##### Table of Contents

Exhibit 13.1



2003 Annual Report



Table of Contents



|                                                |  |   
|----------------------------------------------- |  | --
|Letter to Stockholders                          |  | 1 
|                                                | 
|Financial Highlights                            |  | 2 
|                                                | 
|Consolidated Balance Sheets                     |  | 3 
|                                                | 
|Consolidated Statements of Income               |  | 4 
|                                                | 
|Consolidated Statements of Stockholders Equity |  | 5 
|                                                | 
|Consolidated Statements of Cash Flows           |  | 7 
|                                                | 
|Notes to Consolidated Financial Statements      |  | 9 
|                                                | 
|Independent Auditors Report                    |  | 32
|                                                | 
|Managements Discussion and Analysis            |  | 33
|                                                | 
|Board of Directors and Officers                 |  | 47
|                                                | 
|Stockholder Information                         |  | 48



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##### Table of Contents

|     |  |                                                                                        
|---- |  | ---------------------------------------------------------------------------------------
|LOGO |  | Post Office Box 1227 Mount Airy, North Carolina 27030 (336) 719-2310 FAX (336) 789-3687
|    
|    
|    



Dear
Shareholder:



It is my pleasure to present you with the 2003 financial report
for Surrey Bancorp. The report reflects our seventh full year of operations. The Board of Directors, management and employees of the Company and its subsidiary operations are committed to building a strong organization focused on supporting the
financial needs of the community and increasing shareholder value. This report reflects our efforts.



Growth rates in 2003 again exceeded expectations. Total assets at year-end 2003 were $135,077,005, a 27% increase over 2002 year-end assets of $106,544,532. The Company experienced strong loan demand in 2003. Net
loans at year-end totaled $117,362,619 versus $85,852,019 in 2002, a 37% increase. Asset quality for the Company is strong considering the current economic environment. Non-performing loans at year-end totaled $236,457, which equates to .2% of gross
loans outstanding. Surrey Bancorp made contributions of $378,401 to loan loss reserves during the year due to loan growth. The provision for loan loss reserves totaled $2,109,820 or 1.77% of gross loans at the end of the year. Deposits increased in
2003 to $111,277,876, a 28% increase over 2002 year-end deposits of $86,898,873.



Surrey Bancorp posted a record year in earnings. Profits in 2003 were $1,261,385 compared to 2002 profits of $1,047,308, a 20% increase. Net interest income after provisions for loan losses totaled $5,040,639 in 2003. This equates to a 28%
increase over the previous year. This significant improvement was due to loan growth and a decline in interest expense as deposit rates fell in response to continued economic conditions. Non-interest income was $2,088,585 in 2003, a 42% increase
over the previous year. The improvement was the result of increases in fees related to deposit operations, revenues from insurance, investment services activities and mortgage loan operations. Mortgage loan operations were the biggest contributor to
the increase in non-interest income. Our success in this area was attributable to a favorable interest rate environment. Non-interest expense for the Company was $5,109,727, a 42% increase over the previous year. This increase was attributable to
the expansion of our branch network and certain costs associated with our mortgage lending operation.



In 2003, the Company made several strategic decisions necessary to support continued growth. Surrey Bancorp was formed in May 2003 to provide the bank greater flexibility in obtaining capital. A private placement of
non-cumulative convertible preferred stock totaling $2,650,325 was completed in August. Additionally, full service branch offices were opened during the year at 2050 Rockford Street in Mount Airy and a temporary location at 108 Heatherly Creek Drive
in Pilot Mountain. These new branch locations will have a negative effect on profitability in 2004 but support our goal to increase customer base and market share in our service area. Our objective for 2004 is to focus on growing the bank within our
existing branch network and improving our operating procedures and efficiencies inside the bank and in our subsidiary operations. This will provide us with a solid foundation for future growth and profitability.



On behalf of the Board of Directors, management and employees of your Company, thank you for
your support.



LOGO

Edward C. Ashby, III

President / CEO



1



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##### Table of Contents

Financial Highlights Summary1



|                                                              |  |      |         |   |      |   |         |      |  |   |        |   |  |      |        |   |  |   |        |  
|------------------------------------------------------------- |  | ---- | ------- | - | ---- | - | ------- | ---- |  | - | ------ | - |  | ---- | ------ | - |  | - | ------ | -
|                                                              |  | 2003 |         |   | 2002 |   |         | 2001 |  |   | 2000   |   |  | 1999 |       
|Summary of Operations                                         |  |      |         |   |      |   |         |      |  |   |        |   |  |      |        |   |  |   |        |  
|Interest income                                               |  | $    | 7,384   |   |      | $ | 6,676   |      |  | $ | 6,405  |   |  | $    | 5,289  |   |  | $ | 3,409  |  
|Interest expense                                              |  |      | 1,965   |   |      |   | 2,096   |      |  |   | 2,963  |   |  |      | 2,569  |   |  |   | 1,570  |  
|                                                              |  |      |         |   |      |   |         |      |  |   |        |   |  |      |        |   |  |   |        |  
|Net interest income                                           |  |      | 5,419   |   |      |   | 4,580   |      |  |   | 3,442  |   |  |      | 2,720  |   |  |   | 1,839  |  
|Provision for credit losses                                   |  |      | 378     |   |      |   | 651     |      |  |   | 450    |   |  |      | 212    |   |  |   | 151    |  
|Other income                                                  |  |      | 2,088   |   |      |   | 1,471   |      |  |   | 1,083  |   |  |      | 499    |   |  |   | 392    |  
|Other expense                                                 |  |      | 5,110   |   |      |   | 3,604   |      |  |   | 3,055  |   |  |      | 2,264  |   |  |   | 1,637  |  
|Income taxes                                                  |  |      | 758     |   |      |   | 640     |      |  |   | 340    |   |  |      | 203    |   |  |   |       |  
|Minority interest                                             |  |      |        |   |      |   | (109    | )    |  |   | (163   | ) |  |      | (53    | ) |  |   |       |  
|                                                              |  |      |         |   |      |   |         |      |  |   |        |   |  |      |        |   |  |   |        |  
|Net income                                                    |  |      | 1,261   |   |      |   | 1,047   |      |  |   | 517    |   |  |      | 487    |   |  |   | 443    |  
|Preferred stock dividends declared                            |  |      | (66     | ) |      |   |        |      |  |   |       |   |  |      |       |   |  |   |       |  
|                                                              |  |      |         |   |      |   |         |      |  |   |        |   |  |      |        |   |  |   |        |  
|Net income available to Common stockholders                   |  | $    | 1,195   |   |      | $ | 1,047   |      |  | $ | 517    |   |  | $    | 487    |   |  | $ | 443    |  
|                                                              |  |      |         |   |      |   |         |      |  |   |        |   |  |      |        |   |  |   |        |  
|Per Common Share Data2                                        |  |      |         |   |      |   |         |      |  |   |        |   |  |      |        |   |  |   |        |  
|                                                              |  |      |         |   |     
|Net income:                                                   |  |      |         |   |      |   |         |      |  |   |        |   |  |      |        |   |  |   |        |  
|Basic                                                         |  | $    | 1.04    |   |      | $ | 0.91    |      |  | $ | 0.45   |   |  | $    | 0.48   |   |  | $ | 0.45   |  
|Diluted                                                       |  |      | 0.93    |   |      |   | 0.84    |      |  |   | 0.44   |   |  |      | 0.47   |   |  |   | 0.43   |  
|Cash dividends declared                                       |  |      | n/a     |   |      |   | n/a     |      |  |   | n/a    |   |  |      | n/a    |   |  |   | n/a    |  
|Book value per common share                                   |  |      | 8.93    |   |      |   | 7.83    |      |  |   | 7.06   |   |  |      | 6.58   |   |  |   | 5.71   |  
|                                                              |  |      |         |   |     
|Balance Sheet                                                 |  |      |         |   |      |   |         |      |  |   |        |   |  |      |        |   |  |   |        |  
|                                                              |  |      |         |   |     
|Loans, net                                                    |  | $    | 117,363 |   |      | $ | 85,852  |      |  | $ | 72,619 |   |  | $    | 52,538 |   |  | $ | 39,708 |  
|Investment securities                                         |  |      | 5,426   |   |      |   | 4,167   |      |  |   | 4,436  |   |  |      | 3,374  |   |  |   | 6,494  |  
|Total assets                                                  |  |      | 135,077 |   |      |   | 106,545 |      |  |   | 86,824 |   |  |      | 69,296 |   |  |   | 53,486 |  
|Deposits                                                      |  |      | 111,278 |   |      |   | 86,899  |      |  |   | 69,562 |   |  |      | 54,806 |   |  |   | 42,299 |  
|Stockholders equity                                          |  |      | 13,073  |   |      |   | 9,164   |      |  |   | 8,099  |   |  |      | 7,477  |   |  |   | 5,623  |  
|Interest-earning assets                                       |  |      | 129,411 |   |      |   | 102,227 |      |  |   | 82,940 |   |  |      | 65,548 |   |  |   | 48,625 |  
|Interest-bearing liabilities                                  |  |      | 105,183 |   |      |   | 82,552  |      |  |   | 67,055 |   |  |      | 51,386 |   |  |   | 40,622 |  
|                                                              |  |      |         |   |     
|Selected Ratios                                               |  |      |         |   |      |   |         |      |  |   |        |   |  |      |        |   |  |   |        |  
|                                                              |  |      |         |   |     
|Return on average assets                                      |  |      | 1.06    | % |      |   | 1.10    | %    |  |   | 0.65   | % |  |      | 0.80   | % |  |   | 0.99   | %
|Return on average equity                                      |  |      | 12.23   | % |      |   | 11.85   | %    |  |   | 6.59   | % |  |      | 8.28   | % |  |   | 8.53   | %
|Dividends declared on common stock as a percent of net income |  |      | n/a     |   |      |   | n/a     |      |  |   | n/a    |   |  |      | n/a    |   |  |   | n/a    |  

---

|1. | In thousands of dollars, except per share data.
|-- | -----------------------------------------------

|2. | Adjusted for the effects of 20% common stock dividend in 1999 and 2000, and a 10% common stock dividend in 2001, and a 6 for 5 common stock exchange on May 1, 2003.
|-- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------



2



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##### Table of Contents

Consolidated Balance Sheets

December 31, 2003 and 2002



|                                                                                                                                                                                                                                                               |  |      |             |      |   |            
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ---- | ----------- | ---- | - | -----------
|                                                                                                                                                                                                                                                               |  | 2003 |             | 2002
|Assets                                                                                                                                                                                                                                                         |  |      |             |      |   |            
|Cash and due from banks                                                                                                                                                                                                                                        |  | $    | 1,956,473   |      | $ | 1,409,407  
|Interest-bearing deposits with banks                                                                                                                                                                                                                           |  |      | 4,068,017   |      |   | 10,096,703 
|Investment securities available for sale                                                                                                                                                                                                                       |  |      | 5,425,973   |      |   | 4,166,680  
|Federal Home Loan Bank stock, at cost                                                                                                                                                                                                                          |  |      | 445,000     |      |   | 280,000    
|Loans, net of allowance for loan losses of $2,109,820 in 2003 and $1,831,167 in 2002, respectively                                                                                                                                                             |  |      | 117,362,619 |      |   | 81,378,106 
|Loans available for sale                                                                                                                                                                                                                                       |  |      |            |      |   | 4,473,913  
|Property and equipment, net                                                                                                                                                                                                                                    |  |      | 4,281,770   |      |   | 3,507,978  
|Accrued income                                                                                                                                                                                                                                                 |  |      | 585,608     |      |   | 550,409    
|Intangible assets                                                                                                                                                                                                                                              |  |      | 120,000     |      |   | 122,465    
|Other assets                                                                                                                                                                                                                                                   |  |      | 831,545     |      |   | 558,871    
|                                                                                                                                                                                                                                                               |  |      |             |      |   |            
|Total assets                                                                                                                                                                                                                                                   |  | $    | 135,077,005 |      | $ | 106,544,532
|                                                                                                                                                                                                                                                               |  |      |             |      |   |            
|Liabilities and Stockholders Equity                                                                                                                                                                                                                           |  |      |             |      |   |            
|Liabilities                                                                                                                                                                                                                                                    |  |      |             |      |   |            
|Deposits:                                                                                                                                                                                                                                                      |  |      |             |      |   |            
|Noninterest-bearing                                                                                                                                                                                                                                            |  | $    | 16,159,584  |      | $ | 13,071,285 
|Interest-bearing                                                                                                                                                                                                                                               |  |      | 95,118,292  |      |   | 73,827,588 
|                                                                                                                                                                                                                                                               |  |      |             |      |   |            
|Total deposits                                                                                                                                                                                                                                                 |  |      | 111,277,876 |      |   | 86,898,873 
|                                                                                                                                                                                                                                                               |  |     
|Federal funds purchased and securities sold under agreements to repurchase                                                                                                                                                                                     |  |      | 3,418,635   |      |   | 1,285,400  
|Short-term debt                                                                                                                                                                                                                                                |  |      | 1,400,000   |      |   | 1,500,000  
|Long-term debt                                                                                                                                                                                                                                                 |  |      | 5,246,080   |      |   | 5,938,629  
|Dividends payable on preferred stock                                                                                                                                                                                                                           |  |      | 30,070      |      |   |           
|Accrued interest payable                                                                                                                                                                                                                                       |  |      | 129,193     |      |   | 136,990    
|Other liabilities                                                                                                                                                                                                                                              |  |      | 501,685     |      |   | 895,568    
|                                                                                                                                                                                                                                                               |  |      |             |      |   |            
|Total liabilities                                                                                                                                                                                                                                              |  |      | 122,003,539 |      |   | 96,655,460 
|                                                                                                                                                                                                                                                               |  |      |             |      |   |            
|Minority interest in subsidiary                                                                                                                                                                                                                                |  |      |            |      |   | 724,686    
|                                                                                                                                                                                                                                                               |  |      |             |      |   |            
|Commitments and contingencies                                                                                                                                                                                                                                  |  |      |            |      |   |           
|                                                                                                                                                                                                                                                               |  |     
|Stockholders equity                                                                                                                                                                                                                                           |  |      |             |      |   |            
|Preferred stock, 1,000,000 shares authorized, 189,356 shares of Series A, issued and outstanding with no par value, 4.5% convertible
non-cumulative, perpetual; with a liquidation value of $14 per share in 2003, and no shares issued or outstanding in 2002 |  |      | 2,620,325   |      |   |           
|Common stock, 5,000,000 shares authorized; 1,170,189 shares issued in 2003 at no par value and 958,376 shares issued in 2002 at $4 par
value                                                                                                                   |  |      | 7,822,387   |      |   | 3,833,504  
|Surplus                                                                                                                                                                                                                                                        |  |      |            |      |   | 3,879,760  
|Retained earnings                                                                                                                                                                                                                                              |  |      | 2,627,529   |      |   | 1,432,493  
|Accumulated other comprehensive income                                                                                                                                                                                                                         |  |      | 3,225       |      |   | 18,629     
|                                                                                                                                                                                                                                                               |  |      |             |      |   |            
|Total stockholders equity                                                                                                                                                                                                                                     |  |      | 13,073,466  |      |   | 9,164,386  
|                                                                                                                                                                                                                                                               |  |      |             |      |   |            
|Total liabilities and stockholders equity                                                                                                                                                                                                                     |  | $    | 135,077,005 |      | $ | 106,544,532
|                                                                                                                                                                                                                                                               |  |      |             |      |   |            



See Notes to Consolidated
Financial Statements



3



---

##### Table of Contents

Consolidated Statements of Income

For the years ended December 31, 2003, 2002 and 2001



|                                                                                                   |  |      |           |   |      |   |           |      |  |   |           |  
|-------------------------------------------------------------------------------------------------- |  | ---- | --------- | - | ---- | - | --------- | ---- |  | - | --------- | -
|                                                                                                   |  | 2003 |           |   | 2002 |   |           | 2001 | 
|Interest income                                                                                    |  |      |           |   |      |   |           |      |  |   |           |  
|Loans and fees on loans                                                                            |  | $    | 7,270,034 |   |      | $ | 6,488,555 |      |  | $ | 5,984,707 |  
|Federal funds sold                                                                                 |  |      |          |   |      |   | 1,005     |      |  |   | 9,446     |  
|Investment securities, taxable                                                                     |  |      | 84,892    |   |      |   | 129,494   |      |  |   | 200,458   |  
|Investment securities, nontaxable                                                                  |  |      | 2,717     |   |      |   | 3,615     |      |  |   | 890       |  
|Deposits with banks                                                                                |  |      | 25,860    |   |      |   | 52,881    |      |  |   | 209,898   |  
|                                                                                                   |  |      |           |   |      |   |           |      |  |   |           |  
|Total interest income                                                                              |  |      | 7,383,503 |   |      |   | 6,675,550 |      |  |   | 6,405,399 |  
|                                                                                                   |  |      |           |   |      |   |           |      |  |   |           |  
|Interest expense                                                                                   |  |      |           |   |      |   |           |      |  |   |           |  
|Deposits                                                                                           |  |      | 1,761,300 |   |      |   | 1,813,628 |      |  |   | 2,587,376 |  
|Federal funds purchased and securities sold under agreements to repurchase                         |  |      | 24,130    |   |      |   | 17,002    |      |  |   | 53,469    |  
|Short-term debt                                                                                    |  |      | 17,449    |   |      |   | 46,734    |      |  |   | 87,852    |  
|Long-term debt                                                                                     |  |      | 161,584   |   |      |   | 218,194   |      |  |   | 234,636   |  
|                                                                                                   |  |      |           |   |      |   |           |      |  |   |           |  
|Total interest expense                                                                             |  |      | 1,964,463 |   |      |   | 2,095,558 |      |  |   | 2,963,333 |  
|                                                                                                   |  |      |           |   |      |   |           |      |  |   |           |  
|Net interest income                                                                                |  |      | 5,419,040 |   |      |   | 4,579,992 |      |  |   | 3,442,066 |  
|                                                                                                   |  |      |          
|Provision for loan losses                                                                          |  |      | 378,401   |   |      |   | 651,005   |      |  |   | 450,003   |  
|                                                                                                   |  |      |           |   |      |   |           |      |  |   |           |  
|Net interest income after provision for loan losses                                                |  |      | 5,040,639 |   |      |   | 3,928,987 |      |  |   | 2,992,063 |  
|                                                                                                   |  |      |           |   |      |   |           |      |  |   |           |  
|Noninterest income                                                                                 |  |      |           |   |      |   |           |      |  |   |           |  
|Service charges on deposit accounts                                                                |  |      | 805,609   |   |      |   | 619,456   |      |  |   | 536,485   |  
|Gain on sale of loans                                                                              |  |      | 411,289   |   |      |   | 182,735   |      |  |   |          |  
|Fees on mortgage loans delivered to correspondents                                                 |  |      | 74,618    |   |      |   | 112,855   |      |  |   | 261,491   |  
|Other service charges and fees                                                                     |  |      | 214,792   |   |      |   | 100,815   |      |  |   | 62,282    |  
|Other operating income                                                                             |  |      | 582,277   |   |      |   | 454,743   |      |  |   | 222,561   |  
|                                                                                                   |  |      |           |   |      |   |           |      |  |   |           |  
|Total noninterest income                                                                           |  |      | 2,088,585 |   |      |   | 1,470,604 |      |  |   | 1,082,819 |  
|                                                                                                   |  |      |           |   |      |   |           |      |  |   |           |  
|Noninterest expense                                                                                |  |      |           |   |      |   |           |      |  |   |           |  
|Salaries and employee benefits                                                                     |  |      | 2,329,385 |   |      |   | 1,896,237 |      |  |   | 1,558,143 |  
|Occupancy expense                                                                                  |  |      | 283,557   |   |      |   | 203,132   |      |  |   | 206,069   |  
|Equipment expense                                                                                  |  |      | 434,493   |   |      |   | 328,762   |      |  |   | 301,449   |  
|Data processing                                                                                    |  |      | 291,204   |   |      |   | 237,226   |      |  |   | 235,824   |  
|Lower of cost or market adjustment on loans transferred from available for sale to portfolio loans |  |      | 213,581   |   |      |   |          |      |  |   |          |  
|Foreclosed assets, net                                                                             |  |      |          |   |      |   | (3,395    | )    |  |   | (860      | )
|Other expense                                                                                      |  |      | 1,557,507 |   |      |   | 941,727   |      |  |   | 754,681   |  
|                                                                                                   |  |      |           |   |      |   |           |      |  |   |           |  
|Total noninterest expense                                                                          |  |      | 5,109,727 |   |      |   | 3,603,689 |      |  |   | 3,055,306 |  
|                                                                                                   |  |      |           |   |      |   |           |      |  |   |           |  
|Net income before income taxes                                                                     |  |      | 2,019,497 |   |      |   | 1,795,902 |      |  |   | 1,019,576 |  
|                                                                                                   |  |      |          
|Income tax expense                                                                                 |  |      | 758,112   |   |      |   | 640,026   |      |  |   | 339,636   |  
|Minority interest in subsidiary earnings                                                           |  |      |          |   |      |   | (108,568  | )    |  |   | (162,796  | )
|                                                                                                   |  |      |           |   |      |   |           |      |  |   |           |  
|Net income                                                                                         |  | $    | 1,261,385 |   |      | $ | 1,047,308 |      |  | $ | 517,144   |  
|Preferred stock dividends                                                                          |  |      | (66,349   | ) |      |   |          |      |  |   |          |  
|                                                                                                   |  |      |           |   |      |   |           |      |  |   |           |  
|Net income available to common stockholders                                                        |  | $    | 1,195,036 |   |      | $ | 1,047,308 |      |  | $ | 517,144   |  
|                                                                                                   |  |      |           |   |      |   |           |      |  |   |           |  
|Basic earnings per share                                                                           |  | $    | 1.04      |   |      | $ | 0.91      |      |  | $ | 0.45      |  
|                                                                                                   |  |      |           |   |      |   |           |      |  |   |           |  
|Diluted earnings per share                                                                         |  | $    | 0.93      |   |      | $ | 0.84      |      |  | $ | 0.44      |  
|                                                                                                   |  |      |           |   |      |   |           |      |  |   |           |  
|Basic weighted average shares outstanding                                                          |  |      | 1,153,172 |   |      |   | 1,149,882 |      |  |   | 1,147,239 |  
|                                                                                                   |  |      |           |   |      |   |           |      |  |   |           |  
|Diluted weighted average shares outstanding                                                        |  |      | 1,355,034 |   |      |   | 1,247,360 |      |  |   | 1,185,902 |  
|                                                                                                   |  |      |           |   |      |   |           |      |  |   |           |  



See Notes to Consolidated
Financial Statements



4



---

##### Table of Contents

Consolidated Statements of Stockholders Equity

For the years ended December 31, 2003, 2002 and 2001



|                                                                                                                                |  |                            |  |              |   |        |         |   |        |                   |           |   |                                      |   |           |       |  |   |           |   |  |   |        |   |  |   |           |  
|------------------------------------------------------------------------------------------------------------------------------- |  | -------------------------- |  | ------------ | - | ------ | ------- | - | ------ | ----------------- | --------- | - | ------------------------------------ | - | --------- | ----- |  | - | --------- | - |  | - | ------ | - |  | - | --------- | -
|                                                                                                                                |  | ConvertiblePreferred Stock |  | Common Stock |   |        | Surplus |   |        | Retained Earnings |           |   | AccumulatedOtherComprehensive Income |   |           | Total | 
|                                                                                                                                |  | Shares                     |  | Amount       |   | Shares |         |   | Amount |                   |           |   |                                      |  
|Balance, December 31, 2000                                                                                                      |  |                           |  | $            |  |        | 860,139 |   |        | $                 | 4,300,695 |   |                                      | $ | 2,490,821 |       |  | $ | 671,977   |   |  | $ | 13,338 |   |  | $ | 7,476,831 |  
|                                                                                                                                |  |                            |  |              |   |        |         |  
|Comprehensive income                                                                                                            |  |                            |  |              |   |        |         |   |        |                   |           |   |                                      |   |           |       |  |   |           |   |  |   |        |   |  |   |           |  
|Net income                                                                                                                      |  |                           |  |              |  |        |        |   |        |                   |          |   |                                      |   |          |       |  |   | 517,144   |   |  |   |       |   |  |   | 517,144   |  
|Net change in unrealized appreciation on investment securities available for sale, net of income taxes of $2,838                |  |                           |  |              |  |        |        |   |        |                   |          |   |                                      |   |          |       |  |   |          |   |  |   | 5,509  |   |  |   | 5,509     |  
|                                                                                                                                |  |                            |  |              |   |        |         |   |        |                   |           |   |                                      |   |           |       |  |   |           |   |  |   |        |   |  |   |           |  
|Total comprehensive income                                                                                                      |  |                            |  |              |   |        |         |   |        |                   |           |   |                                      |   |           |       |  |   |           |   |  |   |        |   |  |   | 522,653   |  
|                                                                                                                                |  |                            |  |              |   |        |         |  
|Stock issued pursuant to secondary stock offering                                                                               |  |                           |  |              |  |        | 8,982   |   |        |                   | 44,910    |   |                                      |   | 67,365    |       |  |   |          |   |  |   |       |   |  |   | 112,275   |  
|Stock offering expense                                                                                                          |  |                           |  |              |  |        |        |   |        |                   |          |   |                                      |   | (12,459   | )     |  |   |          |   |  |   |       |   |  |   | (12,459   | )
|Stock dividend, 10%                                                                                                             |  |                           |  |              |  |        | 86,912  |   |        |                   | 434,560   |   |                                      |   | 369,376   |       |  |   | (803,936  | ) |  |   |       |   |  |   |          |  
|                                                                                                                                |  |                            |  |              |   |        |         |   |        |                   |           |   |                                      |   |           |       |  |   |           |   |  |   |        |   |  |   |           |  
|Balance, December 31, 2001                                                                                                      |  |                           |  |              |  |        | 956,033 |   |        |                   | 4,780,165 |   |                                      |   | 2,915,103 |       |  |   | 385,185   |   |  |   | 18,847 |   |  |   | 8,099,300 |  
|                                                                                                                                |  |                            |  |              |   |        |         |  
|Comprehensive income                                                                                                            |  |                            |  |              |   |        |         |   |        |                   |           |   |                                      |   |           |       |  |   |           |   |  |   |        |   |  |   |           |  
|Net income                                                                                                                      |  |                           |  |              |  |        |        |   |        |                   |          |   |                                      |   |          |       |  |   | 1,047,308 |   |  |   |       |   |  |   | 1,047,308 |  
|Net change in unrealized appreciation (depreciation) on investment securities available for sale, net of income taxes of
$(112) |  |                           |  |              |  |        |        |   |        |                   |          |   |                                      |   |          |       |  |   |          |   |  |   | (218   | ) |  |   | (218      | )
|                                                                                                                                |  |                            |  |              |   |        |         |   |        |                   |           |   |                                      |   |           |       |  |   |           |   |  |   |        |   |  |   |           |  
|Total comprehensive income                                                                                                      |  |                            |  |              |   |        |         |   |        |                   |           |   |                                      |   |           |       |  |   |           |   |  |   |        |   |  |   | 1,047,090 |  
|                                                                                                                                |  |                            |  |              |   |        |         |  
|Change par value of common stock from $5 to $4                                                                                  |  |                           |  |              |  |        |        |   |        |                   | (958,376  | ) |                                      |   | 958,376   |       |  |   |          |   |  |   |       |   |  |   |          |  
|Fractional shares purchased                                                                                                     |  |                           |  |              |  |        | (426    | ) |        |                   | (1,704    | ) |                                      |   | (2,238    | )     |  |   |          |   |  |   |       |   |  |   | (3,942    | )
|Common stock reissued                                                                                                           |  |                           |  |              |  |        | 426     |   |        |                   | 1,704     |   |                                      |   | 2,938     |       |  |   |          |   |  |   |       |   |  |   | 4,642     |  
|Stock options exercised                                                                                                         |  |                           |  |              |  |        | 2,343   |   |        |                   | 11,715    |   |                                      |   | 5,581     |       |  |   |          |   |  |   |       |   |  |   | 17,296    |  
|                                                                                                                                |  |                            |  |              |   |        |         |   |        |                   |           |   |                                      |   |           |       |  |   |           |   |  |   |        |   |  |   |           |  
|Balance, December 31, 2002                                                                                                      |  |                           |  |              |  |        | 958,376 |   |        |                   | 3,833,504 |   |                                      |   | 3,879,760 |       |  |   | 1,432,493 |   |  |   | 18,629 |   |  |   | 9,164,386 |  



Continued



5



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##### Table of Contents

Consolidated Statements of Stockholders Equity, continued

For the years ended December 31, 2003, 2002 and 2001



|                                                                                                                                  |  |                             |  |              |           |        |           |   |        |                  |           |   |                                     |   |            |       |  |   |           |   |  |   |         |   |  |   |            |  
|--------------------------------------------------------------------------------------------------------------------------------- |  | --------------------------- |  | ------------ | --------- | ------ | --------- | - | ------ | ---------------- | --------- | - | ----------------------------------- | - | ---------- | ----- |  | - | --------- | - |  | - | ------- | - |  | - | ---------- | -
|                                                                                                                                  |  | Convertible Preferred Stock |  | Common Stock |           |        | Surplus   |   |        | RetainedEarnings |           |   | AccumulatedOtherComprehensiveIncome |   |            | Total | 
|                                                                                                                                  |  | Shares                      |  | Amount       |           | Shares |           |   | Amount |                  |           |   |                                     |  
|Balance, December 31, 2002, forward                                                                                               |  |                            |  |              |          |        | 958,376   |   |        |                  | 3,833,504 |   |                                     |   | 3,879,760  |       |  |   | 1,432,493 |   |  |   | 18,629  |   |  |   | 9,164,386  |  
|Comprehensive income                                                                                                              |  |                             |  |              |           |        |           |   |        |                  |           |   |                                     |   |            |       |  |   |           |   |  |   |         |   |  |   |            |  
|Net income                                                                                                                        |  |                            |  |              |          |        |          |   |        |                  |          |   |                                     |   |           |       |  |   | 1,261,385 |   |  |   |        |   |  |   | 1,261,385  |  
|Net change in unrealized appreciation (depreciation) on investment securities available for sale, net of income taxes of
$(9,698) |  |                            |  |              |          |        |          |   |        |                  |          |   |                                     |   |           |       |  |   |          |   |  |   | (15,404 | ) |  |   | (15,404    | )
|                                                                                                                                  |  |                             |  |              |           |        |           |   |        |                  |           |   |                                     |   |            |       |  |   |           |   |  |   |         |   |  |   |            |  
|Total comprehensive income                                                                                                        |  |                             |  |              |           |        |           |   |        |                  |           |   |                                     |   |            |       |  |   |           |   |  |   |         |   |  |   | 1,245,981  |  
|6 for 5 common stock exchange pursuant to plan of reorganization and share exchange                                               |  |                            |  |              |          |        | 191,675   |   |        |                  | 3,879,760 |   |                                     |   | (3,879,760 | )     |  |   |          |   |  |   |        |   |  |   |           |  
|Common stock options exercised                                                                                                    |  |                            |  |              |          |        | 20,928    |   |        |                  | 121,174   |   |                                     |   |           |       |  |   |          |   |  |   |        |   |  |   | 121,174    |  
|Fractional shares purchased                                                                                                       |  |                            |  |              |          |        | (790      | ) |        |                  | (12,051   | ) |                                     |   |           |       |  |   |          |   |  |   |        |   |  |   | (12,051    | )
|Issuance of convertible preferred stock                                                                                           |  | 189,356                     |  |              | 2,620,325 |        |          |   |        |                  |          |   |                                     |   |           |       |  |   |          |   |  |   |        |   |  |   | 2,620,325  |  
|Dividends declared on convertible preferred stock ($.35 per share)                                                                |  |                            |  |              |          |        |          |   |        |                  |          |   |                                     |   |           |       |  |   | (66,349   | ) |  |   |        |   |  |   | (66,349    | )
|                                                                                                                                  |  |                             |  |              |           |        |           |   |        |                  |           |   |                                     |   |            |       |  |   |           |   |  |   |         |   |  |   |            |  
|Balance, December 31, 2003                                                                                                        |  | 189,356                     |  | $            | 2,620,325 |        | 1,170,189 |   |        | $                | 7,822,387 |   |                                     | $ |           |       |  | $ | 2,627,529 |   |  | $ | 3,225   |   |  | $ | 13,073,466 |  
|                                                                                                                                  |  |                             |  |              |           |        |           |   |        |                  |           |   |                                     |   |            |       |  |   |           |   |  |   |         |   |  |   |            |  



See Notes to Consolidated
Financial Statements



6



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##### Table of Contents

Consolidated Statements of Cash Flows

For the years ended December 31, 2003, 2002 and 2001



|                                                                                                      |  |      |             |   |      |   |             |      |  |   |             |  
|----------------------------------------------------------------------------------------------------- |  | ---- | ----------- | - | ---- | - | ----------- | ---- |  | - | ----------- | -
|                                                                                                      |  | 2003 |             |   | 2002 |   |             | 2001 | 
|Cash flows from operating activities                                                                  |  |      |             |   |      |   |             |      |  |   |             |  
|Net income                                                                                            |  | $    | 1,261,385   |   |      | $ | 1,047,308   |      |  | $ | 517,144     |  
|Adjustments to reconcile net income to net cash provided by operations:                               |  |      |             |   |      |   |             |      |  |   |             |  
|Minority interest in subsidiary earnings                                                              |  |      |            |   |      |   | 108,568     |      |  |   | 162,796     |  
|Depreciation and amortization                                                                         |  |      | 369,476     |   |      |   | 333,865     |      |  |   | 309,133     |  
|Provision for loan losses                                                                             |  |      | 378,401     |   |      |   | 651,005     |      |  |   | 450,003     |  
|Lower of cost or market adjustment on loans transferred from available for sale to portfolio loans    |  |      | 213,581     |   |      |   |            |      |  |   |            |  
|Gain on sale of fixed assets                                                                          |  |      | (125        | ) |      |   |            |      |  |   |            |  
|Deferred income taxes                                                                                 |  |      | (180,746    | ) |      |   | (134,727    | )    |  |   | (41,769     | )
|Accretion of discount on securities, net of amortization of premiums                                  |  |      | 21,578      |   |      |   | (4,551      | )    |  |   | (40,689     | )
|Changes in assets and liabilities:                                                                    |  |      |             |   |      |   |             |      |  |   |             |  
|Accrued income                                                                                        |  |      | (48,662     | ) |      |   | (169,091    | )    |  |   | (22,750     | )
|Loans held for sale                                                                                   |  |      | (14,272,620 | ) |      |   | (2,746,457  | )    |  |   | (746,928    | )
|Other assets                                                                                          |  |      | (82,264     | ) |      |   | 41,324      |      |  |   | (59,317     | )
|Accrued interest payable                                                                              |  |      | (7,797      | ) |      |   | (57,889     | )    |  |   | (42,304     | )
|Other liabilities                                                                                     |  |      | (393,883    | ) |      |   | 471,768     |      |  |   | 51,712      |  
|                                                                                                      |  |      |             |   |      |   |             |      |  |   |             |  
|Net cash provided (used) by operating activities                                                      |  |      | (12,741,676 | ) |      |   | (458,877    | )    |  |   | 537,031     |  
|                                                                                                      |  |      |             |   |      |   |             |      |  |   |             |  
|Cash flows from investing activities                                                                  |  |      |             |   |      |   |             |      |  |   |             |  
|Net decrease (increase) in interest-bearing deposits with banks                                       |  |      | 6,028,686   |   |      |   | (5,924,892  | )    |  |   | 4,141,823   |  
|Net decrease (increase) in federal funds sold                                                         |  |      |            |   |      |   | 250,000     |      |  |   |            |  
|Purchases of investment securities                                                                    |  |      | (6,987,095  | ) |      |   | (8,383,284  | )    |  |   | (12,650,707 | )
|Maturities of investment securities                                                                   |  |      | 5,681,156   |   |      |   | 8,656,345   |      |  |   | 11,639,253  |  
|Purchase of Federal Home Loan Bank stock                                                              |  |      | (165,000    | ) |      |   | (67,700     | )    |  |   |            |  
|Net increase in loans                                                                                 |  |      | (18,541,185 | ) |      |   | (11,137,466 | )    |  |   | (19,784,137 | )
|Increase in goodwill                                                                                  |  |      |            |   |      |   |            |      |  |   | (73,000     | )
|Proceeds from the sale of property and equipment                                                      |  |      | 8,900       |   |      |   |            |      |  |   | 7,296       |  
|Purchases of property and equipment                                                                   |  |      | (1,149,578  | ) |      |   | (1,025,031  | )    |  |   | (564,245    | )
|                                                                                                      |  |      |             |   |      |   |             |      |  |   |             |  
|Net cash used in investing activities                                                                 |  |      | (15,124,116 | ) |      |   | (17,632,028 | )    |  |   | (17,283,717 | )
|                                                                                                      |  |      |             |   |      |   |             |      |  |   |             |  
|Cash flows from financing activities                                                                  |  |      |             |   |      |   |             |      |  |   |             |  
|Net increase in deposits                                                                              |  |      | 24,379,003  |   |      |   | 17,336,669  |      |  |   | 14,755,833  |  
|Net increase (decrease) in federal funds purchased and securities sold under agreements to repurchase |  |      | 2,133,235   |   |      |   | (884,089    | )    |  |   | 244,045     |  
|Net increase (decrease) in short-term debt                                                            |  |      | (100,000    | ) |      |   | (887,500    | )    |  |   | 487,500     |  
|Net increase in long-term debt                                                                        |  |      | (692,548    | ) |      |   | 2,568,028   |      |  |   | 1,245,601   |  
|Dividends paid on preferred stock                                                                     |  |      | (36,279     | ) |      |   |            |      |  |   |            |  
|Preferred stock issued, net                                                                           |  |      | 2,620,325   |   |      |   |            |      |  |   |            |  
|Fractions purchased                                                                                   |  |      | (12,051     | ) |      |   | (3,942      | )    |  |   |            |  
|Common stock reissued                                                                                 |  |      |            |   |      |   | 4,642       |      |  |   |            |  
|Stock options exercised                                                                               |  |      | 121,173     |   |      |   | 17,296      |      |  |   |            |  
|Common stock issued, net of cost                                                                      |  |      |            |   |      |   |            |      |  |   | 99,816      |  
|                                                                                                      |  |      |             |   |      |   |             |      |  |   |             |  
|Net cash provided by financing activities                                                             |  |      | 28,412,858  |   |      |   | 18,151,104  |      |  |   | 16,832,795  |  
|                                                                                                      |  |      |             |   |      |   |             |      |  |   |             |  
|Net increase (decrease) in cash and cash equivalents                                                  |  |      | 547,066     |   |      |   | 60,199      |      |  |   | 86,109      |  
|Cash and cash equivalents, beginning                                                                  |  |      | 1,409,407   |   |      |   | 1,349,208   |      |  |   | 1,263,099   |  
|                                                                                                      |  |      |             |   |      |   |             |      |  |   |             |  
|Cash and cash equivalents, ending                                                                     |  | $    | 1,956,473   |   |      | $ | 1,409,407   |      |  | $ | 1,349,208   |  
|                                                                                                      |  |      |             |   |      |   |             |      |  |   |             |  



(Continued)



7



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##### Table of Contents

Consolidated Statements of Cash Flows (continued)



|                                                                                 |  |      |            |      |   |           |  |   |          
|-------------------------------------------------------------------------------- |  | ---- | ---------- | ---- | - | --------- |  | - | ---------
|                                                                                 |  | 2003 |            | 2002 |   | 2001     
|Supplemental disclosures of cash flow information                                |  |      |            |      |   |           |  |   |          
|Interest paid                                                                    |  | $    | 1,972,260  |      | $ | 2,153,447 |  | $ | 3,005,637
|                                                                                 |  |      |            |      |   |           |  |   |          
|Income taxes paid                                                                |  | $    | 1,350,135  |      | $ | 507,663   |  | $ | 298,809  
|                                                                                 |  |      |            |      |   |           |  |   |          
|Supplemental disclosure of non-cash transactions                                 |  |      |            |      |   |           |  |   |          
|Non-cash transactions related to acquisition of minority interest in subsidiary: |  |      |            |      |   |           |  |   |          
|Cancellation of loan and interest receivable                                     |  |      | 422,984    |      |   |          |  |   |         
|Cancellation of loans receivable from recourse obligations                       |  |      | 243,850    |      |   |          |  |   |         
|Addition to allowance for loans losses                                           |  |      | 57,852     |      |   |          |  |   |         
|                                                                                 |  |      |            |      |   |           |  |   |          
|Total transaction                                                                |  | $    | 724,686    |      | $ |          |  | $ |         
|                                                                                 |  |      |            |      |   |           |  |   |          
|Transfer of loans held for sale to loan portfolio                                |  | $    | 18,746,533 |      | $ |          |  | $ |         
|                                                                                 |  |      |            |      |   |           |  |   |          



See Notes to Consolidated
Financial Statements



8



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##### Table of Contents

Notes to Consolidated Financial Statements



Note 1. Organization and Summary of Significant Accounting Policies



Organization



Surrey Bancorp (the Company)
began operation on May 1, 2003 and was created for the purpose of acquiring all the outstanding shares of common stock of Surrey Bank & Trust. Shareholders of the Bank received six shares of Surrey Bancorp common shares for every five shares of
Surrey Bank & Trust common shares owned. The Company is subject to regulation by the Federal Reserve.



Surrey Bank & Trust (the Bank) was organized and incorporated under the laws of the State of North Carolina on July 15, 1996 and commenced operations on July 22, 1996. The Bank currently serves Surry
County, North Carolina and Patrick County, Virginia and surrounding areas through five banking offices. As a state chartered bank which is not a member of the Federal Reserve, the Bank is subject to regulation by the State of North Carolina Banking
Commission and the Federal Deposit Insurance Corporation.



Surrey Investment
Services, Inc. (Subsidiary) was organized and incorporated under the laws of the State of North Carolina on February 10, 1998. The subsidiary provides insurance services through SB&T Insurance and investment advice and brokerage services through
U-VEST.



On July 31, 2000, Surrey Bank & Trust formed Friendly Finance,
LLC, a subsidiary operation specializing in the purchase of sales finance contracts from local automobile dealers. The Bank originally had a 60% majority interest in the company. On March 1, 2003 the Bank acquired the minority interest in Friendly
Finance, LLC in exchange for the satisfaction of other commitments of the holder of the minority interest.



The accounting and reporting policies of the Company and subsidiaries follow generally accepted accounting principles and general practices within the financial services industry. Following is a summary of the more
significant policies.



Critical Accounting Policies



The notes to our audited consolidated financial statements for the year ended December
31, 2003 contain a summary of our significant accounting policies. We believe our policies with respect to the methodology for our determination of the allowance for loan losses, and asset impairment judgments, including the recoverability of
intangible assets involve a higher degree of complexity and require management to make difficult and subjective judgments which often require assumptions or estimates about highly uncertain matters. Changes in these judgments, assumptions or
estimates could cause reported results to differ materially. These critical policies and their application are periodically reviewed with the Audit Committee and our Board of Directors.



Principles of Consolidation



The consolidated financial statements include the accounts of the Company, the Bank, and Subsidiaries. All significant, intercompany transactions and balances have been
eliminated in consolidation.



Business Segments



The Company reports its activities in two business segments. In determining the
appropriateness of segment definition, the Company considers the materiality of potential business segments and components of the business about which financial information is available and regularly evaluated relative to resource allocation and
performance assessment.



Use of Estimates



The preparation of financial statements in conformity with generally accepted accounting
principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of
revenues and expenses during the reporting period. Actual results could differ from those estimates.



9



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##### Table of Contents

Notes to Consolidated Financial Statements



Note 1. Organization and Summary of Significant Accounting Policies, continued



Use of Estimates, continued



Material estimates that are particularly susceptible to significant change relate to the
determination of the allowance for loan losses and the valuation of real estate acquired in connection with foreclosures or in satisfaction of loans. In connection with the determination of the allowances for loan and foreclosed real estate losses,
management obtains independent appraisals for significant properties.



Substantially all of the Companys loan portfolio consists of loans in its market area. Accordingly, the ultimate collectibility of a substantial portion of the Companys loan portfolio and the recovery of a substantial portion of
the carrying amount of foreclosed real estate are susceptible to changes in local market conditions. The regional economy is diverse, but influenced to an extent by the manufacturing and agricultural segments.



While management uses available information to recognize loan and foreclosed real estate
losses, future additions to the allowances may be necessary based on changes in local economic conditions. In addition, regulatory agencies, as a part of their routine examination process, periodically review the Companys allowances for loan
and foreclosed real estate losses. Such agencies may require the Company to recognize additions to the allowances based on their judgments about information available to them at the time of their examinations. Because of these factors, it is
reasonably possible that the allowances for loan and foreclosed real estate losses may change materially in the near term.



Cash and Cash Equivalents



For the purpose of presentation in the statement of cash flows, cash and cash equivalents are defined as those amounts included in the balance sheet caption cash
and due from banks.



Trading Securities



The Company does not hold securities for short-term resale and therefore does not maintain a
trading securities portfolio.



Securities Held to Maturity



Bonds, notes, and debentures for which the Company has the positive
intent and ability to hold to maturity are reported at cost, adjusted for premiums and discounts that are recognized in interest income using the interest method over the period to maturity or to call dates. All securities held by the Company at
December 31, 2003 and 2002 were classified as available-for-sale.



Securities Available for Sale



Available for sale
securities are reported at fair value and consist of bonds, notes, debentures, and certain equity securities not classified as trading securities or as held to maturity securities.



Unrealized holding gains and losses, net of tax, on available for sale securities are reported as a net amount in a separate component of
stockholders equity. Realized gains and losses on the sale of available for sale securities are determined using the specific-identification method. Premiums and discounts are recognized in interest income using the interest method over the
period to maturity or to call dates.



Declines in the fair value of individual
held to maturity and available for sale securities below cost that are other than temporary are reflected as write-downs of the individual securities to fair value. Related write-downs are included in earnings as realized losses.



10



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##### Table of Contents

Notes to Consolidated Financial Statements



Note 1. Organization and Summary of Significant Accounting Policies, continued



Loans Held for Sale



Mortgage loans originated and intended for sale in the secondary market are carried at the
lower of cost or estimated market value in the aggregate. Net unrealized losses are recognized through a valuation allowance by charges to income.



Loans Receivable



Loans receivable that management has the intent and ability to hold for the foreseeable future or until maturity or pay-off are reported at their outstanding principal amount adjusted for any charge-offs, the
allowance for loan losses, and any deferred fees or costs on originated loans and unamortized premiums or discounts on purchased loans.



Loan origination fees and certain direct origination costs are capitalized and recognized as an adjustment of the yield of the related loan. Discounts and premiums on any
purchased residential real estate loans are amortized to income using the interest method over the remaining period to contractual maturity, adjusted for anticipated prepayments. Discounts and premiums on any purchased consumer loans are recognized
over the expected lives of the loans using methods that approximate the interest method.



Interest is accrued and credited to income based on the principal amount outstanding. The accrual of interest on impaired loans is discontinued when, in managements opinion, the borrower may be unable to meet
payments as they become due. When interest accrual is discontinued, all unpaid accrued interest is reversed. Interest income is subsequently recognized only to the extent cash payments are received. When facts and circumstances indicate the borrower
has regained the ability to meet the required payments, the loan is returned to accrual status. Past due loans are determined on the basis of contractual terms.



Allowance for Loan Losses



The allowance for loan losses is established as losses are estimated to have occurred through a provision for loan losses charged to earnings. Loan losses are charged
against the allowance when management believes the uncollectability of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance.



The allowance for loan losses is evaluated on a regular basis by management and is based upon managements periodic review of the
collectibility of the loans in light of historical experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrowers ability to repay, estimated value of any underlying collateral and prevailing economic
conditions. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available.



A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect the
scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting
scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls
on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrowers prior payment record, and the amount of the
shortfall in relation to the principal and interest owed. Impairment is measured on a loan by loan basis for commercial and construction loans by either the present value of expected future cash flows discounted at the loans effective interest
rate, the loans obtainable market price, or the fair value of the collateral if the loan is collateral dependent.



Large groups of smaller balance homogeneous loans are collectively evaluated for impairment. Accordingly, the Company does not separately identify individual consumer and
residential loans for impairment disclosures.



11



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##### Table of Contents

Notes to Consolidated Financial Statements



Note 1. Organization and Summary of Significant Accounting Policies, continued



Property and Equipment



Land is carried at cost. Premises, furniture and equipment, and leasehold improvements are
carried at cost, less accumulated depreciation and amortization computed principally by the straight-line method over the following estimated useful lives:



|                           |  |      
|-------------------------- |  | -----
|                           |  | Years
|Buildings and improvements |  | 5-40 
|Furniture and equipment    |  | 3-7  



Foreclosed Properties



Real estate properties acquired through, or in lieu of, loan
foreclosure are to be sold and are initially recorded at fair value less anticipated cost to sell at the date of foreclosure establishing a new cost basis. After foreclosure, valuations are periodically performed by management and the real estate is
carried at the lower of carrying amount or fair value less cost to sell. Revenue and expenses from operations and changes in the valuation allowance are included in loss on foreclosed real estate. The historical average holding period for such
properties is less than six months.



Intangible assets



Intangible assets consist of premiums paid on acquisitions of
insurance agencies. This intangible asset is evaluated for impairment on an annual basis. Any impairment is charged against income in the period of impairment.



Stock-based Compensation



The Company accounts for its stock-based compensation plans using the accounting prescribed by Accounting Principles Board Opinion No. 25, Accounting for Stock Issued
to Employees. The Company is not required to adopt the fair value based recognition provisions prescribed under SFAS No. 123, Accounting for Stock-Based Compensation (issued in October 1995), but complies with the disclosure requirements
set forth in the Statement, which includes disclosing pro forma net income as if the fair value based method of accounting had been applied.



Transfers of Financial Assets



Transfers of financial assets are accounted for as sales, when control over the assets has been surrendered. Control over transferred assets is deemed to be surrendered
when (1) the assets have been isolated from the Company, (2) the transferee obtains the right (free of conditions that constrain it from taking advantage of that right) to pledge or exchange the transferred assets, and (3) the Company does not
maintain effective control over the transferred assets through an agreement to repurchase them before their maturity.



Income Taxes



Provision for income taxes is based on amounts reported in the statements of income (after exclusion of non-taxable income such as interest on state and municipal securities) and consists of taxes currently due plus
deferred taxes on temporary differences in the recognition of income and expense for tax and financial statement purposes. Deferred tax assets and liabilities are included in the financial statements at currently enacted income tax rates applicable
to the period in which the deferred tax assets or liabilities are expected to be realized or settled. As changes in tax laws or rates are enacted, deferred tax assets and liabilities are adjusted through the provision for income taxes.



Deferred income tax liability relating to unrealized appreciation (or the deferred tax
asset in the case of unrealized depreciation) on investment securities available for sale is recorded in other liabilities (assets). Such unrealized appreciation or depreciation is recorded as an adjustment to equity in the financial statements and
not included in income determination until realized. Accordingly, the resulting deferred income tax liability or asset is also recorded as an adjustment to equity.



12



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##### Table of Contents

Notes to Consolidated Financial Statements



Note 1. Organization and Summary of Significant Accounting Policies, continued



Basic Earnings per Share



Basic earnings per share is computed by dividing income available to common shareholders by
the weighted average number of common shares outstanding during the period, after giving retroactive effect to stock splits and dividends.



Diluted Earnings per Share



The computation of diluted earnings per share is similar to the computation of basic earnings per share except that the denominator is increased to include the number of
additional common shares that would have been outstanding if dilutive potential common shares had been issued. The numerator is adjusted for any changes in income or loss that would result from the assumed conversion of those potential common
shares.



Comprehensive Income



Annual comprehensive income reflects the change in the Companys equity during the year
arising from transactions and events other than investments by and distributions to shareholders. It consists of net income plus certain other changes in assets and liabilities that are reported as separate components of shareholders equity
rather than as income or expense.



Financial Instruments



Credit related financial instruments: In the ordinary course
of business, the Company has entered into commitments to extend credit, including commitments under credit card arrangements, commercial letters of credit, standby letters of credit and forward sales commitments to various credit card trusts. Such
financial instruments are recorded when they are funded.



Derivative
financial instruments designated as hedges: As part of the Companys asset/liability management, the Company uses interest rate contracts, which include, swaps, futures, forwards and option agreements to hedge various exposures or to modify
interest rate characteristics of various balance sheet accounts.



Derivatives
that are used as part of the asset/liability management process are linked to specific assets or liabilities and have high correlation between the contract and the underlying item being hedged, both at inception and throughout the hedge period. In
addition, forwards and option contracts must reduce an exposures risk, and for hedges of anticipatory transactions, the significant terms and characteristics of the transaction must be identified and the transactions must be probable of
occurring.



The derivative instruments that meet the preceding qualifications
are accounted for as follows:



| |  | Swaps and options are accounted for on the accrual method. Under that method, the interest component associated with the contract is recognized over the life of the
contract in net interest income. Except for contracts designated as a hedge of an available for sale security, swaps and options are not carried at fair value. For contracts that are designated as a hedge of an available for sale security, in
addition to the accrual method of accounting, these contracts are carried at fair value with the resulting gain or loss recognized in other comprehensive income. Option premiums paid are amortized to net interest income over the life of the
contract.
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Futures and forwards are carried at fair value with the resulting gain or loss deferred and recognized in net interest income in a manner consistent with the objectives of the use
of the instrument.
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | When a contract is terminated the resulting gain or loss is deferred and amortized into net interest income based upon the shorter of the contracts life or the underlying
hedged item. If the underlying hedged item is disposed, the deferred gain or loss is immediately recognized as part of the gain or loss on the disposed item.
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Other derivative financial instruments: Those contracts that do not meet the hedging criteria above are classified as trading
activities and are recorded at fair value with changes in fair value recorded in earnings.



13



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##### Table of Contents

Notes to Consolidated Financial Statements



Note 1. Organization and Summary of Significant Accounting Policies, continued



Fair Value of Financial Instruments



Statement of Financial Accounting Standards No. 107, Disclosures about Fair Value of
Financial Instruments, requires disclosure of fair value information about financial instruments, whether or not recognized in the balance sheet. In cases where quoted market prices are not available, fair values are based on estimates using present
value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. In that regard, the derived fair value estimates cannot be substantiated by
comparison to independent markets and, in many cases, could not be realized in immediate settlement of the instruments. Statement No. 107 excludes certain financial instruments and all nonfinancial instruments from its disclosure requirements.
Accordingly, the aggregate fair value amounts presented do not represent the underlying value of the Company.



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



Cash and cash equivalents: The carrying amounts reported in the balance sheet for cash and cash equivalents approximate their fair
values.



Interest-bearing deposits with banks: Fair values for time
deposits are estimated using a discounted cash flow analysis that applies interest rates currently being offered on certificates to a schedule of aggregated contractual maturities on such time deposits.



Available-for-sale and held-to-maturity securities: Fair values for securities,
excluding restricted equity securities, are based on quoted market prices, where available. If quoted market prices are not available, fair values are based on quoted market prices of comparable instruments. The carrying values of restricted equity
securities approximate fair values.



Loans receivable: For variable-rate
loans that reprice frequently and with no significant change in credit risk, fair values are based on carrying amounts. The fair values for other loans are estimated using discounted cash flow analysis, based on interest rates currently being
offered for loans with similar terms to borrowers of similar credit quality. Loan fair value estimates include judgments regarding future expected loss experience and risk characteristics. Fair values for impaired loans are estimated using
discounted cash flow analysis or underlying collateral values, where applicable. The carrying amount of accrued interest receivable approximates its fair value.



Deposit liabilities: The fair values disclosed for demand and savings deposits are, by definition, equal to the amount payable on demand at the reporting date.
The fair values for certificates of deposit are estimated using a discounted cash flow calculation that applies interest rates currently being offered on certificates to a schedule of aggregated contractual maturities on such time deposits. The
carrying amount of accrued interest payable approximates fair value.



Short-term debt: The carrying amounts of short-term debt approximate their fair values.



Long-term debt: The fair value of long-term debt is estimated using a discounted cash flow calculation that applies interest rates currently available on similar instruments.



Other liabilities: For fixed-rate loan commitments, fair value considers the
difference between current levels of interest rates and the committed rates. The carrying amounts of other liabilities approximates fair value.



Reclassification



Certain reclassifications have been made to the prior years financial statements to place them on a comparable basis with the current year. Net income and stockholders equity previously reported were not
affected by these reclassifications.



14



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##### Table of Contents

Notes to Consolidated Financial Statements



Note 2. Restrictions on Cash



To comply with banking regulations, the Company is required to maintain certain average cash reserve balances. The daily average cash reserve requirement was
approximately $545,000 and $65,000 for the periods including December 31, 2003 and 2002, respectively.



Note 3. Securities



Debt and equity
securities have been classified in the balance sheets according to managements intent. The carrying amounts of securities and their approximate fair values at December 31, 2003 and 2002 follow:



|                                  |  |               |           |                 |   |                  |  |            |       |  |   |          
|--------------------------------- |  | ------------- | --------- | --------------- | - | ---------------- |  | ---------- | ----- |  | - | ---------
|2003                              |  | AmortizedCost |           | UnrealizedGains |   | UnrealizedLosses |  | Fair Value
|Available for sale                |  |               |           |                 |   |                  |  |            |       |  |   |          
|U.S. Government agency securities |  | $             | 4,998,923 |                 | $ | 1,839            |  | $          | 1,812 |  | $ | 4,998,950
|Mortgage-backed securities        |  |               | 321,674   |                 |   | 4,961            |  |            |      |  |   | 326,635  
|State and municipal               |  |               | 100,127   |                 |   | 261              |  |            |      |  |   | 100,388  
|                                  |  |               |           |                 |   |                  |  |            |       |  |   |          
|                                  |  | $             | 5,420,724 |                 | $ | 7,061            |  | $          | 1,812 |  | $ | 5,425,973
|                                  |  |               |           |                 |   |                  |  |            |       |  |   |          
|                                  |  |               |           |                
|2002                              |  | AmortizedCost |           | UnrealizedGains |   | UnrealizedLosses |  | Fair Value
|Available for sale                |  |               |           |                 |   |                  |  |            |       |  |   |          
|U.S. Government agency securities |  | $             | 3,535,557 |                 | $ | 16,024           |  | $          | 239   |  | $ | 3,551,342
|Mortgage-backed securities        |  |               | 499,896   |                 |   | 13,000           |  |            |      |  |   | 512,896  
|State and municipal               |  |               | 100,910   |                 |   | 1,532            |  |            |      |  |   | 102,442  
|                                  |  |               |           |                 |   |                  |  |            |       |  |   |          
|                                  |  | $             | 4,136,363 |                 | $ | 30,556           |  | $          | 239   |  | $ | 4,166,680
|                                  |  |               |           |                 |   |                  |  |            |       |  |   |          



Restricted equity securities were
$445,000 and $280,000 at December 31, 2003 and 2002. Restricted equity securities consist of investments in stock of the Federal Home Loan Bank of Atlanta (FHLB), which is carried at cost. The FHLB requires financial institutions to make
equity investments in the FHLB in order to borrow money. The Company is required to hold that stock so long as it borrows from the FHLB.



Investment securities with amortized cost of approximately $5,321,000 and $4,036,000 at December 31, 2003 and 2002, respectively, were pledged as collateral on public
deposits and for other purposes as required or permitted by law.



Maturities of
mortgage-backed bonds are stated based on contractual maturities. Actual maturities of these bonds may vary as the underlying mortgages are prepaid. The scheduled maturities of securities (all available for sale) at December 31, 2003 were as
follows:



|                                       |  |               |           |            |   |          
|-------------------------------------- |  | ------------- | --------- | ---------- | - | ---------
|                                       |  | AmortizedCost |           | Fair Value
|Due in one year or less                |  | $             | 4,099,671 |            | $ | 4,101,213
|Due after one year through five years  |  |               | 999,379   |            |   | 998,125  
|Due after five years through ten years |  |               |          |            |   |         
|Due after ten years                    |  |               | 321,674   |            |   | 326,635  
|                                       |  |               |           |            |   |          
|                                       |  | $             | 5,420,724 |            | $ | 5,425,973
|                                       |  |               |           |            |   |          



15



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##### Table of Contents

Notes to Consolidated Financial Statements



Note 3. Securities, continued



The following table details unrealized losses and related fair values in the Companys and available for sale investment securities portfolio. All unrealized loss
positions at December 31, 2003 have been for less than twelve months.



|                                      |  |            |           |                  |   |      
|------------------------------------- |  | ---------- | --------- | ---------------- | - | -----
|                                      |  | Fair Value |           | UnrealizedLosses
|U.S. Treasury securities              |  | $          |          |                  | $ |     
|U.S. Government agency securities     |  |            | 1,746,489 |                  |   | 1,812
|State and municipal securities        |  |            |          |                  |   |     
|Mortgage backed securities            |  |            |          |                  |   |     
|Other securities                      |  |            |          |                  |   |     
|                                      |  |            |           |                  |   |      
|Total temporarily impaired securities |  | $          | 1,746,489 |                  | $ | 1,812
|                                      |  |            |           |                  |   |      



Management considers the nature of the
investment, the underlying causes of the decline in market value, the severity and duration of the decline in market value and other evidence, on a security by security basis, in determining if the decline in market value is other than temporary.
Management believes all unrealized losses presented in the table above to be temporary in nature.



Note 4. Loans Receivable



The major
components of loans in the balance sheets at December 31, 2003 and 2002 are as follows:



|                                             |  |      |             |   |      |   |            |  
|-------------------------------------------- |  | ---- | ----------- | - | ---- | - | ---------- | -
|                                             |  | 2003 |             |   | 2002 |  
|Commercial                                   |  | $    | 66,675,083  |   |      | $ | 48,285,949 |  
|Real estate:                                 |  |      |             |   |      |   |            |  
|Construction and land development            |  |      | 5,799,087   |   |      |   | 5,921,098  |  
|Residential, 1-4 families                    |  |      | 38,499,158  |   |      |   | 18,094,720 |  
|Residential, 5 or more families              |  |      |            |   |      |   | 322,243    |  
|Farmland                                     |  |      | 127,277     |   |      |   | 198,336    |  
|Nonfarm, nonresidential                      |  |      | 879,280     |   |      |   | 1,027,211  |  
|Agricultural                                 |  |      | 107,685     |   |      |   | 148,659    |  
|Consumer                                     |  |      | 7,595,515   |   |      |   | 8,880,464  |  
|Other                                        |  |      | 78,178      |   |      |   | 481,762    |  
|                                             |  |      |             |   |      |   |            |  
|                                             |  |      | 119,761,263 |   |      |   | 83,360,442 |  
|                                             |  |     
|Unearned loan origination fees, net of costs |  |      | (288,824    | ) |      |   | (151,169   | )
|                                             |  |      |             |   |      |   |            |  
|                                             |  |      | 119,472,439 |   |      |   | 83,209,273 |  
|                                             |  |     
|Allowance for loan losses                    |  |      | (2,109,820  | ) |      |   | (1,831,167 | )
|                                             |  |      |             |   |      |   |            |  
|                                             |  | $    | 117,362,619 |   |      | $ | 81,378,106 |  
|                                             |  |      |             |   |      |   |            |  



Note 5. Allowance for Loan Losses



Changes in the allowance for loan losses are as follows:



|                                  |  |      |           |   |      |   |           |      |  |   |           |  
|--------------------------------- |  | ---- | --------- | - | ---- | - | --------- | ---- |  | - | --------- | -
|                                  |  | 2003 |           |   | 2002 |   |           | 2001 | 
|Balance, beginning                |  | $    | 1,831,167 |   |      | $ | 1,251,496 |      |  | $ | 859,403   |  
|                                  |  |      |          
|Provision charged to expense      |  |      | 378,401   |   |      |   | 651,005   |      |  |   | 450,003   |  
|Recoveries of amounts charged off |  |      | 42,487    |   |      |   | 8,589     |      |  |   | 6,567     |  
|Amounts charged off               |  |      | (142,235  | ) |      |   | (79,923   | )    |  |   | (64,477   | )
|                                  |  |      |           |   |      |   |           |      |  |   |           |  
|Balance, ending                   |  | $    | 2,109,820 |   |      | $ | 1,831,167 |      |  | $ | 1,251,496 |  
|                                  |  |      |           |   |      |   |           |      |  |   |           |  



16



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##### Table of Contents

Notes to Consolidated Financial Statements



Note 5. Allowance for Loan Losses, continued



The following is a summary of information pertaining to impaired loans at December 31:



|                                              |  |      |         |      |   |        
|--------------------------------------------- |  | ---- | ------- | ---- | - | -------
|                                              |  | 2003 |         | 2002
|                                              |  |     
|Impaired loans without a valuation allowance  |  | $    | 45,600  |      | $ | 250,300
|Impaired loans with a valuation allowance     |  |      | 190,900 |      |   | 188,100
|                                              |  |      |         |      |   |        
|Total impaired loans                          |  | $    | 236,500 |      | $ | 438,400
|                                              |  |      |         |      |   |        
|Valuation allowance related to impaired loans |  | $    | 135,100 |      | $ | 72,655 
|                                              |  |      |         |      |   |        



Nonaccrual loans were $236,500 and
$438,400 at December 31, 2003 and December 31, 2002, respectively. There were no other loans past due 90 days or more at December 31, 2003 or December 31, 2002.



The average annual recorded investment in impaired loans and interest income recognized on impaired loans for the years ended December 31, 2003, 2002, and 2001 (all
approximate) are summarized below:



|                                                             |  |      |        |      |   |         |  |   |        
|------------------------------------------------------------ |  | ---- | ------ | ---- | - | ------- |  | - | -------
|                                                             |  | 2003 |        | 2002 |   | 2000   
|Average investment in impaired loans                         |  | $    | 95,100 |      | $ | 308,300 |  | $ | 138,400
|                                                             |  |      |        |      |   |         |  |   |        
|Interest income recognized on impaired loans                 |  | $    | 25,000 |      | $ | 31,100  |  | $ | 31,800 
|                                                             |  |      |        |      |   |         |  |   |        
|Interest income recognized on a cash basis on impaired loans |  | $    | 17,000 |      | $ | 27,800  |  | $ | 24,900 
|                                                             |  |      |        |      |   |         |  |   |        



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



Note 6. Loan Servicing



Mortgage loans serviced for others are not included in the accompanying
consolidated balance sheets. The unpaid principal balances of mortgage loans serviced for others were $44,982,897 and $23,180,689 at December 31, 2003 and 2002, respectively.



Note 7. Property and Equipment



Components of property and equipment and total accumulated depreciation at December 31, 2003 and 2002 are as follows:



|                              |  |      |            |   |      |   |            |  
|----------------------------- |  | ---- | ---------- | - | ---- | - | ---------- | -
|                              |  | 2003 |            |   | 2002 |  
|Land and improvements         |  | $    | 950,732    |   |      | $ | 822,848    |  
|Buildings and improvements    |  |      | 2,704,182  |   |      |   | 2,226,512  |  
|Furniture and equipment       |  |      | 2,091,782  |   |      |   | 1,567,257  |  
|                              |  |      |            |   |      |   |            |  
|                              |  |      | 5,746,696  |   |      |   | 4,616,617  |  
|                              |  |     
|Less accumulated depreciation |  |      | (1,464,926 | ) |      |   | (1,108,639 | )
|                              |  |      |            |   |      |   |            |  
|                              |  | $    | 4,281,770  |   |      | $ | 3,507,978  |  
|                              |  |      |            |   |      |   |            |  



At December 31, 2003, Company premises
with a carrying value of $121,351 were pledged as collateral for a mortgage loan.



17



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##### Table of Contents

Notes to Consolidated Financial Statements



Note 7. Property and Equipment, continued



The Companys West Pine Street branch, Stuart branch (land only) and Pilot Mountain branch are leased under operating leases at a monthly rental of $1,750, $1,428
and $1,741, respectively. The West Pine Street lease is for a five-year term, which expires March 31, 2005. The Company has the option to renew the lease for four additional five-year terms. The Stuart, Virginia branch land lease is for a term of
one year, which expires in 2004. The Company has the option to renew the lease for three additional one-year terms. The Pilot Mountain lease is for a term of one year, which expiries in 2004. Rental expense was $43,379, $37,800 and $38,800 for 2003,
2002 and 2001, respectively.



Pursuant to the terms of noncancelable lease
agreements in effect at December 31, 2003, pertaining to banking premises and equipment, future minimum rent commitments under various operating leases are as follows:



|           |  |   |       
|---------- |  | - | ------
|2004       |  | $ | 55,546
|2005       |  |   | 5,250 
|2006       |  |   |      
|2007       |  |   |      
|2008       |  |   |      
|thereafter |  |   |      
|           |  |   |       
|           |  | $ | 60,796
|           |  |   |       



Note 8. Deposits



The aggregate amount of time deposits in denominations of $100,000 or more at December 31,
2003 and 2002 was $19,798,705 and $20,621,907, respectively.



At December 31,
2003, the scheduled maturities of time deposits are as follows:



|           |  |   |           
|---------- |  | - | ----------
|2004       |  | $ | 58,654,474
|2005       |  |   | 2,717,998 
|2006       |  |   | 986,345   
|2007       |  |   | 1,752,316 
|thereafter |  |   | 797,290   
|           |  |   |           
|           |  | $ | 64,908,423
|           |  |   |           



Note 9. Short-Term Debt



Short-term debt consists of federal funds purchased and securities sold
under agreements to repurchase, which generally mature within one to four days from the transaction date, and other short-term borrowings. Additional information at December 31, 2003 and 2002 and for the periods then ended is summarized below:



|                                                     |  |      |           |   |      |   |           |  
|---------------------------------------------------- |  | ---- | --------- | - | ---- | - | --------- | -
|                                                     |  | 2003 |           |   | 2002 |  
|Outstanding balance at December 31                   |  | $    | 4,818,635 |   |      | $ | 2,785,400 |  
|                                                     |  |      |           |   |      |   |           |  
|Year-end weighted average rate                       |  |      | 0.74      | % |      |   | 0.90      | %
|                                                     |  |      |           |   |      |   |           |  
|Daily average outstanding during the year            |  | $    | 4,488,100 |   |      | $ | 3,710,414 |  
|                                                     |  |      |           |   |      |   |           |  
|Average rate for the period                          |  |      | 0.92      | % |      |   | 1.72      | %
|                                                     |  |      |           |   |      |   |           |  
|Maximum outstanding at any month-end during the year |  | $    | 7,259,156 |   |      | $ | 4,044,998 |  
|                                                     |  |      |           |   |      |   |           |  



Lines of Credit



The Company has established various credit facilities to provide
additional liquidity if and as needed. These include unsecured lines of credit with correspondent banks totaling $10,000,000 and a secured line of credit with the Federal Home Loan Bank of Atlanta of approximately $20,798,000. At December 31, 2003
and 2002 there were outstanding balances of $6,400,000 and $5,000,000, respectively, under credit arrangements with correspondent banks.



18



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##### Table of Contents

Notes to Consolidated Financial Statements



Note 10. Long-Term Debt



The Companys long-term debt includes instruments bearing fixed rates ranging from 1.80% to 8.0%. The weighted average rate at December 31, 2003 was 3.18%.
Collateral consists of real estate, certain residential real estate loans and certain investment securities. The contractual maturities of long-term debt are as follows:



|           |  |   |          
|---------- |  | - | ---------
|2004       |  | $ | 1,008,176
|2005       |  |   | 1,648,855
|2006       |  |   | 1,009,589
|2007       |  |   | 10,385   
|2008       |  |   | 1,511,247
|thereafter |  |   | 57,828   
|           |  |   |          
|           |  | $ | 5,246,080
|           |  |   |          



Note 11. Fair Value of Financial
Instruments



Fair Values



The estimated fair values of the Banks financial instruments are as follows (dollars
in thousands):



|                                        |  |                   |         |                   |   |                |  |           |        |  |   |       
|--------------------------------------- |  | ----------------- | ------- | ----------------- | - | -------------- |  | --------- | ------ |  | - | ------
|                                        |  | December 31, 2003 |         | December 31, 2002
|                                        |  | CarryingAmount    |         | Fair Value        |   | CarryingAmount |  | FairValue
|Financial assets                        |  |                   |         |                   |   |                |  |           |        |  |   |       
|Cash and cash equivalents               |  | $                 | 1,956   |                   | $ | 1,956          |  | $         | 1,409  |  | $ | 1,409 
|Interest-bearing deposits with banks    |  |                   | 4,068   |                   |   | 4,068          |  |           | 10,097 |  |   | 10,097
|Securities, available for sale          |  |                   | 5,426   |                   |   | 5,426          |  |           | 4,167  |  |   | 4,167 
|Federal Home Loan Bank stock            |  |                   | 445     |                   |   | 445            |  |           | 280    |  |   | 280   
|Loans, net of allowance for loan losses |  |                   | 117,363 |                   |   | 120,976        |  |           | 85,852 |  |   | 88,741
|                                        |  |                   |         |                  
|Financial liabilities                   |  |                   |         |                   |   |                |  |           |        |  |   |       
|Deposits                                |  |                   | 111,278 |                   |   | 111,782        |  |           | 86,899 |  |   | 87,573
|Short-term debt                         |  |                   | 4,819   |                   |   | 4,827          |  |           | 2,785  |  |   | 2,785 
|Long-term debt                          |  |                   | 5,246   |                   |   | 5,281          |  |           | 5,939  |  |   | 5,979 



Derivative Financial Instruments



In order to better manage interest rate risk, the Company entered
into a forward contract with Compass Bank on November 6, 2003. The face amount of the contract was $8,000,000 for a 69 day term. The company terminated the contract on December 3, 2003 for a loss of $52,500 which is classified in other expenses.



Note 12. Stockholders Equity



On May 1, 2003, Surrey Bancorp exchanged six shares of its no par value common stock for
every five shares of $4.00 par value common stock of Surrey Bank & Trust. Fractional shares resulting from the transaction were paid in cash.



On June 12, 2003, the Company issued 189,356 shares of Series A, 4.5% Convertible Non-Cumulative Perpetual Preferred Stock at a liquidation value of $14.00 per share. The
issue was a private placement of which the net proceeds amounted to $2,620,325. The shares are convertible into .8695 shares of common stock.



On May 22, 2002, the stockholders of Surrey Bank & Trust approved an amendment to the Articles of Incorporation changing the par value of the Companys common
stock from $5.00 per share to $4.00 per share. The effect of the change is reflected in the consolidated statements of changes in stockholders equity for the year ended December 31, 2002.



19



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##### Table of Contents

Notes to Consolidated Financial Statements



Note 13. Earnings Per Share



The following table details the computation of basic and diluted earnings per share for each year ended December 31.



|                                                     |  |      |           |   |      |   |           |  |   |          
|---------------------------------------------------- |  | ---- | --------- | - | ---- | - | --------- |  | - | ---------
|                                                     |  | 2003 |           |   | 2002 |   | 2001     
|Net income                                           |  | $    | 1,261,385 |   |      | $ | 1,047,308 |  | $ | 517,144  
|Preferred stock dividends                            |  |      | (66,349   | ) |      |   |          |  |   |         
|                                                     |  |      |           |   |      |   |           |  |   |          
|Net income (income available to common shareholders) |  | $    | 1,195,036 |   |      | $ | 1,047,308 |  | $ | 517,144  
|                                                     |  |      |           |   |      |   |           |  |   |          
|Weighted average common shares outstanding           |  |      | 1,153,172 |   |      |   | 1,149,882 |  |   | 1,147,239
|Effect of dilutive securities:                       |  |      |           |   |      |   |           |  |   |          
|Options                                              |  |      | 110,292   |   |      |   | 97,478    |  |   | 38,663   
|Convertible preferred stock                          |  |      | 91,570    |   |      |   |          |  |   |         
|                                                     |  |      |           |   |      |   |           |  |   |          
|Weighted average common shares outstanding, diluted  |  |      | 1,355,034 |   |      |   | 1,247,360 |  |   | 1,185,902
|                                                     |  |      |           |   |      |   |           |  |   |          
|Basic earnings per share                             |  | $    | 1.04      |   |      | $ | .91       |  | $ | .45      
|                                                     |  |      |           |   |      |   |           |  |   |          
|Diluted earnings per share                           |  | $    | .93       |   |      | $ | .84       |  | $ | .44      
|                                                     |  |      |           |   |      |   |           |  |   |          



20



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##### Table of Contents

Notes to Consolidated Financial Statements



Note 14. Stock Options



The Company has adopted a qualified incentive stock option plan, which reserves 103,422 shares (adjusted for stock exchange and dividends) for purchase by eligible
employees. Options granted under this plan vest at the rate of 20% per year, expire not more than ten years from the date of grant, and are exercisable at not less than the fair market value of the stock at the date grant. On February 15, 2001, the
Company amended the Qualified Incentive Stock Plan to increase the shares available under the ISO plan.



The Company also adopted a non-qualified stock option plan, which reserves 101,912 shares (adjusted for stock exchange and dividends) for purchase by non-employee directors. Options granted under this plan are
exercisable after six months from the date of grant at not less than the fair market value of the stock at the date of grant. The life of such options shall not extend more than ten years from the date of grant. On February 15, 2001, the Company
amended the Non-qualified Stock Option Plan increasing the shares available under the plan.



Activity under Company plans during the years ended December 31, 2003, 2002 and 2001 is summarized below:



|                                   |  |                    |   |  |                    |   |  |                    |   |  |         |  
|---------------------------------- |  | ------------------ | - |  | ------------------ | - |  | ------------------ | - |  | ------- | -
|                                   |  | Qualified Plan     |   |  | Non-Qualified Plan |  
|                                   |  | AvailableFor Grant |   |  | Granted            |   |  | AvailableFor Grant |   |  | Granted |  
|Balance, December 31, 2000         |  | 16,326             |   |  | 55,392             |   |  |                   |   |  | 72,000  |  
|                                   |  |                    |   | 
|Plan amendment                     |  | 14,912             |   |  |                   |   |  | 14,912             |   |  |        |  
|Stock dividend                     |  | 1,466              |   |  | 7,197              |   |  |                   |   |  | 8,691   |  
|Granted                            |  | (16,600            | ) |  | 16,600             |   |  | (14,910            | ) |  | 14,910  |  
|Exercised                          |  |                   |   |  |                   |   |  |                   |   |  |        |  
|Forfeited                          |  |                   |   |  |                   |   |  |                   |   |  |        |  
|Expired                            |  |                   |   |  |                   |   |  |                   |   |  |        |  
|                                   |  |                    |   |  |                    |   |  |                    |   |  |         |  
|Balance, December 31, 2001         |  | 16,104             |   |  | 79,189             |   |  | 2                  |   |  | 95,601  |  
|                                   |  |                    |   | 
|Granted                            |  |                   |   |  |                   |   |  |                   |   |  |        |  
|Exercised                          |  |                   |   |  |                   |   |  |                   |   |  | (2,343  | )
|Forfeited                          |  |                   |   |  |                   |   |  |                   |   |  |        |  
|Expired                            |  |                   |   |  |                   |   |  |                   |   |  |        |  
|                                   |  |                    |   |  |                    |   |  |                    |   |  |         |  
|Balance, December 31, 2002         |  | 16,104             |   |  | 79,189             |   |  | 2                  |   |  | 93,258  |  
|                                   |  |                    |   | 
|Surrey Bancorp conversion/exchange |  | 3,440              |   |  | 15,617             |   |  | 1                  |   |  | 18,651  |  
|Granted                            |  | (4,800             | ) |  | 4,800              |   |  |                   |   |  |        |  
|Exercised                          |  |                   |   |  | (10,928            | ) |  |                   |   |  | (10,000 | )
|Forfeited                          |  | 2,420              |   |  | (2,420             | ) |  |                   |   |  |        |  
|Expired                            |  |                   |   |  |                   |   |  |                   |   |  |        |  
|                                   |  |                    |   |  |                    |   |  |                    |   |  |         |  
|Balance, December 31, 2003         |  | 17,164             |   |  | 86,258             |   |  | 3                  |   |  | 101,909 |  
|                                   |  |                    |   |  |                    |   |  |                    |   |  |         |  



21



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Notes to Consolidated Financial Statements



Note 14. Stock Options, continued



Additional information related to Company plans is detailed below:(3)



|                                                                               |  |      |           |   |      |   |           |  |   |         |  
|------------------------------------------------------------------------------ |  | ---- | --------- | - | ---- | - | --------- |  | - | ------- | -
|                                                                               |  | 2003 |           |   | 2002 |   | 2001      | 
|Outstanding options:                                                           |  |      |           |   |      |   |           |  |   |         |  
|Exercise price, beginning of the year(1)                                       |  | $    | 6.10      |   |      | $ | 6.10      |  | $ | 5.93    |  
|Exercise price, end of the year(1)                                             |  | $    | 6.27      |   |      | $ | 6.10      |  | $ | 6.10    |  
|Range of exercise prices:                                                      |  |      |           |   |      |   |           |  |   |         |  
|From                                                                           |  | $    | 5.79      |   |      | $ | 5.78      |  | $ | 5.78    |  
|To                                                                             |  | $    | 12.71     |   |      | $ | 9.47      |  | $ | 9.47    |  
|Remaining contractual life in months(1)                                        |  |      | 55        |   |      |   | 65        |  |   | 77      |  
|                                                                               |  |      |          
|Exercisable options outstanding at December 31:                                |  |      |           |   |      |   |           |  |   |         |  
|Number                                                                         |  |      | 169,597   |   |      |   | 189,304   |  |   | 150,619 |  
|Exercise price(1)                                                              |  | $    | 6.27      |   |      | $ | 6.08      |  | $ | 5.95    |  
|                                                                               |  |      |          
|Weighted average exercise price of options:                                    |  |      |           |   |      |   |           |  |   |         |  
|Granted during the year                                                        |  | $    | 12.71     |   |      | $ |          |  | $ | 6.87    |  
|Exercised during the year                                                      |  | $    | 5.79      |   |      | $ | 6.77      |  | $ |        |  
|Forfeited during the year                                                      |  | $    | 8.52      |   |      | $ |          |  | $ |        |  
|Expired during the year                                                        |  | $    |          |   |      | $ |          |  | $ |        |  
|                                                                               |  |      |          
|Grant-date fair value:                                                         |  |      |           |   |      |   |           |  |   |         |  
|Options granted during the year                                                |  | $    | 31,423    |   |      | $ |          |  | $ | 153,700 |  
|                                                                               |  |      |          
|Significant assumptions used in determining fair value of options granted:     |  |      |           |   |      |   |           |  |   |         |  
|Risk-free interest rate                                                        |  |      | 4.06      | % |      |   | n/a       |  |   | 5.25    | %
|Expected life in years                                                         |  |      | 10        |   |      |   | n/a       |  |   | 10      |  
|Expected dividends                                                             |  |      |          |   |      |   | n/a       |  |   |        |  
|Expected volatility                                                            |  |      | 10.22     | % |      |   | n/a       |  |   | .80     | %
|                                                                               |  |      |          
|Results of operations:                                                         |  |      |           |   |      |   |           |  |   |         |  
|Compensation cost recognized in income for all stock-based compensation awards |  | $    |          |   |      | $ |          |  | $ |        |  
|                                                                               |  |      |           |   |      |   |           |  |   |         |  
|Pro forma net income(2)                                                        |  | $    | 1,172,763 |   |      | $ | 1,033,088 |  | $ | 426,788 |  
|                                                                               |  |      |           |   |      |   |           |  |   |         |  
|Basic pro forma earnings per share(2)                                          |  | $    | 1.02      |   |      | $ | 0.90      |  | $ | 0.37    |  
|                                                                               |  |      |           |   |      |   |           |  |   |         |  
|Diluted pro forma earnings per share(2)                                        |  | $    | 0.91      |   |      | $ | 0.83      |  | $ | 0.36    |  
|                                                                               |  |      |           |   |      |   |           |  |   |         |  

---

|(1) | Weighted average
|--- | ----------------

|(2) | As if the fair value based method prescribed by SFAS No. 123 had been applied
|--- | -----------------------------------------------------------------------------

|(3) | Adjustment for the effects of a 20% common stock dividend in 1999, a 20% common stock dividend in January 2000, and a 10% common stock dividend in 2001, and a 6 for
5 common stock exchange on May 1, 2003.
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Note 15.
Income Taxes



Current and Deferred Income Tax Components



The components of income tax expense are as follows:



|         |  |      |          |   |      |   |          |      |  |   |         |  
|-------- |  | ---- | -------- | - | ---- | - | -------- | ---- |  | - | ------- | -
|         |  | 2003 |          |   | 2002 |   |          | 2001 | 
|Current  |  | $    | 938,858  |   |      | $ | 774,753  |      |  | $ | 381,405 |  
|Deferred |  |      | (180,746 | ) |      |   | (134,727 | )    |  |   | (41,769 | )
|         |  |      |          |   |      |   |          |      |  |   |         |  
|         |  | $    | 758,112  |   |      | $ | 640,026  |      |  | $ | 339,636 |  
|         |  |      |          |   |      |   |          |      |  |   |         |  



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##### Table of Contents

Notes to Consolidated Financial Statements



Note 15. Income Taxes, continued



Rate Reconciliation



A reconciliation of expected income tax expense (benefit) computed at the statutory federal income tax rate to income tax expense included in the statements of income is
as follows:



|                     |  |      |         |      |   |         |  |   |         |  
|-------------------- |  | ---- | ------- | ---- | - | ------- |  | - | ------- | -
|                     |  | 2003 |         | 2002 |   | 2001    | 
|Expected tax expense |  | $    | 686,629 |      | $ | 610,607 |  | $ | 346,656 |  
|Other                |  |      | 71,483  |      |   | 29,419  |  |   | (7,020  | )
|                     |  |      |         |      |   |         |  |   |         |  
|                     |  | $    | 758,112 |      | $ | 640,026 |  | $ | 339,636 |  
|                     |  |      |         |      |   |         |  |   |         |  



Deferred Income Tax Analysis



The significant components of net deferred tax assets (primary
Federal) at December 31, 2003 and 2002 are summarized as follows:



|                                                                                             |  |      |         |      |   |        
|-------------------------------------------------------------------------------------------- |  | ---- | ------- | ---- | - | -------
|                                                                                             |  | 2003 |         | 2002
|Deferred tax assets                                                                          |  |      |         |      |   |        
|Allowance for loan losses                                                                    |  | $    | 660,941 |      | $ | 477,636
|Investee timing differences                                                                  |  |      | 42,078  |      |   | 123,881
|Lower of cost or market adjustment on loans transferred from available for sale to portfolio |  |      | 80,502  |      |   |       
|                                                                                             |  |      |         |      |   |        
|                                                                                             |  |      | 783,521 |      |   | 601,517
|                                                                                             |  |      |         |      |   |        
|Deferred tax liabilities                                                                     |  |      |         |      |   |        
|Net unrealized appreciation on securities available for sale                                 |  |      | 2,023   |      |   | 11,688 
|Depreciation                                                                                 |  |      | 191,987 |      |   | 182,679
|Other                                                                                        |  |      | 20      |      |   | 12     
|                                                                                             |  |      |         |      |   |        
|                                                                                             |  |      | 194,030 |      |   | 194,379
|                                                                                             |  |      |         |      |   |        
|Net deferred tax asset                                                                       |  | $    | 589,491 |      | $ | 407,138
|                                                                                             |  |      |         |      |   |        



Note 16. Commitments and
Contingencies



Litigation



In the normal course of business the Company is involved in various legal proceedings. After
consultation with legal counsel, management believes that any liability resulting from such proceedings will not be material to the financial statements.



Financial Instruments with Off-Balance-Sheet Risk



The Company is party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of its customers. These financial
instruments include commitments to extend credit and standby letters of credit. These instruments involve, to varying degrees, credit risk in excess of the amount recognized in the balance sheets.



23



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##### Table of Contents

Notes to Consolidated Financial Statements



Note 16. Commitments and Contingencies, continued



Financial Instruments with Off-Balance-Sheet Risk, continued



The Companys exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to
extend credit and standby letters of credit is represented by the contractual amount of those instruments. The Company uses the same credit policies in making commitments and conditional obligations as for on-balance-sheet instruments. A summary of
the Companys commitments at December 31, 2003 and 2002 is as follows:



|                                                               |  |      |            |      |   |           
|-------------------------------------------------------------- |  | ---- | ---------- | ---- | - | ----------
|                                                               |  | 2003 |            | 2002
|Commitments to extend credit, including unused lines of credit |  | $    | 20,186,000 |      | $ | 17,533,000
|Standby letters of credit                                      |  |      | 938,000    |      |   | 301,000   
|                                                               |  |      |            |      |   |           
|                                                               |  | $    | 21,124,000 |      | $ | 17,834,000
|                                                               |  |      |            |      |   |           



Commitments to extend credit are
agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the
commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Company evaluates each customers creditworthiness on a case-by-case basis. The amount of
collateral obtained, if deemed necessary by the Company upon extension of credit, is based on managements credit evaluation of the party. Collateral held varies, but may include accounts receivable, inventory, property and equipment,
residential real estate and income-producing commercial properties.



Standby
letters of credit are conditional commitments issued by the Company to guarantee the performance of a customer to a third party. Those guarantees are primarily issued to support public and private borrowing arrangements. The credit risk involved in
issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. Collateral held varies as specified above and is required in instances which the Company deems necessary.



Concentrations of Credit Risk



Substantially all of the Companys loans, commitments to extend credit, and standby
letters of credit have been granted to customers in the Companys market area and such customers are generally depositors of the Company. The concentrations of credit by type of loan are set forth in Note 4. The distribution of commitments to
extend credit approximates the distribution of loans outstanding. The Company, as a matter of policy, does not extend credit to any single borrower or group of related borrowers in excess of approximately $1,900,000 unless guaranteed by SBA or USDA
Rural Development Corporation. Although the Company has a reasonably diversified loan portfolio, the following industries are considered to be concentrations: medical offices and related, trucking, used car dealers, and non-residential building
operators.



Other Commitments



The Company has entered into employment agreements with certain of its key officers covering
duties, salary, benefits, provisions for termination and Company obligations in the event of merger or acquisition.



Note 17. Regulatory Restrictions



Dividends



The Companys dividend payments are made from dividends received from the Bank. The Bank, as a North Carolina banking corporation, may pay dividends only out of its retained earnings. However, regulatory
authorities may limit payment of dividends by an bank when it is determined that such a limitation is in the public interest and is necessary to ensure financial soundness of the Bank.



24



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##### Table of Contents

Notes to Consolidated Financial Statements



Note 17. Regulatory Restrictions, continued



Dividends, continued



The Bank, as a North Carolina banking corporation, may pay dividends only out of undivided profits (retained earnings) as determined pursuant to North Carolina General
Statutes Section 53-87. However, regulatory authorities may limit payment of dividends by any bank when it is determined that such a limitation is in the public interest and is necessary to ensure financial soundness of the bank.



Intercompany Transactions



The Banks legal lending limit on loans to the Company are governed by Federal Reserve
Act 23A, and differ from legal lending limits on loans to external customers. Generally, a bank may lend up to 10% of its capital and surplus to its Parent, if the loan is secured. If collateral is in the form of stocks, bonds, debentures or similar
obligations, it must have a market value when the loan is made of at least 20% more than the amount of the loan, and if obligations of a state or political subdivision or agency thereof, it must have a market value of at least 10% more than the
amount of the loan. If such loans are secured by obligations of the United States or agencies thereof, or by notes, drafts, bills of exchange or bankers acceptances eligible for rediscount or purchase by a Federal Reserve Bank, requirements
for collateral in excess of the loan amount do not apply. Under this definition, the legal lending limit for the Bank on loans to the Company was approximately $870,000 at December 31, 2003. No 23A transactions were deemed to exist between the
Company and the Bank at December 31, 2003.



Capital Requirements



The Company and the Bank are subject to various regulatory capital
requirements administered by federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory (and possibly additional discretionary) actions by regulators that, if undertaken, could have a direct material effect
on the Companys consolidated financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the
Banks assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. The Banks capital amounts and classification are also subject to qualitative judgments by the regulators about
components, risk weightings, and other factors.



Quantitative measures
established by regulation to ensure capital adequacy require the Bank to maintain minimum amounts and ratios (set forth in the table below) of total and Tier I capital to risk-weighted assets, and of Tier I capital to average assets, as all those
terms are defined in the regulations. Management believes, as of December 31, 2003, that the Bank meets all capital adequacy requirements to which it is subject.



As of December 31, 2003, the most recent notification from the Federal Deposit Insurance Corporation categorized the Bank as well
capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized the Bank must maintain minimum total risk-based, Tier I risk-based, and Tier I leverage ratios as set forth in the following table. There
are no conditions or events since that notification that management believes have changed the institutions category.



25



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##### Table of Contents

The Companys and Banks actual capital amounts (in thousands) and ratios are also presented in the following
table.



Notes to Consolidated Financial Statements



Note 17. Regulatory Restrictions, continued



|                                         |  |        |        |       |                                              |   |        |                                                                       |       |  |     |        |  |       |        |  |      |  
|---------------------------------------- |  | ------ | ------ | ----- | -------------------------------------------- | - | ------ | --------------------------------------------------------------------- | ----- |  | --- | ------ |  | ----- | ------ |  | ---- | -
|                                         |  | Actual |        |       | MinimumRequired ForCapital Adequacy Purposes |   |        | Minimum To Be WellCapitalized UnderPrompt CorrectiveAction Provisions |      
|                                         |  | Amount |        | Ratio |                                              |   | Amount |                                                                       | Ratio |  |     | Amount |  | Ratio |       
|December 31, 2003:                       |  |        |        |       |                                              |   |        |                                                                       |       |  |     |        |  |       |        |  |      |  
|Total Capital (to Risk-Weighted Assets)  |  |        |        |       |                                              |   |        |                                                                       |       |  |     |        |  |       |        |  |      |  
|Consolidated                             |  | $      | 13,874 |       | 11.52                                        | % |        | $                                                                     | 9,636 |  | 8.0 | %      |  | $     | 12,045 |  | 10.0 | %
|Surrey Bank & Trust                      |  | $      | 12,201 |       | 10.13                                        | % |        | $                                                                     | 9,636 |  | 8.0 | %      |  | $     | 12,045 |  | 10.0 | %
|Tier I Capital (to Risk-Weighted Assets) |  |        |        |       |                                              |   |        |                                                                       |       |  |     |        |  |       |        |  |      |  
|Consolidated                             |  | $      | 12,361 |       | 10.26                                        | % |        | $                                                                     | 4,818 |  | 4.0 | %      |  | $     | 7,227  |  | 6.0  | %
|Surrey Bank & Trust                      |  | $      | 10,687 |       | 8.87                                         | % |        | $                                                                     | 4,818 |  | 4.0 | %      |  | $     | 7,227  |  | 6.0  | %
|Tier I Capital (to Average Assets)       |  |        |        |       |                                              |   |        |                                                                       |       |  |     |        |  |       |        |  |      |  
|Consolidated                             |  | $      | 12,361 |       | 10.50                                        | % |        | $                                                                     | 4,709 |  | 4.0 | %      |  | $     | 5,886  |  | 5.0  | %
|Surrey Bank & Trust                      |  | $      | 10,687 |       | 8.13                                         | % |        | $                                                                     | 5,259 |  | 4.0 | %      |  | $     | 6,574  |  | 5.0  | %
|                                         |  |        |        |       |                                              |  
|December 31, 2002:                       |  |        |        |       |                                              |   |        |                                                                       |       |  |     |        |  |       |        |  |      |  
|Total Capital (to Risk-Weighted Assets)  |  | $      | 10,530 |       | 11.15                                        | % |        | $                                                                     | 7,556 |  | 8.0 | %      |  | $     | 9,445  |  | 10.0 | %
|Tier I Capital (to Risk-Weighted Assets) |  | $      | 9,341  |       | 9.89                                         | % |        | $                                                                     | 3,778 |  | 4.0 | %      |  | $     | 5,667  |  | 6.0  | %
|Tier I Capital (to Average Assets)       |  | $      | 9,341  |       | 8.97                                         | % |        | $                                                                     | 4,165 |  | 4.0 | %      |  | $     | 5,206  |  | 5.0  | %



Note 18. Transactions with Related
Parties



The Company has entered into transactions with its directors,
significant shareholders and their affiliates (related parties). Such transactions were made in the ordinary course of business on substantially the same terms and conditions, including interest rates and collateral, as those prevailing at the same
time for comparable transactions with other customers, and did not, in the opinion of management, involve more than normal credit risk or present other unfavorable features.



Aggregate loan transactions with related parties were as follows:



|                   |  |      |            |   |      |   |            |  
|------------------ |  | ---- | ---------- | - | ---- | - | ---------- | -
|                   |  | 2003 |            |   | 2002 |  
|Balance, beginning |  | $    | 1,661,882  |   |      | $ | 2,146,283  |  
|                   |  |     
|New loans          |  |      | 1,455,880  |   |      |   | 1,390,201  |  
|Repayments         |  |      | (1,082,276 | ) |      |   | (1,874,602 | )
|                   |  |      |            |   |      |   |            |  
|Balance, ending    |  | $    | 2,035,486  |   |      | $ | 1,661,882  |  
|                   |  |      |            |   |      |   |            |  



26



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##### Table of Contents

Notes to Consolidated Financial Statements



Note 19. Investment in Limited Liability Company



Prior to March 1, 2003, the Company participated in a limited liability company with Friendly Auto Finance, Inc. (Friendly Finance, LLC). On
March 1, 2003, the Company acquired the minority interest in exchange for the satisfaction of other commitments of the holder of the minority interest. Friendly Finance, LLC purchases sales finance contracts from automobile dealers in the
Companys trade area. As of December 31, 2003 and 2002, the LLCs summarized unaudited balance sheet and for each of the three years in the period ended December 31, 2003 the statements of income and cash flows were as follows:



Balance Sheets

December 31, 2003 and 2002



|                                                                                                |  |      |           |      |   |          
|----------------------------------------------------------------------------------------------- |  | ---- | --------- | ---- | - | ---------
|                                                                                                |  | 2003 |           | 2002
|Assets                                                                                          |  |      |           |      |   |          
|Cash and due from banks                                                                         |  | $    | 52,167    |      | $ | 201,851  
|Interest-bearing deposits with banks                                                            |  |      | 63,279    |      |   | 137,913  
|Loans, net of allowance for loan losses of $324,964 and $539,162 in 2003 and 2002, respectively |  |      | 1,515,953 |      |   | 3,906,047
|Property and equipment, net                                                                     |  |      | 12,527    |      |   | 14,355   
|Other assets                                                                                    |  |      | 39,797    |      |   | 18,528   
|                                                                                                |  |      |           |      |   |          
|                                                                                                |  | $    | 1,683,723 |      | $ | 4,278,694
|                                                                                                |  |      |           |      |   |          
|Liabilities and Capital                                                                         |  |      |           |      |   |          
|Liabilities                                                                                     |  |      |           |      |   |          
|Long-term debt                                                                                  |  | $    | 140,000   |      | $ | 2,325,000
|Other liabilities                                                                               |  |      | 68,373    |      |   | 141,977  
|                                                                                                |  |      |           |      |   |          
|                                                                                                |  |      | 208,373   |      |   | 2,466,977
|                                                                                                |  |      |           |      |   |          
|Capital                                                                                         |  |      |           |      |   |          
|Equity                                                                                          |  |      | 600,000   |      |   | 1,000,000
|Retained earnings                                                                               |  |      | 875,350   |      |   | 811,717  
|                                                                                                |  |      |           |      |   |          
|                                                                                                |  |      | 1,475,350 |      |   | 1,811,717
|                                                                                                |  |      |           |      |   |          
|                                                                                                |  | $    | 1,683,723 |      | $ | 4,278,694
|                                                                                                |  |      |           |      |   |          



Statements of
Income

For the years ended December 31, 2003, 2002 and 2001



|                                     |  |      |          |   |      |   |         |  |   |          
|------------------------------------ |  | ---- | -------- | - | ---- | - | ------- |  | - | ---------
|                                     |  | 2003 |          |   | 2002 |   | 2001   
|Income                               |  |      |          |   |      |   |         |  |   |          
|Interest income                      |  | $    | 525,512  |   |      | $ | 955,577 |  | $ | 998,558  
|Other income                         |  |      | 41,938   |   |      |   | 27,169  |  |   | 24,981   
|                                     |  |      |          |   |      |   |         |  |   |          
|Total income                         |  |      | 567,450  |   |      |   | 982,746 |  |   | 1,023,539
|                                     |  |      |          |   |      |   |         |  |   |          
|Expenses                             |  |      |          |   |      |   |         |  |   |          
|Interest expense                     |  |      | 50,311   |   |      |   | 141,201 |  |   | 215,553  
|Provision for loan losses (recovery) |  |      | (168,601 | ) |      |   | 307,753 |  |   | 174,126  
|Salaries and employee benefits       |  |      | 113,017  |   |      |   | 146,773 |  |   | 140,962  
|Occupancy expense                    |  |      | 10,770   |   |      |   | 10,524  |  |   | 10,361   
|Equipment expense                    |  |      | 11,027   |   |      |   | 14,437  |  |   | 14,943   
|Other expense                        |  |      | 162,606  |   |      |   | 90,638  |  |   | 60,603   
|                                     |  |      |          |   |      |   |         |  |   |          
|Total expense                        |  |      | 179,130  |   |      |   | 711,326 |  |   | 616,548  
|                                     |  |      |          |   |      |   |         |  |   |          
|Net income                           |  | $    | 388,320  |   |      | $ | 271,420 |  | $ | 406,991  
|                                     |  |      |          |   |      |   |         |  |   |          



27



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Notes to Consolidated Financial Statements



Note 19. Investment in Limited Liability Company, continued



Statements of Cash Flows

For the years ended December 31, 2003, 2002 and 2001



|                                                                                 |  |      |            |   |      |   |          |      |  |   |            |  
|-------------------------------------------------------------------------------- |  | ---- | ---------- | - | ---- | - | -------- | ---- |  | - | ---------- | -
|                                                                                 |  | 2003 |            |   | 2002 |   |          | 2001 | 
|Cash flows from operating activities                                             |  |      |            |   |      |   |          |      |  |   |            |  
|Net income                                                                       |  | $    | 388,320    |   |      | $ | 271,420  |      |  | $ | 406,991    |  
|Adjustments to reconcile net income to net cash provided by operating activities |  |      |            |   |      |   |          |      |  |   |            |  
|Depreciation                                                                     |  |      | 6,751      |   |      |   | 6,052    |      |  |   | 5,531      |  
|Provision for loan losses                                                        |  |      | (168,601   | ) |      |   | 307,753  |      |  |   | 174,126    |  
|Net increase in other assets                                                     |  |      | (21,269    | ) |      |   | (6,845   | )    |  |   | (108,766   | )
|Net increase (decrease) in other liabilities                                     |  |      | (73,604    | ) |      |   | 4,432    |      |  |   | 27,644     |  
|                                                                                 |  |      |            |   |      |   |          |      |  |   |            |  
|Net cash provided by operating activities                                        |  |      | 131,597    |   |      |   | 582,812  |      |  |   | 505,526    |  
|                                                                                 |  |      |            |   |      |   |          |      |  |   |            |  
|Cash flows from investing activities                                             |  |      |            |   |      |   |          |      |  |   |            |  
|Net increase in interest-bearing deposits with banks                             |  |      | 74,634     |   |      |   | (4,833   | )    |  |   | (133,080   | )
|Purchase of property and equipment                                               |  |      | (4,923     | ) |      |   | (6,318   | )    |  |   | (798       | )
|Net (increase) decrease in loans                                                 |  |      | 1,834,008  |   |      |   | 277,873  |      |  |   | (1,364,237 | )
|                                                                                 |  |      |            |   |      |   |          |      |  |   |            |  
|Net cash provided (used) in investing activities                                 |  |      | 1,903,719  |   |      |   | 266,722  |      |  |   | (1,498,115 | )
|                                                                                 |  |      |            |   |      |   |          |      |  |   |            |  
|Cash flows from financing activities                                             |  |      |            |   |      |   |          |      |  |   |            |  
|Net increase (decrease) in long-term debt                                        |  |      | (2,185,000 | ) |      |   | (675,000 | )    |  |   | 875,000    |  
|                                                                                 |  |      |            |   |      |   |          |      |  |   |            |  
|Net cash provided (used) by financing activities                                 |  |      | (2,185,000 | ) |      |   | (675,000 | )    |  |   | 875,000    |  
|                                                                                 |  |      |            |   |      |   |          |      |  |   |            |  
|Net increase (decrease) in cash and due from banks                               |  |      | (149,684   | ) |      |   | 174,534  |      |  |   | (117,589   | )
|                                                                                 |  |      |           
|Cash and cash equivalents, beginning                                             |  |      | 201,851    |   |      |   | 27,317   |      |  |   | 144,906    |  
|                                                                                 |  |      |            |   |      |   |          |      |  |   |            |  
|Cash and cash equivalents, ending                                                |  | $    | 52,167     |   |      | $ | 201,851  |      |  | $ | 27,317     |  
|                                                                                 |  |      |            |   |      |   |          |      |  |   |            |  
|Supplemental disclosure of non-cash transactions                                 |  |      |            |   |      |   |          |      |  |   |            |  
|Non-cash transactions related to acquisition of minority interest in subsidiary: |  |      |            |   |      |   |          |      |  |   |            |  
|Cancellation of loan and interest receivable                                     |  |      | 422,984    |   |      |   |         |      |  |   |           |  
|Cancellation of loans receivable from recourse obligations                       |  |      | 243,850    |   |      |   |         |      |  |   |           |  
|Addition to allowance for loans losses                                           |  |      | 57,852     |   |      |   |         |      |  |   |           |  
|                                                                                 |  |      |            |   |      |   |          |      |  |   |            |  
|Total transaction                                                                |  | $    | 724,686    |   |      | $ |         |      |  | $ |           |  
|                                                                                 |  |      |            |   |      |   |          |      |  |   |            |  



28



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Notes to Consolidated Financial Statements



Note 20. Segment Reporting



The Company has two reportable segments, the Bank and Friendly Finance, LLC (subsidiary). The Bank provides mortgage, consumer, and commercial loans. Friendly Finance,
LLC specializes in the purchase of sales finance contracts from local automobile dealers. Information about reportable segments, and reconciliation of such information to the consolidated financial statements as of and for the years ended December
31, 2003, 2002 and 2001 is as follows:



|                                                                                                                      |  |      |             |                        |   |           |                         |  |   |            |   |  |                    |          |   |  |   |            
|--------------------------------------------------------------------------------------------------------------------- |  | ---- | ----------- | ---------------------- | - | --------- | ----------------------- |  | - | ---------- | - |  | ------------------ | -------- | - |  | - | -----------
|2003                                                                                                                  |  |      |             |                        |   |           |                         |  |   |            |   |  |                    |          |   |  |   |            
|                                                                                                                      |  |      |             |                        |  
|                                                                                                                      |  | Bank |             | Friendly  Finance, LLC |   |           | IntersegmentElimination |  |   | Other      |   |  | ConsolidatedTotals
|Net interest income                                                                                                   |  | $    | 4,943,839   |                        | $ | 475,201   |                         |  | $ |           |   |  | $                  |         |   |  | $ | 5,419,040  
|Other revenue  external customers                                                                                    |  |      | 2,046,647   |                        |   | 41,938    |                         |  |   |           |   |  |                    |         |   |  |   | 2,088,585  
|Depreciation and amortization                                                                                         |  |      | 362,725     |                        |   | 6,751     |                         |  |   |           |   |  |                    |         |   |  |   | 369,476    
|Provision for loan losses                                                                                             |  |      | 547,002     |                        |   | (168,601  | )                       |  |   |           |   |  |                    |         |   |  |   | 378,401    
|Net income                                                                                                            |  |      | 873,065     |                        |   | 388,320   |                         |  |   |           |   |  |                    |         |   |  |   | 1,261,385  
|Assets                                                                                                                |  |      | 135,397,988 |                        |   | 1,683,723 |                         |  |   | (2,004,706 | ) |  |                    |         |   |  |   | 135,077,005
|                                                                                                                      |  |      |             |                        |  
|2002                                                                                                                  |  |      |             |                        |   |           |                         |  |   |            |   |  |                    |          |   |  |   |            
|                                                                                                                      |  |      |             |                        |  
|                                                                                                                      |  | Bank |             | Friendly  Finance, LLC |   |           | IntersegmentElimination |  |   | Other      |   |  | ConsolidatedTotals
|Net interest income                                                                                                   |  | $    | 3,765,616   |                        | $ | 814,376   |                         |  | $ |           |   |  | $                  |         |   |  | $ | 4,579,992  
|Other revenue  external customers                                                                                    |  |      | 1,443,435   |                        |   | 27,169    |                         |  |   |           |   |  |                    |         |   |  |   | 1,470,604  
|Depreciation and amortization                                                                                         |  |      | 327,813     |                        |   | 6,052     |                         |  |   |           |   |  |                    |         |   |  |   | 333,865    
|Provision for loan losses                                                                                             |  |      | 343,252     |                        |   | 307,753   |                         |  |   |           |   |  |                    |         |   |  |   | 651,005    
|Net income                                                                                                            |  |      | 884,456     |                        |   | 271,420   |                         |  |   |           |   |  |                    | (108,568 | ) |  |   | 1,047,308  
|Assets                                                                                                                |  |      | 103,990,688 |                        |   | 4,278,694 |                         |  |   | (1,724,850 | ) |  |                    |         |   |  |   | 106,544,532
|                                                                                                                     
|Amount included in the other column is minority shareholders 40% interest in net income of Friendly Finance, LLC .
|                                                                                                                      |  |      |             |                        |  
|2001                                                                                                                  |  |      |             |                        |   |           |                         |  |   |            |   |  |                    |          |   |  |   |            
|                                                                                                                      |  |      |             |                        |  
|                                                                                                                      |  | Bank |             | Friendly  Finance, LLC |   |           | IntersegmentElimination |  |   | Other      |   |  | ConsolidatedTotals
|Net interest income                                                                                                   |  | $    | 2,659,061   |                        | $ | 783,005   |                         |  | $ |           |   |  | $                  |         |   |  | $ | 3,442,066  
|Other revenue  external customers                                                                                    |  |      | 1,057,838   |                        |   | 24,981    |                         |  |   |           |   |  |                    |         |   |  |   | 1,082,819  
|Depreciation and amortization                                                                                         |  |      | 303,602     |                        |   | 5,531     |                         |  |   |           |   |  |                    |         |   |  |   | 309,133    
|Provision for loan losses                                                                                             |  |      | 275,877     |                        |   | 174,126   |                         |  |   |           |   |  |                    |         |   |  |   | 450,003    
|Net income (loss)                                                                                                     |  |      | 272,949     |                        |   | 406,991   |                         |  |   |           |   |  |                    | (162,796 | ) |  |   | 517,144    
|Assets                                                                                                                |  |      | 83,393,760  |                        |   | 4,677,842 |                         |  |   | (1,247,711 | ) |  |                    |         |   |  |   | 86,823,891 



Amount included in the
other column is minority shareholders 40% interest in net income of Friendly Finance, LLC.



29



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Notes to Consolidated Financial Statements



Note 20. Segment Reporting, continued



The accounting policies of the segments are the same as those described in the summary of significant accounting policies.



The Companys reportable segments are strategic business units that offer different
products and services. They are managed separately because each segment appeals to different markets and, accordingly, requires different technology and marketing strategies.



The Bank derives a majority of its revenue from interest income and relies primarily on net interest income to assess the performance of the
segments and make decisions about resources to be allocated to the segment. Therefore, the segments are reported using net interest income for the period ended December 31, 2003. The Bank does allocate income taxes to the segments. Other revenue
represents noninterest income which is also allocated to the segments.



The
Bank includes an insurance and investment agency in its Bank segment above.



The Bank does not have any single external customer from which it derives 10 percent or more of its revenues and operates in one geographical area.



Note 21. Parent Company Activity



Surrey Bancorp owns all of the outstanding shares of the Bank. Summary financial statements of Surrey Bancorp follow:



Balance Sheet

December 31, 2003



|                                       |  |      |           
|-------------------------------------- |  | ---- | ----------
|                                       |  | 2003
|Assets                                 |  |      |           
|Cash and due from banks                |  | $    | 152,470   
|Interest-bearing deposits with banks   |  |      | 1,550,000 
|Investment in subsidiaries             |  |      | 11,400,132
|Other assets                           |  |      | 934       
|                                       |  |      |           
|                                       |  | $    | 13,103,536
|                                       |  |      |           
|Liabilities and Capital                |  |      |           
|                                       | 
|Liabilities                            |  |      |           
|Dividends payable                      |  | $    | 30,070    
|Other liabilities                      |  |      |          
|                                       |  |      |           
|                                       |  |      | 30,070    
|                                       |  |      |           
|Capital                                |  |      |           
|Preferred stock                        |  |      | 2,620,325 
|Common stock                           |  |      | 7,822,387 
|Accumulated other comprehensive income |  |      | 3,225     
|Retained earnings                      |  |      | 2,627,529 
|                                       |  |      |           
|                                       |  |      | 13,073,466
|                                       |  |      |           
|                                       |  | $    | 13,103,536
|                                       |  |      |           



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Notes to Consolidated Financial Statements



Note 21. Parent Company Activity, continued



Statements of Income

For the period ended December 31, 2003



|                                            |  |      |         |  
|------------------------------------------- |  | ---- | ------- | -
|                                            |  | 2003 |        
|Income                                      |  |      |         |  
|Equity income from Surrey Bank & Trust      |  | $    | 791,314 |  
|Interest income                             |  |      | 11,359  |  
|                                            |  |      |         |  
|Total income                                |  |      | 802,673 |  
|                                            |  |      |         |  
|Expenses                                    |  |      |         |  
|Other expense                               |  |      | 14,109  |  
|                                            |  |      |         |  
|Total expense                               |  |      | 14,109  |  
|                                            |  |      |         |  
|Income before income taxes                  |  |      | 788,564 |  
|Income tax benefit                          |  |      | 935     |  
|                                            |  |      |         |  
|Net income                                  |  | $    | 789,499 |  
|Preferred stock dividends                   |  |      | (66,349 | )
|                                            |  |      |         |  
|Net income available to common stockholders |  | $    | 723,150 |  
|                                            |  |      |         |  



Statements of
Cash Flows

For the period ended December 31, 2003



|                                                                                |  |      |            |  
|------------------------------------------------------------------------------- |  | ---- | ---------- | -
|                                                                                |  | 2003 |           
|Cash flows from operating activities                                            |  |      |            |  
|Net income                                                                      |  | $    | 789,499    |  
|Adjustment to reconcile net income to net cash provided by operating activities |  |      |            |  
|Equity in undistributed earnings of subsidiary                                  |  |      | (791,314   | )
|Net increase in other assets                                                    |  |      | (935       | )
|Net increase in other liabilities                                               |  |      |           |  
|                                                                                |  |      |            |  
|Net cash used by operating activities                                           |  |      | (2,750     | )
|                                                                                |  |      |            |  
|Cash flows from investing activities                                            |  |      |            |  
|Net increase in interest-bearing deposits with banks                            |  |      | (1,550,000 | )
|Net increase in investment in subsidiaries                                      |  |      | (1,000,000 | )
|                                                                                |  |      |            |  
|Net cash used in investing activities                                           |  |      | (2,550,000 | )
|                                                                                |  |      |            |  
|Cash flows from financing activities                                            |  |      |            |  
|Preferred stock issued                                                          |  |      | 2,620,325  |  
|Common stock options exercised                                                  |  |      | 121,173    |  
|Dividends paid                                                                  |  |      | (36,278    | )
|                                                                                |  |      |            |  
|Net cash provided by financing activities                                       |  |      | 2,705,220  |  
|                                                                                |  |      |            |  
|Net increase in cash and due from banks                                         |  |      |            |  
|Cash and cash equivalents, beginning                                            |  |      |           |  
|                                                                                |  |      |            |  
|Cash and cash equivalents, ending                                               |  | $    | 152,470    |  
|                                                                                |  |      |            |  
|Supplemental disclosure of non-cash transactions                                |  |      |            |  
|Non-cash transactions related to acquisition of Surrey Bank & Trust:            |  |      |            |  
|Issuance of common stock in exchange for common stock of Surrey Bank & Trust    |  | $    | 7,704,439  |  
|Retained earnings acquired in exchange                                          |  |      | 1,904,379  |  
|Increase in investment in Surrey Bank & Trust                                   |  |      | (9,608,818 | )



31



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LOGO



Post Office Box 760

Cranberry Office Park

104 Cranberry Road

Galax, Virginia 24333

276-238-1800

Fax 276-238-1801



Independent Auditors Report



Board of
Directors and Stockholders

Surrey Bancorp

Mount Airy, North
Carolina



We have audited the consolidated balance sheets of Surrey Bancorp and
subsidiaries as of December 31, 2003 and 2002, and the related consolidated statements of income, stockholders equity and cash flows for each of the three years in the period ended December 31, 2003. These consolidated financial statements are
the responsibility of the Companys management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.



We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the
audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting 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 Surrey Bancorp and subsidiaries at December 31, 2003 and 2002, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2003, in conformity
with accounting principles generally accepted in the United States of America.



LOGO

Galax, Virginia

February 6, 2004



32



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---





Managements Discussion and Analysis





---



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33



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Managements Discussion and Analysis



General



Surrey Bancorp was formed on May 1, 2003 and was created for the purpose of acquiring all the outstanding shares of common stock of Surrey Bank & Trust.



Surrey Bank & Trust was incorporated on July 15, 1996 as a North Carolina banking
corporation and opened for business on July 22, 1996. The Bank operates for the primary purpose of serving the banking needs of individuals and small to medium sized businesses in northern Surry County and the surrounding area, while developing
personal, hometown associations with these customers. The Bank offers a wide range of banking services including checking and savings accounts; commercial, installment, mortgage and personal loans; safe deposit boxes; and other associated services.
Through its subsidiaries, Surrey Investment Services, Inc. and Friendly Finance, LLC, the Bank offers insurance and investment products and sales finance services, respectively. The Banks primary sources of revenue are interest income from its
commercial and real estate lending activities and, to a lesser extent, from its investment portfolio. The Bank also earns fees from lending and deposit activities. The major expenses of the Bank are interest on deposit accounts and general and
administrative expenses, such as salaries, occupancy and related expenses.



Primary Market Area



The Banks market area
consists of an area extending from Surry County, with offices in Mount Airy and Pilot Mountain, North Carolina, north into the southern portions of Carroll and Patrick Counties, Virginia. Mount Airy is the industrial and trading center of Surry
County with a population of approximately 8,500 people living in the city limits and 30,000 in the metropolitan area. The total population of Surry County is approximately 72,000 people. Mount Airy is served by Interstate Highway 77 and U.S.
Highways 52 and 601. Surry County has a civilian labor force of over 35,000. Major industries include manufacturing, furniture, rubber and fabricated metals, and lumber and wood. The Bank has a branch office in Stuart, Virginia, which is located in
Patrick County, Virginia. The primary industries found in Patrick County are lumber and wood, textiles and agricultural.



Managements Discussion and Analysis of Operations



Managements Discussion and Analysis is provided to assist in the understanding and evaluation of the Companys financial condition and its results of
operations. The following discussion should be read in conjunction with the Companys financial statements and related notes.



Critical Accounting Policies



Surrey Bancorps financial statements are prepared in accordance with accounting principles generally accepted in the United States (GAAP). The notes to the audited
consolidated financial statements included in the Annual Report on Form 10-KSB for the year ended December 31, 2003 contain a summary of its significant accounting policies. Management believes the Companys policies with respect to the
methodology for the determination of the allowance for loan losses, and asset impairment judgments, such as the recoverability of intangible assets, involve a higher degree of complexity and require management to make difficult and subjective
judgments that often require assumptions or estimates about highly uncertain matters. Accordingly, management considers the policies related to those areas as critical.



The allowance for loan losses is an estimate of the losses that may be sustained in the loan portfolio. The allowance is based on two basic
principles of accounting: (i) Statements of Financial Accounting Standards (SFAS) 5, Accounting for Contingencies, which requires that losses be accrued when they are probable of occurring and estimable, and (ii) SFAS 114,
Accounting by Creditors for Impairment of a Loan, which requires that losses be accrued based on the differences between the value of collateral, present value of future cash flows or values that are observable in the secondary market, and the loan
balance.



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Managements Discussion and Analysis



The allowance for loan losses has three basic components: (i) the formula allowance, (ii) the specific allowance, and
(iii) the unallocated allowance. Each of these components is determined based upon estimates that can and do change when the actual events occur. The formula allowance used a historical loss view as an indicator of future losses and, as a
result, could differ from the loss incurred in the future. However, since this history is updated with the most recent loss information, the errors that might otherwise occur are mitigated. The specific allowance uses various techniques to arrive at
an estimate of loss. Historical loss information, expected cash flows and fair market value of collateral are used to estimate these losses. The use of these values is inherently subjective and our actual losses could be greater or less that the
estimates. The unallocated allowance captures losses that are attributable to various economic events, industry or geographic sectors whose impact on the portfolio have occurred but have yet to be recognized in either the formula or specific
allowance.



Accounting for intangible assets is as prescribed by SFAS 142,
Goodwill and Other Intangible Assets. The Company accounts for recognized intangible assets based on their estimated useful lives. Intangible assets with finite useful lives are amortized, while intangible assets with an indefinite useful life are
not amortized.



Estimated useful lives of intangible assets are based on an
analysis of pertinent factors, including (as applicable):



| |  | the expected use of the asset;
| | - | ------------------------------



| |  | the expected useful life of another asset or a group of assets to which the useful life of the intangible asset may relate;
| | - | ---------------------------------------------------------------------------------------------------------------------------



| |  | any legal, regulatory, or contractual provisions that may limit the useful life;
| | - | --------------------------------------------------------------------------------



| |  | any legal, regulatory, or contractual provisions that enable renewal or extension of the assets legal or contractual life without substantial cost;
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------



| |  | the effects of obsolescence, demand, competition, and other economic factors; and
| | - | ---------------------------------------------------------------------------------



| |  | the level of maintenance expenditures required to obtain the expected future cash flows from the asset.
| | - | -------------------------------------------------------------------------------------------------------



Straight-line amortization is used to expense recognized amortizable intangible assets since a method that more closely reflects the pattern
in which the economic benefits of the intangible assets are consumed cannot reliably be determined. Intangible assets are not written off in the period of acquisition unless they become impaired during that period.



The Company evaluates the remaining useful life of each intangible asset that is being
amortized each reporting period to determine whether events and circumstances warrant a revision to the remaining period of amortization. If the estimate of the intangible assets remaining useful life is changed, the remaining carrying amount
of the intangible asset shall be amortized prospectively of that revised remaining useful life.



If an intangible asset that is being amortized is subsequently determined to have an indefinite useful life, the asset will be tested for impairment. That intangible asset will no longer be amortized and will be
accounted for in the same manner as intangible assets that are not subject to amortization.



Intangible assets that are not subject to amortization are reviewed for impairment in accordance with SFAS 121 and tested annually, or more frequently if events or changes in circumstances indicate that the asset
might be impaired. The impairment test consists of a comparison of the fair value of the intangible asset with its carrying amount. If the carrying amount of the intangible asset exceeds its fair value, an impairment loss is recognized in an amount
equal to that excess. After an impairment loss is recognized, the adjusted carrying amount of the intangible asset becomes its new accounting basis. Subsequent reversal of a previously recognized impairment loss is not allowed. Currently, the
Companys only intangible asset is goodwill from the purchase of two insurance agencies.



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Managements Discussion and Analysis



Table 1. Net Interest Income and Average Balances (dollars in thousands)



|                                             |  |                            |          |   |                        |   |            |      |      |                |  |   |                        |   |            |   |       |                |      |   |                        |   |            |   |  |   |       |  |      |  
|-------------------------------------------- |  | -------------------------- | -------- | - | ---------------------- | - | ---------- | ---- | ---- | -------------- |  | - | ---------------------- | - | ---------- | - | ----- | -------------- | ---- | - | ---------------------- | - | ---------- | - |  | - | ----- |  | ---- | -
|                                             |  | Periods Ended December 31, |         
|                                             |  | 2003                       |          |   | 2002                   |   |            | 2001 |     
|                                             |  | AverageBalance             |          |   | InterestIncome/Expense |   | Yield/Cost |      |      | AverageBalance |  |   | InterestIncome/Expense |   | Yield/Cost |   |       | AverageBalance |      |   | InterestIncome/Expense |   | Yield/Cost |  
|Interest-earning assets:                     |  |                            |          |   |                        |   |            |      |      |                |  |   |                        |   |            |   |       |                |      |   |                        |   |            |   |  |   |       |  |      |  
|Deposits in other banks                      |  | $                          | 5,205    |   |                        | $ | 26         |      | .50  | %              |  | $ | 6,294                  |   |            | $ | 53    |                | .84  | % |                        | $ | 7,783      |   |  | $ | 210   |  | 2.70 | %
|Taxable investment securities                |  |                            | 3,878    |   |                        |   | 85         |      | 2.19 |                |  |   | 3,795                  |   |            |   | 129   |                | 3.40 |   |                        |   | 3,663      |   |  |   | 200   |  | 5.46 |  
|Non-taxable investments                      |  |                            | 101      |   |                        |   | 3          |      | 2.97 |                |  |   | 146                    |   |            |   | 4     |                | 2.74 |   |                        |   | 38         |   |  |   | 1     |  | 2.63 |  
|Federal funds sold                           |  |                            |         |   |                        |   |           |      |     |                |  |   | 64                     |   |            |   | 1     |                | 1.56 |   |                        |   | 250        |   |  |   | 9     |  | 3.78 |  
|Loans                                        |  |                            | 104,648  |   |                        |   | 7,270      |      | 6.95 |                |  |   | 80,748                 |   |            |   | 6,489 |                | 8.04 |   |                        |   | 63,551     |   |  |   | 5,985 |  | 9.42 |  
|                                             |  |                            |          |   |                        |   |            |      |      |                |  |   |                        |   |            |   |       |                |      |   |                        |   |            |   |  |   |       |  |      |  
|Total interest-earning assets                |  |                            | 113,8327 |   |                        |   | 7,384      |      |      |                |  |   | 91,047                 |   |            |   | 6,676 |                |      |   |                        |   | 75,285     |   |  |   | 6,405 |  |      |  
|                                             |  |                            |          |   |                        |   |            |      |      |                |  |   |                        |   |            |   |       |                |      |   |                        |   |            |   |  |   |       |  |      |  
|Yield on average interest-earning assets     |  |                            |          |   |                        |   |            |      | 6.49 | %              |  |   |                        |   |            |   |       |                | 7.33 | % |                        |   |            |   |  |   |       |  | 8.51 | %
|                                             |  |                            |          |   |                        |   |            |      |      |                |  |   |                        |   |            |   |       |                |      |   |                        |   |            |   |  |   |       |  |      |  
|Noninterest-earning assets:                  |  |                            |          |   |                        |   |            |      |      |                |  |   |                        |   |            |   |       |                |      |   |                        |   |            |   |  |   |       |  |      |  
|Cash and due from banks                      |  |                            | 1,370    |   |                        |   |            |      |      |                |  |   | 1,134                  |   |            |   |       |                |      |   |                        |   | 1,087      |   |  |   |       |  |      |  
|Property and equipment                       |  |                            | 3,885    |   |                        |   |            |      |      |                |  |   | 3,013                  |   |            |   |       |                |      |   |                        |   | 2,782      |   |  |   |       |  |      |  
|Other real estate owned                      |  |                            |         |   |                        |   |            |      |      |                |  |   |                       |   |            |   |       |                |      |   |                        |   |           |   |  |   |       |  |      |  
|Interest receivable and other                |  |                            | 1,347    |   |                        |   |            |      |      |                |  |   | 1,139                  |   |            |   |       |                |      |   |                        |   | 1,257      |   |  |   |       |  |      |  
|Allowance for loan losses                    |  |                            | (2,002   | ) |                        |   |            |      |      |                |  |   | (1,427                 | ) |            |   |       |                |      |   |                        |   | (1,005     | ) |  |   |       |  |      |  
|                                             |  |                            |          |   |                        |   |            |      |      |                |  |   |                        |   |            |   |       |                |      |   |                        |   |            |   |  |   |       |  |      |  
|Total noninterest-earning assets             |  |                            | 4,600    |   |                        |   |            |      |      |                |  |   | 3,859                  |   |            |   |       |                |      |   |                        |   | 4,121      |   |  |   |       |  |      |  
|                                             |  |                            |          |   |                        |   |            |      |      |                |  |   |                        |   |            |   |       |                |      |   |                        |   |            |   |  |   |       |  |      |  
|Total assets                                 |  | $                          | 118,432  |   |                        |   |            |      |      |                |  | $ | 94,906                 |   |            |   |       |                |      |   |                        | $ | 79,406     |   |  |   |       |  |      |  
|                                             |  |                            |          |   |                        |   |            |      |      |                |  |   |                        |   |            |   |       |                |      |   |                        |   |            |   |  |   |       |  |      |  
|Interest-bearing liabilities:                |  |                            |          |   |                        |   |            |      |      |                |  |   |                        |   |            |   |       |                |      |   |                        |   |            |   |  |   |       |  |      |  
|Demand deposits                              |  | $                          | 12,010   |   |                        | $ | 168        |      | 1.40 | %              |  | $ | 5,265                  |   |            | $ | 49    |                | 0.93 | % |                        | $ | 3,648      |   |  | $ | 37    |  | 1.00 | %
|Savings deposits                             |  |                            | 12,781   |   |                        |   | 167        |      | 1.31 |                |  |   | 11,145                 |   |            |   | 166   |                | 1.48 |   |                        |   | 10,538     |   |  |   | 331   |  | 3.14 |  
|Time deposits                                |  |                            | 58,595   |   |                        |   | 1,438      |      | 2.45 |                |  |   | 47,061                 |   |            |   | 1,599 |                | 3.40 |   |                        |   | 39,959     |   |  |   | 2,220 |  | 5.56 |  
|Fed funds sold/Repurchase agreements         |  |                            | 3,049    |   |                        |   | 24         |      | .79  |                |  |   | 1,739                  |   |            |   | 17    |                | 0.98 |   |                        |   | 1,684      |   |  |   | 53    |  | 3.18 |  
|Short-term debt                              |  |                            | 1,439    |   |                        |   | 17         |      | 1.18 |                |  |   | 1,972                  |   |            |   | 47    |                | 2.38 |   |                        |   | 2,042      |   |  |   | 88    |  | 4.30 |  
|Long-term debt                               |  |                            | 4,827    |   |                        |   | 162        |      | 3.35 |                |  |   | 5,286                  |   |            |   | 218   |                | 4.12 |   |                        |   | 3,200      |   |  |   | 234   |  | 7.33 |  
|                                             |  |                            |          |   |                        |   |            |      |      |                |  |   |                        |   |            |   |       |                |      |   |                        |   |            |   |  |   |       |  |      |  
|Total interest-bearing liabilities           |  |                            | 92,701   |   |                        |   | 1,976      |      |      |                |  |   | 72,468                 |   |            |   | 2,096 |                |      |   |                        |   | 61,071     |   |  |   | 2,963 |  |      |  
|                                             |  |                            |          |   |                        |   |            |      |      |                |  |   |                        |   |            |   |       |                |      |   |                        |   |            |   |  |   |       |  |      |  
|Cost of average interest bearing liabilities |  |                            |          |   |                        |   |            |      | 2.13 | %              |  |   |                        |   |            |   |       |                | 2.89 | % |                        |   |            |   |  |   |       |  | 4.85 | %
|                                             |  |                            |          |   |                        |   |            |      |      |                |  |   |                        |   |            |   |       |                |      |   |                        |   |            |   |  |   |       |  |      |  
|Noninterest-bearing liabilities:             |  |                            |          |   |                        |   |            |      |      |                |  |   |                        |   |            |   |       |                |      |   |                        |   |            |   |  |   |       |  |      |  
|Demand deposits                              |  |                            | 14,211   |   |                        |   |            |      |      |                |  |   | 12,104                 |   |            |   |       |                |      |   |                        |   | 9,290      |   |  |   |       |  |      |  
|Interest payable and other                   |  |                            | 1,090    |   |                        |   |            |      |      |                |  |   | 915                    |   |            |   |       |                |      |   |                        |   | 654        |   |  |   |       |  |      |  
|                                             |  |                            |          |   |                        |   |            |      |      |                |  |   |                        |   |            |   |       |                |      |   |                        |   |            |   |  |   |       |  |      |  
|Total noninterest-bearing liabilities        |  |                            | 15,301   |   |                        |   |            |      |      |                |  |   | 13,019                 |   |            |   |       |                |      |   |                        |   | 9,944      |   |  |   |       |  |      |  
|                                             |  |                            |          |   |                        |   |            |      |      |                |  |   |                        |   |            |   |       |                |      |   |                        |   |            |   |  |   |       |  |      |  
|Total liabilities                            |  |                            | 108,002  |   |                        |   |            |      |      |                |  |   | 85,487                 |   |            |   |       |                |      |   |                        |   | 71,015     |   |  |   |       |  |      |  
|Minority interest                            |  |                            | 121      |   |                        |   |            |      |      |                |  |   | 582                    |   |            |   |       |                |      |   |                        |   | 546        |   |  |   |       |  |      |  
|Stockholders equity                         |  |                            | 10,309   |   |                        |   |            |      |      |                |  |   | 8,837                  |   |            |   |       |                |      |   |                        |   | 7,845      |   |  |   |       |  |      |  
|                                             |  |                            |          |   |                        |   |            |      |      |                |  |   |                        |   |            |   |       |                |      |   |                        |   |            |   |  |   |       |  |      |  
|Total liabilities and stockholders equity   |  | $                          | 118,432  |   |                        |   |            |      |      |                |  | $ | 94,906                 |   |            |   |       |                |      |   |                        | $ | 79,406     |   |  |   |       |  |      |  
|                                             |  |                            |          |   |                        |   |            |      |      |                |  |   |                        |   |            |   |       |                |      |   |                        |   |            |   |  |   |       |  |      |  
|Net interest income                          |  |                            |          |   |                        | $ | 5,408      |      |      |                |  |   |                        |   |            | $ | 4,580 |                |      |   |                        |   |            |   |  | $ | 3,442 |  |      |  
|                                             |  |                            |          |   |                        |   |            |      |      |                |  |   |                        |   |            |   |       |                |      |   |                        |   |            |   |  |   |       |  |      |  
|Net yield on interest-earning assets         |  |                            |          |   |                        |   |            |      | 4.75 | %              |  |   |                        |   |            |   |       |                | 5.03 | % |                        |   |            |   |  |   |       |  | 4.57 | %
|                                             |  |                            |          |   |                        |   |            |      |      |                |  |   |                        |   |            |   |       |                |      |   |                        |   |            |   |  |   |       |  |      |  



36



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Managements Discussion and Analysis



Table 2. Rate/Volume Variance Analysis (dollars in thousands)



|                               |  |                                |      |   |                       |   |        |                     |  |   |                                |   |  |              |       |   |                     |   |        |   |  |   |       |  
|------------------------------ |  | ------------------------------ | ---- | - | --------------------- | - | ------ | ------------------- |  | - | ------------------------------ | - |  | ------------ | ----- | - | ------------------- | - | ------ | - |  | - | ----- | -
|                               |  | 2003 Compared to 2002          |      |   | 2002 Compared to 2001 |  
|                               |  | InterestIncome/ExpenseVariance |      |   | VarianceRate          |   |        | Attributed ToVolume |  |   | InterestIncome/ExpenseVariance |   |  | VarianceRate |       |   | Attributed ToVolume |  
|Interest-earning assets:       |  |                                |      |   |                       |   |        |                     |  |   |                                |   |  |              |       |   |                     |   |        |   |  |   |       |  
|Deposits in other banks        |  | $                              | (27  | ) |                       | $ | (15    | )                   |  | $ | (12                            | ) |  | $            | (157  | ) |                     | $ | (106   | ) |  | $ | (51   | )
|Taxable investments securities |  |                                | (45  | ) |                       |   | (48    | )                   |  |   | 3                              |   |  |              | (71   | ) |                     |   | (78    | ) |  |   | 7     |  
|Non taxable securities         |  |                                | (1   | ) |                       |   |       |                     |  |   | (1                             | ) |  |              | 3     |   |                     |   | (1     | ) |  |   | 4     |  
|Federal funds sold             |  |                                | (1   | ) |                       |   |       |                     |  |   | (1                             | ) |  |              | (8    | ) |                     |   | (20    | ) |  |   | 12    |  
|Loans                          |  |                                | 782  |   |                       |   | (960   | )                   |  |   | 1,742                          |   |  |              | 504   |   |                     |   | (960   | ) |  |   | 1,464 |  
|                               |  |                                |      |   |                       |   |        |                     |  |   |                                |   |  |              |       |   |                     |   |        |   |  |   |       |  
|Total                          |  |                                | 708  |   |                       |   | (1,023 | )                   |  |   | 1,731                          |   |  |              | 271   |   |                     |   | (1,165 | ) |  |   | 1,436 |  
|                               |  |                                |      |   |                       |   |        |                     |  |   |                                |   |  |              |       |   |                     |   |        |   |  |   |       |  
|Interest-bearing liabilities:  |  |                                |      |   |                       |   |        |                     |  |   |                                |   |  |              |       |   |                     |   |        |   |  |   |       |  
|Demand deposits                |  |                                | 119  |   |                       |   | 4      |                     |  |   | 115                            |   |  |              | 12    |   |                     |   | (3     | ) |  |   | 15    |  
|Savings deposits               |  |                                | 2    |   |                       |   | (21    | )                   |  |   | 23                             |   |  |              | (165  | ) |                     |   | (183   | ) |  |   | 18    |  
|Time deposits                  |  |                                | (173 | ) |                       |   | (502   | )                   |  |   | 329                            |   |  |              | (621  | ) |                     |   | (967   | ) |  |   | 346   |  
|Federal funds purchased/       |  |                                |      |   |                       |   |        |                     |  |   |                                |   |  |              |       |   |                     |   |        |   |  |   |       |  
|Repurchase agreements          |  |                                | 7    |   |                       |   | (2     | )                   |  |   | 9                              |   |  |              | (36   | ) |                     |   | (38    | ) |  |   | 2     |  
|Short-term debt                |  |                                | (29  | ) |                       |   | (9     | )                   |  |   | (20                            | ) |  |              | (41   | ) |                     |   | (38    | ) |  |   | (3    | )
|Long-term debt                 |  |                                | (57  | ) |                       |   | (35    | )                   |  |   | (22                            | ) |  |              | (16   | ) |                     |   | (129   | ) |  |   | 113   |  
|                               |  |                                |      |   |                       |   |        |                     |  |   |                                |   |  |              |       |   |                     |   |        |   |  |   |       |  
|Total                          |  |                                | (131 | ) |                       |   | (565   | )                   |  |   | 434                            |   |  |              | (867  | ) |                     |   | (1,358 | ) |  |   | 491   |  
|                               |  |                                |      |   |                       |   |        |                     |  |   |                                |   |  |              |       |   |                     |   |        |   |  |   |       |  
|Net interest income            |  | $                              | 839  |   |                       | $ | (458   | )                   |  | $ | 1,297                          |   |  | $            | 1,138 |   |                     |   | 193    |   |  |   | 945   |  
|                               |  |                                |      |   |                       |   |        |                     |  |   |                                |   |  |              |       |   |                     |   |        |   |  |   |       |  



Net Interest Income



Net interest income is the Companys principal source of earnings. Net interest
income is the amount of income generated by earning assets (primarily loans and investment securities) less the interest expense incurred on interest-bearing liabilities (primarily deposits used to fund earning assets). Table 1 summarizes the major
components of net interest income for the years ended December 31, 2003 and 2002 and 2001.



Compared to 2002, yields on interest-earning assets decreased during the year ended December 31, 2003 due to the general decrease in interest rates. The cost of interest bearing liabilities also decreased in 2002 due
to the lower average rates experienced in 2003. The net yield on interest earning assets decreased from 5.03% to 4.75% during the year ended December 31, 2003.



Provision for Credit Losses



The allowance for credit losses is established to provide for expected losses in the Banks loan portfolio. Loan losses and recoveries are charged or credited
directly to the allowance. Management determines the provision for credit losses required to maintain an allowance adequate to provide for probable losses. Generally, the factors considered in making this decision are the collectability of past due
loans, volume of new loans, composition of the loan portfolio, and general economic outlook. However, due to the Banks short operating history, no trends have been established to effectively estimate an allowance for credit losses. At this
time management has decided to establish an allowance for loan losses equaling 1.75% of outstanding loans excluding mortgage loans and the guaranteed portion of United States Government guaranteed loans. Mortgage loans are reserved at a rate of
1.0%. Specific reserves for individual loans were established in addition to the basic reserve as deemed necessary.



37



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##### Table of Contents

Managements Discussions and Analysis



Other Income



Noninterest income consists of revenues generated from a broad range of financial services and activities. The majority of noninterest income is a result of fees on
mortgage loans sold and service charges on deposit accounts including charges for insufficient funds, checks, and fees charged for nondeposit services. Table 3 discloses noninterest income for the periods ended December 31, 2003, 2002 and 2001.



Table 3. Sources of Noninterest Income



|                                                   |  |                                   |           |      |   |           |  |   |          
|-------------------------------------------------- |  | --------------------------------- | --------- | ---- | - | --------- |  | - | ---------
|                                                   |  | For the period ended December 31,
|                                                   |  | 2003                              |           | 2002 |   | 2001     
|Service charges on deposit accounts                |  | $                                 | 805,609   |      | $ | 619,456   |  | $ | 536,485  
|Fees on mortgage loans delivered to correspondents |  |                                   | 74,618    |      |   | 112,855   |  |   | 261,491  
|Other service charges and fees                     |  |                                   | 214,792   |      |   | 100,815   |  |   | 62,282   
|Other income                                       |  |                                   | 582,277   |      |   | 454,743   |  |   | 220,307  
|Gain on sale of assets                             |  |                                   | 411,289   |      |   | 182,735   |  |   | 2,254    
|                                                   |  |                                   |           |      |   |           |  |   |          
|                                                   |  | $                                 | 2,088,585 |      | $ | 1,470,604 |  | $ | 1,082,819
|                                                   |  |                                   |           |      |   |           |  |   |          



Activity in the deposit related
noninterest income accounts increased in 2003 as deposit customers increased. Due to the banks entry into mortgage loan servicing, lower fees were received on loans delivered to mortgage companies in 2003. However, due to the change in our
mortgage department operations gains of approximately $411,289 were recognized from the sale of mortgage loans to the Federal Home Loan Mortgage Corporation. With a few exceptions, these loans were sold with servicing being retained by the bank. The
largest increase in noninterest income resulted from the sale of investment products through our affiliation with UVEST. Net investment income revenue of approximately $292,000 is primarily responsible for the increase in other income in 2003. This
represents an $84,000 increase over 2002 investment income levels.



Other
Expense



The major components of other expense for the periods ended
December 31, 2003, 2002 and 2001 are as follows:



Table 4. Sources of
Noninterest Expense



|                                                                                        |  |                                   |           |      |   |           |  |   |          
|--------------------------------------------------------------------------------------- |  | --------------------------------- | --------- | ---- | - | --------- |  | - | ---------
|                                                                                        |  | For the period ended December 31,
|                                                                                        |  | 2003                              |           | 2002 |   | 2001     
|Salary and benefits                                                                     |  | $                                 | 2,329,385 |      | $ | 1,896,237 |  | $ | 1,558,143
|Occupancy expenses                                                                      |  |                                   | 283,557   |      |   | 203,132   |  |   | 206,069  
|Furniture/equipment expenses                                                            |  |                                   | 434,493   |      |   | 328,762   |  |   | 301,449  
|Postage/printing and supplies                                                           |  |                                   | 307,131   |      |   | 209,847   |  |   | 192,887  
|Advertising and business promotion                                                      |  |                                   | 79,534    |      |   | 62,261    |  |   | 67,619   
|Professional fees                                                                       |  |                                   | 209,322   |      |   | 133,852   |  |   | 76,013   
|Lower of cost or market adjustment on loans available for sale transferred to portfolio |  |                                   | 213,581   |      |   |          |  |   |         
|Other expenses                                                                          |  |                                   | 1,252,724 |      |   | 769,598   |  |   | 653,126  
|                                                                                        |  |                                   |           |      |   |           |  |   |          
|                                                                                        |  | $                                 | 5,109,727 |      | $ | 3,603,689 |  | $ | 3,055,306
|                                                                                        |  |                                   |           |      |   |           |  |   |          



The overhead ratio of noninterest
expense to adjusted total revenue (net interest income plus noninterest income) increased from 59.6% in 2002 to 68.1% for the year ended December 31, 2003. The increase is attributable to the opening of two branches in 2003 as well as the addition
of an administrative office which houses our finance, operations, mortgage and insurance departments. Additional cost associated with the mortgage lending operation also had an adverse effect on the efficiency ratio in 2003.





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##### Table of Contents

Managements Discussions and Analysis



Analysis of Financial Condition



Average earning assets have increased 25.0% from December 31, 2002 to December 31, 2003. Total earning assets represented 96.12% of total average assets at December 31,
2003 compared to 95.93% at the end of 2002. The mix of average earning assets changed moderately from December 31, 2002 to December 31, 2003. The most notable change in the mix of average earning assets was the increase in loans funded primarily by
the reduction in interest-bearing bank balances.



Table 5. Average Asset Mix



|                               |  |                                     |             |   |                                     |        |    |                |   |            |   |  |        |   
|------------------------------ |  | ----------------------------------- | ----------- | - | ----------------------------------- | ------ | -- | -------------- | - | ---------- | - |  | ------ | --
|                               |  | For the Year EndedDecember 31, 2003 |             |   | For the Year EndedDecember 31. 2002 |       
|                               |  | AverageBalance                      |             |   | %                                   |        |    | AverageBalance |   |            | % | 
|Earning assets:                |  |                                     |             |   |                                     |        |    |                |   |            |   |  |        |   
|Loans, net                     |  | $                                   | 104,647,997 |   |                                     | 88.36  | %  |                | $ | 80,747,520 |   |  | 85.08  | % 
|Investment securities          |  |                                     | 3,978,919   |   |                                     | 3.36   | %  |                |   | 3,941,041  |   |  | 4.15   | % 
|Federal funds sold             |  |                                     |            |   |                                     |       | %  |                |   | 63,699     |   |  | 0.07   | % 
|Interest-bearing bank balances |  |                                     | 5,205,369   |   |                                     | 4.40   | %  |                |   | 6,294,297  |   |  | 6.63   | % 
|                               |  |                                     |             |   |                                     |        |    |                |   |            |   |  |        |   
|Total earning assets           |  |                                     | 113,832,285 |   |                                     | 96.12  | %  |                |   | 91,046,557 |   |  | 95.93  | % 
|                               |  |                                     |             |   |                                     |        |    |                |   |            |   |  |        |   
|                               |  |                                     |             |  
|Nonearning assets:             |  |                                     |             |   |                                     |        |    |                |   |            |   |  |        |   
|Cash and due from banks        |  |                                     | 1,370,286   |   |                                     | 1.16   | %  |                |   | 1,134,358  |   |  | 1.20   | % 
|Property and equipment         |  |                                     | 3,884,532   |   |                                     | 3.28   | %  |                |   | 3,013,180  |   |  | 3.17   | % 
|Other assets                   |  |                                     | 1,347,002   |   |                                     | 1.13   | %  |                |   | 1,139,236  |   |  | 1.20   | % 
|Allowance for loan losses      |  |                                     | (2,002,083  | ) |                                     | (1.69  | )% |                |   | (1,427,215 | ) |  | (1.50  | )%
|                               |  |                                     |             |   |                                     |        |    |                |   |            |   |  |        |   
|Total nonearning assets        |  |                                     | 4,599,737   |   |                                     | 3.88   | %  |                |   | 3,859,559  |   |  | 4.07   | % 
|                               |  |                                     |             |   |                                     |        |    |                |   |            |   |  |        |   
|                               |  |                                     |             |  
|Total assets                   |  | $                                   | 118,432,022 |   |                                     | 100.00 | %  |                | $ | 94,906,116 |   |  | 100.00 | % 
|                               |  |                                     |             |   |                                     |        |    |                |   |            |   |  |        |   



At December 31, 2003, average net
loans represented 88.36% of total average assets compared to 85.08% at the end of 2002. Investments decreased from 4.15% of average assets to 3.36% of average assets over the same time period. Interest-bearing bank balances decreased over the period
from 6.63% to 4.40% of average assets. Even though a higher percentage of average assets were invested in higher yielding loans in 2003, the continued reduction in rates and a change in the mix of loans within the loan portfolio resulted in a
decrease in the net yield on interest earning assets as shown in Table 1.



Loans



Average net loans totaled $104,647,997 for the year
ended December 31, 2003. This represents an increase of 29.6% over the average net loans for 2002. Even though general economic conditions did not recover greatly in 2003, loan demand remained relatively strong.



The loan portfolio is dominated by real estate and commercial loans. These loans make up
93.5% of the total loan portfolio at December 31, 2003. This is up from the 89.2% that the two categories maintained at December 31, 2002. The amount of loans outstanding by type at December 31, 2003 and December 31, 2002 and the maturity
distribution for variable and fixed rate loans as of December 31, 2003 are presented in Tables 6 & 7 respectively.





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##### Table of Contents

Managements Discussions and Analysis



Table 6. Loan Portfolio Summary (includes loans available for sale)



|                             |  |                   |             |   |                   |   |        |   |            |  |        |  
|---------------------------- |  | ----------------- | ----------- | - | ----------------- | - | ------ | - | ---------- |  | ------ | -
|                             |  | December 31, 2003 |             |   | December 31, 2002 |  
|                             |  | Amount            |             | % |                   |   | Amount |   | %          | 
|Construction and development |  | $                 | 5,799,087   |   | 4.84              | % |        | $ | 5,921,098  |  | 6.74   | %
|1-4 family residential       |  |                   | 38,499,158  |   | 32.15             | % |        |   | 22,568,632 |  | 25.69  | %
|5 or more family residential |  |                   |            |   |                  | % |        |   | 322,243    |  | 0.37   | %
|Farmland                     |  |                   | 127,277     |   | 0.11              | % |        |   | 198,336    |  | 0.23   | %
|Nonfarm, nonresidential      |  |                   | 879,280     |   | 0.73              | % |        |   | 1,027,211  |  | 1.17   | %
|                             |  |                   |             |   |                   |   |        |   |            |  |        |  
|Total real estate            |  |                   | 45,304,802  |   | 37.83             | % |        |   | 30,037,520 |  | 34.20  | %
|                             |  |                   |             |  
|Agricultural                 |  |                   | 107,685     |   | 0.09              | % |        |   | 148,659    |  | 0.17   | %
|Commercial and industrial    |  |                   | 66,675,083  |   | 55.67             | % |        |   | 48,285,949 |  | 54.97  | %
|Consumer                     |  |                   | 7,595,515   |   | 6.34              | % |        |   | 8,880,464  |  | 10.11  | %
|Other                        |  |                   | 78,178      |   | 0.07              | % |        |   | 481,762    |  | 0.55   | %
|                             |  |                   |             |   |                   |   |        |   |            |  |        |  
|Total                        |  | $                 | 119,761,263 |   | 100.00            | % |        | $ | 87,834,354 |  | 100.00 | %
|                             |  |                   |             |   |                   |   |        |   |            |  |        |  



Table 7. Maturity Schedule of Loans



|                                   |  |                                     |            |             |   |            |  |       |           |  |   |             |  |        |  
|---------------------------------- |  | ----------------------------------- | ---------- | ----------- | - | ---------- |  | ----- | --------- |  | - | ----------- |  | ------ | -
|                                   |  | CommercialFinancial andAgricultural |            | Real Estate |   | Others     |  | Total |          
|                                   |  |                                     |            | Amount      |   | %          | 
|Fixed rate loans:                  |  |                                     |            |             |   |            |  |       |           |  |   |             |  |        |  
|Three months or less               |  | $                                   | 1,064,075  |             | $ | 443,314    |  | $     | 1,301,209 |  | $ | 2,808,598   |  | 2.35   | %
|Over three months to twelve months |  |                                     | 2,730,941  |             |   | 1,102,294  |  |       | 1,778,543 |  |   | 5,611,778   |  | 4.69   | %
|Over one year to five years        |  |                                     | 11,833,903 |             |   | 8,808,662  |  |       | 4,142,696 |  |   | 24,785,261  |  | 20.69  | %
|Over five years                    |  |                                     | 2,753,838  |             |   | 18,094,273 |  |       | 5,302     |  |   | 20,853,413  |  | 17.41  | %
|                                   |  |                                     |            |             |   |            |  |       |           |  |   |             |  |        |  
|Total fixed rate loans             |  | $                                   | 18,382,757 |             | $ | 28,448,543 |  | $     | 7,227,750 |  | $ | 54,059,050  |  | 45.14  | %
|                                   |  |                                     |            |             |   |            |  |       |           |  |   |             |  |        |  
|                                   |  |                                     |            |             |  
|Variable rate loans:               |  |                                     |            |             |   |            |  |       |           |  |   |             |  |        |  
|Three months or less               |  | $                                   | 48,400,011 |             | $ | 16,843,442 |  | $     | 445,943   |  | $ | 65,689,396  |  | 54.85  | %
|Over three months to twelve months |  |                                     |           |             |   |           |  |       |          |  |   |             |  |       | %
|Over one year to five years        |  |                                     |           |             |   |           |  |       |          |  |   |             |  |       | %
|Over five years                    |  |                                     |           |             |   | 12,817     |  |       |          |  |   |             |  | 0.01   | %
|                                   |  |                                     |            |             |   |            |  |       |           |  |   |             |  |        |  
|Total variable rate loans          |  | $                                   | 48,400,011 |             | $ | 16,856,259 |  | $     | 445,943   |  | $ | 65,702,213  |  | 54.86  | %
|                                   |  |                                     |            |             |   |            |  |       |           |  |   |             |  |        |  
|                                   |  |                                     |            |             |  
|Total loans:                       |  |                                     |            |             |   |            |  |       |           |  |   |             |  |        |  
|Three months or less               |  | $                                   | 49,464,086 |             | $ | 17,286,756 |  | $     | 1,747,152 |  | $ | 68,497,994  |  | 57.20  | %
|Over three months to twelve months |  |                                     | 2,730,941  |             |   | 1,102,294  |  |       | 1,778,543 |  |   | 5,611,778   |  | 4.69   | %
|Over one year to five years        |  |                                     | 11,833,903 |             |   | 8,808,662  |  |       | 4,142,696 |  |   | 24,785,261  |  | 20.70  | %
|Over five years                    |  |                                     | 2,753,838  |             |   | 18,107,090 |  |       | 5,302     |  |   | 20,866,230  |  | 17.42  | %
|                                   |  |                                     |            |             |   |            |  |       |           |  |   |             |  |        |  
|Total loans                        |  | $                                   | 66,782,768 |             | $ | 45,304,802 |  | $     | 7,673,693 |  | $ | 119,767,263 |  | 100.00 | %
|                                   |  |                                     |            |             |   |            |  |       |           |  |   |             |  |        |  



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Managements Discussion and Analysis



Interest rates charged on loans vary with the degree of risk, maturity and amount of the loan. Competitive pressures, money market rates,
availability of funds, and government regulation also influence interest rates. On average, loans yielded 6.95% for the year ended December 31, 2003 compared to an average yield of 8.04% in 2002. This decrease was due to the general decreasing of
rates plus a change in loan mix. Higher yielding consumer loans decreased from 10.11% of total loans at December 31, 2002 to 6.34% of total loans at December 31, 2003. Much of this decrease was due to a reduction in the sales finance loans in the
finance company subsidiary. Additionally, mortgage loans increased from 25.69% of total loans at December 31, 2002 to 32.15% of total loans at December 31, 2003. These loans usually carry lower yielding rates than consumer loans, which decreased in
2003. Mortgage loans increased as the Company made the decision to discontinue the sale of mortgage loans in the secondary market during the third quarter of 2003.



Investment Securities



The Company uses its investment portfolio to provide for unexpected deposit decreases or loan generation, to meet the Companys interest rate sensitivity goals, and
to generate income.



Management of the investment portfolio has been
conservative with virtually all investments taking the form of purchases of U.S. Government Agencies and Mortgage-backed Securities. Management views the investment portfolio as a source of income, and purchases securities with that in mind.
However, adjustments are necessary in the portfolio to provide an adequate source of liquidity, which can be used to meet funding requirements for loan demand and deposit fluctuations and to control interest rate risk. Therefore, from time to time
management may sell certain securities prior to their maturity. Table 8 presents the investment portfolio at December 31, 2003 by major type of investments and maturity ranges.



The general turnover of U. S. Government Agencies and the investment in adjustable-rate Mortgage-backed Securities, which adjust annually,
caused the average yield of the investment portfolio to decrease to 2.01% for the year ended December 31, 2003 compared to 2.45% for 2002. At December 31, 2003, the market value of the investment portfolio was $5,870,973, representing a $5,249
appreciation of book value. At December 31, 2002 the market value of the investment portfolio was $30,317 above book value.



Table 8. Investment Securities



December 31, 2003, Available for Sale and Restricted



|                                     |  |                    |           |   |                           |   |         |                            |  |   |                |   |  |       |         |   |             |   |           |   |  |   |          
|------------------------------------ |  | ------------------ | --------- | - | ------------------------- | - | ------- | -------------------------- |  | - | -------------- | - |  | ----- | ------- | - | ----------- | - | --------- | - |  | - | ---------
|                                     |  | In One Yearor Less |           |   | One YearThrough FiveYears |   |         | After FiveThroughTen Years |  |   | After TenYears |   |  | Total |         |   | MarketValue
|Investment securities:               |  |                    |           |   |                           |   |         |                            |  |   |                |   |  |       |         |   |             |   |           |   |  |   |          
|U.S. Government agencies             |  | $                  | 3,999,544 |   |                           | $ | 999,380 |                            |  | $ |               |   |  | $     |        |   |             | $ | 4,998,924 |   |  | $ | 4,998,950
|U.S. Government agencies pools (MBS) |  |                    |          |   |                           |   |        |                            |  |   |               |   |  |       | 321,673 |   |             |   | 321,673   |   |  |   | 326,635  
|Municipal securities                 |  |                    | 100,127   |   |                           |   |        |                            |  |   |               |   |  |       |        |   |             |   | 100,127   |   |  |   | 100,388  
|Restricted                           |  |                    | 445,000   |   |                           |   |        |                            |  |   |               |   |  |       |        |   |             |   | 445,000   |   |  |   | 445,000  
|                                     |  |                    |           |   |                           |   |         |                            |  |   |                |   |  |       |         |   |             |   |           |   |  |   |          
|Total                                |  | $                  | 4,544,671 |   |                           | $ | 999,380 |                            |  | $ |               |   |  | $     | 321,673 |   |             | $ | 5,865,724 |   |  | $ | 5,870,973
|                                     |  |                    |           |   |                           |   |         |                            |  |   |                |   |  |       |         |   |             |   |           |   |  |   |          
|                                     |  |                    |           |   |                           |  
|Weighted average yields:             |  |                    |           |   |                           |   |         |                            |  |   |                |   |  |       |         |   |             |   |           |   |  |   |          
|U.S. Government agencies             |  |                    | 1.50      | % |                           |   | 2.53    | %                          |  |   |               | % |  |       |        | % |             |   | 1.71      | % |  |   |          
|U.S. Government agencies pools (MBS) |  |                    |          | % |                           |   |        | %                          |  |   |               | % |  |       | 4.47    | % |             |   | 4.47      | % |  |   |          
|Municipal securities                 |  |                    | 2.70      | % |                           |   |        | %                          |  |   |               | % |  |       |        | % |             |   | 2.70      | % |  |   |          
|Restricted                           |  |                    | 3.50      | % |                           |   |        | %                          |  |   |               | % |  |       |        | % |             |   | 3.50      | % |  |   |          
|                                     |  |                    |           |   |                           |   |         |                            |  |   |                |   |  |       |         |   |             |   |           |   |  |   |          
|Consolidated                         |  |                    | 1.72      | % |                           |   | 2.53    | %                          |  |   |               | % |  |       | 4.47    | % |             |   | 2.01      | % |  |   |          
|                                     |  |                    |           |   |                           |   |         |                            |  |   |                |   |  |       |         |   |             |   |           |   |  |   |          



(continued)



41



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##### Table of Contents

Managements Discussion and Analysis



Table 8. Investment Securities, continued



December 31, 2002, Available for Sale and Restricted



|                                     |  |                    |           |                           |   |                            |  |                |   |       |   |             |  |   |           |  |   |          
|------------------------------------ |  | ------------------ | --------- | ------------------------- | - | -------------------------- |  | -------------- | - | ----- | - | ----------- |  | - | --------- |  | - | ---------
|                                     |  | In One Yearor Less |           | One YearThrough FiveYears |   | After FiveThroughTen Years |  | After TenYears |   | Total |   | MarketValue
|Investment securities:               |  |                    |           |                           |   |                            |  |                |   |       |   |             |  |   |           |  |   |          
|U.S. Government agencies             |  | $                  | 1,995,790 |                           | $ | 1,539,767                  |  | $              |  |       | $ |            |  | $ | 3,535,557 |  | $ | 3,551,342
|U.S. Government agencies pools (MBS) |  |                    |          |                           |   |                           |  |                |  |       |   | 499,896     |  |   | 499,896   |  |   | 512,896  
|Municipal Securities                 |  |                    |          |                           |   | 100,910                    |  |                |  |       |   |            |  |   | 100,910   |  |   | 102,442  
|Restricted                           |  |                    | 280,000   |                           |   |                           |  |                |  |       |   |            |  |   | 280,000   |  |   | 280,000  
|                                     |  |                    |           |                           |   |                            |  |                |   |       |   |             |  |   |           |  |   |          
|Total                                |  | $                  | 2,275,790 |                           | $ | 1,640,677                  |  | $              |  |       | $ | 499,896     |  | $ | 4,416,363 |  | $ | 4,446,680
|                                     |  |                    |           |                           |   |                            |  |                |   |       |   |             |  |   |           |  |   |          



|                                     |  |                    |   |  |                           |   |  |                            |   |  |                |   |  |       |  
|------------------------------------ |  | ------------------ | - |  | ------------------------- | - |  | -------------------------- | - |  | -------------- | - |  | ----- | -
|                                     |  |                    |   |  |                          
|                                     |  | In One Yearor Less |   |  | One YearThrough FiveYears |   |  | After FiveThroughTen Years |   |  | After TenYears |   |  | Total |  
|Weighted average yields:             |  |                    |   |  |                           |   |  |                            |   |  |                |   |  |       |  
|U.S. Government agencies             |  | 1.41               | % |  | 2.31                      | % |  |                           | % |  |               | % |  | 1.80  | %
|U.S. Government agencies pools (MBS) |  |                   | % |  |                          | % |  |                           | % |  | 5.60           | % |  | 5.60  | %
|Municipal Securities                 |  |                   | % |  | 2.70                      | % |  |                           | % |  |               | % |  | 2.70  | %
|Restricted                           |  | 5.00               | % |  |                          | % |  |                           | % |  |               | % |  | 5.00  | %
|                                     |  |                    |   |  |                           |   |  |                            |   |  |                |   |  |       |  
|Consolidated                         |  | 1.85               | % |  | 2.33                      | % |  |                           | % |  | 5.60           | % |  | 2.45  | %
|                                     |  |                    |   |  |                           |   |  |                            |   |  |                |   |  |       |  



There were no average federal funds
sold for the year ended December 31, 2003, which is down over the 2002 average. Federal funds represent the most liquid portion of the Banks invested funds and generally the lowest yielding portion of earning assets. Deposits in other banks
primarily represent deposits at the Federal Home Loan Bank of Atlanta, which pays an overnight rate on those deposits. This rate usually mirrors the federal funds rate. Management has made an effort to maintain these funds at the lowest level
possible consistent with prudent risk management strategies, while having available resources to fund loan demand and the maturity of time deposits. Our entry into the mortgage loans servicing market has made it necessary to fund mortgage loans
before we sell them. This has had the effect of tightening our liquidity position. During the year ended December 31, 2003, average federal funds and deposits in other banks represented 0.0% and 4.40% of average earning assets, respectively. This is
down from 0.07% and 6.53% in 2002, respectively.



Deposits



The Bank relies on deposits generated in its market area to provide the majority of funds
needed to support lending activities and for investment in liquid assets. More specifically, core deposits (total deposits less certificates of deposit in denominations of $100,000 or more) are the primary funding source. The Banks balance
sheet growth is largely determined by the availability of deposits in its markets, the cost of attracting the deposits, and the prospects of profitably utilizing the available deposits by increasing loans or investment portfolios. Market conditions
have resulted in depositors shopping for deposit rates more than in the past. An increased customer awareness of interest rates adds to the importance of rate management. The Banks management must continually monitor market pricing,
competitors rates, and internal interest rate spreads to maintain the Banks growth and profitability. The Bank attempts to structure rates so as to promote deposit and asset growth, while at the same time, increasing overall
profitability of the Bank.



42



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##### Table of Contents

Managements Discussion and Analysis



Average deposits for the year ended December 31, 2003 amounted to $99,068,501, which was an increase of $21,755,186, or 28.1% over 2002.
Average core deposits totaled $79,024,208 for the year ended December 31, 2003, an increase of $19,157,168, or 32.0% over 2002. The percentage of the Banks average deposits that are interest bearing increased to 85.66% for the year ended
December 31, 2003 from 84.34% in 2002. Average demand deposits, which earn no interest, increased 17.4% from $12,103,559 in 2002 to $14,211,139 in 2003. Average deposits for the periods ended December 31, 2003 and December 31, 2002 are summarized in
Table 9 below:



Table 9. Deposit Mix



|                                |  |                   |            |   |                   |   |                |   |            |  |        |  
|------------------------------- |  | ----------------- | ---------- | - | ----------------- | - | -------------- | - | ---------- |  | ------ | -
|                                |  | December 31, 2003 |            |   | December 31, 2002 |  
|                                |  | AverageBalance    |            | % |                   |   | AverageBalance |   | %          | 
|Interest-bearing deposits:      |  |                   |            |   |                   |   |                |   |            |  |        |  
|NOW Accounts                    |  | $                 | 12,010,221 |   | 12.12             | % |                | $ | 5,264,788  |  | 6.81   | %
|Money Market                    |  |                   | 8,919,936  |   | 9.00              | % |                |   | 7,939,773  |  | 10.27  | %
|Savings                         |  |                   | 3,860,766  |   | 3.90              | % |                |   | 3,204,792  |  | 4.15   | %
|Small denomination certificates |  |                   | 38,550,484 |   | 38.91             | % |                |   | 29,615,221 |  | 38.30  | %
|Large denomination certificates |  |                   | 20,044,293 |   | 20.23             | % |                |   | 17,446,275 |  | 22.56  | %
|Repurchase agreements           |  |                   | 1,471,662  |   | 1.50              | % |                |   | 1,738,907  |  | 2.25   | %
|                                |  |                   |            |   |                   |   |                |   |            |  |        |  
|Total interest-bearing deposits |  |                   | 84,857,362 |   | 85.66             | % |                |   | 65,209,756 |  | 84.34  | %
|Noninterest-bearing deposits    |  |                   | 14,211,139 |   | 14.34             | % |                |   | 12,103,559 |  | 15.66  | %
|                                |  |                   |            |   |                   |   |                |   |            |  |        |  
|Total deposits                  |  | $                 | 99,068,501 |   | 100.00            | % |                | $ | 77,313,315 |  | 100.00 | %
|                                |  |                   |            |   |                   |   |                |   |            |  |        |  



The average balance of certificates of
deposit issued in denominations of $100,000 or more increased by $2,597,998, or 14.9% for the year ended December 31, 2003. The strategy of management has been to support loan and investment growth with core deposits and not to aggressively solicit
the more volatile, large denomination certificates of deposit. In 2003, the loan demand continued to require that management change that strategy somewhat. Table 10 provides maturity information relating to certificates of deposit of $100,000 or
more at December 31, 2003.



Table 10. Large Time Deposit Maturities



|                                                                    |  |   |           
|------------------------------------------------------------------- |  | - | ----------
|Analysis of time deposits of $100,000 or more at December 31, 2003: |  |   |           
|Remaining maturity of three months or less                          |  | $ | 2,202,327 
|Remaining maturity over three through twelve months                 |  |   | 15,619,383
|Remaining maturity over twelve months                               |  |   | 1,976,995 
|                                                                    |  |   |           
|Total time deposits of $100,000 or more                             |  | $ | 19,798,705
|                                                                    |  |   |           



Borrowings



From time to time the Bank will find that funds raised through deposits and repurchase
agreements will not fully satisfy the Banks liquidity needs. When this occurs the Bank uses borrowings from correspondent banks and the Federal Home Loan Bank (FHLB) to fund the shortfall. At year-end 2003, all short-term borrowings were from
the FHLB. These borrowings consisted of adjustable rate short-term debt of $1,400,000. The average interest rate paid for federal funds purchased and short-term debt for the year ended December 31, 2003, were .79% and 1.18%, respectively. Long-term
debt consist of long term, fixed rate advances from the FHLB, a revolving line of credit with a commercial bank, proceeds of which are to fund the purchase of sales finance contracts by Friendly Finance, LLC, and a mortgage loan. The rate on the
Friendly Finance, LLC debt is tied to the prime rate. The average interest rate paid on long-term debt for the year ended December 31, 2003, was 3.35%.



Capital Adequacy



Stockholders equity amounted to $13,073,466 at December 31, 2003, a 42.7% increase over the 2002 year-end total of $9,164,386. Average stockholders equity as a percentage of average total assets amounted
to 8.70% for the year ended December 31, 2003 and 11.26% in 2002.



43



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##### Table of Contents

Managements Discussion and Analysis



Regulatory guidelines relating to capital adequacy provide minimum risk-based ratios which assess capital adequacy while encompassing all
credit risks, including those related to off-balance sheet activities. Capital ratios under these guidelines are computed by weighing the relative risk of each asset category to derive risk-adjusted assets. The risk-based capital guidelines require
minimum ratios of core (Tier 1) capital (common stockholders equity) to risk-weighted assets of 4.0% and total regulatory capital (core capital plus allowance for loan losses up to 1.25% of risk-weighted assets) to risk-weighted assets of
8.0%. As of December 31, 2003 the Bank has a ratio of Tier 1 capital to risk-weighted assets of 8.87% and a ratio of total capital to risk-weighted assets of 10.13%. All capital ratio levels indicate that the Bank is well capitalized.



At December 31, 2003 the Company had 1,170,189 shares of common stock outstanding, which were
held by approximately 1,700 stockholders of record. During the year ended December 2003, the stockholders of the Bank voted to reduce the par value of the stock from $5.00 per share to $4.00. Additionally, stock options for 20,928 shares of
common stock were exercised in 2003.



Nonperforming and Problem Assets



Certain credit risks are inherent in making loans, particularly
commercial and consumer loans. Management prudently assesses these risks and attempts to manage them effectively. The Bank also attempts to reduce repayment risks by adhering to internal credit policies and procedures. These policies and procedures
include officer and customer limits, periodic loan documentation review and follow up on exceptions to credit policies.



Nonperforming assets at December 31, 2003 and 2002 are analyzed in Table 11.



Table 11. Nonperforming Assets



|                        |  |      |         |      |   |        
|----------------------- |  | ---- | ------- | ---- | - | -------
|                        |  | 2003 |         | 2002
|Nonaccrual loans        |  | $    | 236,457 |      | $ | 438,416
|Other real estate owned |  |      |        |      |   |       
|                        |  |      |         |      |   |        
|                        |  | $    | 236,457 |      | $ | 438,416
|                        |  |      |         |      |   |        



Nonaccrual loans were 0.20% and 0.50%
of outstanding loans at December 31, 2003 and 2002, respectively. The Bank had no other real estate owned at December 31, 2003 and 2002, respectively.



Credit Losses



The allowance for loan losses is maintained at a level adequate to absorb probable losses. Some of the factors which management considers in determining the appropriate level of the allowance for credit losses are:
past loss experience, an evaluation of the current loan portfolio, identified loan problems, the loan volume outstanding, the present and expected economic conditions in general, and in particular, how such conditions relate to the market area that
the Bank serves. Bank regulators also periodically review the Banks loans and other assets to assess their quality. Loans deemed uncollectible are charged to the allowance. Provisions for loan losses and recoveries on loans previously charged
off are added to the allowance.



Net loans charged off as a percentage of
average loans were 0.095% and 0.088% in 2003 and 2002 respectively.



The
provision for loan losses and the activity in the allowance for credit losses are detailed in Table 12.



Table 12. Credit Losses



|                                       |  |      |           |   |      |   |           |  
|-------------------------------------- |  | ---- | --------- | - | ---- | - | --------- | -
|                                       |  | 2003 |           |   | 2002 |  
|Allowance for credit losses, beginning |  | $    | 1,831,167 |   |      | $ | 1,251,496 |  
|Provision for credit losses, added     |  |      | 378,401   |   |      |   | 651,005   |  
|Net charge-offs                        |  |      | (99,748   | ) |      |   | (71,334   | )
|                                       |  |      |           |   |      |   |           |  
|Allowance for credit losses, ending    |  | $    | 2,109,820 |   |      | $ | 1,831,167 |  
|                                       |  |      |           |   |      |   |           |  



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##### Table of Contents

Managements Discussion and Analysis



Liquidity and Sensitivity



The principal goals of the Banks asset and liability management strategy are the maintenance of adequate liquidity and the management of interest rate risk.
Liquidity is the ability to convert assets to cash in order to fund depositors withdrawals or borrowers loans without significant loss. Interest rate risk management balances the effects of interest rate changes on assets that earn
interest or liabilities on which interest is paid, to protect the Bank from wide fluctuations in its net interest income which could result from interest rate changes.



Management must insure that adequate funds are available at all times to meet the needs of its customers. On the asset side of the balance
sheet, maturing investments, loan payments, maturing loans, federal funds sold, and unpledged investment securities are principal sources of liquidity. On the liability side of the balance sheet, liquidity sources include core deposits, the ability
to increase large denomination certificates, federal fund lines from correspondent banks, borrowings from the Federal Reserve Bank, as well as the ability to generate funds through the issuance of long-term debt and equity.



The liquidity ratio (the level of liquid assets divided by total deposits plus short-term
liabilities) was 9.86% at December 31, 2003, compared to 22.46% at December 31, 2002. While the liquidity ratio at December 31, 2003 is low the Bank has additional borrowing line capacity with correspondent banks and the Federal Home Loan Bank in
excess of $22,700,000 at that date.



Interest rate risk is the effect that
changes in interest rates would have on interest income and interest expense as interest-sensitive assets and interest-sensitive liabilities either reprice or mature. Management attempts to maintain the portfolios of interest-earning assets and
interest-bearing liabilities with maturities or repricing opportunities at levels that will afford protection from erosion of net interest margin, to the extent practical, from changes in interest rates. Table 13 shows the sensitivity of the
Banks balance sheet as of that specific date and is not necessarily indicative of the position on other dates. At December 31, 2003, the Bank appeared to be cumulatively asset-sensitive (earning assets subject to interest rate changes
exceeding interest-bearing liabilities subject to changes in interest rates). However, in the one-year window liabilities subject to change in interest rates exceed assets subject to interest rate changes (non-asset sensitive).



Matching sensitive positions alone does not ensure the Bank has no interest rate risk. The
repricing characteristics of assets are different from the repricing characteristics of funding sources. Thus, net interest income can be impacted by changes in interest rates even if the repricing opportunities of assets and liabilities are
perfectly matched.



45



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##### Table of Contents

Managements Discussion and Analysis



Table 13. Interest Rate Sensitivity



|                                                              |  |                              |            |   |               |   |             |               |  |   |               |   |  |       |            |   |  |   |             |  
|------------------------------------------------------------- |  | ---------------------------- | ---------- | - | ------------- | - | ----------- | ------------- |  | - | ------------- | - |  | ----- | ---------- | - |  | - | ----------- | -
|                                                              |  | December 31, 2003 Maturities |           
|                                                              |  | 1 - 3 Months                 |            |   | 4 - 12 Months |   |             | 13 - 60Months |  |   | Over 60Months |   |  | Total |           
|Earning Assets:                                               |  |                              |            |   |               |   |             |               |  |   |               |   |  |       |            |   |  |   |             |  
|Loans                                                         |  | $                            | 48,327,383 |   |               | $ | 10,174,459  |               |  | $ | 30,477,513    |   |  | $     | 30,781,908 |   |  | $ | 119,761,263 |  
|Investments                                                   |  |                              | 3,098,855  |   |               |   | 1,000,816   |               |  |   | 999,380       |   |  |       | 321,673    |   |  |   | 5,420,724   |  
|Interest-bearing balances with banks                          |  |                              | 4,068,017  |   |               |   |            |               |  |   |              |   |  |       |           |   |  |   | 4,068,017   |  
|Federal funds sold                                            |  |                              |           |   |               |   |            |               |  |   |              |   |  |       |           |   |  |   |            |  
|                                                              |  |                              |            |   |               |   |             |               |  |   |               |   |  |       |            |   |  |   |             |  
|Total                                                         |  | $                            | 55,494,255 |   |               | $ | 11,175,275  |               |  | $ | 31,476,893    |   |  | $     | 31,103,581 |   |  | $ | 129,250,004 |  
|                                                              |  |                              |            |   |               |   |             |               |  |   |               |   |  |       |            |   |  |   |             |  
|Interest-bearing deposits:                                    |  |                              |            |   |               |   |             |               |  |   |               |   |  |       |            |   |  |   |             |  
|NOW accounts                                                  |  | $                            | 16,814,051 |   |               | $ |            |               |  | $ |              |   |  | $     |           |   |  | $ | 16,814,051  |  
|Money market                                                  |  |                              | 9,376,625  |   |               |   |            |               |  |   |              |   |  |       |           |   |  |   | 9,376,625   |  
|Savings                                                       |  |                              | 4,025,721  |   |               |   |            |               |  |   |              |   |  |       |           |   |  |   | 4,025,721   |  
|Certificates of deposit                                       |  |                              | 10,029,993 |   |               |   | 48,622,482  |               |  |   | 6,249,420     |   |  |       |           |   |  |   | 64,901,895  |  
|Repurchase agreements/fed funds purchased                     |  |                              | 3,418,635  |   |               |   |            |               |  |   |              |   |  |       |           |   |  |   | 3,418,635   |  
|Short-term debt                                               |  |                              | 1,400,000  |   |               |   |            |               |  |   |              |   |  |       |           |   |  |   | 1,400,000   |  
|Long-term debt                                                |  |                              | 1,983      |   |               |   | 1,006,193   |               |  |   | 4,180,076     |   |  |       | 57,828     |   |  |   | 5,246,080   |  
|                                                              |  |                              |            |   |               |   |             |               |  |   |               |   |  |       |            |   |  |   |             |  
|Total                                                         |  | $                            | 45,067,008 |   |               | $ | 49,628,675  |               |  | $ | 10,429,496    |   |  | $     | 57,828     |   |  | $ | 105,183,007 |  
|                                                              |  |                              |            |   |               |   |             |               |  |   |               |   |  |       |            |   |  |   |             |  
|Interest sensitivity gap                                      |  | $                            | 10,427,247 |   |               | $ | (38,453,400 | )             |  | $ | 21,047,397    |   |  | $     | 31,045,753 |   |  | $ |            |  
|Cumulative interest sensitivity gap                           |  | $                            | 10,427,247 |   |               | $ | (28,026,153 | )             |  | $ | (6,978,756    | ) |  | $     | 24,066,997 |   |  | $ | 24,066,997  |  
|Ratio of sensitive assets to sensitive liabilities            |  |                              | 123.14     | % |               |   | 22.52       | %             |  |   | 301.81        | % |  |       | 53,786.37  | % |  |   | 122.88      | %
|Cumulative ratio of sensitive assets to sensitive liabilities |  |                              | 123.14     | % |               |   | 70.40       | %             |  |   | 93.36         | % |  |       | 122.88     | % |  |   | 122.88      | %



Table 14. Key Financial Ratios



|                                 |  |                  |   |  |                  |  
|-------------------------------- |  | ---------------- | - |  | ---------------- | -
|                                 |  | December 31,2003 |   |  | December 31,2002 |  
|Return on average assets         |  | 1.06             | % |  | 1.10             | %
|Return on average equity         |  | 12.23            | % |  | 11.85            | %
|Average equity to average assets |  | 8.70             | % |  | 9.31             | %



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##### Table of Contents

Board of Directors and Officers



Board of Directors



|                           |  |                          
|-------------------------- |  | -------------------------
|Edward C. Ted Ashby, III |  | Surrey Bank & Trust      
|                           | 
|William A. Bill Johnson  |  | J. G. Coram Company, Inc.
|                           | 
|Elizabeth Johnson Lovill   |  | Town & Country Builders  
|                           | 
|Robert H. Moody            |  | Moody Funeral Services   
|                           | 
|Gene Rees                  |  | F. Rees Clothing         
|                           | 
|Tom G. Webb                |  | Araneum, LLC             
|                           | 
|Buddy Williams             |  | Williams & Birkett, LLC  
|                           | 
|Hylton Wright              |  | Retired                  



Bank
Officers



|                           |  |                                         
|-------------------------- |  | ----------------------------------------
|Hylton Wright              |  | Chairman                                
|                           | 
|Edward C. Ted Ashby, III |  | President and CEO                       
|                           | 
|Peter A. Pequeno           |  | Senior Vice President and CLO           
|                           | 
|Mark H. Towe               |  | Senior Vice President, Treasurer and CFO
|                           | 
|Brenda J. Harding          |  | Senior Vice President, Secretary and COO
|                           | 
|Christopher Nichols        |  | Vice President                          
|                           | 
|Lonnie Dillon              |  | Vice President                          
|                           | 
|Kenneth Shelton            |  | Vice President                          



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##### Table of Contents

Stockholder Information



Annual
Meeting



The annual meeting of stockholders will be held
Wednesday, April 28, 2004 at 10:00 a.m. at Cross Creek Country Club, 1129 Greenhill Road, Mount Airy, North Carolina.



Requests for Information



Requests for information should be directed to Mr. Mark H. Towe, Senior Vice President and CFO, at Surrey Bank & Trust, Post Office Box 1227, Mount Airy, North
Carolina, 27030; telephone (336) 719-2310. A copy of the Banks Form 10-KSB for 2002 will be furnished, without charge, after March 31, 2003 upon written request.



|                             |  |                              
|---------------------------- |  | -----------------------------
|Independent Auditors         |  | Stock Transfer Agent         
|Larrowe & Company, PLC       |  | First Citizens Bank          
|Certified Public Accountants |  | & Trust Company              
|Post Office Box 760          |  | Post Office Box 29522        
|Galax, Virginia 24333        |  | Raleigh, North Carolina 27626



Federal Deposit Insurance
Corporation



The Bank is a member of the FDIC. This statement has
not been reviewed, or confirmed for accuracy or relevance by the Federal Deposit Insurance Corporation.



Banking Offices



|                           |  |                            |  |                               
|-------------------------- |  | -------------------------- |  | ------------------------------
|145 North Renfro Street    |  | 1280 West Pine Street      |  | 303 South Main Street         
|Mount Airy, North Carolina |  | Mount Airy, North Carolina |  | Stuart Virginia               
|(336) 783-3900             |  | (336) 783-3920             |  | (276) 694-4825                
|                           |  |                           
|2050 Rockford Street       |  |                            |  | 108 Heatherly Creek Drive     
|Mount Airy, North Carolina |  |                            |  | Pilot Mountain, North Carolina
|(336) 783-3940             |  |                            |  | (336) 368-1122                
|                           |  |                           
|Friendly Finance, LLC      |  | Mortgage Lending Office    |  | SB & T Insurance              
|521 Atkins Street          |  | 199 North Renfro Street    |  | 199 North Renfro Street       
|Dobson, North Carolina     |  | Mount Airy, North Carolina |  | Mount Airy, North Carolina    
|                           |  | (336) 789-1035             |  |                               



48