805Total Assets
    
    $
    137,447,618
    
    
    
    
    
    
    
    
    
    
    $
    139,049,920Interest Bearing Liabilities:Deposits:NOW accounts
    
    $
    10,612,198
    
    
    $
    19,403
    
    
    
    .18
    %
    
    $
    11,208,905
    
    
    $
    63,071
    
    
    
    .56
    %Money market demand
    
    
    54,929
    
    
    
    54
    
    
    
    .10
    %
    
    
    46,293
    
    
    
    161
    
    
    
    .35
    %Statement savings
    
    
    11,494,036
    
    
    
    25,921
    
    
    
    .23
    %
    
    
    12,142,016
    
    
    
    74,506
    
    
    
    .61
    %CDs, other than Jumbos
    
    
    64,272,679
    
    
    
    1,482,260
    
    
    
    2.31
    %
    
    
    63,192,912
    
    
    
    2,024,399
    
    
    
    3.20
    %Jumbo certificates
    
    
    5,466,536
    
    
    
    207,212
    
    
    
    3.79
    %
    
    
    9,116,476
    
    
    
    358,691
    
    
    
    3.93
    %Total interest-bearing deposits
    
    
    91,900,378
    
    
    
    1,734,850
    
    
    
    1.89
    %
    
    
    95,706,602
    
    
    
    2,520,828
    
    
    
    2.63
    %Borrowed funds
    
    
    29,241,967
    
    
    
    1,077,477
    
    
    
    3.68
    %
    
    
    25,217,611
    
    
    
    1,023,365
    
    
    
    4.06
    %Total interest-bearing liabilities
    
    
    121,142,345
    
    
    
    2,812,327
    
    
    
    2.32
    %
    
    
    120,924,213
    
    
    
    3,544,193
    
    
    
    2.93
    %Non-interest bearing demand accounts
    
    
    4,077,675
    
    
    
    
    
    
    
    
    
    
    
    3,585,780Advances by borrowers for property taxes
    
    
    179,793
    
    
    
    
    
    
    
    
    
    
    
    208,122Accrued interest payable
    
    
    490,022
    
    
    
    
    
    
    
    
    
    
    
    726,747Income taxes payable
    
    
    (396,075
    )
    
    
    
    
    
    
    
    
    
    
    447,058Accrued expenses and other liabilities
    
    
    1,002,548
    
    
    
    
    
    
    
    
    
    
    
    431,172Total liabilities
    
    
    126,496,308
    
    
    
    
    
    
    
    
    
    
    
    126,323,092Stockholders equity
    
    
    10,951,309
    
    
    
    
    
    
    
    
    
    
    
    12,726,828Total liabilities & stockholders equity
equity
    
    $
    137,447,617
    
    
    
    
    
    
    
    
    
    
    $
    139,049,920Net interest income
    
    
    
    
    
    $
    4,308,614
    
    
    
    
    
    
    
    
    
    
    $
    3,892,451Interest rate spread
    
    
    
    
    
    
    
    
    
    
    3.48
    %
    
    
    
    
    
    
    
    
    
    
    3.16
    %Net yield on total interest earning assets
    
    
    
    
    
    
    
    
    
    
    3.51
    %
    
    
    
    
    
    
    
    
    
    
    3.19
    %Average interest-earning assets to average
total interest-bearing liabilities ratio
    
    
    
    
    
    
    
    
    
    
    101.28
    %
    
    
    
    
    
    
    
    
    
    
    101.03
    %
   [Continued from above table, first column(s) repeated] Year Ended September 30,2002Average
    
    
    
    
    
    Yield/Balance
    
    Interest
    
    CostInterest Earning Assets:Interest earnings deposited
in other financial institutions
    
    $
    1,131,360
    
    
    $
    99,189
    
    
    
    8.77
    %Total securities
    
    
    30,907,198
    
    
    
    1,600,346
    
    
    
    5.18
    %Loans receivable
    
    
    96,599,905
    
    
    
    6,827,657
    
    
    
    7.07
    %Total interest earning assets
    
    
    128,638,463
    
    
    
    8,527,192
    
    
    
    6.63
    %Allowance for loan losses
    
    
    (1,386,892
    )Cash and amounts due from
depository institutions
    
    
    6,341,587Premises and equipment
    
    
    4,881,979FHLB stock, at cost
    
    
    2,229,800Foreclosed real estate
    
    
    226,899Accrued interest receivable
    
    
    783,703Other assets
    
    
    2,532,819Total Assets
    
    $
    144,248,358Interest Bearing Liabilities:Deposits:NOW accounts
    
    $
    10,968,447
    
    
    $
    142,688
    
    
    
    1.30
    %Money market demand
    
    
    66,441
    
    
    
    850
    
    
    
    1.28
    %Statement savings
    
    
    11,946,198
    
    
    
    179,579
    
    
    
    1.50
    %CDs, other than Jumbos
    
    
    64,985,484
    

    
    
    2,830,798
    
    
    
    4.36
    %Jumbo certificates
    
    
    7,396,298
    
    
    
    336,800
    
    
    
    4.55
    %Total interest-bearing deposits
    
    
    95,362,868
    
    
    
    3,490,715
    
    
    
    3.66
    %Borrowed funds
    
    
    30,000,755
    
    
    
    1,239,081
    
    
    
    4.13
    %Total interest-bearing liabilities
    
    
    125,363,623
    
    
    
    4,729,796
    
    
    
    3.77
    %Non-interest bearing demand accounts
    
    
    3,472,967Advances by borrowers for property taxes
    
    
    258,250Accrued interest payable
    
    
    1,032,802Income taxes payable
    
    
    9,084Accrued expenses and other liabilities
    
    
    381,893Total liabilities
    
    
    130,518,619Stockholders equity
    
    
    13,729,739Total liabilities & stockholders equity
equity
    
    $
    144,248,358Net interest income
    
    
    
    
    
    $
    3,797,396Interest rate spread
    
    
    
    
    
    
    
    
    
    
    2.86
    %Net yield on total interest earning assets
    
    
    
    
    
    
    
    
    
    
    2.95
    %Average interest-earning assets to average
total interest-bearing liabilities ratio
    
    
    
    
    
    
    
    
    
    
    102.61
    %
 33




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##### Table of Contents



Financial Condition Investment Securities First Federals portfolio of securities available-for-sale totaled
$14,180,000 and $32,600,000 at September 30, 2004 and 2003, respectively.
First Federals portfolio of securities held-to-maturity totaled $15,082,000
and $0 at September 30, 2004 and 2003, respectively. The balance in
held-to-maturity securities at September 30, 2004 is based on managements
decision to reclassify approximately $16,000,000 of available-for-sale
securities to held-to-maturity to better meet the investment strategy of the
Company. The composition of First Federals total investment securities portfolio
partly reflects First Federals former investment strategy of providing
acceptable levels of interest income from portfolio yields while maintaining a
level of liquidity allowing First Federal a degree of control over its interest
rate position. In previous years, First Federal invested primarily in
investment grade CMOs and mortgage-backed securities because of their
liquidity, credit quality and yield characteristics. The yields, values and
duration of such securities generally vary with interest rates, prepayment
levels, and general economic conditions and, as a result, the values of such
instruments may be more volatile than other instruments with similar
maturities. Such securities also may have longer stated maturities than other
securities, which may result in further price volatility. With First Federals purchase of the construction loan portfolio of
another Alabama thrift institution in April of 1994, First Federal revised its
investment strategy, curtailing its purchases of CMOs and mortgage-backed
securities and utilizing principal repayments on these securities to fund
construction loans. Accordingly, First Federal did not purchase any CMOs or
mortgage-backed securities from 1994 through 1997. However, as a result of
First Federals acquisition of Chilton County in October 1997, First Federal
acquired approximately $466,000 in CMOs and $16,101,000 in mortgage-backed
securities. In addition, as a result of the excess cash on hand from the
Chilton County acquisition, First Federal purchased approximately $18,670,000
in mortgage-backed securities in 1998. During 1999, First Federal purchased
approximately $10,500,000 of FNMA and FHLMC adjustable rate CMOs that reprice
to LIBOR on a monthly basis. These CMOs were funded by FHLB advances that also
reprice each month to LIBOR. During fiscal year 2003, First Federal re-invested available liquidity in
purchases of FNMA and FHLMC fixed rate callable notes and bonds in the amount
of approximately $35,000,000. In an interest rate environment of record lows,
the yield on these investments was higher than normal, therefore enhancing the
overall yield of First Federals investment portfolio. Of this amount, First
Federal sold $8,000,000 in callable bonds, and booked a gain from the sale of
this investment in the amount of $83,750. In addition, First Federal purchased
a mortgage-backed security in the amount of $3,425,000 during fiscal 2003. During fiscal year 2004, First Federal purchased $3,500,000 in FHLMC
callable bonds and approximately $8,000,000 in FNMA fixed rate mortgage backed
securities. Also, during the fiscal year, the company sold mortgage-backed
securities, callable notes and callable bonds for approximately $5,500,000,
$1,000,000 and $5,000,000, respectively. As a result of the sale of these
investments, a pre-tax gain was recorded for approximately $80,000. Principal repayments on both CMOs and mortgage-backed securities for the
years ended September 30, 2004, 2003 and 2002 were $8,159,000, $10,041,000, and
$674,700, respectively. As of September 30, 2004, First Federal had an
investment in available-for-sale U.S. Government agencies of $4,533,000
compared to $22,608,000 as of September 30, 2003. As a result of a change in
investment strategy, management made a decision to reclassify approximately
$16,000,000 of available-for-sale securities to held-to-maturity during the
June 2004 quarter. At September 30, 2004, First Federal had investments of
approximately $1,129,000 in equity securities, such as FHLB stock and other
common stock. 34




---



##### Table of Contents



The following table indicates the fair value of the portfolio of
investment securities available for sale at September 30, 2004, 2003 and 2002. Total Fair Value2004
    
    2003
    
    2002(in thousands)Available-for-Sale Securities :U.S. Government agencies
    
    $
    4,533
    
    
    $
    22,608
    
    
    $
    9,867Corporate obligations
    
    
    403
    
    
    
    355
    
    
    
    98Mortgage-backed securities
    
    
    8,350
    
    
    
    8,175
    
    
    
    11,679Collateralized mortgage obligations
    
    
    882
    
    
    
    1,456
    
    
    
    5,115Other investments
    
    
    12
    
    
    
    6
    
    
    
    8Total Available-for-Sale Securities
    
    $
    14,180
    
    
    $
    32,600
    
    
    $
    26,767Held-to-Maturity Securities :U.S. Government agencies
    
    $
    15,675
    
    
    $
    
    
    
    $
    +
 At September 30, 2004, First Federal owned CMOs totaling $882,000. These
securities are all backed by federal agency guaranteed mortgages. The mortgage backed securities portfolio, consists of fixed rate mortgages
totaling $8,350,000 at September 30, 2004. Adjustable rate mortgage-backed
securities totaling $357,240 were sold during fiscal year 2003. When
purchasing these securities, First Federal looks at various prepayment speeds
and makes the purchase based on the ability to accept the yield and average
life based on both increasing and decreasing prepayment speeds. The following table presents the contractual maturities and weighted
average yields of investment securities, other than equity securities,
available for sale at September 30, 2004. Maturities of SecuritiesAfter one
    
    After fiveWithin
    
    through
    
    through
    
    Afterone year
    
    five years
    
    ten years
    
    ten years(in thousands)Available-for-Sale Securities:U.S. Government agencies, excluding
mortgage-backed securities
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    4,533Mortgage-backed securities
    
    
    
    
    
    
    48
    
    
    
    4,872
    
    
    
    3,430Collateralized mortgage obligations
    
    
    
    
    
    
    882
    
    
    
    
    
    
    
    Corporate obligations
    
    
    100
    
    
    
    153
    
    
    
    150
    
    
    
    Total Available-for-Sale Securities
    
    $
    100
    
    
    $
    1,083
    
    
    $
    5,022
    
    
    $
    7,963Held-to-Maturity Securities
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    15,675
 35




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##### Table of Contents



Weighted Average Yields(Taxable-equivalent basis) (1)After one
    
    After fiveWithin
    
    through
    
    through
    
    Afterone year
    
    five years
    
    ten years
    
    Ten yearsAvailable-for-Sale Securities:U.S. Government agencies, excluding
mortgage-backed securities
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    5.390
    %Mortgage-backed securities
    
    
    
    
    
    
    6.760
    %
    
    
    4.450
    %
    
    
    4.900
    %Collateralized mortgage obligations
    
    
    
    
    
    
    2.740
    %
    
    
    
    
    
    
    Corporate obligations
    
    
    3.470
    %
    
    
    4.950
    %
    
    
    6.600
    %
    
    
    Total Weighted Average Yield
    
    
    3.470
    %
    
    
    3.230
    %
    
    
    4.514
    %
    
    
    5.179
    %Held-to-Maturity Securities:U.S. Government agencies
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    5.290
    %
   (1)
    
    None of First Federals investment securities are tax exempt. The maturities for the CMOs and mortgage-backed securities presented above
represent contractual maturities of such securities. Due to the nature of
these securities, the timing and the amount of principal repayments is
generally unpredictable. However, assuming current prepayment rates are normal
and required principal repayments, the following table sets forth certain
information regarding the expected principal payments, carrying values, fair
values, and weighted average yields of First Federals CMOs and mortgage-backed
securities at September 30, 2004. Principal Payments Expected During the Year Ended September 30,
(Dollars in thousands) WeightedAmortized
    
    Fair
    
    Average2005
    
    2006
    
    2007
    
    2008
    
    2009
    
    Thereafter
    
    Cost
    
    Value
    
    YieldCollateralized mortgage
Obligations
    
    $
    370
    
    
    $
    260
    
    
    $
    180
    
    
    $
    65
    
    
    $
    
    
    
    $
    
    
    
    $
    875
    
    
    $
    882
    
    
    
    2.74
    %Mortgage-backed securities
    
    
    1,600
    
    
    
    1,339
    
    
    
    1,118
    
    
    
    929
    
    
    
    773
    
    
    
    2,494
    
    
    
    8,253
    
    
    
    8,350
    
    
    
    4.65
    %Agencies
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    19,671
    
    
    
    19,671
    
    
    
    20,208
    
    
    
    5.31
    %Corporate obligations
    
    
    100
    
    
    
    100
    
    
    
    50
    
    
    
    100
    
    
    
    
    
    
    
    50
    
    
    
    400
    
    
    
    403
    
    
    
    5.15
    %
 Loans Total loans of $94,574,000 at September 30, 2004 reflected an increase of
$10,192,000 (12.1%) compared to September 30, 2003. Total loans of $84,383,000
at September 2003 reflected a decrease of 9.2% from total loans of $92,985,000
at September 30, 2002. The increase in the volume of loans for fiscal 2004 was
due primarily to the strategy to rebuild portfolio loans in an effort to
enhance our overall net interest margin. The decrease in the volume of loans
for fiscal 2003 was due primarily to the sale of loans of approximately
$6,400,000 to First Financial Bank, Bessemer, Alabama, as result of closing the
Centreville branch location in September 2003. The decrease in the volume of
loans for fiscal 2002 was due primarily to the sale of loans in the amount of
$8,392,000 to another financial institution in Dothan, Alabama, as a result of
closing the Dothan loan production office in February 2002. First Federal has
experienced strong demand in its one-to-four family construction loan portfolio
since First Federals purchase of the construction loan portfolio and the
opening of a loan production office in Birmingham in 1994. 36




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##### Table of Contents



One-to-four family real estate mortgage loans increased $5,065,000 (12.7%)
from September 30, 2003 to September 30, 2004 and decreased $4,508,000 (10.2%)
from September 30, 2002 to September 30, 2003. First Federal aggressively
pursues real estate mortgage loans within its market area. In addition to
originating mortgage loans for its own portfolio, First Federal also actively
originates residential mortgage loans, which are sold in the secondary market,
with servicing released. First Federal sells a significant portion of all fixed
rate residential mortgage loans. For the most part, such sales are composed of
residential mortgage loans with terms of 30 years. Proceeds from loan sales
were $31,097,000, $55,990,000 and $27,159,000 for the years ended September 30,
2004, 2003 and 2002, respectively. Had First Federal not sold residential
mortgage loans over the last several years, the one-to-four family real estate
mortgage loan portfolio would have increased by a larger margin (or decreased
by lesser margin) than the percentage indicated above. The low interest rate
environment that has existed for much of 2004, 2003 and 2002 resulted in an
increase in the volume of loans sold during the periods indicated above
compared to previous years, which had a higher interest rate environment. The
following table presents the composition of the loan portfolio for each of the
past five years: 37




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##### Table of Contents



Loan Portfolio CompositionAt September 30,(Dollars in thousands)2004
    
    2003
    
    2002Percent
    
    
    
    
    
    Percent
    
    
    
    
    
    PercentAmount
    
    of Total
    
    Amount
    
    of Total
    
    Amount
    
    of TotalReal estate mortgage loans:One-to-four family
    
    $
    44,904
    
    
    
    47.48
    %
    
    $
    39,839
    
    
    
    47.21
    %
    
    $
    44,347
    
    
    
    47.69
    %Multi-family and commercial
    
    
    14,003
    
    
    
    14.81
    %
    
    
    11,407
    
    
    
    13.52
    %
    
    
    13,490
    
    
    
    14.51
    %Construction loans
    
    
    12,836
    
    
    
    13.57
    %
    
    
    12,629
    
    
    
    14.97
    %
    
    
    16,621
    
    
    
    17.87
    %Land
    
    
    3,271
    
    
    
    3.46
    %
    
    
    3,635
    
    
    
    4.31
    %
    
    
    5,077
    
    
    
    5.46
    %Savings account loans
    
    
    768
    
    
    
    .81
    %
    
    
    881
    
    
    
    1.04
    %
    
    
    1,190
    
    
    
    1.28
    %Installment loans
    
    
    3,192
    
    
    
    3.38
    %
    
    
    3,921
    
    
    
    4.65
    %
    
    
    3,599
    
    
    
    3.87
    %Second mortgage loans
    
    
    16,670
    
    
    
    17.63
    %
    
    
    13,404
    
    
    
    15.88
    %
    
    
    9,665
    
    
    
    10.39
    %Total loans
    
    
    95,644
    
    
    
    
    
    
    
    85,716
    
    
    
    
    
    
    
    93,989Less:Loans in process
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Discounts and other, net
    
    
    (158
    )
    
    
    (.17
    )%
    
    
    (142
    )
    
    
    (0.17
    )%
    
    
    (149
    )
    
    
    (.16
    )%Allowance for loan losses
    
    
    (912
    )
    
    
    (.96
    )%
    
    
    (1,191
    )
    
    
    (1,41
    )%
    
    
    (855
    )
    
    
    (.92
    )%Total loans, net
    
    $
    94,574
    
    
    
    100.00
    %
    
    $
    84,383
    
    
    
    100.00
    %
    
    $
    92,985
    
    
    
    100.00
    %
   [Continued from above table, first column(s) repeated] Loan Portfolio CompositionAt September 30,(Dollars in thousands)2001
    
    2000Percent
    
    
    
    
    
    PercentAmount
    
    of Total
    
    Amount
    
    Of TotalReal estate mortgage loans:One-to-four family
    
    $
    51,083
    
    
    
    50.51
    %
    
    $
    58,595
    
    
    
    54.08
    %Multi-family and commercial
    
    
    14,205
    
    
    
    14.05
    %
    
    
    13,790
    
    
    
    12.73
    %Construction loans
    
    
    25,378
    
    
    
    25.09
    %
    
    
    24,381
    
    
    
    22.50
    %Land
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Savings account loans
    
    
    1,144
    
    
    
    1.13
    %
    
    
    1,097
    
    
    
    1.01
    %Installment loans
    
    
    3,507
    
    
    
    3.47
    %
    
    
    4,089
    
    
    
    3.77
    %Second mortgage loans
    
    
    7,593
    
    
    
    7.51
    %
    
    
    7,334
    
    
    
    6.77
    %Total loans
    
    
    102,910
    
    
    
    
    
    
    
    109,286Less:Loans in process
    
    
    (8
    )
    
    
    (.01
    )%
    
    
    (39
    )
    
    
    (.03
    )%Discounts and other, net
    
    
    (189
    )
    
    
    (.19
    )%
    
    
    (192
    )
    
    
    (.18
    )%Allowance for loan losses
    
    
    (1,578
    )
    
    
    (1.56
    )%
    
    
    (701
    )
    
    
    (.65
    )%Total loans, net
    
    $
    101,135
    
    
    
    100.00
    %
    
    $
    108,354
    
    
    
    100.00
    %
 38




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##### Table of Contents



The following table shows the maturity of First Federals loan portfolio
at September 30, 2004, based upon contractual maturity dates. Demand loans,
loans having no schedule of repayment and no stated maturity and overdrafts are
reflected as due during the twelve months ended September 30, 2005. The table
below does not include an estimate of prepayments, the occurrence of which
would significantly shorten the average life of all mortgage loans and cause
First Federals actual repayment to be different from the table set forth
below. Loan MaturitiesDue during theyear ending Sept 30,Due after
    
    Due after
    
    Due After
    
    Due After2005
    
    2006
    
    2007
    
    3-5 years
    
    5-10 years
    
    10-15 years
    
    15 years
    
    Total(Dollars in thousands)Residential loans
    
    $
    1,419
    
    
    $
    681
    
    
    $
    1,705
    
    
    $
    9,409
    
    
    $
    6,155
    
    
    $
    13,280
    
    
    $
    22,735
    
    
    $
    55,384Commercial loans
    
    
    1,447
    
    
    
    286
    
    
    
    1,097
    
    
    
    2,161
    
    
    
    1,947
    
    
    
    3,982
    
    
    
    2,916
    
    
    
    13,836Construction loans
    
    
    16,105
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    16,105Consumer loans
    
    
    1,447
    
    
    
    486
    
    
    
    817
    
    
    
    1,462
    
    
    
    2,208
    
    
    
    2,026
    
    
    
    1,873
    
    
    
    10,319Total
    
    $
    20,418
    
    
    $
    1,453
    
    
    $
    3,619
    
    
    $
    13,032
    
    
    $
    10,310
    
    
    $
    19,288
    
    
    $
    27,524
    
    
    $
    95,644
   (1)
    
    The maturity period for construction loans is typically one year. If the
home is not sold at the maturity date, however, the loan may be extended for
an
additional six months, provided that the builder restructures the loan to
provide for principal reduction or arranges for permanent financing that will
pay off the construction loan. The following tables set forth, at September 30, 2004 and 2003, the dollar
amount of loans due after September 30, 2004 and 2003, respectively, based upon
whether such loans have fixed interest rates or adjustable interest rates: September 30, 2004Fixed
    
    Floating orRates
    
    Adjustable Rate
    
    Total(Dollars in thousands)Residential loans
    
    $
    26,037
    
    
    $
    26,347
    
    
    $
    55,384Commercial loans
    
    
    5,466
    
    
    
    8,370
    
    
    
    13,836Construction loans
    
    
    16,105
    
    
    
    
    
    
    
    16,105Consumer loans
    
    
    10,319
    
    
    
    
    
    
    
    10,319Total
    
    $
    57,927
    
    
    $
    37,717
    
    
    $
    95,644
 September 30, 2003Fixed
    
    Floating orRates
    
    Adjustable Rate
    
    Total(Dollars in thousands)Residential loans
    
    $
    26,129
    
    
    $
    22,490
    
    
    $
    48,619Commercial loans
    
    
    4,611
    
    
    
    5,792
    
    
    
    10,403Construction loans
    
    
    16,263
    
    
    
    
    
    
    
    16,263Consumer loans
    
    
    10,431
    
    
    
    
    
    
    
    10,431Total
    
    $
    57,434
    
    
    $
    28,282
    
    
    $
    85,716
 39




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##### Table of Contents



The following table sets forth First Federals loan originations, sales and
principal repayments for the periods indicated. Year ended September 30,2004
    
    2003
    
    2002(Dollars in thousands)Loan Originations:Real estate mortgage loans
    
    $
    86,214
    
    
    $
    101,134
    
    
    $
    87,131All other loans
    
    
    4,026
    
    
    
    4,407
    
    
    
    6,790Total
    
    $
    90,240
    
    
    $
    105,541
    
    
    $
    93,921Portfolio Loan Purchases:Real estate mortgage loans
    
    $
    
    
    
    $
    
    
    
    $
    Portfolio Loan Sales Proceeds:Real estate mortgage loans
    
    $
    31,097
    
    
    $
    55,222
    
    
    $
    32,346Principal Repayments:Real estate mortgage loans
    
    $
    24,835
    
    
    $
    53,222
    
    
    $
    46,578All other loans
    
    
    4,889
    
    
    
    4,394
    
    
    
    6,652Total
    
    $
    29,724
    
    
    $
    57,616
    
    
    $
    53,230
 Allowance for Loan Losses and Risk Elements The performance of loans is evaluated primarily on the basis of a review
of each customer relationship over a period of time and the judgment of lending
officers as to the ability of borrowers to meet the repayment terms of loans.
If there is a reasonable doubt as to the repayment of a loan in accordance with
the agreed terms, the loan may be placed on a non-accrual basis pending the
sale of any collateral or a determination as to whether sources of repayment
exist. Generally, delinquency of 90 days or more creates reasonable doubt as to
repayment. This action may be taken even though the financial condition of the
borrower or the collateral may be sufficient to ultimately reduce or satisfy
the obligation. Generally, when a loan is placed on a non-accrual basis, all
payments are applied to reduce principal to the extent necessary to eliminate
doubt as to the repayment of the loan. Interest income on a non-accrual loan is
recognized only on a cash basis. See Non Performing Assets below. The Asset Classification committee is responsible for the on going review
and administration of each particular loan. As such, they make the initial
identification of loans, which present some difficulty in collection or where
circumstances indicate that the probability of loss exists. Once the committee
determines there is a potential collection problem, the loan is turned over to
First Federals collections officer. It is the responsibility of the
collections officer to coordinate all collection efforts on troubled and
delinquent loans. Senior management and the First Federal board of directors
are informed of the status of delinquent loans on a monthly basis. Senior
management reviews the allowance for loan losses and makes recommendations to
the board as to loan charge offs on a monthly basis. At September 30, 2004, 2003 and 2002, loans accounted for on a non-accrual
basis were approximately $1,194,000, $2,149,000, and $764,000, respectively, or
1.3%, 2.6%, and .8% of the total loans outstanding, net of unearned income. The
balances of accruing loans past due 90 days or more as to principal and
interest payments were $0 at September 30, 2004, 2003 and 2002. The allowance for loan losses represents managements assessment of the
risk associated with extended credit and its evaluation of the quality of the
loan portfolio. Management analyzes the loan portfolio to determine the
adequacy of the allowance for loan losses and the appropriate provision
required to maintain a level considered adequate to absorb all anticipated loan
losses. In assessing the adequacy of the allowance, management reviews the
size, quality, and risk of loans in the portfolio. Management also considers
such factors as First Federals historical loan loss experience, the level,
severity, and trend of criticized assets, the distribution of loans by risk
class, and various qualitative factors such as current and anticipated economic
conditions. 40




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##### Table of Contents



While it is First Federals policy to charge off loans in the period in
which the loss is considered probable, there are additional risks of future
losses, which cannot be quantified precisely or attributed to the particular
loans or classes of loans. Because these risks include the state of the
economy, managements judgment as to the adequacy of the allowance is
necessarily approximate and imprecise. In assessing the adequacy of the allowance, management relies
predominately on the on going review of the loan portfolio, which is undertaken
both to ascertain whether there are probable losses which must be charged off
and to assess the risk characteristics of the portfolio in the aggregate. This
review takes into consideration the judgments of the responsible lending
officers, senior management and those of bank regulatory agencies that review
the loan portfolio as part of First Federals examination process. Specific
percentages are allocated to each loan type. Management recognizes that there
is more risk traditionally associated with commercial and consumer lending as
compared to real estate mortgage lending; correspondingly, a greater allocation
is made for commercial and consumer loans than real estate mortgage loans.
While management to recognize losses in the loan portfolio utilizes all
information, there can be no assurances that future additions to the allowance
will not be necessary. First Federals Board of Directors reviews the
assessments of management in determining the adequacy of the allowance for loan
losses. Generally, the only loans, including construction loans, which are
classified, are loans, which are greater than 90 days delinquent. However, the
Board of Directors may classify loans less than 90 days delinquent should such
classification be deemed necessary. First Federals allowance for loan losses is also subject to regulatory
examinations and determinations as to the adequacy, which may take into account
such factors as the methodology used to calculate the allowance for loan loss
reserves and the size of the loan loss reserve in comparison to a group of peer
banks identified by the regulators. During its routine examinations of banks,
the OTS has, from time to time, required additions to the banks provisions for
loan losses and allowances for loan losses as the regulators credit
evaluations and allowance for loan loss methodology have differed from those of
management of such banks. Such regulatory examinations have focused on loan
quality, particularly that of real estate loans. First Federal attempts to
reduce the risks of real estate lending through maximum loan-to-value
requirements as well as systematic cash flow and initial customer credit
history analyses. Management believes that the $912,000 allowance for loan losses, at
September 30, 2004, is adequate to absorb known risks in the portfolio. No
assurance can be given, however, that adverse economic circumstances will not
result in increased losses in First Federals loan portfolio. At September 30,
2004, $335,000 of the allowance for loan losses was reserved for possible
losses on real estate mortgage loans and $577,000 was reserved for possible
losses on all other loans. See also, Item 6. MANAGEMENTS DISCUSSION AND
ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS  Provision for Loan
Losses. 41




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##### Table of Contents



The following table summarizes the levels of the allowance for loan losses
at the end of the last five fiscal years: Year Ended September 30,2004
    
    2003
    
    2002
    
    2001
    
    2000(Dollars in thousands)Balance at beginning of period
    
    $
    1,191
    
    
    $
    854
    
    
    $
    1,578
    
    
    $
    701
    
    
    $
    852Charge-offs:Real estate
    
    
    1,561
    
    
    
    219
    
    
    
    
    
    
    
    
    
    
    
    54Installment
    
    
    103
    
    
    
    22
    
    
    
    79
    
    
    
    49
    
    
    
    138Total charge-offs
    
    
    1,664
    
    
    
    241
    
    
    
    79
    
    
    
    49
    
    
    
    192Recoveries:Real estate mortgage
    
    
    
    
    
    
    1
    
    
    
    
    
    
    
    
    
    
    
    Installment
    
    
    28
    
    
    
    27
    
    
    
    23
    
    
    
    68
    
    
    
    35Total recoveries
    
    
    28
    
    
    
    28
    
    
    
    23
    
    
    
    68
    
    
    
    35Net loans (recovered) charged off
    
    
    1,636
    
    
    
    213
    
    
    
    56
    
    
    
    (19
    )
    
    
    157Provisions for loan losses (benefit)
    
    
    1,357
    
    
    
    550
    
    
    
    (668
    )
    
    
    858
    
    
    
    6Balance at end of period
    
    $
    912
    
    
    $
    1,191
    
    
    $
    854
    
    
    $
    1,578
    
    
    $
    701Ratio of net charge-offs to total loans
outstanding, net of unearned income
    
    
    1.73
    %
    
    
    0.25
    %
    
    
    0.06
    %
    
    
    ( .02
    )%
    
    
    0.14
    %Ratio of allowance for loan losses
to loans outstanding, net of
unearned income
    
    
    .96
    %
    
    
    1.41
    %
    
    
    0.92
    %
    
    
    1.56
    
    
    
    0.65
    %Total Loans Outstanding  Net
    
    $
    94,574
    
    
    $
    84,383
    
    
    $
    92,985
    
    
    $
    101,135
    
    
    $
    108,354
 As indicated in the above table, First Federal decreased its loan loss
allowance in fiscal year 2002 from the level reported in 2001. This decrease in
loss allowance is primarily due to the successful repayment of the Vawter loan
in 2002, which had been classified in the loan loss reserve in 2001. 42




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##### Table of Contents



The following table sets forth the breakdown of the allowance for loan
losses by loan category at the dates indicated. Management believes that the
allowance can be allocated by category only on an approximate basis. The
allocation of the allowance to each category is not necessarily an indication
of future losses and does not restrict the use of the allowance to absorb
losses in any category. At September 30,2004
    
    2003
    
    2002Percent of
    
    
    
    
    
    Percent of
    
    
    
    
    
    Percent ofloans in each
    
    
    
    
    
    loans in each
    
    
    
    
    
    loans in eachcategory
    
    
    
    
    
    category
    
    
    
    
    
    categoryAmount
    
    to total loans
    
    Amount
    
    to total loans
    
    Amount
    
    to total loans(Dollars in thousands)Real estate mortgage loans
    
    $
    335
    
    
    
    36.73
    %
    
    $
    738
    
    
    
    61.96
    %
    
    $
    303
    
    
    
    35.48
    %All other loans
    
    
    577
    
    
    
    63.27
    %
    
    
    453
    
    
    
    38.04
    %
    
    
    551
    
    
    
    64.52
    %Total allowance for
loan losses
    
    $
    912
    
    
    
    100.00
    %
    
    $
    1,191
    
    
    
    100.00
    %
    
    $
    854
    
    
    
    100.00
    %
 At September 30, 2004 and 2003, the total recorded investment in impaired
loans was approximately $618,000 and $2,393,000, respectively. The average
recorded investment in impaired loans amounted to approximately $822,000 and
$413,000 for the years ended September 30, 2004 and 2003, respectively. The
allowance for loan losses related to impaired loans was approximately $393,000
and $896,000 for fiscal 2004 and 2003, respectively. Interest income on
impaired loans of approximately $25,000 and $23,000 was recognized in 2004 and
2003, respectively. Loans impaired at September 30, 2002 were $874,000. Non-Performing Assets First Federal has policies, procedures and underwriting guidelines
intended to assist in maintaining the overall quality of its loan portfolio.
First Federal monitors delinquency levels for any adverse trends.
Non-performing assets consist of loans on non-accrual status, accruing loans,
which are 90 days or more past due and foreclosed real estate. First Federals policy generally is to place a loan on non-accrual status
when there is reasonable doubt as to the repayment of the loan in accordance
with the agreed terms. Generally, delinquency for 90 days or more creates
reasonable doubt as to repayment. At the time the loan is placed on non-accrual
status, interest previously accrued but not collected is reversed and charged
against current earnings. Income is subsequently recognized only to the extent
that cash payments are received until, in managements judgment, the borrower
is able to make periodic interest and principal payments and the loan is no
longer delinquent and is returned to accrual status. Non-performing assets were $1,703,000, $2,217,000, and $844,000 at
September 30, 2004, 2003 and 2002, respectively. As a percentage of total
loans, non-performing assets continued to be at levels which management
considers to be acceptable and commensurate with First Federals conservative
lending policies. 43




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##### Table of Contents



An analysis of the components of non-performing assets at September 30,
2004, 2003 and 2002 is presented in the following table: At September 30,2004
    
    2003
    
    2002(Dollars in thousands)Loans accounted for on a non-accrual basis:Real estate mortgage loans
    
    $
    891
    
    
    $
    2,077
    
    
    $
    762All other loans
    
    
    303
    
    
    
    72
    
    
    
    2Total
    
    
    1,194
    
    
    
    2,149
    
    
    
    764Accruing loans which are past due 90 days or more:Real estate mortgage loans
    
    
    
    
    
    
    
    
    
    
    All other loans
    
    
    
    
    
    
    
    
    
    
    Total
    
    
    
    
    
    
    
    
    
    
    Total of non-accrual and 90 days past due loans
    
    
    1,194
    
    
    
    2,149
    
    
    
    764Foreclosed real estate (net of related loss provisions)
    
    
    509
    
    
    
    68
    
    
    
    80Total non-performing assets
    
    $
    1,703
    
    
    $
    2,217
    
    
    $
    844Non-accrual and 90 days past due loans as a
percent of total loans
    
    
    1.26
    %
    
    
    2.55
    %
    
    
    0.82
    %Non-performing assets as a percent of total loans
    
    
    1.80
    %
    
    
    2.63
    %
    
    
    0.91
    %Total loans outstanding
    
    $
    94,574
    
    
    $
    84,383
    
    
    $
    92,985
 Management regularly reviews and monitors the loan portfolio in an effort
to identify borrowers experiencing financial difficulties, but such measures
are subject to uncertainties that cannot be predicted. Deposits Total deposits increased $4,235,000 (4.5%) in fiscal 2004 to $97,793,000,
and decreased $2,925,000 (3.0%) to $93,558,000 in fiscal 2003. In fiscal 2002
deposits decreased $2,572,000 (2.6%) to $96,483,000. Non interest-bearing
deposits were $4,003,000, $3,657,000, and $2,850,000, while total
interest-bearing deposits were $93,790,000, $89,901,000, and $93,632,000 at
September 30, 2004, 2003 and 2002, respectively. First Federals deposit mix, at September 30, 2004, changed when compared
to that at September 30, 2003. NOW accounts increased $598,000 (5.9%), while
money-market demand accounts increased $75,000 (48.3%). Certificates of
deposit, other than jumbo certificates of deposit, which are certificates of
deposit greater than or equal to $100,000 with specially negotiated rates
(Jumbos), increased $5,278,000 (8.7%). Non-interest bearing demand deposits
increased $346,000 (9.5%). During 2004, certificates of deposit, excluding
Jumbos, comprised approximately 67.3% of total deposits, while low cost of
funds, including NOW accounts, money market demand accounts, and passbook
savings accounts made up 27.1% of First Federals total deposits. Jumbos
comprised 5.6% of total deposits as of September 30, 2004. In order to offset the sale of deposits at the Centreville branch to First
Financial Bank on September 9, 2003, First Federal purchased $7,382,000 of
brokered certificates of deposit with a weighted average rate of 2.1%. At
September 30, 2004, First Federal has approximately $18,300,000 in brokered
certificates of deposits with a weighted average interest rate of approximately
1.93%, varying in terms from six months to thirty-three months. 44




---



##### Table of Contents



The composition of total deposits for the last three fiscal years is set forth
in the following table: September 30,2004
    
    2003
    
    2002Percent
    
    
    
    
    
    Percent
    
    
    
    
    
    Percentchange
    
    
    
    
    
    change
    
    
    
    
    
    changefrom prior
    
    
    
    
    
    from prior
    
    
    
    
    
    from priorAmount
    
    year-end
    
    Amount
    
    year-end
    
    Amount
    
    year-end(Dollars in thousands)Non-interest bearing
demand deposits
    
    $
    4,003
    
    
    
    9.46
    %
    
    $
    3,657
    
    
    
    28.32
    %
    
    $
    2,850
    
    
    
    (14.90
    )%Interest bearing deposits:NOW accounts
    
    
    10,662
    
    
    
    5.94
    %
    
    
    10,064
    
    
    
    (2.24
    )%
    
    
    10,295
    
    
    
    8.48
    %Money market demand
    
    
    230
    
    
    
    48.39
    %
    
    
    155
    
    
    
    (66.88
    )%
    
    
    468
    
    
    
    14.99
    %Passbook savings
    
    
    11,634
    
    
    
    1.19
    %
    
    
    11,497
    
    
    
    (5.37
    )%
    
    
    12,149
    
    
    
    8.88
    %CDs other than Jumbos
    
    
    65,796
    
    
    
    8.72
    %
    
    
    60,518
    
    
    
    (4.46
    )%
    
    
    63,346
    
    
    
    (5.82
    )%Jumbos
    
    
    5,468
    
    
    
    (28.68
    )%
    
    
    7,667
    
    
    
    3.97
    %
    
    
    7,374
    
    
    
    (.18
    )%Total interest bearing deposits
    
    
    93,790
    
    
    
    4.33
    %
    
    
    89,901
    
    
    
    (3.98
    )%
    
    
    93,632
    
    
    
    (2.17
    )%Total deposits
    
    $
    97,793
    
    
    
    4.53
    %
    
    $
    93,558
    
    
    
    (3.03
    )%
    
    $
    96,483
    
    
    
    (2.60
    )%
 The following tables set forth the distribution of First Federals deposit
accounts, at the dates indicated and the weighted average nominal interest
rates on each category of deposits presented, based on average balances: At September 30, 2004PercentageInterest
    
    
    
    
    
    
    
    
    
    
    
    
    
    of TotalRate
    
    Term
    
    Category
    
    Minimum
    
    Balance
    
    Balances(Dollars in thousands, except minimum balance)0.00%
    
    None
    
    Non-interest bearing demand
    
    $
    50
    
    
    $
    4,003
    
    
    
    4.09
    %0.10%
    
    None
    
    NOW accounts
    
    
    250
    
    
    
    10,507
    
    
    
    10.74
    %0.10%
    
    None
    
    Non-profit
    
    
    100
    
    
    
    155
    
    
    
    .16
    %0.10%
    
    None
    
    Money market checking
    
    
    50
    
    
    
    230
    
    
    
    .24
    %0.15%
    
    None
    
    Statement savings
    
    
    100
    
    
    
    11,634
    
    
    
    11.90
    %1.50%
    
    3 months
    
    Fixed-term fixed rate certificate
    
    
    2,500
    
    
    
    696
    
    
    
    .71
    %1.60%
    
    6 months
    
    Fixed-term fixed rate certificate
    
    
    2,500
    
    
    
    8,248
    
    
    
    8.43
    %2.30%
    
    12 months
    
    Fixed-term fixed rate certificate
    
    
    500
    
    
    
    12,754
    
    
    
    13.04
    %2.50%
    
    14 months
    
    Fixed-term fixed rate certificate
    
    
    500
    
    
    
    360
    
    
    
    .37
    %2.25%
    
    18 months
    
    Fixed-term fixed rate certificate
    
    
    500
    
    
    
    2,957
    
    
    
    3.02
    %2.25%
    
    18 mth Roth IRA
    
    Fixed-term fixed rate certificate
    
    
    500
    
    
    
    88
    
    
    
    .09
    %2.25%
    
    18 mth IRA
    
    Fixed-term fixed rate certificate
    
    
    500
    
    
    
    8,202
    
    
    
    8.39
    %3.75%
    
    60 mth IRA
    
    Fixed-term fixed rate certificate
    
    
    500
    
    
    
    2,194
    
    
    
    2.24
    %2.75%
    
    24 months
    
    Fixed-term fixed rate certificate
    
    
    500
    
    
    
    14
    
    
    
    .01
    %2.80%
    
    30 months
    
    Fixed-term fixed rate certificate
    
    
    500
    
    
    
    6,262
    
    
    
    6.40
    %3.70%
    
    4 year
    
    Fixed-term fixed rate certificate
    
    
    1,500
    
    
    
    332
    
    
    
    .34
    %3.75%
    
    5  year
    
    Fixed-term fixed rate certificate
    
    
    1,500
    
    
    
    5,410
    
    
    
    5.53
    %5.08%
    
    Jumbo
    
    Fixed-term fixed rate certificate
    
    
    100,000
    
    
    
    5,468
    
    
    
    5.59
    %1.46%
    
    6 months
    
    6 month brokered TD
    
    
    
    
    
    
    2,463
    
    
    
    2.52
    %1.78%
    
    9 months
    
    9 month brokered TD
    
    
    
    
    
    
    3,926
    
    
    
    4.01
    %1.88%
    
    12  months
    
    12 month brokered TD
    
    
    
    
    
    
    2,871
    
    
    
    2.94
    %1.75%
    
    13 months
    
    13 month brokered TD
    
    
    
    
    
    
    2,244
    
    
    
    2.29
    %
 45




---



##### Table of Contents



At September 30, 2004PercentageInterest
    
    
    
    
    
    
    
    
    
    
    
    
    
    of TotalRate
    
    Term
    
    Category
    
    Minimum
    
    Balance
    
    Balances(Dollars in thousands, except minimum balance)1.77%
    
    14 months
    
    14 month brokered TD
    
    
    
    
    
    
    3,099
    
    
    
    3.17
    %2.25%
    
    24 months
    
    24 month brokered TD
    
    
    
    
    
    
    1,559
    
    
    
    1.59
    %2.60%
    
    30 months
    
    30 month brokered TD
    
    
    
    
    
    
    1,055
    
    
    
    1.082.75%
    
    33 months
    
    33 month brokered TD
    
    
    
    
    
    
    1,062
    
    
    
    1.09$
    97,793
    
    
    
    100.00
    %
 At September 30, 2003PercentageInterest
    
    
    
    
    
    
    
    
    
    
    
    
    
    of TotalRate
    
    Term
    
    Category
    
    Minimum
    
    Balance
    
    Balances(Dollars in thousands, except minimum balance)0.00%
    
    None
    
    Non-interest bearing demand
    
    $
    50
    
    
    $
    3,657
    
    
    
    3.91
    %0.10%
    
    None
    
    NOW accounts
    
    
    250
    
    
    
    9,956
    
    
    
    10.64
    %0.10%
    
    None
    
    Non-profit
    
    
    100
    
    
    
    108
    
    
    
    .12
    %0.10%
    
    None
    
    Money market checking
    
    
    50
    
    
    
    155
    
    
    
    .17
    %0.15%
    
    None
    
    Statement savings
    
    
    100
    
    
    
    11,497
    
    
    
    12.29
    %0.50%
    
    3 months
    
    Fixed-term fixed rate certificate
    
    
    2,500
    
    
    
    138
    
    
    
    .15
    %1.20%
    
    6 months
    
    Fixed-term fixed rate certificate
    
    
    2,500
    
    
    
    8,613
    
    
    
    9.21
    %1.30%
    
    12 months
    
    Fixed-term fixed rate certificate
    
    
    500
    
    
    
    16,915
    
    
    
    18.08
    %1.50%
    
    18 months
    
    Fixed-term fixed rate certificate
    
    
    500
    
    
    
    3,604
    
    
    
    3.85
    %1.25%
    
    18 mth Roth IRA
    
    Fixed-term fixed rate certificate
    
    
    250
    
    
    
    74
    
    
    
    .08
    %1.25%
    
    18 mth IRA
    
    Fixed-term fixed rate certificate
    
    
    250
    
    
    
    9,452
    
    
    
    10.10
    %2.75%
    
    60 mth IRA
    
    Fixed-term fixed rate certificate
    
    
    250
    
    
    
    1,798
    
    
    
    1.92
    %2.00%
    
    30 months
    
    Fixed-term fixed rate certificate
    
    
    500
    
    
    
    7,439
    
    
    
    7.95
    %2.50%
    
    4 year
    
    Fixed-term fixed rate certificate
    
    
    1,500
    
    
    
    332
    
    
    
    .35
    %3.00%
    
    5  year
    
    Fixed-term fixed rate certificate
    
    
    1,500
    
    
    
    4,771
    
    
    
    5.10
    %1.30%
    
    Jumbo
    
    Fixed-term fixed rate certificate
    
    
    100,000
    
    
    
    7,667
    
    
    
    8.19
    %1.40%
    
    9 months
    
    9 month brokered TD
    
    
    0
    
    
    
    2,495
    
    
    
    2.67
    %1.50%
    
    12  months
    
    12 month brokered TD
    
    
    0
    
    
    
    1,693
    
    
    
    1.81
    %1.60%
    
    14 months
    
    14 month brokered TD
    
    
    0
    
    
    
    1,466
    
    
    
    1.57
    %2.10%
    
    24 months
    
    24 month brokered TD
    
    
    0
    
    
    
    1,728
    
    
    
    1.85
    %$
    93,558
    
    
    
    100.00
    %
 The following table provides information about the average balances of
interest-bearing demand deposits and time deposits, for the periods indicated,
based upon average balances: Year ended September 30,2004
    
    2003
    
    2002(Dollars in thousands)Interest bearing
    
    Time
    
    Interest bearing
    
    Time
    
    Interest bearing
    
    Timedemand deposits
    
    Deposits
    
    demand deposits
    
    deposits
    
    demand deposits
    
    depositsAverage balance
    
    $
    22,161
    
    
    $
    69,739
    
    
    $
    23,397
    
    
    $
    72,309
    
    
    $
    22,981
    
    
    $
    72,382Average rate
    
    
    .20
    %
    
    
    2.42
    %
    
    
    .59
    %
    
    
    3.29
    %
    
    
    1.41
    %
    
    
    4.38
    %
 46




---



##### Table of Contents



The following table presents, by various interest rate categories, the
amount of certificate accounts outstanding at the end of the last three fiscal
years: Year ended September 30,Interest Rate
    
    2004
    
    2003
    
    2002(Dollars in thousands)0.00 - 1.99%
    
    $
    36,801
    
    
    $
    24,554
    
    
    $
    2,7752.00 - 2.99%
    
    
    22,498
    
    
    
    21,937
    
    
    
    22,0603.00 - 3.99%
    
    
    3,781
    
    
    
    11,570
    
    
    
    18,7714.00 - 4.99%
    
    
    1,946
    
    
    
    3,520
    
    
    
    11,6945.00 - 5.99%
    
    
    2,179
    
    
    
    2,411
    
    
    
    3,9226.00 - 6.99%
    
    
    529
    
    
    
    626
    
    
    
    5,4717.00 - 7.99%
    
    
    3,530
    
    
    
    3,567
    
    
    
    6,028Total
    
    $
    71,264
    
    
    $
    68,185
    
    
    $
    70,721
 At September 30, 2004, First Federal had approximately $71.3 million
outstanding in certificate accounts that mature as follows: Amount dueLess than
    
    One to
    
    Two to
    
    Three to
    
    Four toInterest Rate
    
    one year
    
    two years
    
    three years
    
    Four years
    
    five years
    
    Thereafter
    
    Total(Dollars in thousands)0.00 - 1.99%
    
    $
    30,782
    
    
    $
    3,589
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    2,430
    
    
    $
    36,8012.00 - 2.99%
    
    
    13,615
    
    
    
    6,444
    
    
    
    2,140
    
    
    
    61
    
    
    
    238
    
    
    
    
    
    
    
    22,4983.00 - 3.99%
    
    
    1,362
    
    
    
    71
    
    
    
    63
    
    
    
    1,176
    
    
    
    1,109
    
    
    
    
    
    
    
    3,7814.00 - 4.99%
    
    
    576
    
    
    
    45
    
    
    
    727
    
    
    
    568
    
    
    
    30
    
    
    
    
    
    
    
    1,9465.00 - 5.99%
    
    
    119
    
    
    
    310
    
    
    
    1,750
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,1796.00 - 6.99%
    
    
    277
    
    
    
    252
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    5297.00 - 7.99%
    
    
    3,164
    
    
    
    366
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    3,530Total
    
    $
    49,895
    
    
    $
    11,077
    
    
    $
    4,680
    
    
    $
    1,805
    
    
    $
    1,377
    
    
    $
    2,430
    
    
    $
    71,264
 At September 30, 2004, First Federal had approximately $34.3 million
outstanding in certificate accounts of $100,000 or more, that mature as
follows: AmountMaturity Period
    
    (In Thousands)Three months or less
    
    $
    10,386After three within six months
    
    
    7,810After six within twelve months
    
    
    6,388Over twelve months
    
    
    9,761$
    34,345
 47




---



##### Table of Contents



The following table presents the maturities of certificates of deposit, as
of September 30, 2004, 2003 and 2002: Maturities of Time DepositsSeptember 30,2004
    
    2003
    
    2002(Dollars in thousands)Three months or less
    
    $
    17,577
    
    
    $
    13,566
    
    
    $
    13,824After three within six months
    
    
    15,543
    
    
    
    12,736
    
    
    
    16,557After six within twelve months
    
    
    16,775
    
    
    
    19,421
    
    
    
    19,772One year to two years
    
    
    11,077
    
    
    
    12,750
    
    
    
    8,941Two years to three years
    
    
    4,680
    
    
    
    2,830
    
    
    
    7,593Three years to four years
    
    
    1,805
    
    
    
    2,617
    
    
    
    1,357Four years to five years
    
    
    1,377
    
    
    
    1,833
    
    
    
    2,677Over five years
    
    
    2,430
    
    
    
    2,432
    
    
    
    Total
    
    $
    71,264
    
    
    $
    68,185
    
    
    $
    70,721Weighted average rate on all certificates of
deposit at period-end
    
    
    2.03
    %
    
    
    2.64
    %
    
    
    3.74
    %
 Short-Term Borrowings SouthFirst has a line of credit of up to $2,500,000, which bears interest
at the prime lending rate, plus 25 basis points. Accrued interest on the
unpaid balance of the principal is due monthly and continuing until June 2005,
at which time the entire unpaid balance along with any unpaid accrued interest
is due. The prime-lending rate was 4.75% at September 30, 2004. Borrowings also include borrowings from the FHLB of Atlanta. These
borrowings included advances with both fixed and variable interest rates. First Federal also has short term borrowings through reverse repurchase
agreements with Morgan Keegan. A summary of these borrowings is as follows: At or for the Year EndedSeptember 30,2004
    
    2003(Dollars in Thousands)Amounts outstanding at end of period:Line of credit
    
    $
    903
    
    
    $
    1,918FHLB advances
    
    
    20,670
    
    
    
    22,340Reverse repurchase agreements
    
    
    10,016
    
    
    
    2,743Weighted average rate paid at period-end:Line of credit
    
    
    5.00
    %
    
    
    4.25
    %FHLB advances
    
    
    4.46
    %
    
    
    4.04
    %Reverse repurchase agreements
    
    
    1.85
    %
    
    
    1.22
    %Maximum amount of borrowings outstanding at any month-end:Line of credit
    
    
    2,353
    
    
    
    2,118FHLB advances
    
    
    22,340
    
    
    
    22,340Reverse repurchase agreements
    
    
    10,016
    
    
    
    5,347Approximate average amount outstanding for period:Line of credit
    
    
    2,081
    
    
    
    1,558FHLB advances
    
    
    22,124
    
    
    
    22,340Reverse repurchase agreements
    
    
    4,901
    
    
    
    1,335
 48




---



##### Table of Contents



At or for the Year EndedSeptember 30,2004
    
    2003(Dollars in Thousands)Approximate weighted average rate paid during period (1):Line of credit
    
    
    4.36
    %
    
    
    4.36
    %FHLB advances
    
    
    4.17
    %
    
    
    4.19
    %Reverse repurchase agreements
    
    
    1.32
    %
    
    
    1.35
    %
   (1)
    
    The approximate weighted average rate paid during the period was
computed by dividing the average amounts outstanding into the related
interest expense for the period. Capital Resources Stockholders Equity SouthFirsts consolidated stockholders equity was $10,355,000 and
$11,677,000 at September 30, 2004 and 2003, respectively. The 2004 decrease
was due to the net loss of $528,000 and the change in accumulated other
comprehensive income in the amount of $317,000 resulting from the increase in
unrealized holding losses on available-for-sale securities. Further,
SouthFirst repurchased shares of its common stock, in the amount of $81,316,
pursuant to its previously announced stock repurchase program. Cash dividends were declared on SouthFirst Common Stock in the amount of
$425,728, $425,031 and $497,345, or $0.60 per share, for the years ended
September 30, 2004, 2003 and 2002, respectively. Management believes that a
strong capital position is vital to the continued profitability of First
Federal and SouthFirst and provides a foundation for future growth, as well as
promoting depositor and investor confidence. The following table provides certain financial ratios for SouthFirst, as
of the end of the most recent three fiscal years: Equity and Asset RatiosSeptember 30,2004
    
    2003
    
    2002Return on average assets
    
    
    (.38
    )%
    
    
    .08
    %
    
    
    .47
    %Return on average stockholders equity
    
    
    (4.82
    )%
    
    
    .91
    %
    
    
    4.89
    %Common dividend payout ratio
    
    
    N/A
    
    
    
    391.45
    %
    
    
    74.14
    %Average stockholders equity to average assets ratio
    
    
    7.97
    %
    
    
    9.15
    %
    
    
    9.52
    %Net Income (Loss)
    
    $
    (527,935
    )
    
    $
    115,864
    
    
    $
    670,805Average Assets
    
    
    137,447,618
    
    
    
    138,049,920
    
    
    
    144,248,358Average Equity
    
    
    10,951,309
    
    
    
    12,726,828
    
    
    
    13,729,739Cash Dividends Paid
    
    
    425,729
    
    
    
    453,547
    
    
    
    497,345
 Capital The regulations of the OTS provide certain capital requirements applicable
to thrifts, including First Federal, and the consequences for failing to comply
with such requirements (as amended from time to time, the OTS Capital
Regulations). The regulatory capital standards contained in the OTS Capital
Regulations include (i) a core capital requirement, (ii) a tangible capital
requirement, and (iii) a risk-based capital requirement and identity certain
minimum regulatory capital requirements, including a tangible capital ratio
equal to 1.50% of adjusted total assets, a core capital ratio equal to 4.0% of
adjusted total assets, and a minimum risk-based capital ratio of 8.0% of
risk-weighted assets. As shown in the table below, First Federal was in
compliance with these regulatory capital requirements, at September 30, 2004
and 2003. 49




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##### Table of Contents



At September 30, 2004
    
    At September 30, 2003Tangible
    
    Core
    
    Risk-based
    
    Tangible
    
    Core
    
    Risk-basedCapital
    
    Capital
    
    Capital
    
    Capital
    
    Capital
    
    CapitalCapital
    
    $
    11,432,000
    
    
    $
    11,432,000
    
    
    $
    11,432,000
    
    
    $
    13,651,000
    
    
    $
    13,651,000
    
    
    $
    13,651,000Adjustments:General valuation
allowance
    
    
    
    
    
    
    
    
    
    
    516,000
    
    
    
    
    
    
    
    
    
    
    
    295,000Goodwill
    
    
    (544,000
    )
    
    
    (544,000
    )
    
    
    (544,000
    )
    
    
    (544,000
    )
    
    
    (544,000
    )
    
    
    (544,000
    )Unrealized gains
    
    
    536,000
    
    
    
    536,000
    
    
    
    536,000
    
    
    
    218,000
    
    
    
    218,000
    
    
    
    218,000Regulatory capital
    
    $
    11,424,000
    
    
    $
    11,424,000
    
    
    $
    11,940,000
    
    
    $
    13,325,000
    
    
    $
    13,325,000
    
    
    $
    13,620,000Regulatory asset base
    
    $
    141,469,000
    
    
    $
    141,469,000
    
    
    $
    90,574,000
    
    
    $
    133,400,000
    
    
    $
    133,400,000
    
    
    $
    82,915,000Capital ratio
    
    
    8.08
    %
    
    
    8.08
    %
    
    
    13.18
    %
    
    
    9.99
    %
    
    
    9.99
    %
    
    
    16.43
    %Minimum required ratio
    
    
    1.50
    %
    
    
    4.00
    %
    
    
    8.00
    %
    
    
    1.50
    %
    
    
    4.00
    %
    
    
    8.00
    %Capital ratio required for
well-capitalized
designation
    
    
    
    
    
    
    5.00
    %
    
    
    10.00
    %
    
    
    
    
    
    
    5.00
    %
    
    
    10.00
    %
 Liquidity First Federal Liquidity is a banks ability to convert assets into cash equivalents in
order to meet daily cash flow requirements, primarily for deposit withdrawals,
loan demand, and maturing liabilities. Without proper management, First
Federal could experience higher costs of obtaining funds due to insufficient
liquidity. On the other hand, excessive liquidity could lead to a decline in
earnings due to the cost of foregoing alternative higher-yielding investment
opportunities. Asset liquidity is provided primarily through the repayment and maturity
of investment securities, and the sale and repayment of loans. Sources of liability liquidity include customer deposits and participation
in the FHLB advance program. Although deposit growth historically has been a
primary source of liquidity, such balances may be influenced by changes in the
banking industry, interest rates available on other investments, general
economic conditions, competition and other factors. FHLB advances include both
fixed and variable terms and are taken out with varying maturities. First
Federal can borrow an amount equal to 10% of its total assets, based on the
most recent quarterly financial information submitted to the appropriate
regulatory agency. At September 30, 2004, First Federal had outstanding FHLB
advances in the amount of $20,670,000, which exceeds the present credit
availability. The bank is not required to re-pay the existing advances to an
amount equivalent to 10% of its current assets, however, new requested advances
would be subject to approval from the FHLB credit review committee. On a consolidated basis, net cash provided by operating activities in
fiscal 2004 was $719,000, a $1,014,000 decrease from 2003. The $10,119,000 in
net cash used by investing activities during 2004 consisted primarily of a
$12,088,000 increase in loan funding activities. Cash provided by calls and
maturities of securities available-for-sale and proceeds from the sale of
securities available-for-sale increased to $14,472,000 from $32,028,000 in
2003, while cash decreased from the purchase of securities available-for-sale
to $11,570,000 from $38,713,000 in 2003. The $8,366,000 in net cash provided
by financing activities resulted from an increase of $4,235,000 in total
deposits and an increase of $4,588,000 as a result of the net proceeds of
borrowed funds. Payments for common stock dividends totaled $425,000, and the
acquisition of treasury stock totaled $81,000. 50




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First Federals liquidity ratio at September 30, 2004 and 2003 was 11.31%
and 37.05%, respectively. Liquidity levels may be increased or decreased
depending upon the yields on investment alternatives, managements expectations
to the level of yield that will be available in the future, and managements
projections as to the short-term demand for funds to be used in loan
originations. First Federal is subject to certain regulatory limitations with
respect to the payment of dividends to SouthFirst. First Federal paid
$1,500,000 and $500,000 to SouthFirst during 2004 and 2003, respectively. SouthFirst SouthFirst also requires cash for various purposes including servicing
debt, paying dividends to stockholders and paying general corporate expenses.
The primary source of funds for SouthFirst is dividends from First Federal.
First Federals capital levels meet the requirements of the OTS Capital
Regulations for classification as a well capitalized institution and,
thereby, enable First Federal to pay dividends to SouthFirst. In addition to
dividends, SouthFirst has access to various capital markets and other sources
of borrowings, including a line of credit in the amount of $2,500,000, from
First Commercial Bank in Birmingham, Alabama. The line of credit is renewable
annually and is secured by all of the issued and outstanding shares of First
Federal, pledged by SouthFirst. SouthFirst, at September 30, 2004, has drawn
$903,000 against the line of credit. SouthFirst retained $3,624,000 of the net proceeds from the initial public
offering of Common Stock in 1994. Substantially all of those funds have been
used to pay dividends (including a special $2.00 per share dividend in 1996) to
repurchase SouthFirst Common Stock, to invest in affiliates and to pay general
corporate expenses. Accordingly, SouthFirst likely will rely on dividends from
First Federal to repay borrowings under its line of credit, which has been
used, in part, to pay dividends to stockholders and to repurchase shares of
SouthFirst pursuant to the current repurchase program announced by SouthFirst
in January 2003, authorizing the Company to repurchase up to 77,000 shares, or
approximately ten percent (10%) of its outstanding common stock. As of
December 9, 2004, SouthFirst has repurchased 69,677 shares of the intended
repurchase of up to 77,000 shares of Common Stock. Under the previous stock
repurchase program, which commenced in January, 2002, the Company repurchased
81,700 shares of the intended repurchase of up to 85,000 shares of Common
Stock, which concluded in January, 2003. 
 ITEM 7. FINANCIAL STATEMENTS The following financial statements are included as part of this Form 10KSB
following the signature page of this Form 10KSB. Report of Independent Registered Public Accounting Firm of Jones &
Kirkpatrick, P.C. Consolidated Statements of Financial Condition as of September 30, 2004
and 2003 Consolidated Statements of Operations for the years ended September
30, 2004, 2003 and 2002 Consolidated Statements of Stockholders Equity for the years ended
September 30, 2004, 2003 and
2002 Consolidated Statements of Cash Flows for the years ended September 30,
2004, 2003 and 2002 Notes to Consolidated Financial Statements 
 ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE There have been no changes in, or disagreements with, the Companys
accountants on accounting and financial disclosure in the preceding two fiscal
years. 
 ITEM 8A. CONTROLS AND PROCEDURES Within 90 days prior to the filing date of this annual report, pursuant to
Rule 13a-15 of the Securities Exchange Act of 1934 (the Exchange Act),
SouthFirsts Chief Executive Officer and Controller (principal financial
officer) evaluated the effectiveness of the design and operation of
SouthFirsts disclosure controls and 51




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procedures (as defined in Rule13a-14(c) of the Exchange Act). Based on
their evaluation, the Chief Executive Officer and Controller have concluded
that SouthFirsts disclosure controls and procedures are effective in timely
alerting them to material information, relating to SouthFirst and SouthFirsts
consolidated subsidiaries, required to be included in periodic reports,
including this annual report, filed by SouthFirst with the SEC. There have not been any significant changes in SouthFirsts internal
controls, or in other factors that could significantly affect these controls,
subsequent to the date of the Chief Executive Officers and Controllers
evaluation. 
 PART III 
 ITEM 9. DIRECTORS, EXECUTIVE OFFICERS AND CONTROL PERSONS OF THE REGISTRANT Management of SouthFirst The SouthFirst Board of Directors currently consists of eight persons and
is divided into three classes, each of which contains approximately one-third
of the members. The directors of SouthFirst are elected by the stockholders of
SouthFirst for staggered, three-year terms, so that approximately one-third of
the directors are elected at each annual meeting of stockholders, to hold
office until their successors are elected and qualified. The executive
officers of SouthFirst are elected annually by the Board of Directors of
SouthFirst and hold office until their successors are elected and qualified. The direction and control of First Federal is vested in the First Federal
Board of Directors, which currently consists of eight members and is divided
into three classes, each of which contains approximately one-third of the
members. The directors of First Federal serve three-year terms. The terms of
the directors of First Federal are staggered (as in the case of SouthFirst), so
that approximately one-third of the directors are elected at each annual
meeting of stockholders. Since SouthFirst owns all of the issued and
outstanding shares of common stock of First Federal, SouthFirst elects the
directors of First Federal, in accordance with applicable law. There are no arrangements or understandings pursuant to which the
directors or executive officers of SouthFirst or First Federal were elected,
and there are no family relationships between or among such persons. 52




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The following table sets forth certain information regarding certain of
the executive officers and directors of SouthFirst and First Federal. Year FirstElected as a
    
    YearDirector of
    
    TermName
    
    Age(1)
    
    Position Held
    
    SouthFirst
    
    ExpiresJoe K. McArthur
    
    
    53
    
    
    Chief Executive Officer of
SouthFirst and First Federal;
President of First Federal;
Director of SouthFirst and
First Federal
    
    
    1996
    
    
    
    2005J. Malcomb Massey
    
    
    55
    
    
    President of SouthFirst;
Director of SouthFirst and
First Federal; President and
Chief Executive Officer of
Pension & Benefit
    
    
    1997
    
    
    
    2006Allen Gray McMillan, III
    
    
    47
    
    
    Chairman of SouthFirst and
First Federal; Director of
SouthFirst and First Federal
    
    
    1994
    
    
    
    2005H. David Foote, Jr.
    
    
    55
    
    
    Director of SouthFirst and
First Federal
    
    
    1994
    
    
    
    2007Kenneth E. Easterling
    
    
    61
    
    
    Director of SouthFirst and
First Federal
    
    
    2001
    
    
    
    2007L. Neal Bice
    
    
    64
    
    
    Director of SouthFirst and
First Federal
    
    
    2001
    
    
    
    2007Donald R. Hardy
    
    
    54
    
    
    Director of SouthFirst and
First Federal
    
    
    2001
    
    
    
    2005Sandra H. Stephens
    
    
    45
    
    
    Executive Vice President and
Chief Operating Officer of
SouthFirst and First Federal;
Director of SouthFirst and
First Federal
    
    
    2002
    
    
    
    2006Ruth M. Roper
    
    
    54
    
    
    Executive Vice President of
Pension & Benefit
   (1)
    
    At September 30, 2004 Set forth below is certain information with respect to the directors and
executive officers of SouthFirst and First Federal. Unless otherwise
indicated, the principal occupation listed for each person below has been his
or her principal occupation for the past five years. Joe K. McArthurhas served as a director of First Federal and SouthFirst
since February 1996. Effective September 1, 2001, Mr. McArthur was elected
President and Chief Executive Officer of SouthFirst and First Federal.
Thereafter, as part of the Companys restructuring efforts, Mr. McArthur
resigned as President of SouthFirst to allow J. Malcomb Massey to assume that
office, as of October 1, 2001. Prior to assuming his 53




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current positions, Mr. McArthur served as the Executive Vice President,
Chief Financial Officer and Secretary of First Federal and SouthFirst from 1992
and 1994, respectively. Mr. McArthur has over 27 years of experience in the
banking industry and received a B.S. in Accounting from the University of
Alabama-Birmingham and a Masters of Business Administration equivalent from the
National School of Finance and Management. He has also completed all courses
with the Institute of Financial Education. Prior to joining First Federal, Mr.
McArthur was Assistant Executive Director of Finance of Humana, a hospital,
from 1990 to 1992, and Senior Vice President of First Federal of Alabama from
1983 to 1990. He has also served as a manager of various Little League and
Babe Ruth Baseball teams, as well as Boys Club basketball teams. Mr. McArthur
is a member of the First United Methodist Church of Sylacauga. J. Malcomb Masseyhas served as a director of First Federal and SouthFirst
since May 1997. On September 26, 2001, Mr. Massey was elected President of
SouthFirst to be effective October 1, 2001. In addition, Mr. Massey is
President and Chief Executive Officer of Pension & Benefit, First Federals
wholly-owned, operating subsidiary. This is a position he has held since he
joined Pension & Benefit in 1997, after it acquired substantially all of the
assets of Lambert, Massey, Roper & Taylor, Inc., an employee benefits
consulting firm, based in Montgomery, for which Mr. Massey had served as
President since 1980. Mr. Massey is a member of the American Society of Pension
Actuaries, South Central Alabama Association of Insurance and Financial
Advisors, Life and Qualifying Member of Million Dollar Roundtable, Top of the
Table, Montgomery Lions Club and Young Meadows Presbyterian Church. Allen Gray McMillan, IIIhas served as a director of First Federal since
1993 and of SouthFirst since 1994. On August 15, 2001, Mr. McMillan was
elected Chairman of SouthFirst and First Federal. Mr. McMillan also
currently serves as a member of the audit committee of SouthFirst. Mr.
McMillan is also President of Brecon Knitting Mill, where he has been employed
since 1979. Mr. McMillan has been active in the Kiwanis Club, United Way, and
Boy Scouts of America. He is a member of the First United Methodist Church. H. David Foote, Jr.has served as a director of First Federal since 1988
and of SouthFirst since 1994. Mr. Foote also currently serves as a member of
the audit committee of SouthFirst. Mr. Foote has been President and owner of
Foote Bros. Furniture since 1973. Mr. Foote has been a director of the
Sylacauga Chamber of Commerce, the Coosa Valley Country Club and Talladega
County E-911. He has served as President of Wesley Chapel Methodist Mens Club
and head of the Wesley Chapel Methodist Administrative Board. Kenneth E. Easterlinghas served as a director of First Federal since 1997
and of SouthFirst since 2001. Mr. Easterling also currently serves as a member
of the audit committee of SouthFirst. Mr. Easterling previously served as a
member of the Board of Directors of First Federal Savings and Loan of Chilton
County from 1992 to 1997. Mr. Easterling is the owner of Home Printing
Company, located in Clanton, Alabama, which was established in 1969. Mr.
Easterling served in the Army National Guard from 1963 to 1969, is a Charter
Member of the Exchange Club of Chilton County, a member of the Board of
Directors of Chilton County Cattlemens Association, a member of the Board of
Directors of Alfa, and has served as a Deacon of the West End Baptist Church
from 1969 to the present. L. Neal Bicehas served as a director of First Federal since 1997 and of
SouthFirst since 2001. Mr. Bice also currently serves as a member of the audit
committee of SouthFirst and as the audit committee financial expert as that
term is defined in Item 401(e)(2) of Regulation S-B. Mr. Bice previously
served as a director of First Federal Savings and Loan of Chilton County, from
1989 to 1997. Mr. Bice is an owner and a director of Chilton County Feed and
Seed Company, located in Clanton, Alabama. Mr. Bice presently is a professor
of economics and business at the Clanton extension of the George C. Wallace
State Community College. Mr. Bice is a past professor of finance at Auburn
University, a past professor of economics, finance and banking at the
University of Southwestern Louisiana, and a past professor of finance at the
University of Alabama. Mr. Bice is a member of the Chilton County Board of
Education, the Alabama Education Association, the Southern School Board
Association, Omicron Delta Epsilon Society in Economics, the Chilton County
High School Athletic Association, and the Chilton County Cattlemens
Association. He is a past President of the Chilton County Board of Education,
and serves as director of the Chilton County Chamber of Commerce, the President
of the Chilton 54




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County University of Alabama Alumni Association, the Zone Chairman of the
Clanton Lions Club, and the President of the War Eagle Lions Club, Auburn,
Alabama. Mr. Bice is a member of the Concord Baptist Church. Donald R. Hardyhas served as a director of First Federal and SouthFirst
since January 2001. Mr. Hardy also currently serves as a member of the audit
committee of SouthFirst. Mr. Hardy is the owner, President and CEO of H & B
Builders, Inc., located in Sylacauga, Alabama. He is a member of the Business
Council of Alabama, Sylacauga Chamber of Commerce and has served on the
Sylacauga Planning Commission since 1992. Mr. Hardy is an active member of the
First Baptist Church of Sylacauga. Sandra H. Stephenswas elected as director of SouthFirst and First
Federal, effective November 12, 2002, and Ms. Stephens was elected as Executive
Vice President and Chief Operating Officer of SouthFirst and First Federal,
effective November 1, 2001. Ms. Stephens previously served as the Chief
Operating Officer, from 1997 to 2001, and Chief Financial Officer, from 1992 to
1997, of First Federal Bank, in Tuscaloosa, Alabama. Prior to her employment
with First Federal Bank, Ms. Stephens held various executive positions with
Federal Home Loan Mortgage Corporation, Atlanta, Georgia from 1990 until 1992,
and with Pinnacle Bank, Jasper, Alabama from 1981 until 1990. Ms. Stephens is
a member of the American Society of Women Accountants, and she is a member of
Saint Mark United Methodist Church in Birmingham, Alabama and serves on the
Board of Trustees of the North Alabama Conference of the United Methodist
Church.. Ruth M. Roperis Executive Vice President of Pension & Benefit, First
Federals wholly-owned, operating subsidiary. This is a position she has held
since she joined Pension & Benefit in 1997, after it acquired substantially all
of the assets of Lambert, Massey, Roper & Taylor, Inc., a Montgomery based
employee benefits consulting firm of which Ms. Roper was a named shareholder.
Since 1983, when Ms. Roper first joined Lambert, Massey & Associates, Inc., she
has served in various capacities related to qualified plan and employee benefit
consulting, including qualified plan administration activities and the
provision of employee benefit consulting services. Ms. Roper is a member of
the American Society of Pension Actuaries and the Montgomery Association of
Life Underwriters. Audit Committee Financial Expert SouthFirst has determined that Mr. Bice, a member of the Audit Committee
of the Board, is an audit committee financial expert, as that term is defined
in Item 401(e)(2) of Regulation S-B. Mr. Bice is an independent director
based on the definition of independence in Rule 4200A(a)(14) of the listing
standards of the National Association of Securities Dealers currently
applicable to small business issuers. Compliance With Section 16(a) of the Securities Exchange Act of 1934 Section 16(a) of the Securities Exchange Act of 1934 requires SouthFirsts
directors, certain of SouthFirsts officers and persons who own more than 10%
of the outstanding Common Stock of SouthFirst (Reporting Persons) to file
with the SEC reports of changes in ownership of the Common Stock of SouthFirst
held by such persons (Section 16(a) Reports). Reporting Persons are also
required to furnish SouthFirst with copies of all Section 16(a) Reports that
they file. SouthFirst has been subject to this regulation since February 13,
1995. To SouthFirsts knowledge, based solely on a review of copies of Section
16(a) Reports furnished to SouthFirst and representations that no other Section
16(a) Reports were required, all Section 16(a) filing requirements applicable
to such Reporting Persons were complied with during fiscal 2004. Code of Ethics for Senior Financial Officers Our Board of Directors has adopted a Code of Ethics for our principal
executive officer, principal financial officer, principal accounting officer or
controller, or persons performing similar functions. A copy of the Code of
Ethics is filed as an exhibit to our Annual Report on Form 10-KSB for the
fiscal year ended September 30, 2003. 55




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##### Table of Contents



We intend to disclose any amendments to or waivers of our Code of Ethics
on our corporate website www.southfirst.com. 
 ITEM 10. EXECUTIVE COMPENSATION The following table provides certain summary information for fiscal 2004,
2003, and 2002 concerning compensation paid, or accrued, by SouthFirst and
First Federal to, or on behalf of, SouthFirsts Chief Executive Officer and the
other executive officers of SouthFirst whose total annual salary and bonus
exceeded $100,000 during fiscal 2004 (the Named Executive Officers): Summary Compensation Table Annual Compensation (1)
    
    Long TermCompensationSecuritiesName and
    
    Fiscal
    
    
    
    
    
    
    
    
    
    Other Annual
    
    Underlying
    
    All OtherPrincipal Position
    
    Year
    
    Salary
    
    Bonus
    
    Compensation (2)
    
    Options (No.)
    
    CompensationJoe K. McArthur
    
    
    2004
    
    
    $
    150,000
    
    
    $
    23,788
    (3)
    
    $
    21,000
    
    
    
    0
    
    
    $
    2,451
    (4)Chief Executive
    
    
    2003
    
    
    
    150,000
    
    
    
    26,669
    (5)
    
    
    24,000
    
    
    
    4,300
    (6)
    
    
    2,451
    (7)Officer of
    
    
    2002
    
    
    
    142,917
    
    
    
    25,439
    (8)
    
    
    22,995
    
    
    
    0
    
    
    
    2,451
    (9)SouthFirst and
First Federal,
President of
First FederalJ. Malcomb Massey (1)
    
    
    2004
    
    
    $
    150,000
    
    
    $
    15,551
    (10)
    
    $
    21,000
    
    
    
    0
    
    
    $
    2,488
    (11)President of
    
    
    2003
    
    
    
    150,000
    
    
    
    5,850
    (12)
    
    
    24,000
    
    
    
    4,300
    (13)
    
    
    2,488
    (14)SouthFirst,
    
    
    2002
    
    
    
    150,000
    
    
    
    13,270
    (15)
    
    
    22,995
    
    
    
    0
    
    
    
    2,488
    (16)President and
Chief Executive
Officer of
Pension & BenefitSandra H. Stephens
    
    
    2004
    
    
    $
    125,000
    
    
    $
    11,887
    (17)
    
    $
    21,000
    
    
    
    0
    
    
    $
    1,747
    (18)Executive Vice
    
    
    2003
    
    
    
    125,000
    
    
    
    14,290
    (19)
    
    
    22,500
    
    
    
    4,300
    (20)
    
    
    1,537
    (21)President, and Chief
    
    
    2002
    
    
    
    105,417
    
    
    
    39,500
    (22)
    
    
    4,500
    
    
    
    7,500
    (23)
    
    
    1,537
    (24)Operating Officer
of SouthFirst and
First FederalRuth M. Roper
    
    
    2004
    
    
    $
    100,000
    
    
    $
    12,649
    (25)
    
    $
    2,850
    
    
    
    0
    
    
    $
    2,744
    (26)Executive Vice
    
    
    2003
    
    
    
    100,000
    
    
    
    5,598
    (27)
    
    
    3,000
    
    
    
    1,950
    (28)
    
    
    2,744
    (29)President of Pension
    
    
    2002
    
    
    
    98,000
    
    
    
    5,778
    (30)
    
    
    3,000
    
    
    
    0
    
    
    
    2,744
    (31)& Benefit
   (1)
    
    All compensation received by the Named Executive Officers was paid by
First Federal and Pension & Benefit, except for an annual salary, in the
amount of $20,000, paid by SouthFirst to its President, J. Malcomb Massey.(2)
    
    Fees received as a member of the Board of Directors of SouthFirst, First
Federal, Pension & Benefit and/or SouthFirst Mortgage.(3)
    
    Consists of a regular bonus of $5,769 as well as $18,019 of compensation
consisting of dividends paid under SouthFirsts Dividend Incentive Plan on
unexercised stock options. See   Compensation of Directors below.(4)
    
    Represents a $1,485 automobile allowance and income of $966 recognized on
employer provided group term life insurance in excess of $50,000.(5)
    
    Consists of a regular bonus of $8,650 as well as $18,019 of compensation
consisting of dividends paid under SouthFirsts Dividend Incentive Plan on
unexercised stock options. See  Compensation of Directors below. 56




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(6)
    
    On October 16, 2002, SouthFirst issued 4,300 options under the 1998 plan
to Mr. McArthur at an exercise price of $12.10 per share. These options
vest in equal increments commencing October 16, 2002 through October 16,
2007.(7)
    
    Represents a $1,485 automobile allowance and income of $966 recognized on
employer provided group term life insurance in excess of $50,000.(8)
    
    Consists of a regular bonus of $10,000 as well as $15,439 of compensation
consisting of dividends paid under SouthFirsts Dividend Incentive Plan on
unexercised stock options. See   Compensation of Directors below.(9)
    
    Represents a $1,485 automobile allowance and income of $966 recognized on
employer provided group term life insurance in excess of $50,000.(10)
    
    Consists of a regular bonus of $9,701 as well as $5,850 of compensation
consisting of dividends paid under SouthFirsts Dividend Incentive Plan on
unexercised stock options. See   Compensation of Directors below.(11)
    
    Represents a $1,522 automobile allowance and income of $966 recognized on
employer provided group term life insurance in excess of $50,000.(12)
    
    Consists of dividends paid under SouthFirsts Dividend Incentive Plan on
unexercised stock options. See   Compensation of Directors below.(13)
    
    On October 16, 2002, SouthFirst issued 4,300 options under the 1995 plan
to Mr. Massey at an exercise price of $12.10 per share. These options
vest in equal annual increments commencing October 16, 2002 through
October 16, 2007.(14)
    
    Represents a $1,522 automobile allowance and income of $966 recognized on
employer provided group term life insurance in excess of $50,000.(15)
    
    Consists of a regular bonus of $10,000 as well as $3,270 of compensation
consisting of dividends paid under SouthFirsts Dividend Incentive Plan on
unexercised stock options. See   Compensation of Directors below.(16)
    
    Represents a $1,522 automobile allowance and income of $966 recognized on
employer provided group term life insurance in excess of $50,000.(17)
    
    Consists of a regular bonus of $ 4,807 as well as $7,080 of compensation
consisting of dividends paid under SouthFirsts Dividend Incentive Plan on
unexercised stock options. See   Compensation of Directors below.(18)
    
    Represents a $1,117 automobile allowance and income of $630 recognized on
employer provided group term life insurance in excess of $50,000.(19)
    
    Consists of a regular bonus of $7,210 as well as $7,080 of compensation
consisting of dividends paid under SouthFirsts Dividend Incentive Plan on
unexercised stock options. See   Compensation of Directors below.(20)
    
    On October 16, 2002, SouthFirst issued 2,589 options under the 1995 plan
and 1,711 options under the 1998 plan to Ms. Stephens at an exercise price
of $12.10 per share. These options vest in equal annual increments
commencing October 16, 2002 through October 16, 2007.(21)
    
    Represents a $1,117 automobile allowance and income of $420 recognized on
employer provided group term life insurance in excess of $50,000.(22)
    
    Consists of a signing bonus of $17,500, a regular bonus of $10,000, a tax
bonus, with respect to MRP shares (see   Management Recognition Plans
below), of $7,500, and $4,500 of compensation consisting of dividends paid
under SouthFirsts Dividend Incentive Plan on unexercised stock options.
See   Compensation of Directors below.(23)
    
    On December 1, 2001, SouthFirst issued 7,500 options under the 1995 plan
to Ms. Stephens at an exercise price of $9.92 per share. These options
vest in equal annual increments commencing on December 1, 2002 through
December 1, 2006.(24)
    
    Represents a $1,117 automobile allowance and income of $420 recognized on
employer provided group term life insurance in excess of $50,000.(25)
    
    Consists of a regular bonus of $9,701 as well as $2,948 of compensation
consisting of dividends paid under SouthFirsts Dividend Incentive Plan on
unexercised stock options. See   Compensation of Directors below.(26)
    
    Represents a $1,778 automobile allowance and income of $966 recognized on
employer provided group term life insurance in excess of $50,000. 57




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(27)
    
    Consists of a regular bonus of $2,650 as well as $2,948 of compensation
consisting of dividends paid under SouthFirsts Dividend Incentive Plan on
unexercised stock options. See   Compensation of Directors below.(28)
    
    On October 16, 2002, SouthFirst issued 1,950 options under the 1998 plan
to Ms. Roper at an exercise price of $12.10 per share. These options vest
in equal annual increments commencing October 16, 2002 through October 16,
2007.(29)
    
    Represents a $1,778 automobile allowance and income of $966 recognized on
employer provided group term life insurance in excess of $50,000.(30)
    
    Consists of a regular bonus of $4,000 as well as $1,778 of compensation
consisting of dividends paid under SouthFirsts Dividend Incentive Plan on
unexercised stock options. See   Compensation of Directors below.(31)
    
    Represents a $1,778 automobile allowance and income of $966 recognized on
employer provided group term life insurance in excess of $50,000. Employment Agreements SouthFirst, First Federal and Pension & Benefit have entered into
employment agreements with each of the following executive officers (including
each of the Named Executive Officers). The terms and conditions of these
employment contracts are described below. Joe K. McArthur Chief Executive Officer of SouthFirst and First Federal, President of
First Federal The amended and restated employment agreement by and between First Federal
and Mr. McArthur was effective as of October 1, 2003, and is for a term of two
years. Mr. McArthurs term of employment was due to be extended on the first
anniversary of the effective date for an additional one-year period beyond the
then effective expiration date, provided the First Federal Board determined, in
a duly adopted resolution, that the performance of Mr. McArthur had met the
Boards requirements and standards, and that such employment agreement shall be
extended. The compensation committee and Mr. McArthur are currently
negotiating an extension of such agreement beyond its stated termination date
of October 1, 2005. Once an extension of this agreement has been entered into,
First Federal will file such document with the SEC on Form 8-K. Under the current agreement, SouthFirst is jointly and severally liable
for the payment of all amounts due under Mr. McArthurs employment agreement
pursuant to a separate employment agreement entered into with SouthFirst, which
was previously filed by SouthFirst as part of its Annual Report on Form 10 KSB
for the year ended September 30, 2003. Under the terms of the employment
agreement with First Federal, First Federal agrees to pay Mr. McArthur a salary
at the rate of $150,000 per annum, payable in cash not less frequently than
monthly. Beginning on the effective date, Mr. McArthur shall be eligible to
receive such performance bonuses as may be determined in the sole discretion of
the First Federal Board. In addition, Mr. McArthur shall participate in
standard retirement and medical plans, and is entitled to customary fringe
benefits, vacation and sick leave. Mr. McArthurs employment agreement terminates upon his death or
disability, and is terminable for cause as defined in the employment
agreement. In the event of termination for cause, no severance benefits are
payable to Mr. McArthur. If SouthFirst or First Federal terminate Mr. McArthur
without cause, he will be entitled to a continuation of his salary from the
date of termination through the remaining term of the employment agreements
plus an additional twelve-month period, and he will be entitled to the cost of
obtaining benefits in which Mr. McArthur would have been eligible to
participate through the termination date. The total amount of such payments
would be required to be paid, at the option of Mr. McArthur, either (i) in
periodic payments over the remaining term of the employment agreement, as if
Mr. McArthurs employment had not been terminated, or (ii) in one lump sum
within ten (10) days of such termination; provided however, that the amount to
be paid by First Federal to Mr. McArthur shall not exceed two (2) times his
average annual compensation (as defined in the employment agreement). Mr.
McArthur may voluntarily terminate his employment agreement by providing sixty
days written notice to the Boards of Directors of SouthFirst and First Federal,
in which case he is entitled to receive only his compensation, vested rights
and benefits up to the date of termination. 58




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Mr. McArthurs employment agreement further provides that, in the event of
Mr. McArthurs involuntary termination in connection with, or within two years
after any change in control of First Federal or SouthFirst, other than for
cause, or death or disability, Mr. McArthur will be paid, within 10 days of
such termination, an amount equal to the difference between (i) 2.99 times his
base amount, as defined in Section 280G(b)(3) of the Code, and (ii) the sum
of any other parachute payments, as defined under Section 280G(b)(2) of the
Code, that Mr. McArthur receives on account of the change in control. Under
Mr. McArthurs employment agreement, a change in control generally refers to
a change in ownership, holding or power to vote more than 25% of SouthFirsts
or First Federals voting stock, a change in the ownership or possession of the
ability to control the election of a majority of First Federals or
SouthFirsts directors or the exercise of a controlling influence over the
management or policies of SouthFirst or First Federal. In addition, under Mr.
McArthurs employment agreement, a change in control occurs when, during any
consecutive two-year period, the directors of SouthFirst or First Federal, at
the beginning of such period, cease to constitute two-thirds of the Boards of
Directors of SouthFirst or First Federal, unless the election of replacement
directors was approved by a two-thirds (66 2/3%) vote of the initial directors
then in office. Mr. McArthurs employment agreement also provides for a
similar lump sum payment to be made in the event of his voluntary termination
of employment within one year following a change in control of First Federal or
SouthFirst. Sandra H. Stephens Executive Vice President and Chief Operating Officer The amended and restated employment agreement by and between First Federal
and Ms. Stephens was effective as of October 1, 2003 and is for a term of two
years. Ms. Stephenss term of employment was due to be extended on the first
anniversary of the effective date for an additional one-year period beyond the
then effective expiration date, provided the First Federal Board determined, in
a duly adopted resolution, that the performance of Ms. Stephens had met the
Boards requirements and standards, and that such employment agreement shall be
extended. The compensation committee and Ms. Stephens are currently
negotiating an extension of such agreement beyond its stated termination date
of October 1, 2005. Once an extension of this agreement has been entered into,
First Federal will file such document with the SEC on Form 8-K. Pursuant to Ms. Stephens employment agreement, First Federal pays Ms.
Stephens an annual base salary of $125,000, payable in cash not less frequently
than monthly. Beginning on the Effective Date, Ms. Stephens shall be eligible
to receive such performance bonuses as may be determined in the sole discretion
of the First Federal Board. In addition, Ms. Stephens shall participate in
standard retirement and medical plans, and is entitled to customary fringe
benefits, vacation and sick leave. Ms. Stephens employment agreement terminates upon her death or
disability, and is terminable for cause as defined in the employment
agreement. In the event of termination for cause, no severance benefits are
payable to Ms. Stephens. If First Federal terminates Ms. Stephens without
cause, she will be entitled to a continuation of her salary from the date of
termination through the remaining term of the employment agreement plus an
additional twelve-month period, and she will be entitled to the cost of
obtaining benefits in which Ms. Stephens would have been eligible to
participate through the termination date. Ms. Stephens may voluntarily
terminate her employment agreement by providing sixty days written notice to
the Board of Directors of First Federal, in which case she is entitled to
receive only her compensation, vested rights and benefits up to the date of
termination. Ms. Stephens employment agreement further provides that, in the event of
her involuntary termination in connection with, or within two years after any
change in control of First Federal or SouthFirst, other than for cause, or
death or disability, Ms. Stephens will be paid, within 10 days of such
termination, an amount equal to the difference between (i) 2.99 times her base
amount, as defined in Section 280G(b)(3) of the Code, and (ii) the sum of any
other parachute payments, as defined under Section 280G(b)(2) of the Code,
that Ms. Stephens receives on account of the change in control. Under Ms.
Stephens employment agreement, a change in control generally refers to a
change in ownership, holding or power to vote more than 25% of First Federals
or SouthFirsts voting stock, a change in the ownership or possession of the
ability to control the election of a 59




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majority of First Federals or SouthFirsts directors, or the exercise of
a controlling influence over the management or policies of First Federal or
SouthFirst. In addition, under Ms. Stephens employment agreement, a change in
control occurs when, during any consecutive two-year period, the directors of
First Federal or SouthFirst, at the beginning of such period, cease to
constitute two-thirds of the Board of Directors of First Federal or SouthFirst,
unless the election of replacement directors was approved by a two-thirds (66
2/3%) vote of the initial directors then in office. Ms. Stephens employment
agreement also provides for a similar lump sum payment to be made in the event
of her voluntary termination of employment within one year following a change
in control of First Federal or SouthFirst. J. Malcomb Massey President and Chief Executive Officer of Pension & Benefit The amended and restated employment agreement by and between Pension &
Benefit and Mr. Massey was effective as of October 1, 2003 and provides for a
term of two years. Mr. Masseys term of employment was due to be extended on
the first anniversary of the effective date for an additional one-year period
beyond the then effective expiration date, provided the Pension & Benefit Board
determined, in a duly adopted resolution, that the performance of Mr. Massey
had met the Pension & Benefit Boards requirements and standards, and that such
employment agreement shall be extended. The Pension & Benefit Board and Mr.
Massey are currently negotiating an extension of such agreement beyond its
stated termination date of October 1, 2005. Once an extension of this
agreement has been entered into, First Federal will file such document with the
SEC on Form 8-K. The employment agreement with Mr. Massey provides for an annual base
salary of $150,000, payable in cash not less frequently than monthly. In
addition, as a provision of a prior employment agreement, Mr. Massey received
15,512 shares of restricted SouthFirst Common Stock, one-fifteenth of which
vest on each of the first fifteen anniversaries of April 11, 1997. Should Mr.
Masseys employment be terminated due to death, disability or the termination
of his employment without cause, as defined in the employment agreement, all
unvested shares shall be deemed earned and fully vested as of such date and
shall be distributed as soon as practicable thereafter. All unvested shares
will also vest upon a change in control of Pension & Benefit, First Federal
or SouthFirst. Under Mr. Masseys employment agreement, change in control
generally refers to a change in ownership, holding or power to vote more than
25% of Pension & Benefits, First Federals or SouthFirsts voting stock, a
change in the ownership or possession of the ability to control the election of
a majority of Pension & Benefits, First Federals or SouthFirsts directors,
or the exercise of a controlling influence over the management or policies of
Pension & Benefit, First Federal or SouthFirst. In addition, under Mr.
Masseys employment agreement, a change in control occurs when, during any
consecutive two-year period, directors of Pension & Benefit, First Federal or
SouthFirst, at the beginning of such period, cease to constitute two-thirds of
the Boards of Directors of Pension & Benefit, First Federal or SouthFirst,
unless the election of replacement directors was approved by a two-thirds (66
2/3%) vote of the initial directors then in office. Mr. Masseys employment agreement entitles him to participate in an
equitable manner with all other senior management employees of Pension &
Benefit in discretionary bonuses that the Pension & Benefit Board may award
from time to time to senior management employees. Mr. Massey may also
participate in standard retirement and medical plans, and is entitled to
customary fringe benefits, vacation and sick leave. Mr. Masseys employment agreement terminates upon his death or disability,
and is terminable for cause, as defined in the employment agreement. In the
event of termination for cause, no severance benefits are payable to Mr.
Massey. If Mr. Massey is terminated without cause, he will be entitled to
severance pay equal to the amount of his salary and benefits from the date of
termination through the remaining term of the employment agreement plus an
additional twelve-month period. Mr. Massey has the option to receive this
payment either (i) in periodic payments, as if the termination had not
occurred, or (ii) in one lump sum payment within ten days of the termination of
his employment. In either case, however, the severance pay shall not exceed
two (2) times Mr. Masseys average annual compensation, which is the average
total annual compensation received by Mr. Massey under the employment agreement
over the five full fiscal years preceding the termination, or, if Mr. 60




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Massey has been employed less than five full fiscal years, over each full
fiscal year preceding the termination. Mr. Massey may voluntarily terminate
his employment agreement by providing sixty days written notice to the Pension
& Benefit Board, in which case he is entitled to receive only his compensation,
vested rights and benefits up to the date of termination. In addition to Mr. Masseys employment agreement, SouthFirst, First
Federal, Pension & Benefit and Mr. Massey have entered into a guaranty of
employment agreement pursuant to which SouthFirst and First Federal have
guaranteed the performance of Pension & Benefit under the terms of the
employment agreement by and between Pension & Benefit and Mr. Massey. Ruth M. Roper Executive Vice President of Pension & Benefit The amended and restated employment agreement by and between Pension &
Benefit and Ms. Roper was effective as of October 1, 2003 and provides for a
term of two years. Ms. Ropers term of employment was due to be extended on
the first anniversary of the effective date for an additional one-year period
beyond the then effective expiration date, provided the Pension & Benefit Board
determined, in a duly adopted resolution, that the performance of Ms. Roper had
met the Pension & Benefit Boards requirements and standards, and that such
employment agreement shall be extended. The Pension & Benefit Board and Ms.
Roper are currently negotiating an extension of such agreement beyond its
stated termination date of October 1, 2005. Once an extension of this
agreement has been entered into, First Federal will file such document with the
SEC on Form 8-K. The employment agreement with Ms. Roper provides for an annual base salary
of $100,000, payable in cash not less frequently than monthly. In addition, as
a provision of a prior employment agreement, Ms. Roper received 5,623 shares of
restricted SouthFirst Common Stock, one-fifteenth of which vest on each of the
first fifteen anniversaries of April 11, 1997. Should Ms. Ropers employment
be terminated due to death, disability or the termination of her employment
without cause, as defined in the employment agreement, all unvested shares
shall be deemed earned and fully vested as of such date and shall be
distributed as soon as practicable thereafter. All unvested shares will also
vest upon a change in control of Pension & Benefit, First Federal or
SouthFirst. Under Ms. Ropers employment agreement, change in control
generally refers to a change in ownership, holding or power to vote more than
25% of Pension & Benefits, First Federals or SouthFirsts voting stock, a
change in the ownership or possession of the ability to control the election of
a majority of Pension & Benefits, First Federals or SouthFirsts directors,
or the exercise of a controlling influence over the management or policies of
Pension & Benefit, First Federal or SouthFirst. In addition, under Ms. Ropers
employment agreement, a change in control occurs when, during any consecutive
two-year period, directors of Pension & Benefit, First Federal or SouthFirst,
at the beginning of such period, cease to constitute two-thirds of the Boards
of Directors of Pension & Benefit, First Federal or SouthFirst, unless the
election of replacement directors was approved by a two-thirds (66 2/3%) vote
of the initial directors then in office. Ms. Ropers employment agreement entitles her to participate in an
equitable manner with all other senior management employees of Pension &
Benefit in discretionary bonuses that the Pension & Benefit Board may award
from time to time to senior management employees. Ms. Roper may also
participate in standard retirement and medical plans, and is entitled to
customary fringe benefits, vacation and sick leave. Ms. Ropers employment agreement terminates upon her death or disability,
and is terminable for cause, as defined in the employment agreement. In the
event of termination for cause, no severance benefits are payable to Ms. Roper.
If Ms. Roper is terminated without cause, she will be entitled to severance
pay equal to the amount of her salary and benefits from the date of termination
through the remaining term of the employment agreement plus an additional
twelve-month period. Ms. Roper has the option to receive this payment either
(i) in periodic payments, as if the termination had not occurred, or (ii) in
one lump sum payment within ten days of the termination of her employment. In
either case, however, the severance pay shall not exceed two (2) times Ms.
Ropers average annual compensation, which is the average total annual
compensation received by Ms. Roper under the employment agreement over the five
full fiscal years preceding the termination, or, if Ms. Roper has 61




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been employed less than five full fiscal years, over each full fiscal year
preceding the termination. Ms. Roper may voluntarily terminate her employment
agreement by providing sixty days written notice to the Board, in which case
she is entitled to receive only her compensation, vested rights and benefits up
to the date of termination. In addition to Ms. Ropers employment agreement, SouthFirst, First
Federal, Pension & Benefit and Ms. Roper have entered into a guaranty of
employment agreement pursuant to which SouthFirst and First Federal have
guaranteed the performance of Pension & Benefit under the terms of the
employment agreement by and between Pension & Benefit and Ms. Roper. Deferred Compensation Agreements First Federal previously entered into deferred compensation agreements
(collectively, the Deferred Compensation Agreements) with each of Mr.
McArthur and Ms. Roper, pursuant to which each would receive certain retirement
benefits at age 65. Under the Deferred Compensation Agreements, benefits would
be payable for 15 years. A portion of the retirement benefits would accrue
each year until age 65 or, if sooner, until termination of employment. If Mr.
McArthur remains in the employment of First Federal until age 65, his annual
benefit will be $45,000. If Mr. McArthur dies prior to age 65, while in the
employment of First Federal, the full retirement benefits available under the
deferred compensation agreement will accrue and will, thereupon, be payable to
his beneficiaries. Similarly, if Ms. Roper remains in the employment of First
Federal until age 65, her annual benefit will be $30,000. If Ms. Roper dies
prior to age 65, while in the employment of First Federal, the full retirement
benefits available under the deferred compensation agreement will accrue and
will, thereupon, be payable to her beneficiaries. The retirement benefits available under the Deferred Compensation
Agreements are unfunded. However, First Federal has purchased life insurance
policies on the lives Mr. McArthur and Ms. Roper that will be available to
SouthFirst and First Federal to provide, both, for retirement benefits and for
key person insurance. The costs of these arrangements was $36,141 for each
of 2004, 2003 and 2002. Management Recognition Plans The SouthFirst Board of Directors has adopted two management recognition
plans (MRPs), denominated SouthFirst Bancshares, Inc. Management Recognition
Plan A (Plan A) and SouthFirst Bancshares, Inc. Management Recognition Plan
B (Plan B) (collectively, the MRP Plans). The objective of the MRP
Plans is to enable SouthFirst and First Federal to reward and retain personnel
of experience and ability in key positions of responsibility by providing such
personnel with a proprietary interest in SouthFirst and by recognizing their
past contributions to SouthFirst and First Federal, and to act as an incentive
to make such contributions in the future. Except for the fact that Plan B provides for awards only to employees of
SouthFirst and First Federal, while Plan A provides for awards to employees as
well as to non-employee directors of SouthFirst and First Federal, the terms of
the MRP Plans are the same. The MRP Plans are administered by a committee (the
Committee) of the SouthFirst Board of Directors. Awards under the MRP Plans
are in the form of restricted stock grants (MRP grants). Each MRP Plan has
reserved a total of 16,600 shares of SouthFirst Common Stock for issuance
pursuant to awards made by the Committee. Such shares, with respect to each
MRP Plan, are held in trust until awards are made by the Committee, at which
time the shares are distributed from the trust to the award recipient. Such
shares will bear restrictive legends until vested, as described below. The
Committee may make awards to eligible participants under the MRP Plans in its
discretion, from time to time. Under Plan A, on November 15, 1995, each
non-employee director, serving in such capacity on February 13, 1995 (the
effective date of the conversion of SouthFirst from a mutual to a stock form of
ownership), automatically received an award of 1,660 shares. In selecting the
employees to whom awards are granted under the MRP Plans, the Committee
considers the position, duties and responsibilities of the employees, the value
of their services to SouthFirst and First Federal and any other factors the
Committee may deem relevant. 62




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Awards under the MRP Plans vest at the rate of 20% per year, commencing on
the first anniversary of the date of the award. The Committee may, however,
from time to time and in its sole discretion, accelerate the vesting with
respect to any participant, if the Committee determines that such acceleration
is in the best interest of SouthFirst. If a participant terminates employment
for reasons other than death or disability, the participant forfeits all rights
to any shares which have not vested, including the dividends received with
respect to such non-vested shares. If the participants termination is caused
by death or disability, all shares become vested. Participants will recognize
compensation income on the date their interests vest, or at such earlier date
pursuant to a participants election to accelerate recognition pursuant to
Section 83(b) of the Code. During the year ended September 30, 2001, SouthFirst repurchased 11,525
shares of its Common Stock, which shares subsequently were designated MRP
shares. During 2002, 1,750 shares were issued to employees under MRP grants
and during 2004, 373 shares were cancelled, leaving 9,402 shares in trust at
September 30, 2004, which the Committee may issue in its sole discretion. Stock Option Plans The SouthFirst Board of Directors has adopted two stock option plans. The
first was adopted November 15, 1995 and is denominated the SouthFirst
Bancshares, Inc. Stock Option and Incentive Plan (the 1995 Plan), and the
second was adopted on January 28, 1998 and is denominated the 1998 Stock Option
and Incentive Plan (the 1998 Plan) (collectively, the Stock Option Plans).
The objective of each of the Stock Option Plans is to attract, retain, and
motivate the best possible personnel for positions of substantial
responsibility with SouthFirst and First Federal. In order to attract and
retain members of the Board of Directors of SouthFirst who contribute to
SouthFirsts success, each of the Stock Option Plans also provides for the
award of non-qualified stock options to non-employee directors of SouthFirst. The 1995 Plan authorizes the grant of up to 83,000 shares of Common Stock
to select officers and employees in the form of (i) incentive and non-qualified
stock options (Options) or (ii) Stock Appreciation Rights (SARs) (Options
and SARs are referred to herein collectively as Awards), as determined by the
committee administering the 1995 Plan. As of September 30, 1996, options to
purchase a total of 83,000 shares had been issued under the 1995 Stock Option
Plan, and, as of that date, no other shares were available for future issuance.
Subsequently, options to purchase 8,300 shares were exercised, which shares
are no longer available for issuance under the 1995 Plan; options to purchase
56,649 shares expired prior to being exercised, which shares then became
available for re-issuance under the 1995 Plan; and additional options to
purchase 55,649 shares were issued. Thus, at September 30, 2004, 1,000 shares
were available for issuance under the 1995 Plan. The 1998 Plan authorizes the grant of up to 63,361 shares of Common Stock
to select officers and employees in the form of (i) Options or (ii) SARs, all
of which shares were granted under the 1998 Plan. Subsequently, options to
purchase 38,450 shares expired prior to being exercised, which shares then
became available for re-issuance under the 1998 Plan, and additional options to
purchase 35,388 shares were issued. Thus, at September 30, 2004, 3,062 shares
were available for issuance under the 1998 Plan. The terms and conditions of the Stock Option Plans are substantially the
same. The exercise price for Options and SARs granted under the Stock Option
Plans may not be less than the fair market value of the shares on the day of
the grant, and no Awards shall be exercisable after the expiration of ten years
from the date of this grant. Each Stock Option Plan has a term of 10 years
unless earlier terminated by the SouthFirst Board of Directors. The Stock
Option Plans are administered by a committee of the directors of SouthFirst
(the Option Plan Committee). Except as discussed below with respect to
non-employee directors, the Option Plan Committee has complete discretion to
make Awards to persons eligible to participate in the Stock Option Plans, and
determines the number of shares to be subject to such Awards, and the terms and
conditions of such Awards. In selecting the persons to whom Awards are granted
under the Stock Option Plans, the Option Plan Committee considers the position,
duties, and responsibilities of the employees, the value of their services to
SouthFirst and First Federal, and any other factor the Option Plan Committee
may deem relevant to achieving the stated purpose of the Stock Option Plan. 63




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Options granted under the Stock Option Plans become exercisable at rates
ranging from 20% to 33% per year commencing one year from the date of grant,
with the exception that all options will become immediately exercisable in the
event the optionees employment is terminated due to the optionees death,
disability or retirement, or in the event of a change in control of First
Federal or SouthFirst, as such term is defined in the respective Stock Option
Plan. Under the 1995 Plan, all directors who were not employees of SouthFirst as
of November 15, 1995 (the date of the approval of the Stock Option Plan by the
stockholders of SouthFirst and the OTS), received non-qualified stock options
to purchase 4,150 shares, which options had an exercise price of $14.00 per
share, the fair market value of SouthFirst Common Stock on the date of grants.
Likewise, under the 1998 Plan, all directors who were not employees of
SouthFirst as of January 28, 1998 (the date of the approval of the Stock Option
Plan by the Board of Directors of SouthFirst) received non-qualified stock
options to purchase 2,700 shares, which options had an exercise price of $21.25
per share, the fair market value of SouthFirst Common Stock on the date of
grants. See also, Item 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT AND RELATED STOCKHOLDER MATTERS. Repricing of Stock Options under the Stock Option Plans On January 28, 1998, the Wage and Compensation Committee, acting on the
approval of the Board of Directors, granted incentive stock options to purchase
7,428 and 3,726 options to Joe K. McArthur and J. Malcomb Massey, respectively
(i.e., the Named Executive Officers at that time). Options to purchase an
aggregate of 50,597 shares were concurrently granted to approximately 19
non-executive employees of SouthFirst and/or First Federal and two former
executive officers. Such options were granted at an exercise price of $21.25
per share, which was equal to the fair market value of SouthFirsts Common
Stock on the date of grant. During the ensuing nine and one half months, the
market price of SouthFirsts Common Stock declined significantly to a point at
which such options no longer served the intended purpose for which they were
issued. In order to protect the intended value of the January 28, 1998
options, the Board of Directors elected to reprice all such options by the
cancellation of such options and the regrant of an equal number of new options
at the then current, lower market price. Such replacement options were granted
on November 4, 1998 at an exercise price of $15.75 per share, which was equal
to the fair market value of SouthFirsts Common Stock on the date of grants.
The following table provides, with respect to the Named Executive Officers, the
name of grantee, number of securities underlying the options repriced, the
original exercise price, the new exercise price, and the length of original
option term remaining after the repricing, as of September 30, 2004: Ten-Year Option/SAR Repricings Number ofSecurities
    
    
    
    
    
    
    
    
    
    Length of OriginalUnderlying
    
    
    
    
    
    
    
    
    
    Option TermOptions
    
    Original Exercise
    
    New Exercise Price
    
    Remaining at DateName
    
    Date
    
    Repriced(1)
    
    Price ($)
    
    ($)
    
    of RepricingJoe K. McArthur
    
    November 4, 1998
    
    
    7,428
    
    
    
    21.25
    
    
    
    15.75
    
    
    9.2 years(1998 Plan)J. Malcomb Massey
    
    November 4, 1998
    
    
    3,726
    
    
    
    21.25
    
    
    
    15.75
    
    
    9.2 years(1998 Plan)
  (1)
    
    The 1998 Plan authorizes the grant of up to 63,361 shares of Common Stock
to select officers and employees in the form of (i) Options or (ii) SARs,
all of which shares were granted under the 1998 Plan. Subsequently,
options to purchase 36,778 shares expired prior to being exercised, which
shares then became available for re-issuance under the 1998 Plan, and
additional options to purchase 35,388 shares were issued. Thus, at
September 30, 2004, 3,062 shares were available for issuance under the
1998 Plan. 64




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The following table provides certain information concerning the exercise
of stock options under SouthFirsts Stock Option Plans during the fiscal year
ended September 30, 2004, by the Named Executive Officers and the
fiscal-year-end value of unexercised options held by those individuals: Aggregated Option Exercises in Last Fiscal Year
and Fiscal Year-End Option Values Number of Securities
    
    Value ofUnderlying
    
    UnexercisedUnexercised Options
    
    In-the-Moneyat
    
    Options at FiscalShares
    
    
    
    
    
    Fiscal Year End
    
    Year EndAcquired
    
    Value
    
    Exercisable/
    
    Exercisable/Name
    
    on Exercise
    
    Realized
    
    Unexercisable
    
    Unexercisable(1)Joe K. McArthur
    
    
    0
    
    
    $
    0
    
    
    
    26,592 / 3,440
    
    
    $
    49,816 / $11,352J. Malcomb Massey
    
    
    0
    
    
    $
    0
    
    
    
    6,310/3,440
    
    
    $
    12,579 / $11,352Sandra H. Stephens
    
    
    0
    
    
    $
    0
    
    
    
    3,860/7,940
    
    
    $
    19,278 / $36,012Ruth M. Roper
    
    
    0
    
    
    $
    0
    
    
    
    3,354/1,560
    
    
    $
    6,734 / $5,148
   (1)
    
    Represents the value of unexercised, in-the-money stock options on
September 30, 2004, using the $15.40 closing price of SouthFirst Common
Stock on that date. Employee Retirement Savings Plan First Federal has established a savings and profit-sharing plan that
qualifies as a tax-deferred savings plan under Section 401(k) of the Internal
Revenue Code (the 401(k)Plan) for its employees who are at least 21 years
old and who have completed one year of service with First Federal. Under the
401(k) Plan, eligible employees may contribute up to $13,000 of their gross
salary to the plan. Currently, all contributions are fully vested under the
401(k) Plan at the time of contribution. Prior to April 1, 2003, all
contributions up to 3% by eligible employees were 100% matched. However, since
401(k) matching is discretionary, upon review by the board of directors,
effective April 1, 2003, all matching contributions were temporarily suspended.
The board of directors will review the 401(k) Plan on an annual basis and
implement any changes as appropriate. Employee Stock Ownership Plan First Federal has adopted an Employee Stock Ownership Plan (the ESOP)
for the exclusive benefit of participating employees. All employees of First
Federal who are at least 21 years old and who have completed a year of service
with First Federal are eligible to participate in the ESOP. SouthFirst loaned
the ESOP $664,000, which the ESOP used to purchase 66,400 shares of SouthFirst
Common Stock. This loan is secured by the shares purchased with the proceeds
of the loan. Shares purchased with the loan proceeds are held in a suspense
account for allocation among participants as the loan is repaid. All loan
proceeds had been repaid at September 30, 2004. Contributions to the ESOP were used to repay the ESOP loan. Shares
released from the suspense account, as the ESOP loan was repaid, any
contributions to the ESOP that were not used to repay the ESOP loan, and
forfeitures will be allocated among participants on the basis of their relative
compensation. With the exception of terminations due to death, disability or
retirement, a participant must be employed by First Federal on the last day of
the ESOP plan year and must have completed 1,000 hours of service during the
plan year in order to share in the allocation for the plan year. Any dividends
paid on unallocated shares of SouthFirst Common Stock were 65




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##### Table of Contents



used to repay the ESOP loan; any dividends paid on shares of SouthFirst
Common Stock allocated to participant accounts will be credited to said
accounts. Benefits under the ESOP vest at a rate of 20% per year of service, with
the first 20% vesting after a participant has served for two years.
Participants benefits also become fully vested upon his or her death,
disability, attainment of normal retirement age, or the termination of the
ESOP. For vesting purposes, a year of service means any plan year in which an
employee completes at least 1,000 hours of service with First Federal. An
employees years of service prior to the ESOPs effective date will be
considered for purposes of determining vesting under the ESOP. A participant who separates from service because of death, disability or
retirement will be entitled to receive an immediate distribution of his or her
benefits. A participant who separates from service for any other reason and
who is not reemployed by an employer will receive a lump sum distribution of
the vested portion of his account as soon as administratively feasible after
his date of termination, unless the participant elects a later distribution.
Distributions generally will be made in whole shares of SouthFirst Common
Stock, with the value of fractional shares being paid in cash. Although
accounts generally will be distributed in a lump sum, if the fair market value
of a participants account is in excess of $500,000, as of the date
distribution is required to begin, distributions will be made in substantially
equal annual payments over a period not longer than five (5) years, plus an
additional one (1) year (up to an additional five (5) years) for each $100,000
increment, or fraction of such increment, by which the value of the
participants account exceeds $500,000. Pension & Benefit serves as the plan administrator and trustee of the ESOP
(the ESOP Trustee). Participants may vote the shares of SouthFirst Common
Stock that are allocated to their account. Any unallocated shares of
SouthFirst Common Stock and allocated shares of SouthFirst Common Stock for
which no timely direction is received are voted by the ESOP Trustee in
accordance with its fiduciary obligations. Dividend Incentive Plan SouthFirst, in November 1995, adopted, by resolution of the Board of
Directors of SouthFirst, a dividend incentive plan (the Dividend Incentive
Plan), pursuant to which each director and/or employee in the SouthFirst
family, who holds options to purchase SouthFirst Common Stock under the Stock
Option Plans, is paid an amount equal to the number of shares underlying the
stock options held by him or her, multiplied by the amount of dividends
SouthFirst pays to the holders of its Common Stock. If the service of an
employee or director is terminated prior to the full vesting of his or her
stock options, then the employee or director immediately forfeits, and must
repay to SouthFirst, all amounts received under the Dividend Incentive Plan
with respect to the non-vested options. Compensation of Directors Director Fees and Dividends Each member of the First Federal Board of Directors, with the exception of
the Chairman of the Board, receives a fee of $1,000 which covers any and all
necessary board meetings occurring during any given month (with one excused
absence). The Chairman of the Board receives a fee of $1,500 for each board
meeting attended. Each non-employee director of First Federal, if a member of
a committee, receives $300 for each committee meeting attended. The members of
the SouthFirst Board of Directors receive a fee in the amount of $750 for each
board meeting attended. During fiscal 2004, each non-employee director was paid from $3,414 to
$7,524 under the Dividend Incentive Plan with respect to the shares of Common
Stock underlying the stock options held by each non-employee director.
Further, certain SouthFirst directors, during fiscal 2004, received a cash
dividend in the amount of $996 with respect to the restricted shares held by
such directors, as granted under Management Recognition Plans A and B. 66




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Director Retirement Benefits The Board of Directors of First Federal has adopted, effective as of
October 1, 2001, the Bank Director Supplemental Retirement Plan (the Director
Plan), under which First Federal will make certain payments to each
participating director, upon the directors retirement, or to the directors
beneficiary(ies) in the event of the directors death. The Director Plan is an
unfunded arrangement maintained primarily to provide supplemental retirement
benefits for each participating director and constitutes a non-qualified
benefit plan for purposes of the Employee Retirement Income Security Act of
1974, as amended (ERISA). A pre-retirement account is established under
the Director Plan, as a liability reserve account on the books of First Federal
for the benefit of each participating director. Such liability reserve account
shall be increased or decreased each plan year, until the participating
director either retires, or has a termination of service, as a director of
First Federal. The annual increase or decrease in this liability reserve account is
determined by an index which, generally, measures the amount of aggregate
annual after-tax income from certain life insurance contracts, owned by First
Federal on the lives of each participating director, against the annual cost of
funds of First Federal represented by the net premiums paid on these life
insurance policies. Each participating director of First Federal will receive,
on a monthly basis beginning at retirement or termination of service, as a
supplemental retirement benefit, the amount attributed to their liability
service account, adjusted, as applicable, under the terms of the Director Plan.
The cost of the Director Plan was $26,073 and $33,869 for fiscal years 2004
and 2003, respectively. However, no benefits were paid under the Director Plan
in fiscal year 2004 or 2003. Compensation Committee Interlocks and Insider Participation SouthFirst presently does not have a compensation committee because,
except for an annual salary, in the amount of $20,000, paid by SouthFirst to
its President, J. Malcomb Massey, no officers of SouthFirst receive any
compensation for services to SouthFirst. All officers of SouthFirst are
compensated by First Federal solely for their services to First Federal. In
addition, directors are paid for attendance at First Federal committee
meetings, but employee members of committees are not paid. Joe K. McArthur,
Chief Executive Officer of First Federal and SouthFirst, and President of First
Federal, and J. Malcomb Massey, President of SouthFirst and Pension & Benefit,
serve as members of the Wage and Compensation Committee of First Federal.
First Federals Wage and Compensation Committee is responsible for reviewing
salaries and benefits of directors, officers, and employees of First Federal.
SouthFirst had no interlocking relationships existing at or before the year
ended September 30, 2004 in which (i) any executive officer was a member of the
board of directors/trustees of another entity, one of whose executive officers
was a member of the First Federal Board of Directors, or where (ii) any
executive officer was a member of the compensation committee of another entity,
one of whose executive officers was a member of the First Federal Board of
Directors. 
 ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS The following table sets forth certain information as of December 9, 2004
with respect to the beneficial ownership of SouthFirsts Common Stock by (i)
each person known by SouthFirst to own beneficially more than five percent (5%)
of SouthFirst Common Stock, (ii) each director of SouthFirst, (iii) each of the
Named Executive Officers (as defined herein) and (iv) all directors and
executive officers of SouthFirst as a group. Unless otherwise indicated, each
of the stockholders has sole voting and investment power with respect to the
shares beneficially owned. 67




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##### Table of Contents



Shares ofCommon Stock
    
    Percent ofBeneficially
    
    OutstandingBeneficial Owner
    
    Owned(1)
    
    Shares(2)Joe K. McArthur(3)
    
    
    40,541
    
    
    
    5.5
    %471 Alta Vista Dr.
Chelsea, AL 35043H. David Foote, Jr.(4)
    
    
    16,113
    
    
    
    2.2
    %2517 Overhill Rd.
Sylacauga, AL 35150J. Malcomb Massey(5)
    
    
    31,174
    
    
    
    4.4
    %8318 Longneedle, Dr.
Montgomery, AL 36117Allen Gray McMillan, III(6)
    
    
    21,613
    
    
    
    3.0
    %One Gunston Ave.
Talladega, AL 35160Kenneth E. Easterling(7)
    
    
    27,903
    
    
    
    3.9
    %4141 Co. Road 85
Clanton, AL 35045L. Neal Bice(8)
    
    
    33,484
    
    
    
    4.7
    %304 Eastwood Dr.
Clanton, AL 35045Donald R. Hardy(9)
    
    
    3,303
    
    
    
    0.5
    %130 Stone Ridge Dr.
Sylacauga, AL 35150Jeffrey L. Gendell, et. al.(10)
    
    
    62,800
    
    
    
    8.9
    %55 Railroad
Ave., 3rd Floor
Greenwich, CT 06830Robert J. Salmon and Mary Anne J. Salmon(11)
    
    
    47,600
    
    
    
    6.7
    %3623 Raymond St.
Chevy Chase, MD 20815Sandra H. Stephens(12)
    
    
    7,163
    
    
    
    1.0
    %4004 Charring Cross Lane
Hoover, AL 35226Ruth M. Roper(13)
    
    
    12,622
    
    
    
    1.8
    %1111 Buck Ridge Rd
Wetumpka, AL 36093Pension & Benefit Financial Services, Inc.(14)
    
    
    37,510
    
    
    
    5.3
    %260 Commerce
St., 3rd Floor
Montgomery, AL 36101All directors and executive officers as a group (9 persons)
    
    
    193,916
    (15)
    
    
    24.6
    %
   (1)
    
    Beneficial Ownership includes shares for which an individual, directly
or indirectly, has or shares voting or investment power or both and also
includes options which are exercisable within sixty days of the date
hereof. Beneficial ownership as reported in the above table has been
determined in accordance with Rule 13d-3 of the Exchange Act. 68




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(2)
    
    The percentages are based upon 709,406 shares outstanding, except for certain parties who hold presently
exercisable options to purchase shares. The percentages for those parties holding presently exercisable options
are based upon the sum of 709,406 shares plus the number of shares subject to presently exercisable options held by
them, as indicated in the following notes.(3)
    
    Of the amount shown, 5,781 shares are held in Mr. McArthurs account under SouthFirsts 401(k) Plan, 7,064 shares
are held in his account under First Federals ESOP, 27,452 shares are subject to presently exercisable options and
244 shares represent restricted stock granted under SouthFirsts Management Recognition Plans A and B, all of
which are fully vested.(4)
    
    Of the amount shown, 3,000 shares are owned jointly by Mr. Foote and his wife, 1,500 shares are held by Mr. Foote
as custodian for each of his two minor children, 9,953 shares are subject to presently exercisable options and
1,660 shares represent restricted stock granted under SouthFirsts Management Recognition Plan A, all of which
are fully vested.(5)
    
    Of the amount shown, 15,521 shares are restricted stock acquired pursuant to that certain employment agreement
between Mr. Massey and Pension & Benefit, vesting in equal increments over a period of 15 years beginning on April
11, 1997, 3,782 shares are held in his account under SouthFirsts 401(k) plan, 2,642 shares are held in an
Individual Retirement Account, 2,059 shares are held in his account under First Federals ESOP, and 7,170 shares
are subject to exercisable options.(6)
    
    Of the amount shown, 10,000 shares are held jointly by Mr. McMillan and his wife, 9,953 shares are subject to
presently exercisable options and 1,660 shares represent restricted stock granted under SouthFirsts Management
Recognition Plan A, all of which are fully vested.(7)
    
    Of the amount shown, 21,099 shares are held jointly by Mr. Easterling and his wife, 1,001 shares are held
individually by Mr. Easterling and 5,803 shares are subject to exercisable options.(8)
    
    Of the amount shown, 27,681 are held individually by Mr. Bice and 5,803 shares are subject to exercisable options.(9)
    
    Of the amount shown, 200 shares are held jointly by Mr. Hardy and his wife and 3,103 shares are subject to
exercisable options.(10)
    
    Of the amount shown, Jeffrey L. Gendell has shared voting power with respect to 62,800 shares, Tontine Management,
L.L.C. (TM) has shared voting power with respect to 62,800 shares, and Tontine Financial Partners, L.P. (TFP)
has shared voting power with respect to 62,800 shares. TM, the general partner of TFP, has the power to direct the
affairs of TFP. Mr. Gendell is the Managing Member of Tontine Management, L.L.C. and, in that capacity, directs
its operations. The business address of Mr. Gendell and TFP is 237 Park Avenue, 9th Floor, New York, New
York 10017. The foregoing information is based on a Schedule 13F, dated November 12, 2004 filed by Mr. Gendell,
TM, and TFP. SouthFirst makes no representation as to the accuracy or completeness of the information reported.(11)
    
    Robert J. Salmon and Mary Anne J. Salmon beneficially own and have shared voting and dispositive power with respect
to 47,600 shares. The foregoing information is based on a Schedule 13G, dated October 8, 1998 received by
SouthFirst from Mr. and Mrs. Salmon. SouthFirst makes no representation as to the accuracy or completeness of the
information reported therein.(12)
    
    Of the amount shown, 6,220 shares are subject to presently exercisable options, 243 shares are held in her
account under First Federals ESOP, and 700 shares represent restricted stock granted under SouthFirsts Management
Recognition Plan(s), all of which shares are fully vested.(13)
    
    Of the amount shown, 1,914 shares are owned jointly by Ms. Roper and her husband, 5,623 shares are restricted stock
acquired pursuant to that certain employment agreement between Ms. Roper and Pension & Benefit, vesting in equal
increments over a period of 15 years beginning on April 11, 1997, 1,341 shares are held in her account in First
Federals ESOP, and 3,744 shares are subject to presently exercisable options.(14)
    
    These shares are held in trust by Pension & Benefit as trustee of First Federals ESOP. See Item 10. EXECUTIVE
COMPENSATION  Employee Stock Ownership Plan.(15)
    
    Of the amount shown, 79,201 shares are subject to exercisable options. 69




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##### Table of Contents



There are no arrangements known to SouthFirst pursuant to which a change
in control of SouthFirst would result. The following table provides information with respect to shares of
SouthFirst Common Stock authorized for issuance under equity compensation
plans: Equity Compensation Plan Information (1) Number of securitiesremaining available forNumber of securities
    
    Weighted-average
    
    future issuance underto be issued upon exercise
    
    exercise price of
    
    equity compensation plansof outstanding options,
    
    outstanding options,
    
    (excluding securitieswarrants and rights
    
    warrants and rights
    
    reflected in column (a))Plan category
    
    (a)
    
    (b)
    
    (c)Equity compensation
plans approved by
security holders
(2)
    
    
    133,999
    
    
    $
    12.84
    
    
    
    4,062Equity compensation
plans not approved
by security holders
    
    
    0
    
    
    $
    0
    
    
    
    0
   (1)
    
    The term equity compensation plan, as used in this table, refers
to compensation plans and individual compensation arrangements for employees
and directors of the Company and its affiliates, which authorize the issuance
of equity securities of the Company, excluding all compensation plans and
arrangements which meet the qualification requirements under Section 401(a) of
the Code.(2)
    
    Includes the SouthFirst Bancshares, Inc. Stock Option and
Incentive Plan, the 1998 Stock Option and Incentive Plan, the
SouthFirst Bancshares, Inc. Management Recognition Plan A and
the SouthFirst Bancshares, Inc. Management Recognition Plan
B. See, also, Item 10. EXECUTIVE COMPENSATION  Management
Recognition Plans, and  Stock Option Plans. 
 ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS First Federal, like many financial institutions, has followed a policy of
granting various types of loans to officers, directors and employees. The
loans have been made in the ordinary course of business and on substantially
the same terms, including interest rates and collateral, as those prevailing at
the time for comparable transactions with First Federals other customers, and
do not involve more than the normal risk of collectibility, nor present other
unfavorable features. All loans by First Federal to its officers and executive
officers are subject to OTS regulations restricting loans and other
transactions with affiliated persons of First Federal. In addition, all future
credit transactions with such directors, officers and related interests of
SouthFirst and First Federal will be on substantially the same terms as, and
following credit underwriting procedures that are not less stringent than those
prevailing at the time for comparable transactions with unaffiliated persons
and must be approved by a majority of the directors of SouthFirst, including a
majority of the disinterested directors. At September 30, 2004, the aggregate
of all loans by First Federal to its officers, directors, and related interests
was $739,000. 70




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ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K  (a)
    
    The following documents are filed as part of this report:  (1)
    
    Financial Statements The following financial statements are included as part of this Form 10KSB
following the signature page of this Form 10KSB. Report of Independent Registered Public Accounting Firm of Jones &
Kirkpatrick, P.C.Consolidated Statements of Financial Condition as of
September 30, 2004 and 2003Consolidated Statements of Operations for the years ended
September 30, 2004, 2003 and 2002Consolidated Statements of Stockholders Equity for the years ended
September 30, 2004, 2003 and 2002Consolidated Statements of Cash Flows for the years ended
September 30, 2004, 2003 and 2002Notes to Consolidated Financial Statements
  (2)
    
    Exhibits The following exhibits are filed with or incorporated by reference into
this report. The exhibits which are denominated by an asterisk (*) were
previously filed with the SEC as a part of, and are hereby incorporated by
reference from, SouthFirsts: Registration Statement on Form S-1 under the
Securities Act of 1933 Registration No. 33-80730 (1994 S-1); Registration
Statement on Form S-8 under the Securities Act of 1933, Registration No.
333-4534 (Plan A S-8); Registration Statement on From S-8 under the
Securities Act of 1933, Registration No. 333-4536 (Plan B S-8);
Registration Statement on Form S-8, Registration No. 333-4538 (Option Plan
S-8); Registration Statement on Form S-8, Registration No. 333-85705 (Amended
Option Plan S-8); Annual Report on Form 10-K for the year ended September 30,
1995 (1995 10-K); Annual Report on Form 10-K for the year ended September 30,
1998 (1998 Form 10-K); Annual Report on Form 10-KSB for the year ended
September 30, 2001 (2001 Form 10-KSB); Annual Report on Form 10-KSB for the
year ended September 30, 2002 (2002 Form 10-KSB); Annual Report on Form
10-KSB for the year ended September 30, 2003 (2003 Form 10-KSB); Other Event
on Form 8-K, filed on March 29, 2002 (March 29, 2002 Form 8-K); Quarterly
Report on Form 10-QSB for the period ended December 31, 2001 (December 31,
2001 10-QSB); Other Event on Form 8-K, filed on July 2, 2002 (July 2, 2002
Form 8-K); Other Event on Form 8-K, filed on December 9, 2004 (December 9,
2004 Form 8-K). Unless otherwise indicated, the exhibit number corresponds to
the exhibit number in the referenced document. Exhibit No.
    
    Description of Exhibit3.1*
    
    Amended and Restated Certificate of Incorporation (1994 S-1).3.2*
    
    Bylaws (1994 S-1, Exhibit 3.2).3.3*
    
    Amendment to Article III, Section 2 of the Bylaws (2002 Form 10-KSB).4*
    
    Form of Common Stock Certificate (1994 S-1).10.1*
    
    Form of Employment Agreement between SouthFirst
Bancshares, Inc. and Joe K. McArthur (2001 Form 10-KSB).10.2*
    
    Form of Amended and Restated Employment Agreement
effective as of October 1, 2003 between First Federal of the South
and Joe K. McArthur (2003 Form 10-KSB).
 71




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##### Table of Contents



Exhibit No.
    
    Description of Exhibit10.3*
    
    Form of Amended and Restated Employment Agreement
effective as of October 1, 2003 between First Federal of the South
and Sandra H. Stephens (2003 Form 10-KSB).10.4*
    
    Form of Amended and Restated Employment Agreement
effective as of October 1, 2003 between Pension & Benefit Financial
Services, Inc. and J. Malcomb Massey (2003 Form 10-KSB).10.5*
    
    Form of Guaranty of Employment Agreement among SouthFirst
Bancshares, Inc., First Federal of the South, Pension & Benefit
Financial Services, Inc. and J. Malcomb Massey (2001 Form 10-KSB,
Exhibit 10.4.2).10.6*
    
    Form of Amended and Restated Employment Agreement
effective as of October 1, 2003 between Pension & Benefit Financial
Services, Inc. and Ruth M. Roper (2003 Form 10-KSB).10.7*
    
    Form of Guaranty of Employment Agreement among SouthFirst
Bancshares, Inc., First Federal of the South, Pension & Benefit
Financial Services, Inc. and Ruth M. Roper (2001 Form 10-KSB,
Exhibit 10.5.2).10.8*
    
    Form of Management Recognition Plan A (1994 S-1, Exhibit 10.5).10.9 *
    
    Form of Management Recognition Plan A, as amended (1995
Form 10-K, Exhibit 10.8.2).10.10*
    
    Management Recognition Plan A Restated and Continued (Plan A S-8, Exhibit 4.1).10.11*
    
    Form of Management Recognition Plan B (1994 S-1, Exhibit 10.6).10.12*
    
    Form of Management Recognition Plan B, as amended (1995 Form
10-K, Exhibit 10.9.2).10.13*
    
    Management Recognition Plan B, Restated and Continued (Plan B
S-8, Exhibit 4.1).10.14*
    
    Form of Stock Option and Incentive Plan (1994 S-1, Exhibit 10.7)
(1995 Form 10-K, Exhibit 10.10.1).10.15*
    
    Form of Stock Option and Incentive Plan, as amended (1995 Form
10-K, Exhibit 10.10.2).10.16 *
    
    From of Stock Option and Incentive Plan, Restated and
Continued (Option Plan S-8, Exhibit 4.1).10.17*
    
    Form of Stock Option and Incentive Plan, as Amended (Amended
Option Plan S-8, Exhibit 10.10.4).10.18*
    
    Form of Incentive Stock Option Agreement (Option Plan S-8,
Exhibit 4.2).10.19*
    
    Form of Incentive Stock Option Agreement, as Amended (Amended
Option Plan S-8, Exhibit 10.10.6)10.20 *
    
    Form of SouthFirst Bancshares, Inc. Employee Stock
Ownership Plan (1994 S-1, Exhibit 10.8).
 72




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##### Table of Contents



Exhibit No.
    
    Description of Exhibit10.21*
    
    Third Amendment to the SouthFirst Bancshares, Inc. Employee Stock
Ownership Plan executed as of September 29, 2001 (2001 Form
10-KSB, Exhibit 10.11.2).10.22*
    
    Deferred Compensation Agreement between First Federal of the
South and Joe K. McArthur (1995 Form 10-K, Exhibit 10.12).10.23*
    
    Deferred Compensation Agreement between Pension & Benefit and
Ruth M. Roper (2001 Form 10-KSB, Exhibit 10.14).10.24*
    
    Stock Option Agreement between SouthFirst Bancshares, Inc. and
Sandra H. Stephens (December 31, 2001 10-QSB, Exhibit 10.16).10.25*
    
    Supervisory Agreement dated March 22, 2002, by and between First Federal of the
South and the Office of Thrift Supervision (March 29, 2002 Form 8-K, Exhibit 99.1).10.26*
    
    Form of Settlement Agreement dated June 28, 2002, by and between First Federal
of the South and Charles R. Vawter, Jr., Charles R. Vawter, Sr., Vawter Properties
& Resources, LP, Angela H. Vawter and Automatic Gas &
Appliance Co., Inc. (July 2, 2002 Form 8-K, Exhibit 99.1).10.27*
    
    Letter from the Office of Thrift Supervision dated December 14,
2004 rescinding Supervisory Agreement dated March 22, 2002, by and
between First Federal of the South and the Office of Thrift
Supervision as of December 14, 2004 (December 9, 2004 Form 8-K,
Exhibit 99.1).11
    
    Statement Regarding Computation of Per Share Earnings.14*
    
    Code of Ethics for Principal Executive Officers and Senior
Financial Officers (2003 Form 10-KSB)21
    
    Subsidiaries of Registrant.23.1
    
    Consent of Jones & Kirkpatrick, P.C.31.1
    
    Rule 13a  14a Certification of the Chief Executive Officer31.2
    
    Rule 13a  14a Certification of the Controller (Chief Financial Officer)32.1
    
    Written Statement of the Chief Executive Officer, Pursuant to 18
U.S.C. Section 135032.2
    
    Written Statement of the Chief Financial Officer, Pursuant to 18
U.S.C. Section 1350
  (b)
    
    Reports on Form 8-K during the fourth quarter SouthFirst filed a report on Form 8-K on December 9, 2004 announcing that
the Office of Thrift Supervision has agrees to rescind the Supervisory
Agreement dated March 22, 2002, by and between First Federal of the South and
the Office of Thrift Supervision, effective as December 14, 2004. 73




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ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES Fees billed by our independent accounting firm, Jones & Kirkpatrick, P.C.,
for audit services, SEC compliance reviews and tax preparation services for the
SouthFirst were as follows, for the fiscal years ending September 30, 2004 and
2003: Audit
    
    Audit-Related
    
    Tax
    
    Other
    
    TotalFees
    
    Fees(1)
    
    Fees(2)
    
    Fees (3)
    
    FeesFiscal Year 2004
    
    $
    109,685
    
    
    $
    29,550
    
    
    $
    10,100
    
    
    $
    
    
    
    $
    149,335Fiscal Year 2003
    
    $
    91,988
    
    
    $
    24,862
    
    
    $
    10,190
    
    
    $
    2,470
    
    
    $
    129,510
  (1)
    
    Audit related fees are for SEC compliance reviews of Form 10-QSB.  (2)
    
    Tax fees are for preparation of federal and state income tax returns.  (3)
    
    Other Fees included primarily assistance with OTS accounting
consultation. No financial information
systems implementation or design services were rendered by Jones &
Kirkpatrick, P.C. during fiscal year
2004 or 2003. In addition to the foregoing, Jones & Kirkpatrick, P.C., performed audit
services and tax preparation services for Pension & Benefit and was paid as
follows: Audit
    
    Tax
    
    TotalFees
    
    Fees
    
    FeesFiscal Year 2004
    
    $
    9,000
    
    
    $
    185
    
    
    $
    9,185Fiscal Year 2003
    
    $
    5,500
    
    
    $
    185
    
    
    $
    8,685
 Effective May 6, 2003, the Securities and Exchange Commission adopted
rules that require that before our independent auditor is engaged by us to
render any auditing or permitted non-audit related service, the engagement be:  
    
    approved by our audit committee; or  
    
    entered into pursuant to pre-approval policies and procedures
established by the audit committee, provided the policies and
procedures are detailed as to the particular service, the audit
committee is informed of each service, and such policies and
procedures do not include delegation of the audit committees
responsibilities to management. The audit committee pre-approves all services provided by our independent
auditors, including those set forth above. The audit committee has considered
the nature and amount of fees billed by Jones & Kirkpatrick, P.C. and believes
that the provision of services for activities unrelated to the audit is
compatible with maintaining Jones & Kirkpatrick, P.C.s independence. [signatures on following page] 74




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##### Table of Contents



SIGNATURES In accordance with Section 13 or 15(d) of the Exchange Act, the registrant
caused this report to be signed on its behalf by the undersigned, thereunto
duly authorized, in the City of Sylacauga, State of Alabama, on the 29th
day of December 2004. SOUTHFIRST BANCSHARES, INC.By:
    
    /s/ Joe K. McArthurJoe K. McArthurChief Executive Officer
 In accordance with the Exchange Act, this report has been signed below by
the following persons on behalf of the registrant and in the capacities and on
the dates indicated. Signature
    
    Title
    
    Date/s/ Joe K. McArthur
    
    Chief Executive Officer &Director (principal executiveJoe K. McArthur
    
    officer)
    
    December 29, 2004/s/ Sandra H. Stephens
    
    Executive Vice President,Chief Operating Officer,Sandra H. Stephens
    
    Secretary & Director
    
    December 29, 2004/s/ Janice Browning
    
    Controller, Treasurer(Principal AccountingJanice Browning
    
    Officer)
    
    December 29, 2004/s/ Allen Gray McMillan, III
    
    Chairman and Director
    
    December 29, 2004Allen Gray McMillan, III/s/ J. Malcomb Massey
    
    President and Director
    
    December 29, 2004J. Malcomb Massey/s/ Kenneth E. Easterling
    
    Director
    
    December 29, 2004Kenneth E. Easterling/s/ H. David Foote, Jr.
    
    Director
    
    December 29, 2004H. David Foote, Jr./s/ L. Neal Bice
    
    Director
    
    December 29, 2004L. Neal Bice/s/ Donald R. Hardy
    
    Director
    
    December 29, 2004Donald R. Hardy
 75




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##### Table of Contents



Exhibit Index Exhibit No.
    
    Description of Exhibit11
    
    Statement Regarding Computation of Per Share Earnings.21
    
    Subsidiaries of Registrant.23.1
    
    Consent of Jones & Kirkpatrick, P.C.31.1
    
    Rule 13a  14a Certification of the Chief Executive Officer31.2
    
    Rule 13a  14a Certification of the Controller (Chief Financial Officer)32.1
    
    Written Statement of the Chief Executive Officer, Pursuant to 18
U.S.C. Section 135032.2
    
    Written Statement of the Chief Financial Officer, Pursuant to 18
U.S.C. Section 13
 76




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##### Table of Contents



REPORT OF INDEPENDENT REGISTERED
PUBLIC ACCOUNTING FIRM November 10, 2004, except for Note 13, as to which the date is December 14,
2004 Board of Directors
SouthFirst Bancshares, Inc.
Sylacauga, Alabama We have audited the accompanying consolidated statements of financial condition
of SouthFirst Bancshares, Inc. (a Delaware corporation) and subsidiaries (the
Company) as of September 30, 2004 and 2003, and the related consolidated
statements of operations, stockholders equity, and cash flows for each of the
three years in the period ended September 30, 2004. 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 the standards of the Public Company
Accounting Oversight Board (United States). 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 SouthFirst
Bancshares, Inc. and subsidiaries as of September 30, 2004 and 2003, and the
consolidated results of their operations and their cash flows for each of the
three years in the period ended September 30, 2004, in conformity with
accounting principles generally accepted in the United States of America. As discussed in Note 1 to the consolidated financial statements, on October 1,
2002 the Company adopted the provisions of Statement of Financial Accounting
Standards No. 142, Goodwill and Other Intangible Assets. /s/ Jones & Kirkpatrick, P.C.
Certified Public Accountants
Birmingham, Alabama




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##### Table of Contents



SOUTHFIRST BANCSHARES, INC.
AND SUBSIDIARIES Consolidated Statements of Financial Condition
September 30, 2004 and 2003 2004
    
    2003ASSETSCash and cash equivalents
    
    $
    5,015,108
    
    
    $
    6,049,325Interest-bearing deposits in other financial institutions
    
    
    713,807
    
    
    
    533,003Securities available for sale, at fair value
    
    
    14,180,243
    
    
    
    32,599,988Securities held to maturity (fair value of $15,674,973)
    
    
    15,081,723
    
    
    
    Loans receivable, net of allowance for loan losses of
$911,964 in 2004 and $1,191,033 in 2003
    
    
    94,574,236
    
    
    
    84,382,703Loans held for sale at cost (which approximates fair value)
    
    
    1,092,619
    
    
    
    1,107,805Foreclosed assets, net
    
    
    514,507
    
    
    
    77,680Premises and equipment, net
    
    
    4,796,390
    
    
    
    4,298,889Federal Home Loan Bank stock, at cost
    
    
    1,117,000
    
    
    
    1,117,000Goodwill
    
    
    543,706
    
    
    
    543,706Accrued interest receivable
    
    
    625,639
    
    
    
    679,402Other assets
    
    
    3,278,179
    
    
    
    2,264,952Total Assets
    
    $
    141,533,157
    
    
    $
    133,654,453LIABILITIES AND STOCKHOLDERS EQUITYLiabilities:Deposits:Non-interest bearing
    
    $
    4,003,251
    
    
    $
    3,657,079Interest bearing
    
    
    93,789,575
    
    
    
    89,900,902Total deposits
    
    
    97,792,826
    
    
    
    93,557,981Advances by borrowers for property taxes and insurance
    
    
    259,427
    
    
    
    213,042Accrued interest payable
    
    
    458,017
    
    
    
    576,676Borrowed funds
    
    
    31,588,773
    
    
    
    27,000,861Accrued expenses and other liabilities
    
    
    1,078,510
    
    
    
    628,522Total liabilities
    
    
    131,177,553
    
    
    
    121,977,082Stockholders equity:Common stock, $.01 par value, 2,000,000 shares authorized;
990,241 shares issued and 709,406 shares outstanding in 2004;
989,868 shares issued and 713,944 shares outstanding in 2003;
    
    
    9,996
    
    
    
    9,996Additional paid-in capital
    
    
    9,838,965
    
    
    
    9,837,058Treasury stock, at cost (280,835 shares in 2004; 275,924 shares in 2003)
    
    
    (3,891,155
    )
    
    
    (3,809,839
    )Deferred compensation on common stock employee benefit plans
    
    
    (159,427
    )
    
    
    (183,179
    )Shares held in trust, at cost (9,402 shares in 2004 and 9,775 shares in 2003)
    
    
    (103,483
    )
    
    
    (107,161
    )Retained earnings
    
    
    5,195,161
    
    
    
    6,148,255Accumulated other comprehensive income (loss)
    
    
    (534,453
    )
    
    
    (217,759
    )Total stockholders equity
    
    
    10,355,604
    
    
    
    11,677,371Total Liabilities and Stockholders equity
    
    $
    141,533,157
    
    
    $
    133,654,453
 See accompanying notes to consolidated financial statements. 2




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##### Table of Contents



SOUTHFIRST BANCSHARES, INC.
AND SUBSIDIARIES Consolidated Statements of Operations
Years Ended September 30, 2004, 2003 and 2002 2004
    
    2003
    
    2002Interest and dividend income:Interest and fees on loans
    
    $
    5,435,692
    
    
    $
    5,948,317
    
    
    $
    6,827,657Interest and dividend income
on securities
available for sale
    
    
    1,302,001
    
    
    
    1,397,105
    
    
    
    1,600,346Interest and dividend income
on securities
held to maturity
    
    
    345,472
    
    
    
    
    
    
    
    Other interest income
    
    
    37,776
    
    
    
    91,223
    
    
    
    99,189Total interest and dividend
income
    
    
    7,120,941
    
    
    
    7,436,645
    
    
    
    8,527,192Interest expense:Interest on deposits
    
    
    1,734,850
    
    
    
    2,520,828
    
    
    
    3,490,715Interest on borrowed funds
    
    
    1,077,477
    
    
    
    1,023,365
    
    
    
    1,239,081Total interest expense
    
    
    2,812,327
    
    
    
    3,544,193
    
    
    
    4,729,796Net interest income
    
    
    4,308,614
    
    
    
    3,892,452
    
    
    
    3,797,396Provision for loan losses (benefit)
    
    
    1,356,937
    
    
    
    549,603
    
    
    
    (667,650
    )Net interest income after
provision for loan losses
    
    
    2,951,677
    
    
    
    3,342,849
    
    
    
    4,465,046Other income:Service charges and other fees
    
    
    546,035
    
    
    
    568,701
    
    
    
    447,728Employee benefit trust and
consulting fees
    
    
    1,582,057
    
    
    
    1,231,622
    
    
    
    1,172,628Gain on sale of loans
    
    
    719,389
    
    
    
    1,170,453
    
    
    
    611,971Gain on sales and calls of
securities
available-for-sale
    
    
    83,614
    
    
    
    238,291
    
    
    
    236,414Gain on sale of premises and
equipment
    
    
    927
    
    
    
    7,759
    
    
    
    162Insurance benefits in excess
of related compensation costs
    
    
    
    
    
    
    
    
    
    
    186,727Net premium on transfer of
deposits
    
    
    
    
    
    
    249,769
    
    
    
    Other
    
    
    307,491
    
    
    
    275,149
    
    
    
    377,824Total other income
    
    
    3,239,513
    
    
    
    3,741,744
    
    
    
    3,033,454
 (Continued) See accompanying notes to consolidated financial statements. 3




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##### Table of Contents



SOUTHFIRST BANCSHARES, INC.
AND SUBSIDIARIES Consolidated Statements of Operations (Continued)
Years Ended September 30, 2004, 2003 and 2002 2004
    
    2003
    
    2002Other expenses:Compensation and benefits
    
    $
    4,331,282
    
    
    $
    4,279,501
    
    
    $
    3,635,805Net occupancy expense
    
    
    419,776
    
    
    
    392,354
    
    
    
    358,244Furniture and fixtures
    
    
    505,295
    
    
    
    451,577
    
    
    
    459,314Data processing
    
    
    382,885
    
    
    
    259,685
    
    
    
    317,093Office supplies and expenses
    
    
    442,189
    
    
    
    436,677
    
    
    
    420,272Deposit insurance premiums
    
    
    102,938
    
    
    
    107,706
    
    
    
    85,610Legal expenses
    
    
    156,519
    
    
    
    214,261
    
    
    
    404,203Other professional services
    
    
    225,212
    
    
    
    259,913
    
    
    
    286,068Goodwill amortization
    
    
    
    
    
    
    
    
    
    
    53,946Other
    
    
    476,220
    
    
    
    495,737
    
    
    
    386,176Total other expenses
    
    
    7,042,316
    
    
    
    6,897,411
    
    
    
    6,406,731Income (loss) before income taxes
    
    
    (851,126
    )
    
    
    187,182
    
    
    
    1,091,769Income tax expense (benefit)
    
    
    (323,191
    )
    
    
    71,318
    
    
    
    420,964Net income (loss)
    
    $
    (527,935
    )
    
    $
    115,864
    
    
    $
    670,805Earnings (loss) per share:Basic
    
    $
    (0.74
    )
    
    $
    0.16
    
    
    $
    0.82Diluted
    
    $
    (0.71
    )
    
    $
    0.15
    
    
    $
    0.82Weighted average shares outstanding:Basic
    
    
    709,106
    
    
    
    744,641
    
    
    
    819,260Diluted
    
    
    738,511
    
    
    
    759,550
    
    
    
    822,631
 See accompanying notes to consolidated financial statements. 4




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##### Table of Contents



SOUTHFIRST BANCSHARES, INC.
AND SUBSIDIARIES Consolidated Statements of Stockholders Equity
Years Ended September 30, 2004, 2003 and 2002 Deferred
    
    
    
    
    
    
    
    
    
    AccumulatedCompensation
    
    
    
    
    
    
    
    
    
    Otheron Common
    
    
    
    
    
    
    
    
    
    Compre-Additional
    
    
    
    
    
    Stock
    
    
    
    
    
    
    
    
    
    hensiveCommon
    
    Paid-in
    
    Retained
    
    Employee
    
    Shares Held
    
    Treasury
    
    IncomeStock
    
    Capital
    
    Earnings
    
    Benefit Plans
    
    in Trust
    
    Stock
    
    (Loss)
    
    TotalBalance  September 30, 2001
    
    $
    9,996
    
    
    $
    9,814,268
    
    
    $
    6,249,938
    
    
    $
    (383,442
    )
    
    $
    (126,411
    )
    
    $
    (1,648,439
    )
    
    $
    366,629
    
    
    $
    14,282,539Comprehensive Income:Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    670,805
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    670,805Change in net unrealized gain (loss) on
available-for-sale securities, net of
reclassification adjustments and tax
effect
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    63,091
    
    
    
    63,091Total comprehensive income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    733,896Release of unallocated ESOP shares
    
    
    
    
    
    
    5,419
    
    
    
    
    
    
    
    55,871
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    61,290Acquisition of ESOP shares
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (188
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (188
    )Vesting of shares on Management
Recognition Plans
    
    
    
    
    
    
    (11
    )
    
    
    
    
    
    
    3,047
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    3,036Issue of Management Recognition
Plan shares
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (19,250
    )
    
    
    19,250
    
    
    
    
    
    
    
    
    
    
    
    Vesting of deferred compensation shares
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    19,902
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    19,902Acquisition of Treasury stock
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (758,792
    )
    
    
    
    
    
    
    (758,792
    )Cash dividends declared ($ .60/share)
    
    
    
    
    
    
    
    
    
    
    (463,300
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (463,300
    )Balance  September 30, 2002
    
    
    9,996
    
    
    
    9,819,676
    
    
    
    6,457,443
    
    
    
    (324,060
    )
    
    
    (107,161
    )
    
    
    (2,407,231
    )
    
    
    429,720
    
    
    
    13,878,383Comprehensive Income (Loss):Net income
    
    
    
    
    
    
    
    
    
    
    115,864
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    115,864Change in net unrealized gain (loss) on
available-for-sale securities, net of
reclassification adjustments and tax
effect
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (647,479
    )
    
    
    (647,479
    )Total comprehensive loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (531,615
    )Release of unallocated ESOP shares
    
    
    
    
    
    
    16,349
    
    
    
    
    
    
    
    58,730
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    75,079Acquisition of ESOP shares
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    58,399
    
    
    
    
    
    
    
    58,363
    )

    
    
    
    
    
    
    36Vesting of shares on Management
Recognition Plans
    
    
    
    
    
    
    1,033
    
    
    
    
    
    
    
    3,850
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    4,883Vesting of deferred compensation shares
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    19,902
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    19,902Acquisition of Treasury stock
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1,344,245
    )
    
    
    
    
    
    
    (1,344,245
    )Cash dividends declared ($ .60/share)
    
    
    
    
    
    
    
    
    
    
    (425,052
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (425,052
    )Balance  September 30, 2003
    
    
    9,996
    
    
    
    9,837,058
    
    
    
    6,148,255
    
    
    
    (183,179
    )
    
    
    (107,161
    )
    
    
    (3,809,839
    )
    
    
    (217,759
    )
    
    
    11,677,371
 (Continued) See accompanying notes to consolidated financial statements. 5




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##### Table of Contents



SOUTHFIRST BANCSHARES, INC.
AND SUBSIDIARIES Consolidated Statements of Stockholders Equity (Continued)
Years Ended September 30, 2004, 2003 and 2002 Deferred
    
    
    
    
    
    
    
    
    
    AccumulatedCompensation
    
    
    
    
    
    
    
    
    
    Otheron Common
    
    
    
    
    
    
    
    
    
    Compre-Additional
    
    
    
    
    
    Stock
    
    
    
    
    
    
    
    
    
    hensiveCommon
    
    Paid-in
    
    Retained
    
    Employee
    
    Shares Held
    
    Treasury
    
    IncomeStock
    
    Capital
    
    Earnings
    
    Benefit Plans
    
    in Trust
    
    Stock
    
    (Loss)
    
    TotalBalance  September 30, 2003
    
    $
    9,996
    
    
    $
    9,837,058
    
    
    $
    6,148,255
    
    
    $
    (183,179
    )
    
    $
    (107,161
    )
    
    $
    (3,809,839
    )
    
    $
    (217,759
    )
    
    $
    11,677,371Comprehensive Income (Loss):Net income (loss)
    
    
    
    
    
    
    
    
    
    
    (527,935
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (527,935
    )Change in net unrealized gain (loss) on
available-for-sale securities, net of
reclassification adjustments and tax
effect
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (316,694
    )
    
    
    (316,694
    )Total comprehensive loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (844,629
    )Release of unallocated ESOP shares
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Cancellation of shares held in trust
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    3,678
    
    
    
    
    
    
    
    
    
    
    
    3,678Vesting of shares on Management
Recognition Plans
    
    
    
    
    
    
    1,907
    
    
    
    
    
    
    
    3,850
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    5,757Vesting of deferred compensation shares
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    19,902
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    19,902Acquisition of Treasury stock
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (81,316
    )Cash dividends declared ($ .60/share)
    
    
    
    
    
    
    
    
    
    
    (425,159
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (425,159
    )Balance  September 30, 2004
    
    $
    9,996
    
    
    $
    9,838,965
    
    
    $
    5,195,161
    
    
    $
    (159,427
    )
    
    $
    (103,483
    )
    
    $
    (3,891,155
    )
    
    $
    (534,453
    )
    
    $
    10,355,604
 See accompanying notes to consolidated financial statements. 6




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##### Table of Contents



SOUTHFIRST BANCSHARES, INC.
AND SUBSIDIARIES Consolidated Statements of Cash Flows
Years Ended September 30, 2004, 2003 and 2002 2004
    
    2003
    
    2002OPERATING ACTIVITIESNet income (loss)
    
    $
    (527,935
    )
    
    $
    115,864
    
    
    $
    670,805Adjustments to reconcile net income (loss) to
net cash provided by operating activities:Provision for loan losses (benefit)
    
    
    1,356,937
    
    
    
    549,603
    
    
    
    (667,650
    )Depreciation and amortization
    
    
    377,681
    
    
    
    331,198
    
    
    
    406,184Proceeds from sales of loans
    
    
    31,096,549
    
    
    
    55,989,812
    
    
    
    27,159,678Loans originated for sale
    
    
    (30,361,974
    )
    
    
    (53,634,764
    )
    
    
    (28,567,757
    )Gain on sale of loans
    
    
    (719,389
    )
    
    
    (1,170,453
    )
    
    
    (611,971
    )Gain on sale of premises and equipment
    
    
    (927
    )
    
    
    (7,759
    )
    
    
    (162
    )Gain on sale of affiliate
    
    
    (25,000
    )
    
    
    
    
    
    
    Loss on sale of foreclosed assets
    
    
    6,770
    
    
    
    69,885
    
    
    
    41,566Compensation expense on ESOP and MRPs
    
    
    25,659
    
    
    
    99,864
    
    
    
    84,228Gain on sale of securities available-for-sale
    
    
    (83,614
    )
    
    
    (238,291
    )
    
    
    (236,414
    )Net amortization of premium on securities
    
    
    7,906
    
    
    
    46,663
    
    
    
    38,126(Increase) decrease in accrued interest receivable
    
    
    53,763
    
    
    
    54,766
    
    
    
    226,057(Increase) decrease in other assets
    
    
    (1,013,227
    )
    
    
    (156,421
    )
    
    
    (1,105,037
    )Increase (decrease) in accrued interest payable
    
    
    (118,659
    )
    
    
    (249,174
    )
    
    
    (502,333
    )Increase (decrease) in accrued expenses and other liabilities
    
    
    644,087
    
    
    
    (67,463
    )
    
    
    535,771Net cash provided (used) by operating activities
    
    
    718,627
    
    
    
    1,733,330
    
    
    
    (2,528,909
    )INVESTING ACTIVITIESNet change in interest-bearing deposits in other financial institutions
    
    
    (180,804
    )
    
    
    350,259
    
    
    
    15,271Proceeds from calls and maturities of securities available-for-sale
    
    
    2,931,352
    
    
    
    15,438,689
    
    
    
    3,559,206Proceeds from sales of securities available-for-sale
    
    
    11,541,353
    
    
    
    16,589,714
    
    
    
    18,598,208Proceeds from redemption of Federal Home Loan Bank stock
    
    
    
    
    
    
    1,112,800
    
    
    
    Purchase of securities available-for-sale
    
    
    (11,569,768
    )
    
    
    (38,713,047
    )
    
    
    (15,572,588
    )Net (increase) decrease in loans
    
    
    (12,088,252
    )
    
    
    7,443,226
    
    
    
    8,441,922Proceeds from sale of premises and equipment
    
    
    10,377
    
    
    
    452,058
    
    
    
    10,095Purchase of premises and equipment
    
    
    (884,632
    )
    
    
    (207,151
    )
    
    
    (463,528
    )Proceeds from sale of foreclosed assets
    
    
    96,185
    
    
    
    541,708
    
    
    
    512,628Proceeds from sale of affiliate
    
    
    25,000
    
    
    
    
    
    
    
    Net cash provided (used) by investing activities
    
    
    (10,119,189
    )
    
    
    3,008,256
    
    
    
    15,101,214
 (Continued) See accompanying notes to consolidated financial statements. 7




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##### Table of Contents



SOUTHFIRST BANCSHARES, INC.
AND SUBSIDIARIES Consolidated Statements of Cash Flows (Continued)
Years Ended September 30, 2004, 2003 and 2002 2004
    
    2003
    
    2002FINANCING ACTIVITIESNet increase (decrease) in demand accounts and savings accounts
    
    $
    1,156,098
    
    
    $
    (390,261
    )
    
    $
    1,358,136Net increase (decrease) in certificates of deposit
    
    
    3,078,747
    
    
    
    (2,535,020
    )
    
    
    (3,930,454
    )Proceeds from borrowed funds
    
    
    70,534,271
    
    
    
    18,588,000
    
    
    
    32,091,611Repayment of borrowed funds
    
    
    (65,946,359
    )
    
    
    (20,644,750
    )
    
    
    (38,639,000
    )Cash dividends paid
    
    
    (425,159
    )
    
    
    (425,052
    )
    
    
    (463,300
    )Acquisition of ESOP and MRP shares
    
    
    3,678
    
    
    
    36
    
    
    
    (188
    )Acquisition of treasury stock
    
    
    (81,316
    )
    
    
    (1,344,245
    )
    
    
    (758,792
    )(Increase) decrease in advances by borrowers
for property taxes and insurance
    
    
    46,385
    
    
    
    (63,867
    )
    
    
    (127,606
    )Net cash provided (used) by financing activities
    
    
    8,366,345
    
    
    
    (6,815,159
    )
    
    
    (10,469,593
    )Increase (decrease) in cash and cash equivalents
    
    
    (1,034,217
    )
    
    
    (2,073,573
    )
    
    
    2,102,712Cash and cash equivalents  beginning of year
    
    
    6,049,325
    
    
    
    8,122,898
    
    
    
    6,020,186Cash and cash equivalents  end of year
    
    $
    5,015,108
    
    
    $
    6,049,325
    
    
    $
    8,122,898Supplemental information on cash payments:Interest paid
    
    $
    2,930,986
    
    
    $
    3,793,367
    
    
    $
    5,232,129Income taxes paid
    
    $
    148,326
    
    
    $
    210,320
    
    
    $
    31,857Supplemental information on non-cash transactions:Real estate owned, obtained through foreclosure
    
    $
    539,782
    
    
    $
    609,290
    
    
    $
    376,294
 See accompanying notes to consolidated financial statements. 8




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##### Table of Contents



SOUTHFIRST BANCSHARES, INC.
AND SUBSIDIARIES Notes to Consolidated Financial Statements (Continued)  17.
    
    PARENT COMPANY The condensed financial information for SouthFirst Bancshares, Inc. (Parent Company) is presented
below: Parent Company
Condensed Balance Sheets
September 30, 2004 and 2003 2004
    
    2003ASSETSCash and cash equivalents
    
    $
    49,303
    
    
    $
    35,351Securities available for sale
    
    
    12,000
    
    
    
    5,400Investment in financial institution subsidiary
    
    
    10,388,146
    
    
    
    12,793,544Investment in other subsidiaries
    
    
    1,044,303
    
    
    
    859,591Other assets
    
    
    24,044
    
    
    
    78,805Total Assets
    
    $
    11,517,796
    
    
    $
    13,772,691LIABILITIES AND STOCKHOLDERS EQUITYLiabilities:Borrowed funds
    
    $
    902,861
    
    
    $
    1,917,861Other liabilities
    
    
    259,331
    
    
    
    177,459Total liabilities
    
    
    1,162,192
    
    
    
    2,095,320Stockholders equity:Common stock, $.01 par value, 2,000,000 shares authorized;
990,241 shares issued and 709,406 shares outstanding in 2004
989,868 shares issued and 713,944 shares outstanding in 2003
    
    
    9,996
    
    
    
    9,996Additional paid-in capital
    
    
    9,838,965
    
    
    
    9,837,058Treasury stock
    
    
    (3,891,155
    )
    
    
    (3,809,839
    )Deferred compensation on common stock employee benefit plans
    
    
    (159,427
    )
    
    
    (183,179
    )Shares held in trust
    
    
    (103,483
    )
    
    
    (107,161
    )Retained earnings
    
    
    5,195,161
    
    
    
    6,148,255Accumulated other comprehensive income (loss)
    
    
    (534,453
    )
    
    
    (217,759
    )Total stockholders equity
    
    
    10,355,604
    
    
    
    11,677,371Total Liabilities and Stockholders Equity
    
    $
    11,517,796
    
    
    $
    13,772,691
 (Continued) 9




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##### Table of Contents



SOUTHFIRST BANCSHARES, INC.
AND SUBSIDIARIES Notes to Consolidated Financial Statements (Continued)  17.
    
    PARENT COMPANY(Continued) Parent Company
Condensed Statements of Operations
Years Ended September 30, 2004, 2003 and 2002 2004
    
    2003
    
    2002Cash dividends from financial institution subsidiary
    
    $
    1,500,000
    
    
    $
    500,000
    
    
    $
    1,100,000Interest and dividend income
    
    
    
    
    
    
    10,986
    
    
    
    31,785Gain (loss) on sale of securities available-for-sale
    
    
    
    
    
    
    (78,610
    )
    
    
    47,553Gain on sale of affiliate
    
    
    25,000
    
    
    
    
    
    
    
    Commission income
    
    
    739
    
    
    
    95,015
    
    
    
    Total income
    
    
    1,525,739
    
    
    
    527,391
    
    
    
    1,179,338Expenses:Interest on borrowed funds
    
    
    90,774
    
    
    
    67,914
    
    
    
    130,208Compensation and benefits
    
    
    44,000
    
    
    
    62,000
    
    
    
    44,585Management fee
    
    
    30,000
    
    
    
    30,000
    
    
    
    30,000Other
    
    
    67,470
    
    
    
    70,029
    
    
    
    13,800232,244
    
    
    
    229,943
    
    
    
    218,593Income before income taxes
    
    
    1,293,495
    
    
    
    297,448
    
    
    
    960,745Income tax benefit
    
    
    78,472
    
    
    
    76,971
    
    
    
    47,913Income before equity in undistributed
earnings of subsidiaries
    
    
    1,371,967
    
    
    
    374,419
    
    
    
    1,008,658Equity in undistributed earnings of subsidiaries
(dividends in excess of earnings):Financial institution
    
    
    (2,085,177
    )
    
    
    (335,185
    )
    
    
    (364,604
    )Other
    
    
    185,275
    
    
    
    76,630
    
    
    
    26,751(1,899,902
    )
    
    
    (258,555
    )
    
    
    (337,853
    )Net income (loss)
    
    $
    (527,935
    )
    
    $
    115,864
    
    
    $
    670,805
 (Continued) 10




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##### Table of Contents



SOUTHFIRST BANCSHARES, INC.
AND SUBSIDIARIES Notes to Consolidated Financial Statements (Continued)  17.
    
    PARENT COMPANY(Continued) Parent Company
Condensed Statements of Cash Flows
Years Ended September 30, 2004, 2003 and 2002 2004
    
    2003
    
    2002Operating Activities:Net income (loss)
    
    $
    (527,935
    )
    
    $
    115,864
    
    
    $
    670,805Adjustments to reconcile net income (loss) to
cash from operating activities:Equity in undistributed earnings of subsidiaries
    
    
    1,899,902
    
    
    
    258,555
    
    
    
    337,853Compensation expense on ESOP and MRP
    
    
    25,659
    
    
    
    99,864
    
    
    
    84,228(Gain) loss on sale of securities available-for-sale
    
    
    
    
    
    
    78,610
    
    
    
    (47,553
    )Gain on sale of affiliate
    
    
    (25,000
    )
    
    
    
    
    
    
    (Increase) decrease in other assets
    
    
    54,761
    
    
    
    20,098
    
    
    
    1,940,038Increase (decrease) in other liabilities
    
    
    81,872
    
    
    
    (47,591
    )
    
    
    220,392Net cash provided by operating activities
    
    
    1,509,259
    
    
    
    525,400
    
    
    
    3,205,763Investing Activities:Investment in subsidiaries, net of dividends received
    
    
    (2,510
    )
    
    
    (28,730
    )
    
    
    (2,937
    )Proceeds from sales of securities available-for-sale
    
    
    
    
    
    
    
    
    
    
    751,640Proceeds from sale of affiliate
    
    
    25,000
    
    
    
    
    
    
    
    Net cash provided (used) by investing activities
    
    
    22,490
    
    
    
    (28,730
    )
    
    
    748,703Financing Activities:Acquisition of ESOP and MRP shares
    
    
    3,678
    
    
    
    36
    
    
    
    (188
    )Proceeds from borrowed funds
    
    
    435,000
    
    
    
    1,519,000
    
    
    
    2,563,861Repayment on borrowed funds
    
    
    (1,450,000
    )
    
    
    (300,000
    )
    
    
    (5,220,000
    )Cash dividends paid
    
    
    (425,159
    )
    
    
    (425,052
    )
    
    
    (463,300
    )Acquisition of treasury stock
    
    
    (81,316
    )
    
    
    (1,344,245
    )
    
    
    (758,792
    )Net cash used in financing activities
    
    
    (1,517,797
    )
    
    
    (550,261
    )
    
    
    (3,878,419
    )Net increase (decrease) in cash and cash equivalents
    
    
    13,952
    
    
    
    (53,591
    )
    
    
    76,047Cash and cash equivalents  beginning of year
    
    
    35,351
    
    
    
    88,942
    
    
    
    12,895Cash and cash equivalents  end of year
    
    $
    49,303
    
    
    $
    35,351
    
    
    $
    88,942
 11




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##### Table of Contents



SOUTHFIRST BANCSHARES, INC.
AND SUBSIDIARIES Notes to Consolidated Financial Statements (Continued)  18.
    
    SELECTED QUARTERLY INFORMATION (UNAUDITED) Year Ended September 30, 2004Three Months EndedSeptember 30,
    
    June 30,
    
    March 31,
    
    December 31,Interest and dividend income
    
    $
    1,791,905
    
    
    $
    1,756,364
    
    
    $
    1,786,609
    
    
    $
    1,786,063Interest expense
    
    
    716,855
    
    
    
    687,347
    
    
    
    708,474
    
    
    
    699,651Net interest income
    
    
    1,075,050
    
    
    
    1,069,017
    
    
    
    1,078,135
    
    
    
    1,086,412Provision for loan losses
    
    
    111,979
    
    
    
    9,268
    
    
    
    1,235,690
    
    
    
    Net interest income after provision for
loan losses
    
    
    963,071
    
    
    
    1,059,749
    
    
    
    (157,555
    )
    
    
    1,086,412Non-interest income
    
    
    789,051
    
    
    
    853,788
    
    
    
    909,110
    
    
    
    687,564Non-interest expenses
    
    
    1,699,529
    
    
    
    1,928,324
    
    
    
    1,807,634
    
    
    
    1,606,829Income (loss) before taxes
    
    
    52,593
    
    
    
    (14,787
    )
    
    
    (1,056,079
    )
    
    
    167,147Provision for income taxes (benefit)
    
    
    18,838
    
    
    
    (4,345
    )
    
    
    (401,262
    )
    
    
    63,578Net income (loss)
    
    $
    33,755
    
    
    $
    (10,442
    )
    
    $
    (654,817
    )
    
    $
    103,569Earnings (loss) per share:Basic
    
    $
    0.05
    
    
    $
    (0.01
    )
    
    $
    (0.92
    )
    
    $
    0.15Diluted
    
    $
    0.05
    
    
    $
    (0.01
    )
    
    $
    (0.88
    )
    
    $
    0.14Dividends per share
    
    $
    0.15
    
    
    $
    0.15
    
    
    $
    0.15
    
    
    $
    0.15
 Year Ended September 30, 2003Three Months EndedSeptember 30,
    
    June 30,
    
    March 31,
    
    December 31,Interest and dividend income
    
    $
    1,877,285
    
    
    $
    1,812,930
    
    
    $
    1,824,613
    
    
    $
    1,921,817Interest expense
    
    
    785,127
    
    
    
    864,317
    
    
    
    893,439
    
    
    
    1,001,310Net interest income
    
    
    1,092,158
    
    
    
    948,613
    
    
    
    931,174
    
    
    
    920,507Provision for loan losses
    
    
    431,152
    
    
    
    29,488
    
    
    
    13,963
    
    
    
    75,000Net interest income after provision for
loan losses
    
    
    661,006
    
    
    
    919,125
    
    
    
    917,211
    
    
    
    845,507Non-interest income
    
    
    1,072,286
    
    
    
    927,624
    
    
    
    829,139
    
    
    
    912,695Non-interest expenses
    
    
    1,873,816
    
    
    
    1,721,630
    
    
    
    1,685,664
    
    
    
    1,616,301Income (loss) before taxes
    
    
    (140,524
    )
    
    
    125,119
    
    
    
    60,686
    
    
    
    141,901Provision for income taxes (benefit)
    
    
    (53,279
    )
    
    
    47,485
    
    
    
    22,705
    
    
    
    54,407Net income (loss)
    
    $
    (87,245
    )
    
    $
    77,634
    
    
    $
    37,981
    
    
    $
    87,494Earnings (loss) per share:Basic
    
    $
    (0.12
    )
    
    $
    0.11
    
    
    $
    0.05
    
    
    $
    0.11Diluted
    
    $
    (0.12
    )
    
    $
    0.11
    
    
    $
    0.05
    
    
    $
    0.11Dividends per share
    
    $
    0.15
    
    
    $
    0.15
    
    
    $
    0.15
    
    
    $
    0.15
 12