UNITED STATES SECURITIES AND EXCHANGE COMMISSION

                             Washington, D.C. 20549

                                    FORM 10-K

              ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
                         SECURITIES EXCHANGE ACT OF 1934

   For the fiscal year ended December 31, 2004 Commission File Number 0-22787

                             FOUR OAKS FINCORP, INC.
                             -----------------------
             (Exact name of registrant as specified in its charter)

                  North Carolina                         56-2028446
          -------------------------------      ----------------------------
          (State or other jurisdiction of      (IRS Employer Identification
           incorporation or organization)                  Number)

                               6114 U.S. 301 South
                            Four Oaks, North Carolina
                    (Address of principal executive offices)

                                      27524
                                   (Zip Code)

       Registrant's telephone number, including area code: (919) 963-2177
                                                           --------------
                    Securities registered under Section 12(b)
                     of the Act: NONE Securities registered
                         under Section 12(g) of the Act:

                     Common Stock, par value $1.00 per share
                                (Title of Class)

     Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days: |X| YES [ ] NO

         Indicate by check mark whether disclosure of delinquent filers pursuant
to Item 405 of Regulation S-K is not contained herein, and will not be
contained, to the best of the registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-K
or any amendment to this Form 10-K. |X|

     Check whether the registrant is an accelerated filer (as defined by Rule
12b-2 of the Act). [ ] YES |X| NO


                                   $51,043,440
                                   -----------

(Aggregate value of voting and non-voting common equity held by non-affiliates
of the registrant based on the price at which the registrant's Common Stock, par
value $1.00 per share was sold on June 30, 2004)

                                    3,454,241
                                    ---------

(Number of shares of Common Stock, par value $1.00 per share, outstanding as of
March 7, 2005)

Documents Incorporated by Reference                          Where Incorporated

(1)  Proxy Statement for the 2005 Annual                          Part III
     Meeting of Shareholders to be held April 25, 2005


                                      -1-

<PAGE>



FORWARD-LOOKING INFORMATION

         Information set forth in this Annual Report on Form 10-K under the
caption "Business" and "Management's Discussion and Analysis of Financial
Condition and Results of Operations" contains various "forward looking
statements" within the meaning of Section 27A of the Securities Act of 1933, as
amended, and Section 21E of the Securities Exchange Act of 1934, as amended,
which statements represent our judgment concerning the future and are subject to
risks and uncertainties that could cause our actual operating results and
financial position to differ materially. Such forward looking statements can be
identified by the use of forward looking terminology, such as "may," "will,"
"expect," "anticipate," "estimate," or "continue" or the negative thereof or
other variations thereof or comparable terminology.

         We caution that any such forward looking statements are further
qualified by important factors that could cause our actual operating results to
differ materially from those in the forward looking statements, including,
without limitation, the effects of future economic conditions, governmental
fiscal and monetary policies, legislative and regulatory changes, the risks of
changes in interest rates on the level and composition of deposits, the effects
of competition from other financial institutions, the failure of assumptions
underlying the establishment of the allowance for possible loan losses and the
low trading volume of our common stock.

                                     PART I


ITEM 1 - BUSINESS.

         On February 5, 1997, Four Oaks Bank & Trust Company (referred to herein
as the "bank") formed Four Oaks Fincorp, Inc. for the purpose of serving as a
holding company for the bank. Four Oaks Fincorp, Inc. has no significant assets
other than cash and the capital stock of the bank as well as $695,000 in
securities available for sale. Our corporate offices are located at 6114 US 301
South, Four Oaks, North Carolina 27524.

         The bank was incorporated under the laws of the State of North Carolina
in 1912. The bank is a state-chartered member of the Federal Reserve System. In
Four Oaks, the main office is located at 6144 US 301 South and an additional
branch is located at 111 North Main Street. The bank also operates a branch
office in Clayton, North Carolina at 102 East Main Street, two in Smithfield,
North Carolina at 128 North Second Street, and 403 South Brightleaf Boulevard,
one in Garner, North Carolina at 200 Glen Road, one in Benson, North Carolina at
200 East Church Street, one in Fuquay-Varina, North Carolina at 325 North Judd
Parkway Northeast, one in Wallace, North Carolina at 406 East Main Street and
one in Holly Springs at 101 Avent Ferry Road, Holly Springs, North Carolina. On
January 10, 2005, the bank opened a new branch office at 590 Tomahawk Highway,
Harrells, North Carolina and a loan production office at 1100 South Horner
Boulevard, Sanford, North Carolina.

         The bank is a community bank engaged in the general commercial banking
business in Johnston, Wake, Sampson and Duplin Counties, North Carolina.
Johnston County is contiguous to Wake, Wayne, Wilson, Harnett, Sampson and Nash
counties. Wake County is contiguous to Johnston, Durham, Harnett, Nash,
Franklin, Granville and Chatham counties. Sampson County is contiguous to
Duplin, Pender, Bladen, Harnett, Cumberland, Johnston, and Wayne counties.
Duplin County is contiguous to Pender, Sampson, Wayne, Lenoir, Jones and Onslow
counties.

         As of December 31, 2004, we had assets of $398.5 million, net loans
outstanding of $308.8 million and deposits of $315.3 million. We have enjoyed
considerable growth over the past five (5) years as evidenced by the 72%
increase in assets, the 88% increase in net loans outstanding, and the 62%
increase in deposits since December 31, 1999.

         The bank provides a full range of banking services, including such
services as checking accounts, savings accounts, individual retirement accounts,
NOW accounts, money market accounts, certificates of deposit, a student checking
and savings program; loans for businesses, agriculture, real estate, personal
uses, home improvement and automobiles; mortgage loans; equity lines of credit;
credit cards; safe deposit boxes; money orders; electronic funds transfer
services, including wire transfers; internet banking and bill pay services;
telephone banking; cashier's checks; traveler's checks; and free notary services
to all bank customers. The bank also provides financial services, offering a
complete line of insurance and investment services, including financial
strategies, mutual funds, annuities, insurance, stock brokerage, IRAs, discount
brokerage services, employee benefit plans, 401(k)'s and SEPs. In addition, the
bank provides worldwide automated teller machine access to its customers for
cash withdrawals through the services of the Star, Cirrus, or Visa networks by
using ATM or Visa check cards. The Visa check cards may also be used at merchant
locations worldwide through the Star, Cirrus, or Visa networks. In 2003, the
bank began issuing stored value cards which are marketed by independent sales
organizations and provide access to funds through the Visa, Plus, Interlink,
Mastercard, Maestro, Cirrus, and Star networks. At present, the bank does not
provide the services of a trust department.


                                       2
<PAGE>


         The majority of the bank's customers are individuals and small to
medium-size businesses located in Johnston, Wake, and Duplin Counties and
surrounding areas. The deposits and loans are well diversified with no material
concentration in a single industry or group of related industries. There are no
seasonal factors that would have any material adverse effect on the bank's
business, and the bank does not rely on foreign sources of funds or income.

         From its headquarters located in Four Oaks and its twelve locations in
Four Oaks, Clayton, Smithfield, Garner, Benson, Fuquay-Varina, Wallace, Holly
Springs, Harrells and a loan production office in Sanford, the bank serves a
major portion of Johnston County, part of Wake, Harnett, Duplin, Sampson and Lee
Counties. Johnston County has a diverse economy and is not dependent on any one
particular industry. The leading industries in the area include retail trade,
manufacturing, pharmaceuticals, government, services, construction, wholesale
trade and agriculture.

         In an effort to offer a more diversified and competitive product line
to better serve our customers and community, we have discontinued our provision
of secondary market-type mortgages through the bank and, through a joint venture
with Centex Corporation, formed Four Oaks Mortgage Company, L.P. During 2003,
Four Oaks Mortgage Company, L.P. started providing secondary market-type
mortgages and will be the vehicle through which all of our mortgage and funding
business will be run going forward. Four Oaks Mortgage Company, L.P. is owned
49.99% by our wholly-owned subsidiary, Four Oaks Mortgage Services, L.L.C., and
50.01% by its general partner, CTX Mortgage Ventures, LLC, a wholly-owned
indirect subsidiary of Centex Corporation.

         Amounts spent on research activities relating to the development or
improvement of services have been immaterial over the past two years. At
December 31, 2004, the bank employed 131 full time equivalent employees.

         The following table sets forth certain of our financial data and ratios
for the years ended December 31, 2004, 2003, and 2002. This information should
be read in conjunction with and is qualified in its entirety by reference to the
more detailed audited financial statements and notes thereto included in this
report:


<TABLE>
<CAPTION>
                                                            2004          2003        2002
                                                          --------     --------     --------
                                                             (In thousands, except ratios)
<S>                                                       <C>          <C>          <C>
Net income                                                $  4,375     $  2,918     $  2,916
Average equity capital accounts                           $ 35,135     $ 32,341     $ 29,931
Ratio of net income to average equity capital accounts       12.45%        9.02%        9.74%
Average daily total deposits                              $295,524     $255,038     $242,878
Ratio of net income to average daily total deposits           1.48%        1.14%        1.20%

Average daily loans (gross)                               $298,783     $249,240     $216,620
Ratio of average daily loans to average
  daily total deposits                                      101.10%       97.73%       89.19%
</TABLE>



COMPETITION

         Commercial banking in North Carolina is extremely competitive due in
large part to statewide branching. The bank competes in its market area with
some of the largest banking organizations in the state and the country and other
financial institutions, such as federally and state-chartered savings and loan
institutions and credit unions, as well as consumer finance companies, mortgage
companies and other lenders engaged in the business of extending credit. Many of
the bank's competitors have broader geographic markets and higher lending limits
than those of the bank and are also able to provide more services and make
greater use of media advertising.

         The enactment of legislation authorizing interstate banking has caused
great increases in the size and financial resources of some of the bank's
competitors. In addition, as a result of interstate banking, out-of-state
commercial banks may acquire North Carolina banks and heighten the competition
among banks in North Carolina. See "Holding Company Regulation" below.


                                       3
<PAGE>


         Despite the competition in its market areas, the bank believes that it
has certain competitive advantages that distinguish it from its competition. The
bank believes that its primary competitive advantages are its strong local
identity, its affiliation with the community and its emphasis on providing
specialized services to small and medium-sized business enterprises, as well as
professional and upper-income individuals. The bank offers customers modern,
high-tech banking without forsaking community values such as prompt, personal
service and friendliness. The bank offers many personalized services and
attracts and retains customers by being responsive and sensitive to their
individualized needs. The bank also relies on goodwill and referrals from our
shareholders and the bank's satisfied customers, as well as traditional media,
to attract new customers. To enhance a positive image in the community, the bank
supports and participates in local events, and its officers and directors serve
on boards of local civic and charitable organizations.

GOVERNMENTAL REGULATION

         Holding companies, banks and many of their non-bank affiliates are
extensively regulated under both federal and state law. The following is a brief
summary of certain statutes, rules and regulations affecting us and the bank.
This summary is qualified in its entirety by reference to the particular
statutory and regulatory provisions referred to below and is not intended to be
an exhaustive description of the statutes or regulations applicable to our
business or the business of the bank. Supervision, regulation and examination of
us and the bank by bank regulatory agencies is intended primarily for the
protection of the bank's depositors rather than our shareholders.



HOLDING COMPANY REGULATION

         GENERAL. We are a holding company registered with the Board of
Governors of the Federal Reserve System under the Bank Holding Company Act of
1956 (the "BHCA"). As such, we are subject to the supervision, examination and
reporting requirements contained in the BHCA and the regulation of the Federal
Reserve. The bank is also subject to the BHCA. The BHCA requires that a bank
holding company obtain the prior approval of the Federal Reserve before (i)
acquiring direct or indirect ownership or control of more than five percent of
the voting shares of any bank, (ii) taking any action that causes a bank to
become a subsidiary of the bank holding company, (iii) acquiring all or
substantially all of the assets of any bank or (iv) merging or consolidating
with any other bank holding company.

         The BHCA generally prohibits a bank holding company, with certain
exceptions, from engaging in activities other than banking, or managing or
controlling banks or other permissible subsidiaries, and from acquiring or
retaining direct or indirect control of any company engaged in any activities
other than those activities determined by the Federal Reserve to be closely
related to banking, or managing or controlling banks, as to be a proper incident
thereto. In determining whether a particular activity is permissible, the
Federal Reserve must consider whether the performance of such an activity can
reasonably be expected to produce benefits to the public, such as greater
convenience, increased competition or gains in efficiency, that outweigh
possible adverse effects, such as undue concentration of resources, decreased or
unfair competition, conflicts of interest or unsound banking practices. For
example, banking, operating a thrift institution, extending credit or servicing
loans, leasing real or personal property, providing securities brokerage
services, providing certain data processing services, acting as agent or broker
in selling credit life insurance and certain other types of insurance
underwriting activities have all been determined by regulations of the Federal
Reserve to be permissible activities.

         Pursuant to delegated authority, the Federal Reserve Bank of Richmond
has authority to approve certain activities of holding companies within its
district, including us, provided the nature of the activity has been approved by
the Federal Reserve. Despite prior approval, the Federal Reserve has the power
to order a holding company or its subsidiaries to terminate any activity or to
terminate its ownership or control of any subsidiary when it believes that
continuation of such activity or such ownership or control constitutes a serious
risk to the financial safety, soundness or stability of any bank subsidiary of
that bank holding company.

         FINANCIAL HOLDING COMPANIES. The Gramm-Leach-Bliley Modernization Act
of 1999 (the "GLB"), which was enacted on November 12, 1999, allows bank holding
companies that meet certain new regulatory standards regarding management,
capital and the Community Reinvestment Act, to engage in a broader range of
non-banking activities than previously permissible, including insurance
underwriting and making merchant banking investments in commercial and financial
companies; allows insurers and other financial services companies to acquire
banks; removes various restrictions that applied to bank holding company
ownership of securities firms and mutual fund advisory companies; and
establishes the overall regulatory structure applicable to bank holding
companies that also engage in insurance and securities operations.


                                       4
<PAGE>


         At the present time, we have elected to remain a bank holding company,
and therefore we remain subject to the same regulatory framework as before the
enactment of the GLB. However, the financial holding company structure created
by the GLB permits insurance companies or securities firms operating under the
financial holding company structure to acquire us, and, if we elect to become a
financial holding company in the future, we could acquire insurance companies or
securities firms.

         In addition to creating the more flexible financial holding company
structure, the GLB introduced several additional customer privacy protections
that will apply to us and the bank. The GLB's privacy provisions require
financial institutions to, among other things, (i) establish and annually
disclose a privacy policy, (ii) give consumers the right to opt out of
disclosures to nonaffiliated third parties, with certain exceptions, (iii)
refuse to disclose consumer account information to third-party marketers and
(iv) follow regulatory standards to protect the security and confidentiality of
consumer information.

         Pursuant to the GLB's rulemaking provisions, the Office of the
Comptroller of the Currency, the Board of Governors of the Federal Reserve
System, the Federal Deposit Insurance Corporation and the Office of Thrift
Supervision adopted regulations, establishing standards for safeguarding
customer information. Such regulations provide financial institutions guidance
in establishing and implementing administrative, technical and physical
safeguards to protect the security, confidentiality and integrity of customer
information.

         MERGERS AND ACQUISITIONS. The Riegle-Neal Interstate Banking and
Branching Efficiency Act of 1994 (the "IBBEA") permits interstate acquisitions
of banks and bank holding companies without geographic limitation, subject to
any state requirement that the bank has been organized for a minimum period of
time, not to exceed five (5) years, and the requirement that the bank holding
company, prior to or following the proposed acquisition, controls no more than
ten percent (10%) of the total amount of deposits of insured depository
institutions in the U.S. and no more than thirty percent (30%) of such deposits
in any state (or such lesser or greater amount set by state law).

         In addition, the IBBEA permits a bank to merge with a bank in another
state as long as neither of the states has opted out of the IBBEA prior to May
31, 1997. In 1995, the state of North Carolina "opted in" to such legislation.
In addition, a bank may establish and operate a de novo branch in a state in
which the bank does not maintain a branch if that state expressly permits de
novo interstate branching. As a result of North Carolina having opted-in,
unrestricted interstate de novo branching is permitted in North Carolina.

         ADDITIONAL RESTRICTIONS AND OVERSIGHT. Subsidiary banks of a bank
holding company are subject to certain restrictions imposed by the Federal
Reserve on any extensions of credit to the bank holding company or any of its
subsidiaries, investments in the stock or securities thereof and the acceptance
of such stock or securities as collateral for loans to any borrower. A bank
holding company and its subsidiaries are also prevented from engaging in certain
tie-in arrangements in connection with any extension of credit, lease or sale of
property or furnishing of services. An example of a prohibited tie-in would be
any arrangement that would condition the provision or cost of services on a
customer obtaining additional services from the bank holding company or any of
its other subsidiaries.

         The Federal Reserve may issue cease and desist orders against bank
holding companies and non-bank subsidiaries to stop actions believed to present
a serious threat to a subsidiary bank. The Federal Reserve also regulates
certain debt obligations, changes in control of bank holding companies and
capital requirements.

         Under the provisions of the North Carolina law, we are registered with
and subject to supervision by the North Carolina Commissioner of Banks.

         CAPITAL REQUIREMENTS. The Federal Reserve has established risk-based
capital guidelines for bank holding companies and state member banks. The
minimum standard for the ratio of capital to risk-weighted assets (including
certain off balance sheet obligations, such as standby letters of credit) is
eight percent (8%). At least half of this capital must consist of common equity,
retained earnings and a limited amount of perpetual preferred stock and minority
interests in the equity accounts of consolidated subsidiaries, less goodwill
items and certain other items ("Tier 1 capital"). The remainder ("Tier 2
capital") may consist of mandatory convertible debt securities and a limited
amount of other preferred stock, subordinated debt and loan loss reserves.


                                       5
<PAGE>

         In addition, the Federal Reserve has established minimum leverage ratio
guidelines for bank holding companies. These guidelines provide for a minimum
leverage ratio of Tier 1 capital to adjusted average quarterly assets less
certain amounts ("Leverage Ratio") equal to three percent for bank holding
companies that meet certain specified criteria, including having the highest
regulatory rating. All other bank holding companies will generally be required
to maintain a Leverage Ratio of between four percent and five percent.

         The guidelines also provide that bank holding companies experiencing
significant growth, whether through internal expansion or acquisitions, will be
expected to maintain strong capital ratios substantially above the minimum
supervisory levels without significant reliance on intangible assets. The same
heightened requirements apply to bank holding companies with supervisory,
financial, operational or managerial weaknesses, as well as to other banking
institutions if warranted by particular circumstances or the institution's risk
profile. Furthermore, the guidelines indicate that the Federal Reserve will
continue to consider a "tangible Tier 1 Leverage Ratio" (deducting all
intangibles) in evaluating proposals for expansion or new activity. The Federal
Reserve has not advised us of any specific minimum Leverage Ratio or tangible
Tier 1 Leverage Ratio applicable to us.

         As of December 31, 2004, we had Tier 1 risk-adjusted, total regulatory
capital and leverage capital of approximately 11.70%, 12.95% and 9.53%,
respectively, all in excess of the minimum requirements to be considered
well-capitalized under prompt corrective action provisions.

         USA PATRIOT ACT OF 2001. Title III of the USA Patriot Act of 2001
contains the International Money Laundering Abatement and Financial
Anti-Terrorism Act of 2001 (the "IMLAFA"). The anti-money laundering provisions
of IMLAFA impose affirmative obligations on a broad range of financial
institutions, including banks, brokers, and dealers. Among other requirements,
IMLAFA requires all financial institutions to establish anti-money laundering
programs that include, at minimum, internal policies, procedures, and controls;
specific designation of an anti-money laundering compliance officer; ongoing
employee training programs; and an independent audit function to test the
anti-money laundering program. IMLAFA requires financial institutions that
establish, maintain, administer, or manage private banking accounts for
non-United States persons or their representatives to establish appropriate,
specific, and, where necessary, enhanced due diligence policies, procedures, and
controls designed to detect and report money laundering. Additionally, IMLAFA
provides for the Department of Treasury to issue minimum standards with respect
to customer identification at the time new accounts are opened. As of the date
of this filing, we believe that IMLAFA has not had a material impact on the
bank's operations. The bank has established policies and procedures to ensure
compliance with the IMLAFA, which are overseen by an Anti-Money Laundering
Officer who was appointed by our Board of Directors.


BANK REGULATION

         The bank is subject to numerous state and federal statutes and
regulations that affect its business, activities, and operations, and is
supervised and examined by the North Carolina Commissioner of Banks and the
Federal Reserve. The Federal Reserve and the North Carolina Commissioner of
Banks regularly examine the operations of banks over which they exercise
jurisdiction. They have the authority to approve or disapprove the establishment
of branches, mergers, consolidations, and other similar corporate actions, and
to prevent the continuance or development of unsafe or unsound banking practices
and other violations of law. The Federal Reserve and the North Carolina
Commissioner of Banks regulate and monitor all areas of the operations of banks
and their subsidiaries, including loans, mortgages, issuances of securities,
capital adequacy, loss reserves, and compliance with the Community Reinvestment
Act of 1977 (the "CRA") as well as other laws and regulations. Interest and
certain other charges collected and contracted for by banks are also subject to
state usury laws and certain federal laws concerning interest rates.

         The deposit accounts of the bank are insured by the Bank Insurance Fund
(the "BIF") of the Federal Deposit Insurance Corporation (the "FDIC") up to a
maximum of one hundred thousand dollars ($100,000) per insured depositor. Any
insured bank that is not operated in accordance with or does not conform to FDIC
regulations, policies, and directives may be sanctioned for noncompliance. Civil
and criminal proceedings may be instituted against any insured bank or any
director, officer or employee of such bank for the violation of applicable laws
and regulations, breaches of fiduciary duties or engaging in any unsafe or
unsound practice. The FDIC has the authority to terminate insurance of accounts
pursuant to procedures established for that purpose.

         Under the North Carolina Business Corporation Act, we may not pay a
dividend or distribution, if after giving it effect, we would not be able to pay
our debts as they become due in the usual course of business or our total assets
would be less than our liabilities. In general, our ability to pay cash
dividends is dependent upon the amount of dividends paid to us by the bank. The
ability of the bank to pay dividends to us is subject to statutory and
regulatory restrictions on the payment of cash dividends, including the
requirement under the North Carolina banking laws that cash dividends be paid
only out of undivided profits and only if the bank has surplus of a specified
level. The Federal Reserve also imposes limits on the bank's payment of
dividends.



                                       6
<PAGE>

         Like us, the bank is required by federal regulations to maintain
certain minimum capital levels. The levels required of the bank are the same as
those required of us. At December 31, 2004, the bank had Tier 1 risk-adjusted,
total regulatory capital and leverage capital of approximately 10.59%, 11.84%
and 8.63%, respectively, in excess of the minimum requirements to be considered
well-capitalized under prompt corrective action provisions.

         The bank is subject to insurance assessments imposed by the FDIC,
including a risk-based assessment schedule providing for annual assessment rates
ranging from 0% to .27% of an institution's average assessment base, applicable
to institutions insured by both the BIF and the Savings Association Insurance
Fund ("SAIF"). The actual assessment to be paid by each insured institution is
based on the institution's assessment risk classification, which focuses on
whether the institution is considered "well capitalized, " "adequately
capitalized" or "under capitalized," as such terms are defined in the applicable
federal regulations. Within each of these three risk classifications, each
institution will be assigned to one of three subgroups based on supervisory risk
factors. In particular, regulators will assess supervisory risk based on whether
the institution is financially sound with only a few minor weaknesses (Subgroup
A), whether it has weaknesses which, if not corrected, could result in an
increased risk of loss to the BIF (Subgroup B) or whether such weaknesses pose a
substantial risk of loss to the BIF unless corrective action is taken (Subgroup
C). The FDIC also is authorized to impose one or more special assessments in an
amount deemed necessary to enable repayment of amounts borrowed by the FDIC from
the United States Treasury Department and, beginning in 1997, all banks are
required to pay additional annual assessments as set by the Financing
Corporation, which was established by the Competitive Equality Banking Act of
1987.

         The Federal Deposit Insurance Corporation Improvement Act of 1991
("FDICIA") provides for, among other things, (i) publicly available annual
financial condition and management reports for certain financial institutions,
including audits by independent accountants, (ii) the establishment of uniform
accounting standards by federal banking agencies, (iii) the establishment of a
"prompt corrective action" system of regulatory supervision and intervention,
based on capitalization levels, with greater scrutiny and restrictions placed on
depository institutions with lower levels of capital, (iv) additional grounds
for the appointment of a conservator or receiver and (v) restrictions or
prohibitions on accepting brokered deposits, except for institutions which
significantly exceed minimum capital requirements. FDICIA also provides for
increased funding of the FDIC insurance funds and the implementation of
risk-based premiums.

         A central feature of FDICIA is the requirement that the federal banking
agencies take "prompt corrective action" with respect to depository institutions
that do not meet minimum capital requirements. Pursuant to FDICIA, the federal
bank regulatory authorities have adopted regulations setting forth a five-tiered
system for measuring the capital adequacy of the depository institutions that
they supervise. Under these regulations, a depository institution is classified
in one of the following capital categories: "well capitalized, " "adequately
capitalized," "under capitalized," "significantly undercapitalized," and
"critically undercapitalized. "An institution may be deemed by the regulators to
be in a capitalization category that is lower than is indicated by its actual
capital position if, among other things, it receives an unsatisfactory
examination rating with respect to asset quality, management, earnings or
liquidity. FDICIA provides the federal banking agencies with significantly
expanded powers to take enforcement action against institutions which fail to
comply with capital or other standards. Such action may include the termination
of deposit insurance by the FDIC or the appointment of a receiver or conservator
for the institution.

         Banks are also subject to the CRA, which requires the appropriate
federal bank regulatory agency, in connection with its examination of a bank, to
assess such bank's record in meeting the credit needs of the community served by
that bank, including low and moderate-income neighborhoods. Each institution is
assigned one of the following four ratings of its record in meeting community
credit needs: "outstanding, " "satisfactory, " "needs to improve" or
"substantial noncompliance. " The regulatory agency's assessment of the bank's
record is made available to the public. Further, such assessment is required of
any bank which has applied to (i) charter a national bank, (ii) obtain deposit
insurance coverage for a newly chartered institution, (iii) establish a new
branch office that will accept deposits, (iv) relocate an office or (v) merge or
consolidate with, or acquire the assets or assume the liabilities of, a
federally regulated financial institution. In the case of a bank holding company
applying for approval to acquire a bank or other bank holding company, the
Federal Reserve will assess the record of each subsidiary bank of the applicant
bank holding company, and such records may be the basis for denying the
application.



                                       7
<PAGE>

         In addition, the GLB's "CRA Sunshine Requirements" call for financial
institutions to disclose publicly certain written agreements made in fulfillment
of the CRA. Banks that are parties to such agreements also must report to
federal regulators the amount and use of any funds expended under such
agreements on an annual basis, along with such other information as regulators
may require. This annual reporting requirement is effective for any agreements
made after May 12, 2000.

MONETARY POLICY AND ECONOMIC CONTROLS

         Both us and the bank are directly affected by governmental policies and
regulatory measures affecting the banking industry in general. Of primary
importance is the Federal Reserve Board, whose actions directly affect the money
supply which, in turn, affects banks' lending abilities by increasing or
decreasing the cost and availability of funds to banks. The Federal Reserve
Board regulates the availability of bank credit in order to combat recession and
curb inflationary pressures in the economy by open market operations in United
States government securities, changes in the discount rate on member bank
borrowings, changes in reserve requirements against bank deposits, and
limitations on interest rates that banks may pay on time and savings deposits.

         Deregulation of interest rates paid by banks on deposits and the types
of deposits that may be offered by banks have eliminated minimum balance
requirements and rate ceilings on various types of time deposit accounts. The
effect of these specific actions and, in general, the deregulation of deposit
interest rates has generally increased banks' cost of funds and made them more
sensitive to fluctuations in money market rates. In view of the changing
conditions in the national economy and money markets, as well as the effect of
actions by monetary and fiscal authorities, no prediction can be made as to
possible future changes in interest rates, deposit levels, or loan demand on our
business and earnings or those of the bank. As a result, banks, including the
bank, face a significant challenge to maintain acceptable net interest margins.

OUR EXECUTIVE OFFICERS

         The following table sets forth certain information with respect to our
executive officers:


<TABLE>
<CAPTION>
                                                                    POSITIONS AND OFFICES WITH FOUR OAKS
                                                                  FINCORP, INC. AND FOUR OAKS BANK & TRUST
                                               YEAR FIRST         COMPANY AND BUSINESS EXPERIENCE DURING
         NAME                     AGE          EMPLOYED                     PAST FIVE (5) YEARS
---------------------------------------------------------------------------------------------------------------------------
<S>                               <C>             <C>             <C>
         Ayden R. Lee, Jr.        56              1980            Chief Executive Officer, President and Director
                                                                  of Four Oaks  Fincorp, Inc. and Four Oaks Bank
                                                                  & Trust Company

         Clifton L. Painter       55              1986            Senior Executive Vice President, Chief Operating
                                                                  Officer of Four Oaks Fincorp, Inc. and Four Oaks
                                                                  Bank & Trust Company

         Nancy S. Wise            49              1991            Executive Vice President, Chief Financial Officer of
                                                                  Four Oaks Fincorp, Inc. and Four Oaks Bank & Trust
                                                                  Company.  Previously, Senior Vice President, Chief
                                                                  Financial Officer of Four Oaks Fincorp, Inc. and Four
                                                                  Oaks Bank & Trust Company

         W. Leon Hiatt, III       37              1994            Executive Vice President of Four Oaks Fincorp, Inc. and
                                                                  Four Oaks Bank & Trust Company, Chief Administrative
                                                                  Officer of Four Oaks Bank & Trust Company.
                                                                  Previously,  Senior Vice President Four Oaks Fincorp,
                                                                  Inc. and Four Oaks Bank & Trust Company,  Loan
                                                                  Administrator of Four Oaks Bank & Trust Company.

         Jeff D. Pope             48              1991            Executive Vice President of Four Oaks Fincorp, Inc. and
                                                                  Four Oaks Bank & Trust Company, Branch Administrator of
                                                                  Four Oaks Bank & Trust Company.  Previously, Senior
                                                                  Vice President, Loan Officer and Regional/Branch
                                                                  Administrator Four Oaks Bank and Trust Company
</TABLE>

                                       8
<PAGE>


ITEM 2 - PROPERTIES.

         The bank owns its main office, which is located at 6144 US 301 South,
Four Oaks, North Carolina. The main office, which was constructed by the bank in
1985, is a 12,000 square foot facility on 1.64 acres of land. The bank leases a
limited-service facility in downtown Four Oaks located at 111 North Main Street
from M.S. Canaday, who is one of our directors as well as a director of the
bank. Under the terms of the lease, which the bank believes to be arms-length,
the bank paid $908 per month in rent in 2004. The lease is month-to-month and we
review its terms on an annual basis. The bank also leases a branch office
located at 101 Avent Ferry Road, Holly Springs, North Carolina. Under the terms
of the lease, the bank will pay $2,166 per month for a period of five years. The
bank's Harrells office located at 590 Tomahawk Highway, Harrells, North Carolina
is under a lease with terms specifying the bank will pay $600 each month for the
period beginning January 1, 2006 and ending December 31, 2009. In addition, the
bank has entered into a yearly lease with an annual option to renew on its
Sanford office located at 1100 South Horner Boulevard, Sanford, North Carolina.
Under the terms of the lease, the bank will pay $1,300 each month. The bank owns
a 5,000 square foot facility renovated in 1992 on 1.15 acres of land located at
5987 US 301 South, Four Oaks, North Carolina which houses its training center.
The bank also owns a 15,000 square foot facility built in 2000 located at 6114
US 301 South, Four Oaks, North Carolina, which houses its administrative
offices, data operations, loan operations and wide area network central link. In
addition, the bank owns the following:


<TABLE>
<CAPTION>

              Location                        Year Built              Present Function          Square Feet
              --------                        ----------              ----------------          -----------
<S>                                           <C>                     <C>                       <C>
         102 East Main Street
         Clayton, North Carolina                 1986                 Branch Office                 4,700

         200 East Church Street
         Benson, North Carolina                  1987                 Branch Office                 2,000

         128 North Second Street
         Smithfield, North Carolina              1991                 Branch Office                 5,000

         403 South Brightleaf Boulevard
         Smithfield, North Carolina              1995                 Limited-Service Facility       720

         200 Glen Road
         Garner, North Carolina                  1996                 Branch Office                 3,600

         325 North Judd Parkway Northeast
         Fuquay-Varina, North Carolina           2002                 Branch Office                 8,900

         406 East Main Street
         Wallace, North Carolina                 2003                 Branch Office (modular)       2,800

</TABLE>

Management believes each of the properties referenced above is adequately
covered by insurance.


ITEM 3 - LEGAL PROCEEDINGS.

         We are not involved in any material legal proceedings at the present
time.



                                       9
<PAGE>


ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.

         None.


                                     PART II

Item 5 - Market for Registrant's Common Equity, Related Shareholder Matters and
Issuer Purchases of Equity Securities.

         Our common stock trades on the OTC Bulletin Board under the symbol
"FOFN." The range of high and low bid prices of our common stock for each
quarter during the two most recent fiscal years, as published by the OTC
Bulletin Board, is as follows (prices reflect inter-dealer prices, without
retail mark-up, mark-down or commissions and may not necessarily represent
actual transactions):


<TABLE>
<CAPTION>
                                   Fiscal Year Ended December 31,
                  -----------------------------------------------------------------
                               2003                                2004
                  -------------------------------     -----------------------------
                     High                Low              High               Low
                  ---------         -------------     -------------     -----------
<S>               <C>               <C>                <C>               <C>
First quarter     $   15.04         $   14.11          $   20.80         $   16.80
Second quarter        15.36             14.43              19.60             17.60
Third quarter         14.72             14.08              18.40             17.60
Fourth quarter        20.80             14.40              25.00             18.60
</TABLE>


         As of March 7, 2005, the approximate number of holders of record of our
common stock was 1,400. We have no other class of equity securities. The bank's
ability to declare a dividend to us and our ability to pay dividends are subject
to the restrictions of the North Carolina Business Corporation Act. There also
are state banking laws that require a surplus of at least 50% of paid-in capital
stock be maintained in order for the bank to declare a dividend to us. Subject
to the legal availability of funds to pay dividends, cash dividends paid by us
in 2004 and 2003, after giving effect to the 5-for-4 stock split during 2004,
were $.32 and $.29 per share, respectively.

         We did not sell any securities in 2004 that were not registered under
the Securities Act of 1933 as amended. We did not make any purchases of our
equity securities registered pursuant to Section 12 of the Securities Exchange
Act of 1934, as amended during the fourth quarter of 2004.


ITEM 6 -  SELECTED FINANCIAL DATA


         The following table sets forth our historical consolidated financial
data for the periods indicated. The selected historical annual consolidated
statement of operations and balance sheet data as of and for each of the five
fiscal years presented are derived from, and are qualified in their entirety by,
our consolidated financial statements. Historical results are not necessarily
indicative of the results to be expected in the future. You should read the
following data together with "Item 1. Business," "Item 7. Management's
Discussion and Analysis of Financial Condition and Results of Operations," and
our consolidated financial statements and the related notes appearing in "Item
8. Financial Statements." (Dollars in thousands, except per share data).



                                       10
<PAGE>


<TABLE>
<CAPTION>
                                                                          AS OF AND FOR THE YEAR ENDED DECEMBER 31,
                                                          -----------------------------------------------------------------------
                                                               2004          2003         2002           2001            2000
                                                          ------------  ------------  -----------   -------------   -------------
<S>                                                       <C>           <C>           <C>           <C>             <C>
OPERATING DATA:
     Total interest income                                $    21,748   $    18,943   $    19,785   $      21,462   $      20,808
     Total interest expense                                     5,811         5,922         7,640          10,167           9,647
                                                          ------------  ------------  -----------   -------------   -------------
     Net interest income                                       15,937        13,021        12,145          11,295          11,161
     Provision for loan losses                                  1,596         1,373         1,248             834             808
                                                          ------------  ------------  -----------   -------------   -------------
     Net interest income after provision for loan losses       14,341        11,648        10,897          10,461          10,353
     Noninterest income                                         3,849         3,470         2,810           2,284           1,852
     Noninterest expense                                       11,507        10,588         9,485           8,834           7,425
                                                          ------------  ------------  -----------   -------------   -------------
        Income before income taxes                              6,683         4,530         4,222           3,911           4,780
     Provision for income taxes                                 2,308         1,612         1,306           1,255           1,664
                                                          ------------  ------------  -----------   -------------   -------------
     Net income                                           $     4,375   $     2,918   $     2,916   $       2,656   $       3,116
                                                          ============  ============  ===========   =============   =============
PER SHARE DATA:
     Earnings per share - basic                           $      1.29   $      0.87   $      0.88   $        0.81   $        0.97
     Earnings per share - diluted                                1.28          0.86          0.87            0.81            0.96
     Cash dividends declared                                     0.32          0.29          0.26            0.26            0.23
     Market price
        High                                                    25.00         20.80         15.04           16.00           17.20
        Low                                                     16.80         14.08         13.12           11.52           11.09
        Close                                                   22.00         16.80         15.04           13.06           14.72
     Book value                                                 10.85          9.83          9.31            8.51            7.81

     Weighted average shares outstanding
        Basic                                               3,397,345     3,356,070     3,325,960       3,266,517       3,221,822
        Diluted                                             3,416,680     3,368,041     3,336,866       3,283,683       3,237,491

SELECTED YEAR-END BALANCE SHEET DATA:
     Total assets                                         $   398,500   $   341,721   $   318,289         299,970         258,329
     Loans                                                    312,815       272,623       229,570         209,822         194,497
     Allowance for loan losses                                  4,055         3,430         2,860           2,650           2,770
     Deposits                                                 315,307       272,918       250,573         235,604         216,693
     Borrowings                                                43,160        33,160        33,160          33,173          12,990
     Shareholders' equity                                      37,295        32,880        31,193          28,025          25,348

SELECTED AVERAGE BALANCES:
     Total assets                                         $   376,422   $   324,222       308,334         274,054         241,165
     Loans                                                    298,783       249,240       216,620         202,500         182,874
     Total interest-earning assets                            349,596       300,672       290,294         256,476         226,191
     Deposits                                                 295,524       255,038       242,878         226,476         198,072
     Total interest-bearing liabilities                       282,743       244,024       236,661         208,381         183,135
     Shareholders' Equity                                      35,135        32,341        29,931          27,306          23,550

SELECTED PERFORMANCE RATIOS:
     Return on average assets                                    1.16%         0.90%         0.95%           0.97%           1.29%
     Return on average equity                                   12.45%         9.02%         9.74%           9.73%          13.23%
     Net interest spread                                         4.16%         3.87%         3.59%           3.49%           3.93%
     Net interest margin                                         4.56%         4.33%         4.18%           4.40%           4.93%
     Non-interest income to total revenue                       19.45%        21.04%        18.79%          16.82%          14.23%
     Non-interest income to average assets                       1.02%         1.07%         0.91%           0.83%           0.77%
     Non-interest expense to average assets                      3.06%         3.27%         3.08%           3.22%           3.08%
     Efficiency ratio                                           58.16%        64.20%        63.42%          65.06%          57.06%
     Dividend payout ratio                                      24.81%        33.33%        29.55%          31.50%          23.84%

ASSET QUALITY RATIOS:
     Nonperforming loans to period-end loans                     0.30%         0.39%         0.67%           0.97%           0.85%
     Allowance for loan losses to period-end loans               1.30%         1.26%         1.25%           1.26%           1.42%
     Allowance for loan losses to nonperforming loans          429.56%       323.89%       186.08%         129.65%         167.47%
     Nonperforming assets to total assets                        0.34%         0.33%         0.62%           0.74%           0.67%
     Net loan charge-offs to average loans                       0.32%         0.32%         0.48%           0.47%           0.21%
</TABLE>


                                       11
<PAGE>


<TABLE>
<CAPTION>
                                                                          AS OF AND FOR THE YEAR ENDED DECEMBER 31,
                                                          -----------------------------------------------------------------------
                                                               2004          2003         2002           2001            2000
                                                          ------------  ------------  -----------   -------------   -------------
<S>                                                       <C>           <C>           <C>           <C>             <C>
CAPITAL RATIOS:
     Total risk-based capital - Bank                            11.80%        12.30%        14.00%          14.10%          12.86%
     Tier 1 risk-based capital - Bank                           10.60%        11.10%        12.80%          13.90%          13.70%
     Leverage ratio - Bank                                       8.60%         9.00%         9.70%           9.50%          12.40%
     Equity to assets ratio                                      9.33%         9.62%         9.80%           9.34%           9.81%
     Equity to assets ratio (averages)                           9.33%         9.97%         9.71%           9.96%           9.77%
     Average interest-earning assets to average
       total assets                                             92.87%        92.74%        94.15%          93.59%          93.79%
     Average loans to average total deposits                   101.10%        97.73%        89.19%          89.41%          92.33%
     Average interest-bearing liabilities
       to average interest-earning assets                       80.88%        81.16%        81.52%          81.25%          80.96%

Other Data:
     Number of banking offices                                     10            10             9               8               8
     Number of full time equivalent employees                     131           126           122             112             100


</TABLE>

ITEM 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.

         The following discussion and analysis provides information about the
major components of our results of operations and financial condition, liquidity
and capital resources and should be read in conjunction with our Consolidated
Financial Statements and Notes thereto which are contained in this report.
Additional discussion and analysis related to fiscal 2004 is contained in our
Quarterly Reports on Form 10-Q for the fiscal quarters ended March 31, 2004,
June 30, 2004 and September 30, 2004, respectively.

OVERVIEW

         We have experienced significant sustained growth in assets and deposits
over the last five years. Our assets have increased from $231.5 million at
December 31, 1999 to $398.5 million at December 31, 2004, while our total
deposits have increased from $194.7 million to $315.3 million over that same
period. In addition, for 69 consecutive years, we have paid dividends (of
course, prior to 1997 when we reorganized into a holding company, it was our
wholly owned subsidiary, Four Oaks Bank & Trust Company, which paid dividends).
For the past five years, dividends have averaged 25.6% of our average net
income.

         We set interest rates on deposits and loans at competitive rates while
maintaining spreads of 4.16% and 3.87% in 2004 and 2003, respectively, between
interest earned on average loans and investments and interest paid on average
interest-bearing deposits and borrowings. Our gross loans have increased from
$166.6 million at December 31, 1999 to $312.8 million at December 31, 2004,
while our average net annual charge-offs over the same period were $831,000. The
sustained growth provided by operations resulted in increases in total assets of
16.6%, 7.4% and 6.1% for 2004, 2003 and 2002, respectively.

         Our gross loans grew 14.7% and 18.8% in 2004 and 2003, respectively.
Our total investments (including interest-earning deposits and FHLB stock)
increased 29.0% in 2004 following a decrease of 31.9% in 2003, which the decline
was primarily due to the decision to build the portfolio as interest rates began
to rise. We closely monitor changes in the financial markets in order to
maximize the yield on our assets. The growth in loans for 2004 and 2003 was
funded by deposit growth of 15.5% and 8.9% in 2004 and 2003, net income of $4.4
million in 2004 and $2.9 million in 2003 and for the year 2003, a reduction of
lower yielding investments. Net income for 2004 was $4.4 million, an increase of
49.9% over 2003's net income of $2.9 million. This increase was primarily due to
an increase in net interest income. Strategic pricing of both loans and deposits
provided improvement in our net interest margin for 2004. Reduced overhead costs
resulting from the effects of cost containment initiatives begun in prior years
also improved net income in 2004.

         During 2004 and 2003, Four Oaks Mortgage Company, L.P. provided
secondary market-type mortgages. Four Oaks Mortgage Company, L.P. is owned
49.99% by our wholly owned subsidiary, Four Oaks Mortgage Services, L.L.C., and
50.01% by its general partner, CTX Mortgage Ventures, LLC, a wholly owned
indirect subsidiary of Centex Corporation.

                                       12
<PAGE>

         In December 2004, we added the Retail Real Estate Lending division
which will work with individuals, developers and contractors involved in real
estate acquisition and development.

         Management historically has monitored and controlled increases in
overhead expenses while being committed to developing the skills and enhancing
the professionalism of our employees. Employee turnover has been minimal, while
the number of full-time equivalent employees has increased from 100 at December
31, 1999 to 131 at December 31, 2004.

RESULTS OF OPERATIONS

COMPARISON OF FINANCIAL CONDITION AT DECEMBER 31, 2004 AND 2003

         During 2004, our total assets increased by $56.8 million, or 16.6%,
from $341.7 million at December 31, 2003 to $398.5 million at December 31, 2004.
This increase in our total assets resulted primarily from growth in our net
loans, which increased from $269.2 million at December 31, 2003 to $308.8
million at December 31, 2004, an increase of $39.6 million. Additionally, our
securities portfolio increased $14.1 million to $52.3 million at December 31,
2004, and other assets increased $4.1 million in 2004 due to our investment in
bank-owned life insurance during the year of $3.2 million. The funding for our
loan growth, increases in our securities portfolio and investment in bank-owned
life insurance was primarily funded by considerable deposit growth of $42.4
million, or 15.5% during 2004 to $315.3 million at December 31, 2004 compared
with $272.9 million at December 31, 2003.

         Shareholders' equity increased by $4.4 million during 2004. This
increase resulted from our net income of $4.4 million, dividend reinvestment
plan proceeds of $506,000 and proceeds from the exercise of stock options of
$924,000, net of repurchases of stock totaling $65,000, and dividends paid of
$1.1 million.


COMPARISON OF FINANCIAL CONDITION AT DECEMBER 31, 2003 AND 2002

         During 2003, our total assets increased by $23.4 million, or 7.4%, from
$318.3 million at December 31, 2002 to $341.7 million at December 31, 2003. This
increase in our total assets resulted primarily from growth in our net loans,
which increased from $226.7 million at December 31, 2002 to $269.2 million at
the end of 2003, an increase of $42.5 million. Additionally, our other assets
increased $3.1 million in 2003 due to our investment in bank-owned life
insurance during the year of $2.9 million. These increases in our assets were
partially offset by the decrease during 2003 in our liquid assets, which
consists of cash and cash equivalents and investment securities, of $22.4
million. This decrease in our liquid assets resulted principally from the net
decrease in our securities portfolio during the year of $18.6 million. In
addition to the aforementioned use of our liquid assets, the funding for our
loan growth and investment in bank-owned life insurance came from deposits,
which increased by $22.3 million during 2003 to $272.9 million at December 31,
2003 compared with $250.6 million at December 31, 2002.

         Shareholders' equity increased by $1.7 million during 2003 compared to
2002. This increase resulted from our net income of $2.9 million, dividend
reinvestment plan proceeds of $469,000 and proceeds from the exercise of stock
options of $300,000, net of repurchases of stock totaling $993,000, and
dividends paid of $952,000.


COMPARISON OF OPERATING RESULTS FOR THE YEARS ENDED DECEMBER 31, 2004 AND 2003

NET INCOME

         We earned net income of $4.4 million or $1.29 basic net income per
share for 2004, which was a 49.9% increase over net income of $2.9 million, or
$.87 basic net income per share for 2003. We believe strategic pricing of both
our loans and deposits improved our net interest margin by lowering our overall
cost of funds and allowing us to attract the higher balance, higher quality
loans in our markets. Cost containment initiatives that began in prior years
continue to positively impact our overhead levels. We incurred only a moderate
increase in non-interest expense of 8.7% in 2004 over the prior year despite
expenses incurred in preparation of the opening of two new offices in January
2005. Non-interest expense increased 11.6% for the year 2003 over the prior year
when one new branch was opened and one branch was permanently relocated from
temporary quarters.


                                       13
<PAGE>


NET INTEREST INCOME

         Like most financial institutions, the primary component of earnings for
the bank is net interest income. Net interest income is the difference between
interest income, principally from loan and investment securities, and interest
expense, principally on customer deposits and borrowings. Changes in net
interest income result from changes in volume, spread and margin. For this
purpose, volume refers to the average dollar level of interest-earning assets
and interest-bearing liabilities, spread refers to the difference between the
average yield on interest-earning assets and the average cost of
interest-bearing liabilities, and margin refers to net interest income divided
by average interest-earning assets. Margin is influenced by the level and
relative mix of interest-earning assets and interest-bearing liabilities, as
well as by levels of non-interest-bearing liabilities and capital.

         Net interest income increased to $15.9 million in 2004, with a net
yield of 4.56%, compared to $13.0 million and a net yield of 4.33% in 2003,
which was an increase of $2.9 million or 23 basis points from 2003. Our level of
average interest-earning assets increased from $300.7 million for 2003 to $349.6
million for 2004. Although the average rate we earned on these assets dropped 8
basis points from 6.30% in 2003 to 6.22% in 2004, the average growth in volume
of earning assets, primarily loans, provided additional interest income of $3.4
million offsetting the $546,000 decrease due to decline in yields. Interest paid
on interest-bearing liabilities declined $111,000 for 2004 due to declines in
rates paid on interest-bearing funds. Our average interest-bearing liabilities,
primarily time deposits, grew 15.9% to $282.7 million for the year 2004
resulting in an increase in interest expense of $828,000. However, declines in
rates paid on interest-bearing funds provided a decrease in interest expense of
$939,000 primarily in time deposits where the average rates paid for time
deposits greater than $100,000 declined 56 basis points and other time deposits
declined 32 basis points. The growth in our non-interest-bearing demand deposits
of 22.9% also contributed to our increase in net interest income.

PROVISION FOR LOAN LOSSES AND ASSET QUALITY

         Our provision for loan losses was $1.6 million during 2004 and $1.4
million during 2003. Net charge-offs in 2004 were $971,000 compared to $803,000
in 2003. This increase resulted primarily from the growth in our loan portfolio
during the year. The allowance for loan losses is maintained at a level deemed
adequate to absorb probable losses inherent in the loan portfolio and results
from management's consideration of such factors as the financial condition of
borrowers, past and expected loss experience, current economic conditions, and
other factors management feels deserve recognition in establishing an
appropriate reserve. Although management attempts to maintain the allowance at a
level deemed adequate, future additions to the allowance may be necessary based
upon changes in market conditions or the status of the loans included in the
loan portfolio. In addition, various regulatory agencies periodically review our
allowance for loan losses. These agencies may require us to make adjustments
based upon their judgments about information available to them at the time of
their examination.

         Our non-performing assets, which consist of loans past due 90 days or
more, real estate acquired in the settlement of loans, and loans in nonaccrual
status, decreased from $1.8 million at December 31, 2003 to $1.6 million at
December 31, 2004. Our allowance for loan losses, expressed as a percentage of
gross loans, was 1.30% and 1.26% at December 31, 2004 and 2003, respectively. At
December 31, 2004, the allowance for loan losses amounted to $4.1 million, which
management believes is adequate to absorb losses inherent in its loan portfolio.

NON-INTEREST INCOME


         Non-interest income increased 10.9% from $3.5 million during 2003 to
$3.8 million in 2004. Our non-interest income is comprised primarily of service
charges on deposit accounts, insurance commissions, gain or loss on sale of
investment securities, gain on sale of loans, merchant fees, bank-owned life
insurance income and various other sources of miscellaneous operating income.
The $379,000 increase in non-interest income from 2003 to 2004 primarily
resulted from increases in service charges on deposits accounts of $74,000,
merchant fees of $23,000, other service charges of $389,000 as well as increases
in income from bank-owned life insurance of $235,000 all of which were in part
offset by declines in net gains from sales of securities and loans. Our net
gains on sales of loans declined $140,000 in 2004 compared to the previous year.
The decline in loan sales was attributable to a slow down in funding of
government-backed loans, which generated net gains of $212,000 during 2003.


NON-INTEREST EXPENSE

         Our non-interest expense increased from $10.6 million in 2003 to $11.5
million in 2004, an increase of $919,000. Approximately 48.9% of this increase
was due to increases in salaries and benefits. In addition to normal salary
increases and increased benefits costs, we opened two new offices in January
2005, incurring additional expense during the fourth quarter of 2004 in
preparation for these two new locations. Professional fees increased due to our
preparation for compliance with Section 404 of the Sarbanes-Oxley Act of 2002.



                                       14
<PAGE>

COMPARISON OF OPERATING RESULTS FOR THE YEARS ENDED DECEMBER 31, 2003 AND 2002

NET INCOME

         We earned net income of $2.9 million or $.87 basic net income per share
for 2003, as compared with net income of $2.9 million or $.88 basic net income
per share for 2002. We were able to maintain the level of our earnings despite
the challenges presented by the historically low rates during the year, which
fell to their lowest level in June 2003. We believe strategic pricing of both
our loans and deposits improved our net interest margin by lowering our overall
cost of funds and allowing us to attract the higher balance, higher quality
loans in our market. Cost containment initiatives that began in prior years
continue to positively impact our overhead levels. Despite opening one new
branch and permanently locating a branch opened in temporary quarters late in
2002, our non-interest expenses only increased 11.6% in 2003 as compared to
2002.

NET INTEREST INCOME

         Net interest income increased to $13.0 million in 2003, compared to the
$12.1 million earned in 2002, an increase of $876,000. During 2003, our level of
average interest-earning assets increased from $290.3 million in 2002 to $300.7
million, but the average rate we earned on those assets dropped 52 basis points
from 6.82% in 2002 to 6.30% in 2003. This decrease in the average rate we earned
on our assets more than offset the effect of the increase in our average
interest earning assets during the year and resulted in the decrease in our
interest income of $842,000 in 2003. This decrease in our interest income,
however, was negated by the decrease in our interest expense during 2003. While
our average interest-bearing liabilities increased from $236.7 million in 2002
to $244.0 million in 2003, it is important to note that 16.1% of the increase in
deposits occurred in our money market and interest-bearing demand deposit
accounts, which have rates significantly less than our other types of
interest-bearing liabilities. The average rate we paid for our interest-bearing
liabilities during the year dropped 80 basis points during 2003 from 3.23% in
2002 to 2.43% in 2003, resulting in a decrease of $1.7 million in our total
interest expense in 2003. We also grew noninterest-bearing demand deposit
accounts by 18.7% in 2003 compared to 2002.

PROVISION FOR LOAN LOSSES AND ASSET QUALITY

         Our provision for loan losses was $1.4 million during 2003 and $1.2
million in 2002. Loan charge-offs in 2003 and 2002 were $1.1 million and $1.2
million, respectively. This increase resulted primarily from the growth in our
loan portfolio during the year.

         Our non-performing assets decreased from $2.1 million at December 31,
2002 to $1.8 million at December 31, 2003. Our allowance for loan losses,
expressed as a percentage of gross loans, was 1.26% and 1.25% at December 31,
2003 and 2002, respectively. At December 31, 2003, the allowance for loan losses
amounted to $3.4 million, which management believes is adequate to absorb losses
inherent in its loan portfolio.

NON-INTEREST INCOME

         Non-interest income increased 23.5% from $2.8 million during 2002 to
$3.5 million in 2003. The $660,000 increase in non-interest income from 2002 to
2003 primarily resulted from increases in the net gains on sale of securities of
$281,000 and merchant fees of $115,000, as well as increases in income from
bank-owned life insurance of $159,000.

NON-INTEREST EXPENSE

         Our non-interest expense increased from $9.5 million in 2002 to $10.6
million in 2003, an increase of $1.1 million. Approximately 64.5% of this
increase was due to salaries and benefits expenses. We opened one new office in
June of 2003. Another office which opened in temporary quarters late in 2002,
relocated to their permanent location in January 2003. These new locations
contributed to the increase in salaries and benefits and to the increase in our
occupancy and equipment expenses during 2003.


                                       15
<PAGE>

LIQUIDITY AND CAPITAL RESOURCES

         Our liquidity position is primarily dependent upon the bank's need to
respond to loan demand, the short-term demand for funds caused by withdrawals
from deposit accounts (other than time deposits) and the liquidity of its
assets. The bank's primary liquidity sources include cash and amounts due from
other banks, federal funds sold, and U.S. Government Agency and other short-term
investment securities. In addition, the bank has the ability to borrow funds
from the Federal Reserve Bank and the Federal Home Loan Bank of Atlanta, to
purchase federal funds from other financial institutions and to obtain wholesale
deposits. Our management believes that our liquidity sources are adequate to
meet our operating needs and the operating needs of the bank for the next
eighteen months. Total shareholders' equity was $37.3 million or 9.4% of total
assets at December 31, 2004 and $32.9 million or 9.6% of total assets at
December 31, 2003.

INTEREST RATE SENSITIVITY ANALYSIS

         As a part of our interest rate risk management policy, we periodically
perform an interest rate sensitivity analysis. Interest rate sensitivity
analysis is a common, though imperfect, measure of interest rate risk, which
measures the relative dollar amounts of interest-earning assets and
interest-bearing liabilities that reprice within a specific time period, either
through maturity or rate adjustment. Any resulting interest rate "gap" is the
difference between the amounts of such assets and liabilities that are subject
to repricing. A positive gap for a given period means that the amount of
interest-earning assets maturing or otherwise repricing within that period
exceeds the amount of interest-bearing liabilities maturing or otherwise
repricing within the same period. Accordingly, in a declining interest rate
environment, an institution with a positive gap would generally be expected,
absent the effects of other factors, to experience a decrease in the yield on
its assets greater than the decrease in the cost of its liabilities, and its net
interest income should be negatively affected. Conversely, the yield on its
assets for an institution with a positive gap would generally be expected to
increase more quickly than the cost of funds in a rising interest rate
environment, and such institution's net interest income generally would be
expected to be positively affected by rising interest rates. Changes in interest
rates generally have the opposite effect on an institution with a negative gap.

         The table below sets forth the amounts of our interest-earning assets
and interest-bearing liabilities outstanding as of December 31, 2004 that are
projected to reprice or mature in each of the future time periods shown. Except
as stated below, the amounts of assets and liabilities shown which reprice or
mature within a particular period were determined in accordance with the
contractual terms of the assets or liabilities. Loans with adjustable rates are
shown as being due at the end of the next upcoming adjustment period. Money
market deposit accounts and negotiable order of withdrawal or other transaction
accounts are assumed to be subject to immediate repricing and depositor
availability and have been placed in the shortest period. In making the gap
computations, none of the traditional assumptions regarding prepayment rates and
deposit decay rates have been used for any interest-earning assets or
interest-bearing liabilities. In addition, the table does not reflect scheduled
principal payments that will be received throughout the lives of the loans or
investments. The interest rate sensitivity of our assets and liabilities
illustrated in the following table would vary substantially if different
assumptions were used or if actual experience differs from that indicated by
such assumptions. (Dollars in thousands).



                                       16
<PAGE>


<TABLE>
<CAPTION>
                                                              INTEREST RATE SENSITIVITY AS OF DECEMBER 31, 2004
                                                      ---------------------------------------------------------------
                                                                     OVER
                                                      3 MONTHS     3 MONTHS     TOTAL WITHIN   OVER 12
                                                       OR LESS   TO 12 MONTHS     12 MONTHS     MONTHS       TOTAL
                                                      ---------  -------------   -----------  ----------   ----------
INTEREST-EARNING ASSETS:
<S>                                                    <C>          <C>           <C>          <C>          <C>
      Loans                                            $227,741     $  9,456      $237,197     $ 75,618     $312,815
      Securities available for sale                        --            926           926       51,416       52,342
      Other earning assets                                3,615         --           3,615        2,621        6,236
                                                       --------     --------      --------     --------     --------
          Total interest-earning assets                $231,356     $ 10,382      $241,738     $129,655     $371,393
                                                       ========     ========      ========     ========     ========
      Percent of total interest-earning assets            62.74%        2.82%        65.55%       34.91%      100.00%
      Cumulative percent of total interest-
        earning assets                                    62.74%       65.55%        65.55%      100.00%      100.00%

INTEREST-BEARING LIABILITIES:
      Fixed maturity deposits                          $ 54,684     $ 66,256      $120,940     $ 64,472     $185,412
      All other deposits                                 70,367         --          70,367         --         70,367
      Borrowings                                           --           --            --         43,160       43,160
                                                       --------     --------      --------     --------     --------
          Total interest-bearing liabilities           $125,051     $ 66,256      $191,307     $107,632     $298,939
                                                       ========     ========      ========     ========     ========
      Percent of total interest-bearing liabilities       41.83%       22.16%        64.00%       36.00%      100.00%
      Cumulative percent of total interest-
        bearing liabilities                               41.83%       64.00%        64.00%      100.00%      100.00%


Interest sensitivity gap                               $106,305     $(55,874)     $ 50,431     $ 22,023     $ 72,454
Cumulative interest sensitivity gap                     106,305       50,431        50,431       72,454       72,454
Cumulative interest sensitivity gap as a
   percent of total interest-earning assets               28.83%       13.68%        13.68%       19.51%       19.51%
Cumulative ratio of interest-sensitive assets
   to interest-sensitive liabilities                     185.01%      126.36%       126.36%      124.24%      124.24%
</TABLE>




CONTRACTUAL OBLIGATIONS AND COMMITMENTS

         In the normal course of business there are various outstanding
contractual obligations that require future cash outflows. The following table
shows our expected contractual obligations and future operating lease
commitments as of December 31, 2004 (in thousands):


<TABLE>
<CAPTION>
                                                                 PAYMENTS DUE BY PERIOD
                                          -------------------------------------------------------------------------
                                                          LESS THAN                                     MORE THAN
                                             TOTAL          1 YEAR        1-3 YEARS      3-5 YEARS       5 YEARS
                                          ------------   ------------   ------------   -------------  -------------
<S>                                       <C>            <C>            <C>            <C>             <C>
Borrowings                                $     43,160   $          -   $     10,160   $           -   $     33,000
Operating leases                                   130             42             66              22              -
Deposits                                       185,412        120,940         33,453           5,017         26,002
Purchase obligations                               650            650              -               -              -
                                          ------------   ------------   ------------   -------------   ------------
     Total                                $    229,352   $    121,632   $     43,679   $       5,039   $     59,002
                                          ============   ============   ============   =============   ============
</TABLE>

         The following table shows our undisbursed lines of credit, other
commitments to extend, undisbursed portion of construction loans and stand-by
letters of credit as of December 31, 2004 (in thousands):

<TABLE>
<CAPTION>

                                                        AMOUNT OF COMMITMENT EXPIRATION PER PERIOD
                                          -------------------------------------------------------------------------
                                                          LESS THAN                                     MORE THAN
                                             TOTAL          1 YEAR        1-3 YEARS      3-5 YEARS       5 YEARS
                                          ------------   ------------   ------------   -------------  -------------
<S>                                       <C>            <C>            <C>            <C>             <C>
Undisbursed lines of credit               $     21,221   $         34   $      6,851   $         278   $     14,058
Other commitments to extend                     49,003         39,107          8,481             900            515
Undisbursed portion of construction loans       19,153         15,542          1,911           1,700              -
Stand-by letters of credit                       1,726            823            870              33              -
                                          ------------   ------------   ------------   -------------   ------------
      Total                               $     91,103   $     55,506   $     18,113   $       2,911   $     14,573
                                          ============   ============   ============   =============   ============
</TABLE>



                                       17
<PAGE>



INFLATION

         The effect of inflation on financial institutions differs somewhat from
the effect it has on other businesses. The performances of banks, with assets
and liabilities that are primarily monetary in nature, are affected more by
changes in interest rates than by inflation. Interest rates generally increase
as the rate of inflation increases, but the magnitude of the change in rates may
not be the same. During periods of high inflation, there are normally
corresponding increases in the money supply, and banks will normally experience
above average growth in assets, loans and deposits. Also, general increases in
the price of goods and services will generally result in increased operating
expenses.

INCOME TAXES

         Income taxes, as a percentage of income before income taxes, for 2004
and 2003 were 34.54% and 35.58%, respectively. The decrease was the result of
management's redirection of funds between loans and different types of taxable
and tax exempt interest-bearing assets in response to economic conditions and
the bank's liquidity requirements.

DISTRIBUTION OF ASSETS, LIABILITIES AND SHAREHOLDERS' EQUITY;
INTEREST RATES AND INTEREST DIFFERENTIAL

         The following schedule presents average balance sheet information for
the years 2004, 2003 and 2002, along with related interest earned and average
yields for interest-earning assets and the interest paid and average rates for
interest-bearing liabilities:

<TABLE>
<CAPTION>

                                              AVERAGE DAILY BALANCES, INTEREST INCOME/EXPENSE, AVERAGE YIELD/RATE


                                                                 FOR THE YEARS ENDED DECEMBER 31,
                                        -----------------------------------------------------------------------------------------
                                                  2004                          2003                             2002
                                        ------------------------   ------------------------------    ----------------------------
                                        AVERAGE          AVERAGE    AVERAGE               AVERAGE    AVERAGE              AVERAGE
                                        BALANCE  INTEREST  RATE     BALANCE    INTEREST    RATE      BALANCE   INTEREST   RATE
                                        -------- -------- ------   ---------   --------   --------   --------  ---------  -------
                                                                       (DOLLARS IN THOUSANDS)
Interest-earning assets:
<S>                                     <C>       <C>       <C>     <C>        <C>           <C>     <C>       <C>         <C>
  Loans                                 $298,783  $19,968   6.68%   $249,240   $17,318       6.95%   $216,620  $16,746     7.73%
  Investment securities - taxable         40,729    1,470   3.61%     40,691     1,272       3.13%     52,348    2,482     4.74%
  Investment securities - tax-exempt       4,278      162   3.79%      4,968       212       4.27%      4,716      213     4.52%
  Other                                    5,806      148   2.55%      5,773       141       2.44%     16,610      344     2.07%
                                        --------  -------           --------   -------               --------  -------

       Total interest-earning assets     349,596   21,748   6.22%    300,672    18,943       6.30%    290,294   19,785     6.82%
                                                  -------   ----               -------    -------              -------   ------
Other assets                              26,826                      23,550                          18,040
                                        --------                    --------                         --------
       Total assets                     $376,422                    $324,222                         $308,334
                                        ========                    ========                         ========
Interest-bearing liabilities:
  Deposits:
    NOW and money market                $ 52,677      361    .69%    $39,313       238        .61%   $ 32,431      302      .93%
    Savings                               13,967       59    .42%     12,659        63        .50%     11,427      124     1.09%
    Time deposits greater
       than $100,000                      94,313    1,978   2.10%     70,567     1,878       2.66%     70,543    2,541     3.60%
    Other time deposits                   78,987    1,725   2.18%     87,285     2,186       2.50%     89,100    3,136     3.52%
  Borrowings                              42,799    1,688   3.94%     34,200     1,557       4.55%     33,160    1,537     4.64%
                                        --------  -------           --------   -------               --------  -------
       Total interest-bearing
          liabilities                    282,743    5,811   2.06%    244,024     5,922       2.43%    236,661    7,640     3.23%
                                                  -------   ----               -------    -------              -------   ------
  Non-interest-bearing deposits           55,580                      45,214                           39,377
  Other liabilities                        2,964                       2,643                            2,365
  Shareholders' equity                    35,135                      32,341                           29,931
                                        --------                    --------                         --------
       Total liabilities and
          shareholders' equity          $376,422                    $324,222                         $308,334
                                        ========                    ========                         ========
Net interest income and
   interest rate spread                          $ 15,937   4.16%              $13,021       3.87%             $12,145     3.59%
                                                =========   ====               =======    =======              =======   ======
Net yield on average interest-
  earning assets                                            4.56%                            4.33%                         4.18%
                                                            ====                          =======                        ======
Ratio of average interest-earning
   assets to average interest-bearing
   liabilities                            123.64%                     123.21%                          122.66%
                                        ========                    ========                         ========
</TABLE>

                                       18
<PAGE>



         The following table shows changes in interest income and expense by
category and rate/volume variances for the years ended December 31, 2004 and
2003. The changes due to rate and volume were allocated on their absolute
values:


<TABLE>
<CAPTION>
                                                  YEAR ENDED                       YEAR ENDED
                                          DECEMBER 31, 2004 VS. 2003       DECEMBER 31, 2003 VS. 2002
                                        -----------------------------     ------------------------------
                                          INCREASE (DECREASE) DUE TO       INCREASE (DECREASE) DUE TO
                                        -----------------------------     ------------------------------
                                         VOLUME      RATE      TOTAL      VOLUME      RATE       TOTAL
                                        -------      ----     ------      ------      ----       -----
                                                                    (IN THOUSANDS)
Interest income:
<S>                                     <C>         <C>       <C>         <C>        <C>        <C>
  Loans                                 $ 3,377     $(727)    $ 2,650     $ 2,394    $(1,822)   $   572
  Investment securities - taxable             1       197         198        (459)      (751)    (1,210)
  Investment securities - tax-exempt        (28)      (22)        (50)         11        (12)        (1)
  Other                                       1         6           7        (245)        42       (203)
                                        -------     -----     -------     -------    -------    --------
      Total interest income               3,351      (546)      2,805       1,701     (2,543)      (842)
                                        -------     -----     -------     -------    -------    --------
Interest expense:
  Deposits:
    NOW and money market                     86        37         123          53       (117)       (64)
    Savings                                   6       (10)         (4)         10        (71)       (61)
    Time deposits greater
      than $100,000                         566      (466)        100           1       (664)      (663)
    Other time deposits                    (195)     (266)       (461)        (55)      (895)      (950)
  Borrowings                                365      (234)        131          48        (28)        20
                                        -------     -----     -------     -------    -------    --------
      Total interest expense                828      (939)       (111)         57     (1,775)    (1,718)
                                        -------     -----     -------     -------    -------    --------
      Net interest income increase
        (decrease)                      $ 2,523     $ 393     $ 2,916     $ 1,644    $  (768)   $    876
                                        =======     =====     =======     =======    =======    ========
</TABLE>


 Market Risk

         Like most  financial  institutions,  our most  significant  market risk
exposure is the risk of economic loss resulting  from adverse  changes in market
price and  interest  rates.  This risk of loss can be  reflected  in  diminished
current  market values and/or  reduced  potential net interest  income in future
periods.  Our market risk arises  primarily  from interest rate risk inherent in
our lending and deposit-taking activities. The structure of our loan and deposit
portfolios  is such that a significant  decline in interest  rates may adversely
impact net market values and net interest  income.  We do not maintain a trading
account nor are we subject to currency  exchange  risk or commodity  price risk.
Interest rate risk is monitored as part of the bank's asset/liability management
function.  The  following  table  presents  information  about  the  contractual
maturities,  average  interest  rates and estimated fair values of our financial
instruments  we  considered  market  risk  sensitive  as of December  31,  2004.
(Dollars in thousands).

<TABLE>
<CAPTION>
                                                                                                           AVERAGE
                                                                                      BEYOND               INTEREST ESTIMATED
                                   2005      2006      2007       2008      2009    FIVE YEARS    TOTAL      RATE   FAIR VALUE
                                ---------  --------  --------   --------  --------  ----------  ---------  -------- ----------
Financial assets:
      Loans:
<S>                             <C>        <C>       <C>        <C>       <C>        <C>        <C>         <C>    <C>
          Fixed rate            $  18,372  $ 10,396  $ 15,232   $ 20,398  $ 16,081   $ 13,511   $  93,990   7.35%  $  93,976
          Variable Rate           218,825         -         -          -         -          -     218,825   5.79%    218,792
      Securities available
          for sale                    926         -     5,963     10,973     5,840     28,640      52,342   3.89%     52,342
      Other earning assets          3,615         -         -          -         -          -       3,615   2.10%      3,615
                                ---------  --------  --------   --------  --------   --------   ---------          ---------
          Total                 $ 241,738  $ 10,396  $ 21,195   $ 31,371  $ 21,921   $ 42,151   $ 368,772   5.88%  $ 368,725
                                =========  ========  ========   ========  ========   ========   =========          =========

Financial liabilities:
      Money market, NOW and
          savings deposits      $  70,367         -         -          -         -          -   $  70,367   0.39%  $  63,959
      Time deposits               120,940  $ 13,490  $ 13,754   $  6,209  $ 20,019   $ 11,000     185,412   2.54%    186,314
      Borrowings                        -    10,160         -          -         -     33,000      43,160   3.87%     41,651
                                ---------  --------  --------   --------  --------   --------   ---------          ---------
          Total                 $ 191,307  $ 23,650  $ 13,754   $  6,209  $ 20,019   $ 44,000   $ 298,939   2.23%  $ 291,924
                                =========  ========  ========   ========  ========   ========   =========          =========
</TABLE>

                                       19
<PAGE>




 Derivative Financial Instruments

         A derivative is a financial instrument that derives its cash flows, and
therefore  its  value,  by  reference  to an  underlying  instrument,  index  or
reference  rate.  These  instruments  primarily  consist of interest rate swaps,
caps,  floors,  financial  forward and futures  contracts and options written or
purchased.  Derivative  contracts are written in amounts referred to as notional
amounts.  Notional  amounts  only  provide  the basis for  calculating  payments
between  counterparties  and do not  represent  amounts to be exchanged  between
parties  and are not a measure of  financial  risks.  Credit  risk  arises  when
amounts  receivable from a counterparty  exceed amounts payable.  We control our
risk of loss on  derivative  contracts by  subjecting  counterparties  to credit
reviews and approvals similar to those used in making loans and other extensions
of credit.

         We have used  interest  rate swaps in the  management  of interest rate
risk.  Interest  rate swaps are  contractual  agreements  between two parties to
exchange a series of cash flows representing  interest  payments.  A swap allows
both parties to alter the  repricing  characteristics  of assets or  liabilities
without affecting the underlying principal positions. Through the use of a swap,
assets and  liabilities may be transformed  from fixed to floating  rates,  from
floating rates to fixed rates, or from one type of floating rate to another.  At
December  31,  2004,  swap  derivatives  with a total  notional  value  of $51.0
million, with terms ranging up to six years, were outstanding.

         Although  off-balance  sheet  derivative  financial  instruments do not
expose us to credit risk equal to the notional amount,  such agreements generate
credit  risk to the  extent  of the  fair  value  gain in an  off-balance  sheet
derivative  financial  instrument  if the  counterparty  fails  to  perform.  We
minimize such risk by evaluating the  creditworthiness of the counterparties and
consistently   monitoring  these   agreements.   The   counterparties  to  these
arrangements are primarily large commercial  banks and investment  banks.  Where
appropriate, master netting agreements are arranged or collateral is obtained in
the form of rights to securities.  At December 31, 2004, our interest rate swaps
reflected a net unrealized loss of $213,000.

         Other risks associated with interest-sensitive  derivatives include the
effect on fixed rate  positions  during  periods  of  changing  interest  rates.
Indexed  amortizing  swaps'  notional  amounts and  maturities  change  based on
certain  interest rate indices.  Generally,  as rates fall the notional  amounts
decline  more  rapidly,  and as rates  increase  notional  amounts  decline more
slowly. As of December 31, 2004, we had no indexed amortizing swaps outstanding.
Under unusual circumstances, financial derivatives also increase liquidity risk,
which  could  result  from an  environment  of  rising  interest  rates in which
derivatives  produce  negative  cash flows while being offset by increased  cash
flows from variable rate loans. We consider such risk to be insignificant due to
the relatively small derivative positions we hold.

         A discussion of derivatives is presented in Note I to our  consolidated
financial statements, which are presented under Item 8 in this Form 10-K.


QUARTERLY FINANCIAL INFORMATION

         The following table, sets forth, for the periods indicated,  certain of
our consolidated  quarterly financial  information.  This information is derived
from our  unaudited  financial  statements,  which  include,  in the  opinion of
management,   all  normal  recurring   adjustments  which  management  considers
necessary  for a fair  presentation  of  the  results  for  such  periods.  This
information  should  be read in  conjunction  with  our  consolidated  financial
statements  included  elsewhere in this report.  The results for any quarter are
not  necessarily  indicative  of results  for any  future  period.  (Dollars  in
thousands, except per share data).



                                       20
<PAGE>

<TABLE>
<CAPTION>
                                                 YEAR ENDED DECEMBER 31, 2004            YEAR ENDED DECEMBER 31, 2003
                                           --------------------------------------   -------------------------------------
                                            FOURTH    THIRD      SECOND    FIRST    FOURTH     THIRD    SECOND     FIRST
                                           QUARTER    QUARTER   QUARTER   QUARTER   QUARTER   QUARTER   QUARTER   QUARTER
                                           --------  --------   --------  -------   -------   -------   -------   -------
OPERATING DATA:
<S>                                          <C>       <C>       <C>       <C>       <C>       <C>       <C>       <C>
      Total interest income                  $5,856    $5,609    $5,215    $5,068    $4,954    $4,685    $4,690    $4,614
      Total interest expense                  1,567     1,505     1,401     1,338     1,345     1,411     1,511     1,655
                                           --------  --------   --------  -------   -------   -------   -------   -------
      Net interest income                     4,289     4,104     3,814     3,730     3,609     3,274     3,179     2,959
      Provision for loan losses                 205       401       422       568       322       285       423       343
                                           --------  --------   --------  -------   -------   -------   -------   -------
      Net interest income after provision     4,084     3,703     3,392     3,162     3,287     2,989     2,756     2,616
      Non-interest income                       938     1,071       982       858       798       951       860       861
      Non-interest expense                    3,068     2,789     2,860     2,790     2,628     2,661     2,753     2,546
                                           --------  --------   --------  -------   -------   -------   -------   -------
         Income before income taxes           1,954     1,985     1,514     1,230     1,457     1,279       863       931
      Provision for income taxes                691       654       532       431       547       517       245       303
                                           --------  --------   --------  -------   -------   -------   -------   -------
      Net income                             $1,263    $1,331    $  982    $  799    $  910    $  762    $  618    $  628
                                           ========  ========   ========  =======   =======   =======   =======   =======
PER SHARE DATA:
  Net income:
      Basic                                  $ 0.37    $ 0.39    $ 0.29    $ 0.24    $ 0.27    $ 0.23    $ 0.18    $ 0.19
      Diluted                                  0.37      0.39      0.28      0.24    $ 0.27    $ 0.22    $ 0.18    $ 0.19

  Cash dividends declared                      0.08      0.08      0.08      0.08      0.08      0.07      0.07      0.07

  Common stock price:
      High                                   $25.00    $18.40    $19.60    $20.80    $20.80    $14.72    $15.36    $15.04
      Low                                     18.60     17.60     17.60     16.80     14.40     14.08     14.43     14.11
</TABLE>



INVESTMENT PORTFOLIO

         The valuations of investment securities at December 31, 2004, 2003 and
2002, respectively, were as follows (in thousands):

<TABLE>
<CAPTION>

                                                                  AVAILABLE FOR SALE
                                    --------------------------------------------------------------------------------
                                              2004                       2003                       2002
                                    ------------------------   -------------------------  --------------------------
                                      AMORTIZED    ESTIMATED    AMORTIZED     ESTIMATED    AMORTIZED     ESTIMATED
                                        COST      FAIR VALUE       COST       FAIR VALUE     COST        FAIR VALUE
                                    -----------   ----------   -----------   -----------  -----------   ------------
<S>                                 <C>           <C>          <C>           <C>          <C>           <C>
U.S. Government and agency
  securities                        $    34,991   $   34,958   $    15,866   $    15,914  $    27,147   $     27,361
State and municipal securities            3,573        3,632         4,664         4,955        4,616          4,860
Mortgage-backed securities               12,759       12,775        16,535        16,502       23,671         23,933
Other                                       628          977           567           832          552            635
                                    -----------   ----------   -----------   -----------  -----------   ------------
Total securities                    $    51,951   $   52,342   $    37,632   $    38,203  $    55,986   $     56,789
                                    ===========   ==========   ===========   ===========  ===========   ============
Pledged securities                                $   33,408                 $    12,329                $     15,339
                                                  ==========                 ===========                ============
</TABLE>


         The following  table sets forth the carrying value of our available for
sale investment portfolio at December 31, 2004 (in thousands):


<TABLE>
<CAPTION>
                                                                     CARRYING VALUE
                                         -----------------------------------------------------------------------
                                                         AFTER 1 YEAR   AFTER 5 YEARS
                                                           THROUGH        THROUGH          AFTER
                                           1 YEAR          5 YEARS       10 YEARS        10 YEARS       TOTAL
                                         ---------      ------------   ---------------  -----------    ---------
<S>                                      <C>             <C>            <C>              <C>            <C>
U.S. Government and Agency
  securities                             $       -       $ 20,251       $ 14,707         $     -        $34,958
State and municipal securities                   -            134          2,390           1,108          3,632
Mortgage-backed securities                       -          2,388          7,968           2,419         12,775
Other                                            -              -              -             977            977
                                         ---------       --------       --------         -------        -------
Total                                    $       -       $ 22,773       $ 25,065         $ 4,504        $52,342
                                         =========       ========       ========         =======        =======

</TABLE>



                                       21
<PAGE>







         The following table sets forth the weighted average yield by maturity
of our available for sale investment portfolio at December 31, 2004:




<TABLE>
<CAPTION>
                                                                 WEIGHTED AVERAGE YIELDS
                                         -----------------------------------------------------------------------
                                                         AFTER 1 YEAR   AFTER 5 YEARS
                                                           THROUGH        THROUGH          AFTER
                                           1 YEAR          5 YEARS       10 YEARS        10 YEARS       TOTAL
                                         ---------      ------------   ---------------  -----------    ---------
<S>                                      <C>             <C>            <C>              <C>            <C>
U.S. Government and agency
   securities                                    -           3.66%           3.90%                -        3.76%
State and municipal securities                   -           4.76%           3.65%             3.94%       3.78%
Mortgage-backed securities                       -           3.51%           3.76%             4.57%       3.87%
Other                                            -              -               -              3.48%       3.48%
                                         ---------       --------      ---------------  -----------    ---------
Total weighted average yields                    -           3.65%           3.83%             4.18%       3.78%
                                         =========       ========      ===============  ===========    =========
</TABLE>


LOAN PORTFOLIO

         Loans consisted of the following, as extracted from the Call Reports of
December 31, 2004, 2003, 2002, 2001 and 2000 (in thousands):



<TABLE>
<CAPTION>
                                                 2004           2003         2002          2001          2000
                                              ---------     ---------     ---------       -------       -------
<S>                                           <C>           <C>           <C>             <C>           <C>
Loans receivable:
 Loans secured by real estate:
   Construction and land development          $  90,742     $  66,242     $  56,780       $44,770       $35,751
   Secured by farmland                           15,203        13,384         8,290         7,171         7,576
   Secured by 1-4 family residential
     properties:
      Revolving open-end loans & lines
       of credit                                 23,295        18,879        16,569        14,603        12,394
       All other                                 58,158        55,113        43,821        48,190        48,589
   Secured by multifamily residential
     properties                                   5,088         3,634         3,265         2,621         1,170
   Secured by nonfarm nonresidential
     properties                                  72,611        63,372        42,941        38,446        31,300
Loans to finance agricultural production
   and other loans to farmers                     4,020         5,084         6,277         6,329         5,954
Commercial and industrial loans                  26,005        27,872        29,908        26,420        30,344
Loans to individuals for household,
   family and other personal expenditures:
     Credit cards and related plans               3,807         3,574         3,527         2,917         2,354
     Other                                       13,400        14,458        17,177        17,169        18,120
Obligations of states and political
   subdivisions in the U.S.:
     Tax exempt obligations                         225           332            --           202           280
All other loans                                     628           836           921           953           712
Lease financing receivables                          12            13            14            20            33
Deferred cost (unearned income) on loans            379           170           (80)          (11)           80
                                              ---------     ---------     ---------    ----------     ---------
Total loans                                     312,815       272,623       229,570       209,822       194,497
Allowance for loan losses                        (4,055)       (3,430)       (2,860)       (2,650)       (2,770)
                                              ---------     ---------     ---------    ----------     ---------
   Net loans                                  $ 308,760     $ 269,193     $ 226,710      $207,172     $ 191,727
                                              =========     =========     =========    ==========     =========
Commitments and contingencies:
Commitments to make loans                     $  89,377     $  68,731     $  44,525     $  45,510     $  35,810

Standby letters of credit                     $   1,726     $   1,003     $   2,408     $     653     $   1,473
</TABLE>

                                       22
<PAGE>



CERTAIN LOAN MATURITIES

         The maturities and carrying amounts of certain loans as of December 31,
2004 are summarized as follows (in thousands):

                                                       REAL ESTATE
                                          COMMERCIAL   CONSTRUCTION
                                        FINANCIAL AND    AND LAND
                                         AGRICULTURAL   DEVELOPMENT   TOTAL
                                        -------------- ------------- ---------
Due within one year                      $ 30,424       $67,898       $98,322

Due after one year to five years:
   Fixed rate                              19,570         4,938        24,508
   Variable rate                           60,521        12,497        73,018

Due after five years:
   Fixed rate                                 771           370         1,141
   Variable rate                            6,156         5,039        11,195
                                         --------       -------      --------
Total                                    $117,442       $90,742      $208,184
                                         ========       =======      ========


RISK ELEMENTS

         Past due and nonaccrual loans, as extracted from the Call Reports of
December 31, 2004, 2003, 2002, 2001 and 2000 were as follows (in thousands):


<TABLE>
<CAPTION>
                                                2004           2003           2002            2001           2000
                                               ------         ------         ------         ------         ------
Nonaccrual loans:
<S>                                            <C>            <C>            <C>            <C>            <C>
   Real estate loans                           $  614         $  739         $1,059         $1,651         $1,150
   Installment loans                               80             96            191             62            445
   Commercial and all other loans                 250            224            287            331             59
                                               ------         ------         ------         ------         ------
     Total                                     $  944         $1,059         $1,537         $2,044         $1,654
                                               ======         ======         ======         ======         ======
 Agricultural loans included above             $  197         $  110         $  163         $   82         $   10
                                               ======         ======         ======         ======         ======
Past due 90 days or more and
  still accruing:
   Real estate loans                           $  188         $  597         $ --           $   24         $  367
   Installment loans                                1              5             36             19             21
   Credit cards and related plans                  11             18             17              9             22
   Commercial and all other loans                  26             15             30             65           --
                                               ------         ------         ------         ------         ------
     Total                                     $  226         $  635         $   83         $  117         $  410
                                               ======         ======         ======         ======         ======
Agricultural loans included above              $   26         $ --           $   17         $   65         $ --
                                               ======         ======         ======         ======         ======
</TABLE>


         Foreclosed assets (included in other assets) were $404,000, $75,000,
$442,000, $170,000, and $85,000 at December 31, 2004, 2003, 2002, 2001 and 2000,
respectively.


Allowance for Loan Losses and Summary of Loan Loss Experience

         As a matter of policy, the bank maintains an allowance for loan losses.
The allowance for loan losses is created by direct charges to income, and losses
on loans are charged against the allowance when realized. The amount of the
allowance is based on management's evaluation of the portfolio, the financial
condition of borrowers, current economic conditions, past and expected loan loss
experience, and other factors management deems appropriate. The bank's
management believes its allowance for loan losses is adequate under existing
economic conditions to absorb loan losses inherent in its loan portfolio.

                                       23
<PAGE>


         The following table summarizes the bank's loan loss experience for the
years ending December 31, 2004, 2003, 2002, 2001 and 2000 (in thousands, except
ratios):


<TABLE>
<CAPTION>
                                            2004          2003            2002           2001           2000
                                          -------        -------         ------         -------        ------
<S>                                        <C>            <C>            <C>            <C>            <C>
Balance at beginning of period             $3,430         $2,860         $2,650         $2,770         $2,350

Charge-offs:
   Commercial and other                       417            311            604            668            192
   Real estate                                395            342            240            174             39
   Installment loans to individuals           237            396            283            176            240
   Credit cards and related plans             297             88             72             60             75
                                          -------        -------         ------         -------        ------
                                            1,346          1,137          1,199          1,078            546
                                          -------        -------         ------         -------        ------
Recoveries:
   Commercial and other                       206             31             74             38             32
   Real estate                                 27            134             13             24             12
   Installment loans                           56            159             62             53             97
   Credit cards and related plans              86             10             12              9             17
                                          -------        -------         ------         -------        ------
                                              375            334            161            124            158
                                          -------        -------         ------         -------        ------
Net charge-offs                               971            803          1,038            954            388
                                          -------        -------         ------         -------        ------
Additions charged to operations             1,596          1,373          1,248            834            808
                                          -------        -------         ------         -------        ------
Balance at end of year                     $4,055         $3,430         $2,860         $2,650         $2,770
                                          =======        =======         ======         =======        ======
Ratio of net charge-offs during
   the year to average gross loans
     outstanding during the year              .32%           .32%           .48%           .47%           .21%
</TABLE>

         The following table summarizes the bank's allocation of allowance for
loan losses for the years ending December 31, 2004, 2003, 2002, 2001 and 2000
(in thousands, except ratios):

<TABLE>
<CAPTION>
                                                                      AT DECEMBER 31,
                                         ---------------------------------------------------------------------------
                                                  2004                      2003                     2002
                                         -----------------------  -------------------------- -----------------------
                                                     % OF TOTAL                % OF TOTAL             % OF TOTAL
                                           AMOUNT      LOANS (1)     AMOUNT      LOANS (1)   AMOUNT    LOANS (1)
                                         ----------  -----------  -----------  -----------  ---------- -------------
<S>                                      <C>          <C>         <C>          <C>          <C>        <C>
Real estate loans                        $    3,432          84%  $     2,773         81%   $    2,139          75%
Commercial and industrial loans                 389          10%          415         12%          451          16%
Installment loans                               223           6%          227          7%          258           9%
Unallocated                                      11           -%           15          -%           12           -%
                                         ----------  -----------  -----------   ---------   ----------  ------------
              Total                      $    4,055         100%  $     3,430        100%   $    2,860         100%
                                         ==========  ===========  ===========   =========   ==========  ============
</TABLE>


<TABLE>
<CAPTION>
                                                                       AT DECEMBER 31,
                                                      ------------------------------------------------
                                                               2001                     2000
                                                      -----------------------  -----------------------
                                                                  % OF TOTAL                % OF TOTAL
                                                        AMOUNT     LOANS (1)     AMOUNT      LOANS (1)
                                                      ----------  ----------   ----------   ----------
<S>                                                   <C>         <C>          <C>         <C>
 Real estate loans                                    $    1,967          74%  $    1,946          70%
 Commercial and industrial loans                             414          16%         517          19%
 Installment loans                                           254          10%         292          11%
 Unallocated                                                  15           -%          15           -%
                                                      ----------  -----------  ----------   ----------
                 Total                                $    2,650         100%  $    2,770         100%
                                                      ==========  ===========  ==========   ==========
--------------------------------------------
(1) Represents total of all outstanding loans in each category as a percentage
of total loans outstanding.
</TABLE>


                                       24
<PAGE>

DEPOSITS

         Time certificates in amounts of $100,000 or more outstanding at
December 31, 2004 by maturity were as follows (in thousands):

 Three months or less                               $ 36,122
 Over three months through twelve months              28,076
 Over twelve months through three years               16,765
 Over three years                                     27,692
                                                    --------
         Total                                      $108,655
                                                    ========

BORROWINGS

         The bank borrows funds principally from the Federal Home Loan Bank of
Atlanta. Information regarding such borrowings is as follows (in thousands,
except rates):

<TABLE>
<CAPTION>
                                                               2004            2003             2002
                                                          ------------     ------------     -------------
<S>                              <C>                      <C>              <C>              <C>
 Balance outstanding at December 31                       $     43,160     $     33,160     $      33,160
 Weighted average rate at December 31                             3.86%            4.58%             4.60%
 Maximum borrowings during the year                       $     43,160     $     35,760     $      33,160
 Average amounts outstanding during year                  $     42,799     $     34,200     $      33,160
 Weighted average rate during year                                3.94%            4.55%             4.64%
</TABLE>


CRITICAL ACCOUNTING ESTIMATES AND POLICIES

         We prepare our consolidated financial statements in conformity with
accounting principles generally accepted in the United States of America. The
preparation of these financial statements requires us 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 amount of revenues and expenses during the
reporting period. Actual results could differ from those estimates.

         Critical accounting estimates and policies are those we believe are
both most important to the portrayal of our financial condition and results, and
require our most difficult, subjective or complex judgments, often as a result
of the need to make estimates about the effect of matters that are inherently
uncertain. Judgments and uncertainties affecting the application of those
policies may result in materially different amounts being reported under
different conditions or using different assumptions. We believe that the
allowance for loan losses represents a particularly sensitive accounting
estimate. The amount of the allowance is based on management's evaluation of the
collectibility of the loan portfolio, including the maturity of the loan
portfolio, credit concentration, trends in historical loss experience, specific
impaired loans and general economic conditions. See Note A to the consolidated
financial statements for a comprehensive discussion of our accounting policy for
the allowance for loan losses.

NEW ACCOUNTING STANDARDS

         In December 2004, the FASB issued SFAS 123 (revised 2004), Share-Based
Payment, ("SFAS No. 123(R)"), which is a revision of SFAS No. 123, Accounting
for Stock-Based Compensation. SFAS No. 123(R) supersedes Accounting Principles
Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees ("APB 25"),
and amends SFAS No. 95 Statement of Cash Flows. SFAS No. 123(R) establishes
standards for the accounting for transactions in which an entity exchanges its
equity instruments for goods or services. This Statement focuses primarily on
accounting for transactions in which an entity obtains employee services in
share-based payment transactions. SFAS No. 123(R) requires that the fair value
of such equity instruments be recognized as an expense in the historical
financial statements as services are performed. Prior to SFAS No. 123(R), only
certain pro forma disclosures of fair value were required. The provisions of
this Statement are effective for the first interim reporting period that begins
after June 15, 2005. Accordingly, we will adopt SFAS No. 123(R) commencing with
the quarter ending September 30, 2005. If we had included the cost of employee
stock option compensation in our consolidated financial statements, our net
income for the fiscal years ended December 31, 2004, 2003 and 2002 would have
decreased by approximately $64,000, $68,000, and $52,000, respectively.
Accordingly, the adoption of SFAS No. 123(R) is not expected to have a material
effect on our consolidated financial statements.


                                       25
<PAGE>

Item 7A - Quantitative and Qualitative Disclosures About Market Risk.

         This information is included under Item 7 of this report under the
captions "Interest Rate Sensitivity," "Market Risk," and "Derivative Financial
Instruments."

Item 8 - Financial Statements.


                                       26
<PAGE>


                                     [LOGO]
                                DIXON HUGHES PLLC
                   CERTIFIED PUBLIC ACCOUNTANTS AND ADVISORS

             REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM



The Board of Directors and Shareholders
Four Oaks Fincorp, Inc.
Four Oaks, North Carolina


We have audited the accompanying consolidated balance sheets of Four Oaks
Fincorp, Inc. and Subsidiaries as of December 31, 2004 and 2003 and the related
consolidated statements of operations, comprehensive income, shareholders'
equity and cash flows for each of the years in the three-year period ended
December 31, 2004. These consolidated financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these consolidated financial statements based on our audits.

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

In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Four Oaks Fincorp,
Inc. and Subsidiaries as of December 31, 2004 and 2003, and the results of their
operations and their cash flows for each of the years in the three-year period
ended December 31, 2004 in conformity with accounting principles generally
accepted in the United States of America.

/s/ Dixon Hughes PLLC

Sanford, North Carolina
March 18, 2005





                                       27
<PAGE>


<TABLE>
<CAPTION>
FOUR OAKS FINCORP, INC.
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 2004 AND 2003
----------------------------------------------------------------------------------------------------
                                                                    2004                  2003
                                                          -----------------------  -------------------
                                                          (AMOUNTS IN THOUSANDS EXCEPT PER SHARE DATA)
ASSETS
<S>                                                               <C>                  <C>
Cash and due from banks                                           $  10,634            $  10,548
Interest-earning deposits                                             3,615                5,277
Investment securities available for sale                             52,342               38,203

Loans                                                               312,815              272,623
Allowance for loan losses                                            (4,055)              (3,430)
                                                                  ---------            ---------
   Net loans                                                        308,760              269,193

Accrued interest receivable                                           2,210                1,893
Bank premises and equipment, net                                     10,149               10,582
FHLB stock                                                            2,621                1,923
Investment in life insurance                                          6,054                2,896
Other assets                                                          2,115                1,206
                                                                  ---------            ---------
            Total assets                                          $ 398,500            $ 341,721
                                                                  =========            =========
LIABILITIES AND SHAREHOLDERS' EQUITY

Deposits:
   Non-interest-bearing demand                                    $  59,528            $  50,829
   Money market and NOW accounts                                     55,467               43,927
   Savings                                                           14,900               13,038
   Time deposits, $100,000 and over                                 108,655               85,100
   Other time deposits                                               76,757               80,024
                                                                  ---------            ---------
            Total deposits                                          315,307              272,918

Borrowings                                                           43,160               33,160
Accrued interest payable                                              1,201                1,284
Other liabilities                                                     1,537                1,479
                                                                  ---------            ---------
            Total liabilities                                       361,205              308,841
                                                                  ---------            ---------
Shareholders' equity:
   Common stock; $1.00 par value, 10,000,000
     shares authorized; 3,438,107 and  2,676,263 shares issued
     and outstanding at December 31, 2004 and 2003, respectively      3,438                2,676
   Additional paid-in capital                                         8,788                8,029
   Retained earnings                                                 25,091               21,867
   Accumulated other comprehensive income (loss)                        (22)                 308
                                                                  ---------            ---------
            Total shareholders' equity                               37,295               32,880
                                                                  ---------            ---------
            Total liabilities and shareholders' equity            $ 398,500            $ 341,721
                                                                  =========            =========
</TABLE>


--------------------------------------------------------------------------------
The  accompanying  notes are an integral  part of these  consolidated  financial
statements

                                       28
<PAGE>

<TABLE>
<CAPTION>
FOUR OAKS FINCORP, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002
--------------------------------------------------------------------------------------------------------------
                                                                 2004               2003              2002
                                                              (AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
Interest and dividend income:
<S>                                                            <C>                <C>                <C>
  Loans, including fees                                        $ 19,968           $ 17,318           $ 16,746
  Investment securities:
     Taxable                                                      1,470              1,272              2,482
     Tax-exempt                                                     162                212                213
  Dividends                                                         109                 88                114
  Interest-earning deposits                                          39                 53                230
                                                               --------           --------           --------
              Total interest and dividend income                 21,748             18,943             19,785
                                                               --------           --------           --------
Interest expense:
  Deposits                                                        4,123              4,365              6,103
  Borrowings                                                      1,688              1,557              1,537
                                                               --------           --------           --------
              Total interest expense                              5,811              5,922              7,640
                                                               --------           --------           --------
              Net interest income                                15,937             13,021             12,145

Provision for loan losses                                         1,596              1,373              1,248
                                                               --------           --------           --------
Net interest income after provision for loan losses              14,341             11,648             10,897
                                                               --------           --------           --------
Non-interest income:
  Service charges on deposit accounts                             1,941              1,867              1,827
  Other service charges, commissions and fees                     1,024                635                618
  Gains (loss) on sale of investment securities                      71                273                 (8)
  Gains on sale of loans                                             72                212                175
  Merchant fees                                                     347                324                198
  Income from investment in bank-owned life insurance               394                159               --
                                                               --------           --------           --------
              Total non-interest income                           3,849              3,470              2,810
                                                               --------           --------           --------
Non-interest expenses:
  Salaries                                                        5,354              4,934              4,320
  Employee benefits                                               1,037              1,008                910
  Occupancy expenses                                                508                493                397
  Equipment expenses                                              1,223              1,124                983
  Professional and consulting fees                                  747                664                730
  Other taxes and licenses                                          251                251                164
  Merchant processing expenses                                      304                277                192
  Other operating expenses                                        2,083              1,837              1,789
                                                               --------           --------           --------
              Total non-interest expenses                        11,507             10,588              9,485
                                                               --------           --------           --------
Income before income taxes                                        6,683              4,530              4,222

Provision for income taxes                                        2,308              1,612              1,306
                                                               --------           --------           --------
              Net income                                       $  4,375           $  2,918           $  2,916
                                                               ========           ========           ========
Basic net income per common share                              $   1.29           $    .87           $    .88
                                                               ========           ========           ========
Diluted net income per common share                            $   1.28           $    .86           $    .87
                                                               ========           ========           ========
</TABLE>



--------------------------------------------------------------------------------
The  accompanying  notes are an integral  part of these  consolidated  financial
statements


                                       29
<PAGE>


<TABLE>
<CAPTION>

FOUR OAKS FINCORP, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
FOR THE YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002
-------------------------------------------------------------------------------------
                                                         2004     2003       2002
                                                      --------  --------   --------
                                                          (AMOUNTS IN THOUSANDS)
<S>                                                    <C>       <C>       <C>
Net income                                             $ 4,375   $ 2,918   $ 2,916
                                                       -------   -------   -------
Other comprehensive income:
  Securities available for sale:
    Unrealized holding gains (losses) on
       available for sale securities                      (109)       40       699
          Tax effect                                        44       (17)     (280)
     Reclassification of (gains) losses recognized in      (71)     (273)        8
        net income
           Tax effect                                       28       109        (3)
                                                       -------   -------   -------
     Net of tax amount                                    (108)     (141)      424
                                                       -------   -------   -------
  Cash flow hedging activities:
    Unrealized holding losses on cash flow
       hedging activities                                 (370)      (56)     --
          Tax effect                                       148        22      --
                                                       -------   -------   -------
     Net of tax amount                                    (222)      (34)     --
                                                       -------   -------   -------
        Total other comprehensive income (loss)           (330)     (175)      424
                                                       -------   -------   -------
Comprehensive income                                   $ 4,045   $ 2,743   $ 3,340
                                                       =======   =======   =======
</TABLE>



--------------------------------------------------------------------------------
The  accompanying  notes are an integral  part of these  consolidated  financial
statements

                                       30
<PAGE>

<TABLE>
<CAPTION>

FOUR OAKS FINCORP, INC.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002
--------------------------------------------------------------------------------------------------------------------

                                                                                        ACCUMULATED
                                           COMMON STOCK        ADDITIONAL                   OTHER        TOTAL
                                           ------------         PAID-IN      RETAINED   COMPREHENSIVE  SHAREHOLDERS'
                                        SHARES      AMOUNT      CAPITAL      EARNINGS   INCOME (LOSS)    EQUITY
                                     -----------  ----------   ----------   ----------  -------------- -------------
                                                       (AMOUNTS IN THOUSANDS, EXCEPT SHARE DATA)
<S>                                   <C>         <C>          <C>          <C>          <C>          <C>
BALANCE, DECEMBER 31, 2001            2,106,477   $    2,106   $    6,706   $   19,154   $       59   $   28,025

   Net income                              --           --           --          2,916         --          2,916

   Other comprehensive income              --           --           --           --            424          424

   Issuance of common stock              54,655           55          957         --           --          1,012

     Current income tax benefit            --           --             53         --           --             53

   Purchases and retirement
     of common stock                    (16,921)         (17)        --           (368)        --           (385)

   Cash dividends of $.26 per share        --           --           --           (852)        --           (852)
                                      ---------   ----------   ----------   ----------   ----------   ----------

BALANCE, DECEMBER 31, 2002            2,144,211        2,144        7,716       20,850          483       31,193

   Net income                              --           --           --          2,918         --          2,918

   Other comprehensive loss                --           --           --           --           (175)        (175)

   Effect of 5-for-4 stock split        533,706          534         (542)        --           --             (8)

   Issuance of common stock              42,014           42          837         --           --            879

     Current income tax benefit            --           --             18         --           --             18

   Purchases and retirement
     of common stock                    (43,668)         (44)        --           (949)        --           (993)

   Cash dividends of $.29 per share        --           --           --           (952)        --           (952)
                                      ---------   ----------   ----------   ----------   ----------   ----------
BALANCE, DECEMBER 31, 2003            2,676,263        2,676        8,029       21,867          308       32,880

   Net income                              --           --           --          4,375         --          4,375

   Other comprehensive loss                --           --           --           --           (330)        (330)

   Effect of 5-for-4 stock split        682,474          683         (683)        --           --             --

   Issuance of common stock              82,170           82        1,348         --           --          1,430

     Current income tax benefit            --           --             94         --           --             94

   Purchases and retirement
     of common stock                     (2,800)          (3)        --            (62)        --            (65)

   Cash dividends of $.32 per share        --           --           --         (1,089)        --         (1,089)
                                      ---------   ----------   ----------   ----------   ----------   ----------
BALANCE, DECEMBER 31, 2004            3,438,107   $    3,438   $    8,788   $   25,091   $      (22)  $   37,295
                                      =========   ==========   ==========   ==========   ==========   ==========
</TABLE>


--------------------------------------------------------------------------------
The  accompanying  notes are an integral  part of these  consolidated  financial
statements

                                       31
<PAGE>


<TABLE>
<CAPTION>

FOUR OAKS FINCORP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002
-------------------------------------------------------------------------------------------------
                                                                2004         2003        2002
                                                              ---------   ---------   -----------
                                                                    (AMOUNTS IN THOUSANDS)
Cash flows from operating activities:
<S>                                                           <C>         <C>         <C>
   Net income                                                 $   4,375   $   2,918   $   2,916
   Adjustments to reconcile net income to net cash
     provided by operations:
        Provision for loan losses                                 1,596       1,373       1,248
        Provision for depreciation and amortization               1,008         946         824
        Deferred income tax expense (benefit)                      (188)       (129)         32
        Net amortization of bond premiums and discounts             109         595         290
        Gain on sale of loans                                       (72)       (212)       (175)
        (Gain) loss on sale of investment securities                (71)       (273)          8
        Loss on sale of foreclosed assets                            25          15          26
        (Gain) loss on disposition of premises and equipment          7        --            (5)
        Increase in cash surrender value of life insurance         (394)       (159)       --
   Changes in assets and liabilities:
         Other assets                                               545        (130)        349
         Loans held for sale                                       --          --         1,483
         Interest receivable                                       (317)       (122)        339
         Other liabilities                                           52        (155)      1,357
         Interest payable                                           (83)       (501)       (946)
                                                              ---------   ---------   ---------
           Net cash provided by operating activities              6,592       4,166       7,746
                                                              ---------   ---------   ---------
Cash flows from investing activities:
   Proceeds from sales and calls of investment
     securities available for sale                               41,422      44,835     100,678
   Proceeds from maturities of investment
     securities available for sale                                 --        10,516       2,739
   Purchase of investment securities available for sale         (55,779)    (37,320)    (97,595)
   Purchase of FHLB stock                                          (698)       (273)       --
   Net increase in loans                                        (42,305)    (43,811)    (22,679)
   Additions to premises and equipment                             (568)       (848)     (1,867)
   Purchases of bank-owned life insurance                        (3,552)     (2,896)       --
   Proceeds from sale of foreclosed assets                          860         521         302
   Expenditures on foreclosed assets                                 --          (2)        (15)
                                                              ---------   ---------   ---------
           Net cash used by investing activities                (60,620)    (29,278)    (18,437)
                                                              ---------   ---------   ---------
Cash flows from financing activities:
   Net proceeds from borrowings                                  10,000        --           (13)
   Net increase in deposit accounts                              42,176      22,345      14,877
   Proceeds from issuance of common stock                         1,430         879       1,012
   Purchases and retirement of common stock                         (65)       (993)       (385)
   Cash dividends paid                                           (1,089)       (960)       (852)
                                                              ---------   ---------   ---------
           Net cash provided by financing activities             52,452      21,271      14,639
                                                              ---------   ---------   ---------
     Net increase (decrease) in cash and cash equivalents        (1,576)     (3,841)      3,948

Cash and cash equivalents at beginning of year                   15,825      19,666      15,718
                                                              ---------   ---------   ---------
Cash and cash equivalents at end of year                      $  14,249   $  15,825   $  19,666
                                                              =========   =========   =========
</TABLE>

--------------------------------------------------------------------------------
The  accompanying  notes are an integral  part of these  consolidated  financial
statements


                                       32
<PAGE>


FOUR OAKS FINCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2004 AND 2003
--------------------------------------------------------------------------------
NOTE A - ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation

The consolidated  financial  statements include the accounts and transactions of
Four Oaks Fincorp,  Inc. (the  "Company"),  a bank holding company  incorporated
under  the  laws  of  the  State  of  North  Carolina,   and  its  wholly  owned
subsidiaries,  Four Oaks Bank & Trust  Company,  Inc. (the "Bank") and Four Oaks
Mortgage  Services,  LLC, the Company's  mortgage  origination  subsidiary.  All
significant intercompany transactions have been eliminated.

NATURE OF OPERATIONS

The Company was  incorporated  under the laws of the State of North  Carolina on
February  5, 1997.  The  Company's  primary  function is to serve as the holding
company for its wholly owned subsidiary, the Bank. The Bank operates ten offices
in eastern  and central  North  Carolina,  and its primary  source of revenue is
derived  from loans to customers  and from its  securities  portfolio.  The loan
portfolio is comprised  mainly of real estate,  commercial  and consumer  loans.
These  loans  are  primarily   collateralized   by  residential  and  commercial
properties, commercial equipment, and personal property.

SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

USE OF ESTIMATES

In preparing  consolidated  financial  statements in conformity  with accounting
principles   generally  accepted  in  the  United  States  of  America  requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities  and the 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.  Material estimates that are particularly  susceptible to significant
change relate to the determination of the allowance for loan losses.

CASH AND CASH EQUIVALENTS

For the purpose of  presentation in the  consolidated  statements of cash flows,
cash and cash  equivalents are defined as those amounts  included in the balance
sheet captions cash and due from banks and interest-earning deposits.

Federal regulations require institutions to set aside specified amounts of cash
as reserves against transactions and time deposits. As of December 31, 2004, the
daily average gross reserve requirement was $5 million.

INVESTMENT SECURITIES

Investment securities are classified into three categories:

(1) Held to Maturity - Debt securities that the Company has the positive intent
and the ability to hold to maturity are classified as held to maturity and
reported at amortized cost;

(2) Trading - Debt and equity securities that are bought and held principally
for the purpose of selling them in the near term are classified as trading
securities and reported at fair value, with unrealized gains and losses included
in earnings; and


--------------------------------------------------------------------------------
                                       33
<PAGE>


FOUR OAKS FINCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2004 AND 2003
--------------------------------------------------------------------------------


NOTE A - ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
             (Continued)

Investment Securities (Continued)

(3) Available  for Sale - Debt and equity  securities  not  classified as either
securities  held to maturity or trading  securities  are reported at fair value,
with  unrealized  gains and losses  excluded from earnings and reported,  net of
income  taxes,  as  other   comprehensive   income,  a  separate   component  of
shareholders' equity.

The Company has  historically  classified  all securities as available for sale.
Gains  and  losses  on  sales  of   securities,   computed   based  on  specific
identification of adjusted cost of each security,  are included in income at the
time of the sale.  Premiums and  discounts are  amortized  into interest  income
using a  method  that  approximates  the  interest  method  over the  period  to
maturity.

LOANS AND ALLOWANCE FOR LOAN LOSSES

Loans are stated at the amount of unpaid principal,  reduced by an allowance for
loan losses. Interest on loans is calculated by using the simple interest method
on daily balances of the principal amount outstanding.

Loan origination  fees are deferred,  as well as certain direct loan origination
costs.  Such costs and fees are  recognized  as an  adjustment to yield over the
contractual lives of the related loans utilizing the interest method.

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

The  allowance  for loan losses is  established  as losses are estimated to have
occurred  through a provision  for loan losses  charged to  earnings.  Loans are
charged against the allowance for loan losses when management  believes that the
uncollectibility  of a loan balance is confirmed.  The provision for loan losses
is based  upon such  factors  as  changes  in the  nature and volume of the loan
portfolio,  overall  portfolio  quality,  review of specific  problem loans, and
current economic conditions and trends that may affect the borrowers' ability to
pay.  Because  these  factors  may  change,  it is  possible  that  management's
assessment of the allowance may change.  In addition,  regulatory  examiners may
require the Bank to recognize  changes to the allowance for loan losses based on
their  judgments  about  information  available  to  them at the  time of  their
examination.




--------------------------------------------------------------------------------
                                       34
<PAGE>


FOUR OAKS FINCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2004 AND 2003
--------------------------------------------------------------------------------


NOTE A - ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
             (Continued)

INCOME RECOGNITION ON IMPAIRED AND NONACCRUAL LOANS

Loans,  including impaired loans, are generally classified as nonaccrual if they
are past due as to maturity or payment of  principal or interest for a period of
more than 90 days,  unless  such loans are  well-secured  and in the  process of
collection.  If a loan or a portion of a loan is  classified  as  doubtful or is
partially  charged-off,  the loan is generally  classified as nonaccrual.  Loans
that are on a current  payment  status or past due less than 90 days may also be
classified as nonaccrual if repayment in full of principal and/or interest is in
doubt.

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

While a loan is classified as nonaccrual  and the future  collectibility  of the
recorded  loan balance is doubtful,  collections  of interest and  principal are
generally  applied as a reduction to the  principal  outstanding,  except in the
case of loans  with  scheduled  amortizations  where the  payment  is  generally
applied  to the  oldest  payment  due.  When the  future  collectibility  of the
recorded loan balance is expected,  interest  income may be recognized on a cash
basis.  In the case  where a  nonaccrual  loan had been  partially  charged-off,
recognition of interest on a cash basis is limited to that which would have been
recognized  on the  recorded  loan  balance at the  contractual  interest  rate.
Receipts in excess of that amount are recorded as  recoveries  to the  allowance
for loan losses until prior charge-offs have been fully recovered.

FORECLOSED ASSETS

Assets  acquired as a result of foreclosure are valued at fair value at the date
of foreclosure  establishing a new cost basis. After foreclosure,  valuations of
the property are periodically performed by management and the assets are carried
at the lower of cost or fair value minus  estimated  costs to sell.  Losses from
the acquisition of property in full or partial  satisfaction of debt are treated
as credit losses. Routine holding costs, subsequent declines in value, and gains
or losses on disposition are included in other income and expense.

BANK PREMISES AND EQUIPMENT

Land is carried at cost.  Bank  premises and  equipment  are stated at cost less
accumulated  depreciation.  Depreciation  is  computed  using the  straight-line
method based on the estimated useful lives of assets.  Useful lives range from 5
to 10 years for furniture and equipment and 40 years for premises.  Expenditures
for repairs and maintenance are charged to expense as incurred.


--------------------------------------------------------------------------------
                                       35
<PAGE>


FOUR OAKS FINCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2004 AND 2003
--------------------------------------------------------------------------------


NOTE A - ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
             (Continued)

INCOME TAXES

Deferred tax assets and liabilities are recognized for the estimated  future tax
consequences  attributable  to  differences  between the tax bases of assets and
liabilities  and  their  carrying  amounts  for  financial  reporting  purposes.
Deferred  tax assets  are also  recognized  for  operating  loss  carryforwards.
Deferred  tax assets and  liabilities  are measured  using  enacted tax rates in
effect  for the year in which  the  temporary  differences  are  expected  to be
recovered or settled.  Deferred tax assets are reduced by a valuation  allowance
if it is more likely than not that the tax benefits will not be realized.

STOCK IN FEDERAL HOME LOAN BANK OF ATLANTA

As a requirement  for  membership,  the Company  invests in stock of the Federal
Home Loan Bank of Atlanta  ("FHLB").  This investment is carried at cost. Due to
the  redemptive  provisions of the FHLB,  the Company  estimated that fair value
equals cost and that this investment was not impaired as of December 31, 2004.

COMPREHENSIVE INCOME

Comprehensive  income is  defined  as the  change in equity  during a period for
non-owner  transactions  and is divided into net income and other  comprehensive
income.  Other  comprehensive  income includes  revenues,  expenses,  gains, and
losses that are excluded  from  earnings  under  current  accounting  standards.
Components  of  other  comprehensive  income  for  the  Company  consist  of the
unrealized gains and losses,  net of taxes, in the Company's  available for sale
securities  portfolio  and  unrealized  gains and losses,  net of taxes,  in the
Company's cash flow hedge instruments.

Accumulated  other  comprehensive  income at December  31,  2004,  2003 and 2002
consists of the following:

<TABLE>
<CAPTION>
                                                           2004     2003     2002
                                                          ------   ------  -------
                                                           (AMOUNTS IN THOUSANDS)
<S>                                                        <C>     <C>     <C>
Unrealized holding gains - investment securities
  available for sale                                       $ 391   $ 571   $ 803
   Deferred income taxes                                    (157)   (229)   (320)
                                                           ------  ------  ------
     Net unrealized holding gains - investment securities
       available for sale                                    234     342     483
                                                           -----   ------  ------

Unrealized holding losses - cash flow hedge instruments     (426)    (56)   --
   Deferred income taxes                                     170      22    --
                                                           -----   ------  ------
     Net unrealized holding losses - cash flow hedge
       instruments                                          (256)    (34)   --
                                                           -----   ------  ------
   Total accumulated other comprehensive income (loss)     $ (22)  $ 308   $ 483
                                                           =====   ======  ======
</TABLE>

--------------------------------------------------------------------------------
                                       36
<PAGE>

FOUR OAKS FINCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2004 AND 2003
--------------------------------------------------------------------------------


NOTE A - ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
             (Continued)

Stock Compensation Plans

SFAS No. 123, Accounting for Stock-Based  Compensation,  encourages all entities
to adopt a fair value based method of accounting for employee stock compensation
plans,  whereby  compensation  cost is  measured  at the grant date based on the
value of the award and is recognized over the service  period,  which is usually
the  vesting  period.  However,  it also allows an entity to continue to measure
compensation  cost for those plans  using the  intrinsic  value based  method of
accounting  prescribed by Accounting  Principles  Board ("APB")  Opinion No. 25,
Accounting  for Stock  Issued to  Employees,  whereby  compensation  cost is the
excess,  if any, of the quoted  market  price of the stock at the grant date (or
other  measurement  date) over the amount an  employee  must pay to acquire  the
stock.  Stock  options  issued  under the  Company's  stock option plans have no
intrinsic value at the grant date and, under APB Opinion No. 25, no compensation
cost is  recognized  for them.  The Company  has  elected to  continue  with the
accounting  methodology  in APB No. 25 and, as a result,  has provided pro forma
disclosures of net income and earnings per share and other disclosures as if the
fair value based method of accounting had been applied.


<TABLE>
<CAPTION>
                                                                2004           2003         2002
                                                            -----------     ----------   ----------
                                                          (AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
Net income:
<S>                                                           <C>           <C>           <C>
   As reported                                                $   4,375     $   2,918     $ 2,916
     Deduct:  Total stock-based employee compensation
           expense determined under fair value method
           for all awards, net of related tax effects               (64)          (68)        (52)
                                                              ---------     ----------    --------
   Pro forma                                                  $   4,311     $   2,850     $ 2,864
                                                              =========     ==========    ========
Basic earnings per share:
   As reported                                                $    1.29     $     .87     $   .88
   Pro forma                                                       1.27           .85         .86

Diluted earnings per share:
   As reported                                                $    1.28     $     .86     $   .87
   Pro forma                                                       1.26           .85         .86
</TABLE>


Net Income Per Common Share and Common Shares Outstanding

Basic  earnings per share  represents  income  available to common  shareholders
divided by the weighted average number of common shares  outstanding  during the
period.  Diluted earnings per share reflect  additional common shares that would
have been outstanding if dilutive  potential  common shares had been issued,  as
well as any  adjustment  to income that would result from the assumed  issuance.
The weighted average number of shares  outstanding  during each period have been
retroactively  adjusted for a 25% stock split  distributed  October 29, 2004 and
November 10,  2003.  Potential  common  shares that may be issued by the Company
relate solely to outstanding stock options.


--------------------------------------------------------------------------------
                                       37
<PAGE>

FOUR OAKS FINCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2004 AND 2003
--------------------------------------------------------------------------------


NOTE A - ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
             (Continued)

Net Income Per Common Share and Common Shares Outstanding (Continued)

Basic and diluted net income per common share have been computed based upon net
income as presented in the accompanying consolidated statements of operations
divided by the weighted average number of common shares outstanding or assumed
to be outstanding as summarized below:


<TABLE>
<CAPTION>
                                                         2004        2003       2002
                                                       ---------- ---------  ----------
<S>                                                   <C>         <C>        <C>
Weighted average number of common shares used
   in computing basic net income per common share      3,397,345  3,356,070  3,325,960

Effect of dilutive stock options                          19,335     11,971     10,906
                                                       ---------- ---------  ----------
Weighted average number of common shares and
   dilutive potential common shares used in computing
   diluted net income per common share                 3,416,680  3,368,041  3,336,866
                                                       =========  =========  =========
</TABLE>

There were no antidilutive shares outstanding for the years ended December 31,
2004, 2003 and 2002. .

DERIVATIVE INSTRUMENTS

The Company  utilizes  interest  rate swaps in the  management  of interest rate
risk.  Interest  rate swaps are  contractual  agreements  between two parties to
exchange a series of cash flows representing  interest  payments.  A swap allows
both parties to alter the  repricing  characteristics  of assets or  liabilities
without affecting the underlying principal positions. Through the use of a swap,
assets and  liabilities may be transformed  from fixed to floating  rates,  from
floating  rates to fixed  rates,  or from one type of floating  rate to another.
Swap terms generally range from one year to ten years depending on the need.

The net  interest  payable  or  receivable  on  interest  rate  swaps  that  are
designated as hedges is accrued and  recognized as an adjustment to the interest
income or expense of the related asset or liability. Gains and losses from early
terminations of derivatives are deferred and amortized as yield adjustments over
the  shorter of the  remaining  term of the  hedged  asset or  liability  or the
remaining term of the derivative  instrument.  Upon disposition or settlement of
the asset or liability being hedged, deferral accounting is discontinued and any
gains or losses are recognized in income. Unrealized holding gains and losses on
derivatives  designated  as cash flow  hedges are  reported,  net of  applicable
income tax effect, in accumulated other comprehensive income.

Derivative financial  instruments that fail to qualify as a hedge are carried at
fair value with gains and losses recognized in current earnings.


--------------------------------------------------------------------------------
                                       38

<PAGE>

FOUR OAKS FINCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2004 AND 2003
--------------------------------------------------------------------------------


NOTE A - ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
             (Continued)

New Accounting Standards

On March 9, 2004,  the SEC Staff  issued  Staff  Accounting  Bulletin  No.  105,
Application of Accounting  Principles to Loan  Commitments  ("SAB 105"). SAB 105
clarifies existing accounting practices relating to the valuation of issued loan
commitments,  including interest rate lock commitments ("IRLC"), subject to SFAS
No. 149 and Derivative Implementation Group Issue C13, Scope Exceptions:  When a
Loan Commitment is included in the Scope of Statement 133. Furthermore,  SAB 105
disallows  the  inclusion  of the  values  of a  servicing  component  and other
internally  developed  intangible  assets in the  initial  and  subsequent  IRLC
valuation. The provisions of SAB 105 were effective for loan commitments entered
into  after  March 31,  2004.  The  adoption  of SAB 105 did not have a material
impact on the Company's  consolidated  financial  statements.

In  March  2004,  the  ("EITF")  released  EITF  Issue  03-01,  The  Meaning  of
Other-Than-Temporary  Impairment and its Application to Certain Investments. The
Issue   provides   guidance   for   determining   whether   an   investment   is
other-than-temporarily impaired and requires certain disclosures with respect to
these    investments.    The   recognition   and   measurement    guidance   for
other-than-temporary  impairment  has been delayed by the issuance of FASB Staff
Position EITF 03-1-1 on September  30, 2004.  The adoption of Issue 03-1 did not
result in any other-than-temporary impairment.

In December 2003, the American Institute of Certified Public Accountants (AICPA)
issued  Statement of Position  (SOP) 03-3,  Accounting for Loans or Certain Debt
Securities Acquired in a Transfer.  The SOP addresses accounting for differences
between  contractual  cash flows and cash flows expected to be collected from an
investor's initial investment in loans or debt securities acquired in a transfer
if those differences  relate to a deterioration of credit quality.  The SOP also
prohibits  companies from "carrying  over" or creating a valuation  allowance in
the initial  accounting  for loans  acquired that meet the scope criteria of the
SOP. The SOP is effective  for loans  acquired in fiscal years  beginning  after
December 15,  2004.  The adoption of this SOP is not expected to have a material
impact on the Company's financial position or results of operations.

In December 2004, the FASB issued SFAS 123 (revised 2004),  Share-Based Payment,
("SFAS  No.  123(R)"),  which is a  revision  of SFAS No.  123,  Accounting  for
Stock-Based Compensation. SFAS No. 123(R) supersedes Accounting Principles Board
(APB) Opinion No. 25,  Accounting for Stock Issued to Employees  ("APB 25"), and
amends  SFAS  No.  95  Statement  of Cash  Flows.  SFAS No.  123(R)  establishes
standards for the accounting for  transactions in which an entity  exchanges its
equity  instruments for goods or services.  This Statement  focuses primarily on
accounting  for  transactions  in which an entity obtains  employee  services in
share-based payment  transactions.  SFAS No. 123(R) requires that the fair value
of such  equity  instruments  be  recognized  as an  expense  in the  historical
financial  statements as services are performed.  Prior to SFAS No. 123(R), only
certain pro forma  disclosures  of fair value were  required.  The provisions of
this Statement are effective for the first interim  reporting period that begins
after June 15, 2005. Accordingly,  we will adopt SFAS No. 123(R) commencing with
the quarter  ending  September 30, 2005. If we had included the cost of employee
stock option  compensation in our  consolidated  financial  statements,  our net
income for the fiscal years ended  December  31, 2004,  2003 and 2002 would have
decreased  by  approximately  $64,000,   $68,000,  and  $52,000,   respectively.
Accordingly,  the adoption of SFAS No. 123(R) is not expected to have a material
effect on our consolidated financial statements.

--------------------------------------------------------------------------------
                                       39
<PAGE>

FOUR OAKS FINCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2004 AND 2003
--------------------------------------------------------------------------------


NOTE A - ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
         (Continued)

Reclassifications

Certain items included in the 2003 and 2002 consolidated financial statements
have been reclassified to conform to the 2004 presentation. These
reclassifications have no effect on the net income or shareholders' equity
previously reported.

NOTE B - INVESTMENT SECURITIES

The amortized cost, gross unrealized gains, gross unrealized losses and fair
values of securities available for sale as of December 31, 2004 and 2003 are as
follows:

<TABLE>
<CAPTION>

                                                              GROSS        GROSS
                                            AMORTIZED       UNREALIZED   UNREALIZED
                                              COST            GAINS        LOSSES        FAIR VALUE
                                             -------        --------      --------       ----------
                                                            (AMOUNTS IN THOUSANDS)
2004:
<S>                                          <C>            <C>            <C>            <C>
U.S. Government and agency securities        $34,991        $    57        $    90        $34,958
State and municipal securities                 3,573             72             13          3,632
Mortgage-backed securities                    12,759             53             37         12,775
Other                                            628            349           --              977

                                             -------        -------        -------        -------
                                             $51,951        $   531        $   140        $52,342
                                             =======        =======        =======        =======


                                                              GROSS        GROSS
                                            AMORTIZED       UNREALIZED   UNREALIZED
                                              COST            GAINS        LOSSES        FAIR VALUE
                                             -------        --------      --------       ----------
                                                            (AMOUNTS IN THOUSANDS)
2003:
U.S. Government and agency securities        $15,866        $    54        $     6        $15,914
State and municipal securities                 4,664            291           --            4,955
Mortgage-backed securities                    16,535             41             74         16,502
Other                                            567            265           --              832
                                             -------        -------        -------        -------
                                             $37,632        $   651        $    80        $38,203
                                             =======        =======        =======        =======

</TABLE>

The following table shows gross unrealized  losses and fair values of investment
securities,  aggregated  by  investment  category  and  length  of time that the
individual  securities have been in a continuous  unrealized  loss position,  at
December  31, 2004 and 2003.  As of December  31, 2004,  the  unrealized  losses
relate to eleven U.S.  government  agency  securities  and four  mortgage-backed
securities, of which none and two such securities,  respectively, had continuous
unrealized  losses for more than twelve months.  The unrealized losses relate to
debt  securities  that have incurred fair value  reductions due to higher market
interest rates since the securities  were purchased.  The unrealized  losses are
not likely to reverse  unless and until  market  interest  rates  decline to the
levels  that  existed  when the  securities  were  purchased.  Since none of the
unrealized  losses relate to the marketability of the securities or the issuer's
ability to honor redemption obligations, none of the securities are deemed to be
other than temporarily impaired. (Amounts in thousands)

--------------------------------------------------------------------------------
                                       40
<PAGE>

FOUR OAKS FINCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2004 AND 2003
--------------------------------------------------------------------------------


         NOTE B - INVESTMENT SECURITIES (Continued)

<TABLE>
<CAPTION>
                                                                              2004
                                       ---------------------------------------------------------------------------------------
                                         LESS THAN 12 MONTHS            12 MONTHS OR MORE                    TOTAL
                                       -------------------------     -----------------------       ---------------------------
                                         FAIR         UNREALIZED      FAIR        UNREALIZED        FAIR           UNREALIZED
                                         VALUE          LOSSES        VALUE         LOSSES          VALUE           LOSSES
                                        -------        ---------     -------      ----------       --------        -----------
<S>                                     <C>            <C>            <C>            <C>            <C>            <C>
Securities available for sale:
  U.S. government and
     agency securities                  $18,892        $    90        $  --          $  --          $18,892        $    90
  State and municipal securities          1,968             13           --             --            1,968             13
  Mortgage-backed securities              2,056             15          2,924             22          4,980             37
                                        -------        -------       -------        -------        --------        -------
  Total temporarily impaired
     securities                         $22,916        $   118        $ 2,924        $    22        $25,840        $   140
                                        =======        =======       ========       ========       ========        =======


                                                                              2003
                                       ---------------------------------------------------------------------------------------
                                         LESS THAN 12 MONTHS            12 MONTHS OR MORE                    TOTAL
                                       -------------------------     -----------------------       ---------------------------
                                         FAIR         UNREALIZED      FAIR        UNREALIZED        FAIR           UNREALIZED
                                         VALUE          LOSSES        VALUE         LOSSES          VALUE           LOSSES
                                        -------        ---------     -------      ----------       --------        -----------
Securities available for sale:
  U.S. government and
     agency securities                  $   750        $     6        $  --          $  --          $   750        $     6
  Mortgage-backed securities              8,938             74           --             --            8,938             74
                                        -------        -------       -------        -------        --------        -------

  Total temporarily impaired
     securities                         $ 9,688        $    80        $  --          $  --          $ 9,688        $    80
                                        =======        =======       ========       ========       ========        =======
</TABLE>


The  amortized  cost and fair value of debt  securities  at December 31, 2004 by
contractual  maturities are shown below.  Expected  maturities  will differ from
contractual  maturities  because  borrowers may have the right to call or prepay
obligations with or without call or prepayment penalties.


                                              AMORTIZED
                                                COST       FAIR VALUE
                                              -------       --------
                                              (AMOUNTS IN THOUSANDS)
Due after one year through five years         $22,761        $22,773
Due after five years through ten years         25,051         25,065
Due after ten years                             4,139          4,504
                                              -------        -------
                                              $51,951        $52,342
                                              =======        =======


Securities  with a  carrying  value of  approximately  $33.4  million  and $12.3
million at December  31,  2004 and 2003,  respectively,  were  pledged to secure
public deposits and for other purposes required or permitted by law.

Sales and calls of securities  available for sale during 2004 and 2003 generated
gross  realized  gains of $224,000 and $295,000,  respectively.  Gross  realized
losses amounted to $153,000 and $22,000, respectively.

--------------------------------------------------------------------------------
                                       41



<PAGE>

FOUR OAKS FINCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2004 AND 2003
--------------------------------------------------------------------------------


NOTE C - LOANS AND ALLOWANCE FOR LOAN LOSSES

Major classifications of loans as of December 31, 2004 and 2003 are summarized
as follows:


                                              2004               2003
                                           ---------         ----------
                                              (AMOUNTS IN THOUSANDS)

Real estate - residential and other        $ 159,152         $ 140,998
Real estate - agricultural                    15,203            13,384
Construction and land development             90,742            66,242
Other agricultural                             4,020             5,084
Consumer loans                                17,207            16,475
Commercial loans                              26,005            27,872
Other loans                                      865             2,738
                                           ---------         ----------
                                             313,194           272,793
Less:
Net deferred loan costs                         (379)             (170)
Allowance for loan losses                     (4,055)           (3,430)
                                           ---------         ----------
                                           $ 308,760         $ 269,193
                                           =========         ==========

Nonperforming assets at December 31, 2004 and 2003 consist of the following:

                                                    2004           2003
                                                  --------        -------
                                                  (AMOUNTS IN THOUSANDS)
Loans past due ninety days or more                  $  226        $  635
Nonaccrual loans                                       944         1,059
Foreclosed assets (included in other assets)           404            75
                                                  --------        -------
                                                    $1,574        $1,769
                                                  ========        =======

At December  31, 2004 and 2003,  the  recorded  investment  in loans  considered
impaired in  accordance  with SFAS No. 114 totaled  $944,000  and $1.1  million,
respectively,  and consisted  entirely of nonaccrual  loans.  Impaired  loans of
$944,000 and $1.1 million had related allowances for loan losses of $151,000 and
$165,000  at  December  31,  2004 and 2003,  respectively.  For the years  ended
December 31, 2004 and 2003,  the average  recorded  investment in impaired loans
was  approximately  $1.5 million and $1.2 million,  respectively.  The amount of
interest  recognized on impaired  loans during the portion of the year that they
were impaired was not material.

A summary of the  allowance  for loan  losses for the years ended  December  31,
2004, 2003 and 2002 is as follows:

<TABLE>
<CAPTION>
                                                    2004            2003            2002
                                                  -------         -------         -------
                                                           (AMOUNTS IN THOUSANDS)

<S>                                               <C>             <C>             <C>
Balance, beginning                                $ 3,430         $ 2,860         $ 2,650
Provision for loan losses                           1,596           1,373           1,248
Loans charged-off                                  (1,346)         (1,137)         (1,199)
Recoveries of loans previously charged-off            375             334             161
                                                  -------         -------         -------
Balance, ending                                   $ 4,055         $ 3,430         $ 2,860
                                                  =======         =======         =======
</TABLE>
--------------------------------------------------------------------------------
                                       42




<PAGE>
FOUR OAKS FINCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2004 AND 2003
--------------------------------------------------------------------------------


NOTE C - LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)

The Bank had loan and deposit relationships with most of its directors and
executive officers and with companies with which certain directors and executive
officers are associated. The following is a reconciliation of loans directly
outstanding to executive officers, directors, and their affiliates (amounts in
thousands):

         Balance at December 31, 2003             $ 5,053
         New loans                                  3,760
         Principal repayments                      (4,103)
                                                  -------
         Balance at December 31, 2004             $ 4,710
                                                  =======

As a matter of policy, these loans and credit lines are approved by the
Company's Board of Directors and are made with interest rates, terms, and
collateral requirements comparable to those required of other borrowers. In the
opinion of management, these loans do not involve more than the normal risk of
collectibility. At December 31, 2004, the Company had pre-approved but unused
lines of credit totaling $135,000 to executive officers, directors and their
affiliates.

NOTE D - BANK PREMISES AND EQUIPMENT

Bank premises and equipment at December 31, 2004 and 2003 are as follows:

                                       2004              2003
                                     --------         --------
                                       (AMOUNTS IN THOUSANDS)
Land                                 $  2,237         $  2,237
Building                                7,042            6,957
Furniture and equipment                 6,952            6,522
                                     --------         ---------
                                       16,231           15,716
Less accumulated depreciation          (6,082)          (5,134)
                                     --------         ---------
                                     $ 10,149         $ 10,582
                                     ========         =========


Depreciation expense for the years ended December 31, 2004 and 2003 amounted to
$994,000 and $932,000, respectively.


NOTE E - DEPOSITS

At December 31, 2004, the scheduled maturities of time deposits are as follows
(amounts in thousands):

<TABLE>
<CAPTION>
                                        LESS THAN        $100,000
                                        $100,000          OR MORE          TOTAL
                                        ----------       ---------       --------
<S>                                      <C>             <C>             <C>
Within one year                          $ 56,742        $ 64,198        $120,940
Over one year through three years          16,688          16,765          33,453
Over three years                            3,327          27,692          31,019
                                         --------        --------        --------
                                         $ 76,757        $108,655        $185,412
                                         ========        ========        ========
</TABLE>

--------------------------------------------------------------------------------
                                       43
<PAGE>

FOUR OAKS FINCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2004 AND 2003
--------------------------------------------------------------------------------




NOTE F - BORROWINGS

At December 31, 2004 and 2003, borrowed funds consisted of the following FHLB
advances (amounts in thousands):


   Maturity              Interest Rate          2004         2003
   -----------------   ----------------       -------     --------
   March 2006          2.52% - Variable       $10,000     $      -
   July 2010              5.75% - Fixed        10,000       10,000
   July 2011              4.44% - Fixed         5,000        5,000
   September 2011         4.38% - Fixed         3,000        3,000
   October 2011           4.30% - Fixed         7,000        7,000
   November 2011       2.31% - Variable         8,000            -
   November 2011          3.54% - Fixed             -        8,000
                                              -------     --------
                                              $43,000     $ 33,000
                                              =======     ========

The above  advances are secured by a floating lien  covering the Company's  loan
portfolio  of  qualifying  residential  (1-4 units)  first  mortgage  loans.  At
December 31, 2004,  the Company had available  lines of credit  totaling  $111.5
million at various financial  institutions for borrowing,  dependent on adequate
collateralization.  The  weighted  average  rates  for the above  borrowings  at
December 31, 2004 and 2003 were 3.86% and 4.58%, respectively.

At December 31, 2004 and 2003,  the Company was obligated  under an  outstanding
promissory  note for $160,000  for the purchase of property.  The note calls for
set monthly  interest only payments,  with a balloon payment at maturity on June
2006. The note bears interest at 7.50%.


NOTE G - INCOME TAXES

Allocation of income tax expense between current and deferred portions is as
follows:


                                      YEARS ENDED DECEMBER 31,
                             ----------------------------------------
                               2004           2003             2002
                             --------        -------         --------
                                      (AMOUNTS IN THOUSANDS)
Current tax expense:
     Federal                 $ 2,086         $ 1,470         $ 1,085
     State                       410             271             189
                             --------        -------         --------
                               2,496           1,741           1,274
                             --------        -------         --------
Deferred tax expense:
     Federal                    (161)           (106)             26
     State                       (27)            (23)              6
                             --------        -------         --------
                                (188)           (129)             32
                             --------        -------         --------
                             $ 2,308         $ 1,612         $ 1,306
                             ========        =======         ========

--------------------------------------------------------------------------------
                                       44
<PAGE>

FOUR OAKS FINCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2004 AND 2003
--------------------------------------------------------------------------------

NOTE G - INCOME TAXES (Continued)

The  reconciliation  of expected income tax at the statutory federal rate of 34%
with income tax expense is as follows:

<TABLE>
<CAPTION>
                                                                       YEARS ENDED DECEMBER 31,
                                                              -----------------------------------------
                                                               2004               2003           2002
                                                              -------          ---------       --------
                                                                        (AMOUNTS IN THOUSANDS)
<S>                                                            <C>             <C>             <C>
   Expense computed at statutory rate of 34%                   $ 2,272         $ 1,540         $ 1,435
   Effect of state income taxes, net of federal benefit            304             164             129
   Tax exempt income                                              (101)           (123)           (203)
   Bank owned life insurance income                               (152)            (61)           --
   Other, net                                                      (15)             92             (55)
                                                               -------         -------         -------
                                                               $ 2,308         $ 1,612         $ 1,306
                                                               =======         =======         =======
Deferred income taxes consist of the following:
                                                                       YEARS ENDED DECEMBER 31,
                                                              -----------------------------------------
                                                               2004               2003           2002
                                                              -------          ---------       --------
                                                                       (AMOUNTS IN THOUSANDS)
   Deferred tax assets:
     Allowance for loan losses                                 $ 1,518         $ 1,277         $ 1,058
     Unamortized investment premiums                                49              44             135
     Net deferred loan fees                                        146              66            --
     Other                                                          38              31              53
                                                               -------         -------         -------
        Total deferred tax assets                                1,751           1,418           1,246
                                                               -------         -------         -------
   Deferred tax liabilities:
     Property and equipment                                        857             818             744
     Other comprehensive income                                    (13)            207             320
     Net deferred loan costs                                        93            --                31
     Unaccreted investment discounts                                13            --              --
                                                               -------         -------         -------
        Total deferred tax liabilities                             950           1,025           1,095
                                                               -------         -------         -------
        Net deferred tax assets                                $   801         $   393         $   151
                                                               =======         =======         =======
</TABLE>


NOTE H - REGULATORY RESTRICTIONS

The Bank,  as a North  Carolina  banking  corporation,  may pay dividends to the
Company only out of undivided  profits 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 the financial soundness of the
bank.

Current  Federal  regulations  require that the Bank maintain a minimum ratio of
total capital to risk weighted  assets of 8%, with at least 4% being in the form
of Tier 1 capital,  as defined in the  regulations.  In addition,  the Bank must
maintain a leverage  ratio of 4%. As of December  31, 2004,  the Bank's  capital
exceeded  the  current  capital  requirements.  The Bank  currently  expects  to
continue  to exceed  these  minimums  without  altering  current  operations  or
strategy.
--------------------------------------------------------------------------------
                                       45


<PAGE>



FOUR OAKS FINCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2004 AND 2003
--------------------------------------------------------------------------------


NOTE H - REGULATORY RESTRICTIONS (Continued)

The Bank is subject to various regulatory capital  requirements  administered by
the  federal  and  state  banking  agencies.  Failure  to meet  minimum  capital
requirements   can  initiate   certain   mandatory,   and  possibly   additional
discretionary,  actions by regulators  that, if undertaken,  could have a direct
material  effect  on the  Bank's  financial  statements.  Quantitative  measures
established  by  regulation  to  ensure  capital  adequacy  require  the Bank to
maintain minimum amounts and ratios, as set forth in the table below. Management
believes,  as of December  31,  2004,  that the Bank meets all capital  adequacy
requirements to which it is subject.

As of December 31, 2004, the most recent  notification from the FDIC categorized
the  Bank  as  well  capitalized  under  the  regulatory  framework  for  prompt
corrective action. To be categorized as well capitalized, the Bank must maintain
minimum  amounts  and  ratios  as set  forth in the  table  below.  There are no
conditions  or events since that  notification  that  management  believes  have
changed the Bank's category.

The Bank's actual capital amounts and ratios are also presented in the table
below (amounts in thousands, except ratios):


<TABLE>
<CAPTION>
                                                                                                              MINIMUM
                                                                                                             TO BE WELL
                                                                                     MINIMUM              CAPITALIZED UNDER
                                                                                   FOR CAPITAL            PROMPT CORRECTIVE
                                                          ACTUAL                ADEQUACY PURPOSES         ACTION PROVISIONS
                                                -----------------------    ------------------------   -----------------------
                                                 AMOUNT           RATIO      AMOUNT           RATIO    AMOUNT           RATIO
                                                -------           -----    --------           -----   -------           -----
As of December 31, 2004:
------------------------
<S>                                             <C>               <C>       <C>                <C>     <C>               <C>
Total Capital (to Risk Weighted Assets)         $37,642           11.8%     $25,427            8.0%    $31,784           10.0%
Tier I Capital (to Risk Weighted Assets)         33,668           10.6%      12,714            4.0%     19,071            6.0%
Tier I Capital (to Average Assets)               33,668            8.6%      15,605            4.0%     19,506            5.0%

As of December 31, 2003:
------------------------
Total Capital (to Risk Weighted Assets)         $33,792           12.3%     $21,973            8.0%    $27,467           10.0%
Tier I Capital (to Risk Weighted Assets)         30,362           11.1%      10,987            4.0%     16,480            6.0%
Tier I Capital (to Average Assets)               30,362            9.0%      13,421            4.0%     16,776            5.0%
</TABLE>

The Company is also subject to these capital requirements. At December 31, 2004
and 2003, the Company's total capital to risk weighted assets, Tier 1 capital to
risk weighted assets and Tier 1 capital to average assets were 13.0% and 13.1%,
11.7% and 11.8%, and 9.5% and 9.7%, respectively.


NOTE I - DERIVATIVES


DERIVATIVE FINANCIAL INSTRUMENTS

The Company has  stand-alone  derivative  financial  instruments  in the form of
interest rate swap agreements, which derive their value from underlying interest
rates.  These  transactions  involve both credit and market  risk.  The notional
amounts  are  amounts  on which  calculations,  payments,  and the  value of the
derivative are based. Notional amounts do not represent direct credit exposures.
Direct credit  exposure is limited to the net difference  between the calculated
amounts to be received and paid, if any. Such difference, which

--------------------------------------------------------------------------------
                                       46
<PAGE>

FOUR OAKS FINCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2004 AND 2003
--------------------------------------------------------------------------------


NOTE I - DERIVATIVES (Continued)

represents  the fair value of the  derivative  instruments,  is reflected on the
Company's  consolidated  balance  sheets as  derivative  assets  and  derivative
liabilities.

The Company is exposed to  credit-related  losses in the event of nonperformance
by the counterparties to these agreements.  The Company controls the credit risk
of its financial  contracts  through  credit  approvals,  limits and  monitoring
procedures,  and does not expect any  counterparties to fail their  obligations.
The Company deals only with primary dealers.

Derivative instruments are generally either negotiated  over-the-counter ("OTC")
contracts  or  standardized   contracts  executed  on  a  recognized   exchange.
Negotiated  OTC  derivative  contracts  are  generally  entered into between two
counterparties   that  negotiate  specific   agreements  terms,   including  the
underlying instruments, amount, exercise prices and maturity.

RISK MANAGEMENT POLICIES - HEDGING INSTRUMENTS

The primary  focus of the  Company's  asset/liability  management  program is to
monitor the  sensitivity  of the Company's  net  portfolio  value and net income
under varying  interest rate scenarios to take steps to control its risks.  On a
quarterly  basis,  the Company  simulates the net portfolio value and net income
expected  to be  earned  over  a  twelve-month  period  following  the  date  of
simulation.  The simulation is based on a projection of market interest rates at
varying  levels and  estimates  the impact of such market rates on the levels of
interest-earning assets and interest-bearing  liabilities during the measurement
period. Based upon the outcome of the simulation analysis, the Company considers
the use of  derivatives  as a means of reducing the  volatility of net portfolio
value and  projected net income within  certain  ranges of projected  changes in
interest rates.  The Company  evaluates the  effectiveness  of entering into any
derivative  instrument  agreement by measuring  the cost of such an agreement in
relation  to the  reduction  in net  portfolio  value and net income  volatility
within an assumed range of interest rates.

INTEREST RATE RISK MANAGEMENT - CASH FLOW HEDGING INSTRUMENTS

The Company originates  variable rate loans for its loan portfolio.  These loans
expose  the  Company  to  variability  in  interest  receipts  due to changes to
interest  rates.  If  interest  rates  increase,   interest  income   increases.
Conversely,  if interest rates decrease,  interest income decreases.  Management
believes  it is prudent to limit the  variability  of a portion of its  interest
receipts  therefore,  generally hedges a portion of its  variable-rate  interest
receipts.  To meet this  objective,  management  enters into  interest rate swap
agreements  whereby the Company  receives fixed rate payments and makes variable
interest rate payments during the contract period.

At December 31, 2004 and 2003,  the  information  pertaining  to an  outstanding
interest  rate swap  agreement  used to hedge  variable rate loans is as follows
(amounts in thousands):

<TABLE>
<CAPTION>
                                                           2004                 2003
                                                       ------------        -----------
<S>                                                    <C>                 <C>
Notional amount                                        $   25,000          $   25,000
Weighted average pay rate                                    4.38%               4.00%
Weighted average receive rate                                5.85%               5.85%
Weighted average maturity in years                            2.7                 3.7
Unrealized loss relating to interest rate swaps        $     (426)         $      (56)
</TABLE>

This  agreement  requires  the  Company  to make  payments  at a  variable  rate
determined by a specified index (prime) in exchange for receiving  payments at a
fixed rate.

--------------------------------------------------------------------------------
                                       47
<PAGE>

FOUR OAKS FINCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2004 AND 2003
--------------------------------------------------------------------------------


NOTE I - DERIVATIVES (Continued)

At December 31, 2004 and 2003,  the Company's  interest rate swaps used to hedge
variable  rate loans  reflected  an  unrealized  loss of $426,000  and  $56,000,
respectively.  The unrealized losses are included in other comprehensive income,
net of tax, in the accompanying consolidated balance sheet.

Risk  management  results for the year ended  December  31, 2004  related to the
balance sheet hedging of variable rate loans  indicate that the hedges were 100%
effective and that there was no component of the derivative instruments' gain or
loss which was excluded from the assessment of hedge effectiveness.

At December 31, 2004, the unrealized loss relating to use of interest rate swaps
was recorded in derivative  liabilities in accordance with SFAS No. 133. Changes
in the fair value of interest rate swaps  designated as hedging  instruments  of
the  variability of cash flows  associated with variable rate loans are reported
in other comprehensive income.

INTEREST RATE RISK MANAGEMENT - FAIR VALUE HEDGING INSTRUMENTS

The Company uses fixed rate time deposits for use in its lending and  investment
activities and other general purposes. These debt obligations expose the Company
to  variability  in their fair  value due to  changes  in the level of  interest
rates.  Management  believes that it is prudent to limit the  variability in the
fair value of a portion of its fixed-rate funding. It is the Company's objective
to hedge the change in fair value of fixed-rate funding coverage levels that are
appropriate, given anticipated or existing interest rate levels and other market
considerations, as well as the relationship of change in this liability to other
liabilities of the Company.  To meet this  objective,  on December 31, 2004, the
Company utilized interest rate swaps as an asset/liability  management  strategy
to hedge the change in value of the funding due to changes in expected  interest
rate  assumptions.  These interest rate swap  agreements are contracts to make a
series of floating  rate  payments in exchange  for  receiving a series of fixed
rate payments.

At  December  31,  2004 and 2003,  the  information  pertaining  to  outstanding
interest rate swap  agreements  used to hedge  fixed-rate  funding is as follows
(amounts in thousands):


<TABLE>
<CAPTION>
                                                           2004              2003
                                                       ----------         -----------
<S>                                                    <C>                <C>
Notional amount                                        $   26,000         $    5,000
Weighted average pay rate                                    2.30%              1.17%
Weighted average receive rate                                3.66%              3.25%
Weighted average maturity in years                            5.6                5.5
Unrealized gain relating to interest rate swaps        $      213         $     --
</TABLE>


These  agreements   require  the  Company  to  make  payments  at  variable-rate
determined by a specified index (LIBOR) in exchange for receiving  payments at a
fixed-rate.

During 2004, an interest rate swap was called at par, with no corresponding gain
or loss  recognized.  No interest  rate swaps were  terminated  during 2004.  At
December 31, 2004,  the Company's  interest rate swaps used to hedge  fixed-rate
funding  reflected  an  unrealized  gain of $213,000  which is recorded in other
liabilities in the accompanying consolidated balance sheet.


--------------------------------------------------------------------------------
                                       48
<PAGE>

FOUR OAKS FINCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2004 AND 2003
--------------------------------------------------------------------------------


NOTE J - COMMITMENTS AND CONTINGENCIES

The Bank is a party to financial  instruments with off-balance sheet credit risk
in the normal course of business to meet the financing  needs of its  customers.
These financial  instruments include commitments to extend credit and letters of
credit.  Those instruments  involve, to varying degrees,  elements of credit and
interest rate risk in excess of the amount  recognized in the balance sheet. The
contract  or  notional  amounts  of those  instruments  reflect  the  extent  of
involvement  the Bank has in particular  classes of financial  instruments.  The
Bank  uses the same  credit  policies  in  making  commitments  and  conditional
obligations as it does for on-balance-sheet instruments.

Commitments  to extend  credit are  agreements  to lend to a customer as long as
there is no violation of conditions  established  in the  contract.  Commitments
generally  have fixed  expiration  dates or other  termination  clauses  and may
require  payment of a fee. Since some of the  commitments are expected to expire
without  being  drawn  upon,  the total  commitment  amounts do not  necessarily
represent  future  cash   requirements.   The  Bank  evaluates  each  customer's
creditworthiness on a case-by-case basis. The amount of collateral obtained,  if
deemed  necessary by the Bank, upon extension of credit is based on management's
credit  evaluation of the borrower.  Collateral  obtained varies but may include
real estate, stocks, bonds, and certificates of deposit.

Unfunded  commitments  under lines of credit are commitments for possible future
extensions of credit to existing customers. These lines of credit usually do not
contain a specified  maturity date and may not be drawn upon to the total extent
to which the Bank is committed.

Stand-by  letters of credit are conditional  lending  commitments  issued by the
Bank to guarantee the performance of a customer to a third party.  Those letters
of  credit  are  primarily  issued  to  support  public  and  private  borrowing
arrangements.  Essentially  all letters of credit issued have  expiration  dates
within  one year.  The credit  risk  involved  in  issuing  letters of credit is
essentially the same as that involved in extending loan facilities to customers.

A summary of the contract  amount of the Bank's  exposure to  off-balance  sheet
credit risk as of December 31, 2004 is as follows (amounts in thousands):

Financial instruments whose contract amounts represent credit risk:

                Commitments to extend credit             $   68,156
                Undisbursed lines of credit                  21,221
                Financial stand-by letters of credit            159
                Performance stand-by letters of credit        1,567


NOTE K - STOCK OPTION PLAN

The  Company has a  non-qualified  stock  option plan for certain key  employees
under which it is authorized to issue options for up to 781,250 shares of common
stock. Options are granted at the discretion of the Company's Board of Directors
at a price approximating  market, as determined by a committee of Board members.
All options granted  subsequent to a 1997 amendment will be 100% vested one year
from the grant date and will expire after such a period as is  determined by the
Board at the time of grant. Options granted prior to the amendment have ten year
lives and a five year level vesting provision.

--------------------------------------------------------------------------------
                                       49


<PAGE>
FOUR OAKS FINCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2004 AND 2003
--------------------------------------------------------------------------------


NOTE K - STOCK OPTION PLAN (Continued)

A summary of the status of the Company's stock options, after giving retroactive
effect to stock splits, as of December 31, 2004, 2003 and 2002, and changes
during the years ending on those dates is presented below:


                                       OPTIONS        OPTION PRICE
                                      OUTSTANDING      PER SHARE
                                      -----------   ---------------
Balance December 31, 2001               149,285     $7.39 - 13.23
  Granted                                38,375     $12.80
  Exercised                             (44,910)    $9.10 -  13.23
  Forfeited                             (10,501)    $12.37 - 13.23
                                      -----------
Balance December 31, 2002               132,249     $7.39 -  13.23

  Granted                                45,079     $14.40
  Exercised                             (24,456)    $12.37
  Forfeited                                   -         -
  Expired                                  (153)    $12.37
                                      -----------
Balance December 31, 2003               152,719     $7.39 - 14.08

  Granted                                33,875     $17.60
  Exercised                             (61,862)    $13.11
  Forfeited                                  (1)    $12.80
  Expired                                    (7)    $13.23
                                      -----------
Balance December 31, 2004               124,724     $14.42
                                      ===========

The weighted average  exercise price of all exercisable  options at December 31,
2004 is $13.24.  There were  326,477  shares  reserved  for future  issuance  at
December 31, 2004.

Additional information concerning the Company's stock options at December 31,
2004 is as follows:



                                        REMAINING
                          NUMBER       CONTRACTUAL         NUMBER
 EXERCISE PRICE        OUTSTANDING         LIFE          EXERCISABLE
 ----------------   ----------------   -----------    -----------------
          $7.40           5,274         2.19 years           5,274
          $12.80         42,841          .83 years          42,841
          $14.40         42,734         2.16 years          42,734
          $17.60         33,875         3.15 years               -
                        -------                             ------
                        124,724                             90,849
                        =======                             ======



--------------------------------------------------------------------------------
                                       50
<PAGE>
FOUR OAKS FINCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2004 AND 2003
--------------------------------------------------------------------------------


NOTE K - STOCK OPTION PLAN (Continued)

The fair value of each option grant is estimated on the date of grant using the
Black-Scholes option-pricing model with the following assumptions used for
grants in 2004, 2003 and 2002:

                                2004          2003          2002
                              --------      --------       -------
Dividend yield                  2.06%         1.69%         1.77%
Expected volatility            21.92%        21.65%        22.04%
Risk free interest rate         3.00%         2.82%         3.00%
Expected life                  4 years       4 years       4 years

The weighted average fair value of options granted during 2004, 2003 and 2002
was $3.07, $3.21, and $2.91, respectively.


NOTE L - OTHER EMPLOYEE BENEFITS

SUPPLEMENTAL RETIREMENT

In 1998, the Company's  subsidiary,  Four Oaks Bank & Trust  Company,  adopted a
Supplemental  Executive Retirement Plan ("SERP") for its president.  The Company
has purchased  life  insurance  policies in order to provide  future  funding of
benefit  payments.  Plan  benefits  will  accrue  and vest  during the period of
employment  and will be paid in  annual  benefit  payments  over  the  officer's
remaining life commencing with the officer's  retirement.  The liability accrued
under the plan  amounts to $99,000 and  $79,000 at  December  31, 2004 and 2003,
respectively.  During 2004, 2003 and 2002, the expense attributable to this plan
amounted to $20,000, $18,000 and $16,000, respectively.

EMPLOYMENT AGREEMENTS

The Company has entered into employment agreements with certain of its executive
officers  to ensure a stable  and  competent  management  base.  The  agreements
provide for benefits as spelled out in the contracts and cannot be terminated by
the Company's  Board of Directors,  except for cause,  without  prejudicing  the
officers' rights to receive certain vested rights,  including  compensation.  In
addition,  the Company has entered into severance  compensation  agreements with
certain of its executive officers to provide them with severance pay benefits in
the event of a change in control of the Company,  as outlined in the agreements,
the acquirer will be bound to the terms of the contracts.


DEFINED CONTRIBUTION PLAN

The  Company  sponsors  a  contributory   profit-sharing   plan  in  effect  for
substantially  all  employees.  Participants  may make  voluntary  contributions
resulting in salary  deferrals in accordance with Section 401(k) of the Internal
Revenue Code. The plans provide for employee  contributions up to $13,000 of the
participant's annual salary and an employer  contribution of 25% matching of the
first 6% of pre-tax salary contributed by each participant.  Expenses related to
these plans for the years ended  December 31, 2004,  2003 and 2002 were $47,000,
$56,000 and $92,000, respectively.  Contributions under the plan are made at the
discretion of the Company's Board of Directors.


--------------------------------------------------------------------------------
                                       51
<PAGE>
FOUR OAKS FINCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2004 AND 2003
--------------------------------------------------------------------------------


NOTE L - OTHER EMPLOYEE BENEFITS (CONTINUED)

EMPLOYEE STOCK OWNERSHIP PLAN

The Company sponsors an employee stock ownership plan (ESOP) which makes the
employees of a company, owners of stock in the company. The Four Oaks Bank &
Trust Company's Employee Stock Ownership Trust is available to full-time
employees at least 21 years of age after six months of service. Contributions
are voluntary by the Company and employees cannot contribute. Stock issued is
purchased on the open market and the Company does not issue new shares in
conjunction with this plan. Voluntary contributions are determined by the
Company's Board of Directors annually based on Company performance and are
allocated to employees based on annual compensation. Contribution expenses for
this plan for 2004, 2003, and 2002 were $180,000, 189,000, and 150,000,
respectively.

EMPLOYEE STOCK PURCHASE AND BONUS PLAN

The Employee Stock Purchase and Bonus Plan (the "Purchase  Plan") is a voluntary
plan that enables  full-time  employees of the Company and its  subsidiaries  to
purchase  shares of our common  stock.  The Purchase Plan is  administered  by a
committee of the Board of Directors,  which has broad discretionary authority to
administer  the Purchase  Plan.  The  Company's  Board of Directors may amend or
terminate the Purchase Plan at any time. The Purchase Plan is not intended to be
qualified as an employee  stock  purchase plan under Section 423 of the Internal
Revenue Code of 1986, as amended.

Once a year,  participants  in the Purchase Plan  purchase the Company's  common
stock at fair market value.  Participants are permitted to purchase shares under
the  Purchase  Plan up to (5%) of their  compensation,  with a maximum  purchase
amount of $1,000 per year. The Company matches,  in cash, fifty percent (50%) of
the amount of each  participant's  purchase,  up to $500. After  withholding for
income and employment taxes,  participants use the balance of our matching grant
to purchase shares of our common stock.

As of December 31, 2004,  156,250  shares of our common stock had been  reserved
for issuance  under the Purchase  Plan,  and 85,294  shares had been  purchased.
During 2004, 6,578 shares were purchased under the Purchase Plan.


NOTE M - LEASES

The Bank has entered into non-cancelable operating leases for three branch
facilities. Future minimum lease payments under the leases for year ending
December 31, 2004 is as follows (amounts in thousands):

      2005                                                  $   42
      2006                                                      33
      2007                                                      33
      2008                                                      15
      2009                                                       7
                                                            ------
                                                            $  130
                                                            ======

In addition,  the Bank has leased a building  from one of its directors for $908
and $891 per month in 2004 and 2003,  respectively under an operating lease on a
month-to-month basis.

Total rental  expense under  operating  leases for the years ended  December 31,
2004, 2003 and 2002 amounted to $45,000 and $31,000 and $14,000, respectively.

--------------------------------------------------------------------------------
                                       52
<PAGE>
FOUR OAKS FINCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2004 AND 2003
--------------------------------------------------------------------------------


NOTE N - PARENT COMPANY FINANCIAL INFORMATION

Condensed financial information of Four Oaks Fincorp, Inc., the parent company,
at December 31, 2004 and 2003 and for the years ended December 31, 2004, 2003
and 2002 is presented below:

                                                      2004             2003
                                                    ---------       ---------
                                                     (AMOUNTS IN THOUSANDS)
CONDENSED BALANCE SHEETS

Assets:
   Cash and cash equivalents                          $ 3,074        $ 1,709
   Equity investment in subsidiaries                   33,665         30,681
   Securities available for sale                          695            595
   Other assets                                          --             --
                                                      -------        -------
      Total assets                                    $37,434        $32,985
                                                      =======        =======
Liabilities and Shareholders' Equity:
   Liabilities:
    Other liabilities                                 $   139        $   105

   Shareholders' equity                                37,295         32,880
                                                      -------        -------
    Total liabilities and shareholders' equity        $37,434        $32,985
                                                      =======        =======


                                        2004            2003            2002
                                      --------        --------        --------
                                               (AMOUNTS IN THOUSANDS)

CONDENSED STATEMENTS OF OPERATIONS

Equity in earnings of subsidiaries    $ 4,361         $ 2,897         $ 2,922
Interest income                            30              22              34
Other investment income                    15              17               9
Miscellaneous expenses                    (31)            (18)            (49)
                                      --------        -------         -------
        Net income                    $ 4,375         $ 2,918         $ 2,916
                                      ========        =======         =======

--------------------------------------------------------------------------------
                                       53

<PAGE>

FOUR OAKS FINCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2004 AND 2003
--------------------------------------------------------------------------------


NOTE N - PARENT COMPANY FINANCIAL INFORMATION (Continued)


<TABLE>
<CAPTION>
                                                             2004           2003            2002
                                                           -------       ---------       ---------
                                                                 (AMOUNTS IN THOUSANDS)
CONDENSED STATEMENTS OF CASH FLOWS

Operating activities:
<S>                                                        <C>             <C>             <C>
   Net income                                              $ 4,375         $ 2,918         $ 2,916
   Equity in undistributed earnings of subsidiaries         (4,361)         (2,897)         (2,922)
   Amortization                                               --              --                10
   Decrease in other assets                                   --              --                67
                                                           -------         -------         -------
     Cash flows provided by operating activities                14              21              71
                                                           -------         -------         -------
Investing activities:
   Purchase of securities available for sale                   (14)            (16)             (9)
   Investment in subsidiaries                                 --              --               (31)
   Upstream dividend received from subsidiary                1,089           1,166             584
                                                           -------         -------         -------
     Cash flows provided by investing activities             1,075           1,150             544
                                                           -------         -------         -------
Financing activities:
   Proceeds from issuance of common stock                    1,430             879           1,012
   Purchases and retirements of common stock                   (65)           (993)           (385)
   Dividends paid                                           (1,089)           (960)           (852)
                                                           -------         -------         -------
     Cash flows used by financing activities                   276          (1,074)           (225)
                                                           -------         -------         -------
     Net increase in cash and cash equivalents               1,365              97             390

Cash and cash equivalents, beginning of year                 1,709           1,612           1,222
                                                           -------         -------         -------
Cash and cash equivalents, end of year                     $ 3,074         $ 1,709         $ 1,612
                                                           =======         =======         =======
</TABLE>


NOTE O - FAIR VALUE OF FINANCIAL INSTRUMENTS

SFAS No. 107, Disclosures about Fair Value of Financial Instruments, requires
the disclosure of estimated fair values for financial instruments. Quoted market
prices, if available, are utilized as an estimate of the fair value of financial
instruments. Because no quoted market prices exist for a significant part of the
Company's financial instruments, the fair value of such instruments has been
derived based on management's assumptions with respect to future economic
conditions, the amount and timing of future cash flows and estimated discount
rates. Different assumptions could significantly affect these estimates.
Accordingly, the net realizable value could be materially different from the
estimates presented below. In addition, the estimates are only indicative of
individual financial instruments' values and should not be considered an
indication of the fair value of the Company taken as a whole. The following
methods and assumptions were used to estimate the fair value of each class of
financial instrument.

--------------------------------------------------------------------------------
                                       54


<PAGE>
FOUR OAKS FINCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2004 AND 2003
--------------------------------------------------------------------------------


NOTE O - FAIR VALUE OF FINANCIAL INSTRUMENTS (Continued)

CASH AND CASH EQUIVALENTS

The carrying amounts of cash and cash equivalents are equal to the fair value
due to the liquid nature of the financial instruments.

INVESTMENT SECURITIES AVAILABLE FOR SALE

Fair  values of  investment  securities  available  for sale are based on quoted
market  prices.  If a  quoted  market  price  is not  available,  fair  value is
estimated using quoted market prices for similar securities.

LOANS

Fair values have been estimated by type of loan:  residential real estate loans,
consumer loans,  and commercial and other loans.  For  variable-rate  loans that
reprice frequently and with no significant credit risk, fair values are based on
carrying  values.  The  fair  values  of  fixed  rate  loans  are  estimated  by
discounting  the future cash flows  using the current  rates at which loans with
similar terms would be made to borrowers with similar credit ratings and for the
same remaining maturities. The Company has assigned no fair value to off-balance
sheet  financial  instruments  since  they are  either  short  term in nature or
subject to immediate repricing.

FHLB STOCK

The carrying amount of FHLB stock approximates fair value.

INVESTMENT IN LIFE INSURANCE

The  carrying  value of life  insurance  approximates  fair value  because  this
investment is carried at cash surrender value, as determined by the insurer.

DEPOSITS

The fair value of demand deposits, savings accounts and money market deposits is
the  amount  payable  on demand at  year-end.  Fair  value of time  deposits  is
estimated  by  discounting  the future cash flows using the current rate offered
for similar deposits with the same maturities.

BORROWINGS

The fair values are based on  discounting  expected  cash flows at the  interest
rate for debt  with the same or  similar  remaining  maturities  and  collection
requirements.

ACCRUED INTEREST RECEIVABLE AND PAYABLE

The carrying amounts of accrued interest approximate fair value.

DERIVATIVE FINANCIAL INSTRUMENTS

Fair values for interest rate swap agreements are based upon the amounts
required to settle the contracts.

--------------------------------------------------------------------------------
                                       55

<PAGE>
FOUR OAKS FINCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2004 AND 2003
--------------------------------------------------------------------------------


NOTE O - FAIR VALUE OF FINANCIAL INSTRUMENTS (Continued)

The following table presents information for financial assets and liabilities as
of December 31, 2004 and 2003 (amounts in thousands):


<TABLE>
<CAPTION>
                                                     2004                                2003
                                         ---------------------------        ----------------------------
                                          CARRYING       ESTIMATED           CARRYING          ESTIMATED
                                           VALUE         FAIR VALUE           VALUE           FAIR VALUE
                                         ---------       -----------        ----------       -----------
FINANCIAL ASSETS:
<S>                                      <C>               <C>               <C>              <C>
  Cash and cash equivalents              $  14,249         $  14,249         $  15,825        $  15,825
  Securities available for sale             52,342            52,342            38,203           38,203
  Loans, net                               308,760           308,713           269,193          271,566
  FHLB stock                                 2,621             2,621             1,923            1,923
  Investment in life insurance               6,054             6,054             2,896            2,896
  Accrued interest receivable                2,210             2,210             1,893            1,893

FINANCIAL LIABILITIES:
Deposits                                 $ 315,307         $ 309,801         $ 272,918        $ 270,127
  Borrowings                                43,160            41,651            33,160           30,665
  Accrued interest payable                   1,201             1,201             1,284            1,284

DERIVATIVE FINANCIAL INSTRUMENTS:
  Interest rate swap agreements:
    Liabilities, net                          (213)             (213)               56               56
</TABLE>


NOTE P - CASH FLOW SUPPLEMENTAL DISCLOSURES

The following information is supplemental information regarding the cash flows
for the years ended December 31, 2004, 2003 and 2002:

<TABLE>
<CAPTION>
                                                                2004            2003            2002
                                                              --------        --------        --------
                                                                       (AMOUNTS IN THOUSANDS)
 Cash paid for:
<S>                                                           <C>             <C>             <C>
   Interest on deposits and borrowings                        $ 5,895         $ 4,365         $ 8,586
   Income taxes                                                 2,192           1,637             997

Summary of noncash investing and financing activities:
   Transfer from loans to foreclosed assets                     1,214             167             585
   Loans to facilitate the sale of foreclosed assets              393             111             137

Tax benefit from the exercise of non-qualified
   stock options                                                   94              18              53

Increase (decrease) in fair value of securities
   available for sale, net of tax                                (108)           (141)            424
Decrease in fair value of cash flow hedge, net of tax            (222)            (34)           --
</TABLE>



--------------------------------------------------------------------------------
                                       56

<PAGE>
FOUR OAKS FINCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2004 AND 2003
--------------------------------------------------------------------------------


NOTE Q - STOCK PURCHASE PLAN

On December 10, 2001, the Company's Board of Directors approved a Stock Purchase
Program   authorizing  the  Company  to  purchase  up  to  100,000  shares,   or
approximately 4.7% of the then outstanding shares of common stock.  During 2003,
the  Company  purchased  43,668  shares at an average  cost of $21.73 per share.
During 2004, the Company purchased 2,800 shares at an average cost of $23.25 per
share. Neither 2004 nor 2003 purchase amounts reflect of the 5-for-4 stock split
during  2004 to  shareholders  of record as of October 15,  2004,  payable on or
after  October 29, 2004.  In December  2004,  the  Company's  Board of Directors
extended this stock purchase plan until December 31, 2005.






























--------------------------------------------------------------------------------
                                       57
<PAGE>

Item 9 - Changes In and Disagreements with Accountants on Accounting and
         Financial Disclosure.

         Not Applicable.

Item 9A - Controls and Procedures

         As required by paragraph (b) of Rule 13a-15 under the Securities
Exchange Act of 1934, as amended (the "Exchange Act"), our Chief Executive
Officer and our Chief Financial Officer have evaluated the effectiveness of our
disclosure controls and procedures (as such term is defined in Rules 13a-15(e)
and 15d-15(e) under the Exchange Act) as of the end of the period covered by
this report. Based on such evaluation, our Chief Executive Officer and our Chief
Financial Officer conclude that, as of the end of the period covered by this
report, our disclosure controls and procedures are effective, in that they
provide reasonable assurance that the information we are required to disclose in
the reports that we file or submit under the Exchange Act is recorded,
processed, summarized, and reported within the time periods required by the
United States Securities and Exchange Commission's rules and forms.

         There have been no changes in our internal control over financial
reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the
Exchange Act) during the fourth quarter of fiscal 2004 that have materially
affected, or are reasonably likely to materially affect, our internal control
over financial reporting.

Item 9B - Other Information

          Not Applicable.


                                    PART III

Item 10 - Directors and Executive Officers of the Registrant.

         Director information is incorporated by reference from the sections
entitled "Information about Our Board of Directors," "Election of Directors,"
and under the section entitled "Section 16(a) Beneficial Ownership Reporting
Compliance," in our Proxy Statement for the 2005 Annual Meeting of Shareholders.
Information on our executive officers is included under the caption "Our
Executive Officers" on Page 8 and 9 of this report. Information about our Code
of Ethics is incorporated by reference from the section entitled "Code of
Ethics," in our Proxy Statement for the 2005 Annual Meeting of Shareholders.


Item 11 - Executive Compensation.

         This information is incorporated by reference from the sections
entitled "Executive Compensation," "Board Compensation Committee Report on
Executive Compensation," "Compensation Committee Interlocks and Insider
Participation" and "Comparison of Cumulative Total Return" in our Proxy
Statement for the 2005 Annual Meeting of Shareholders.

Item 12 - Security Ownership of Certain Beneficial Owners and Management and
Related Shareholder Matters.

         This information is incorporated by reference from the section entitled
"Security Ownership of Management and Certain Beneficial Owners" and the
sections entitled "Equity Compensation Plan Information," "Nonqualified Stock
Option Plan" and "Employee Stock Purchases and Bonus Plan" in our Proxy
Statement for the 2005 Annual Meeting of Shareholders.

Item 13 - Certain Relationships and Related Transactions.

         This information is incorporated by reference from the section entitled
"Certain Transactions" in our Proxy Statement for the 2005 Annual Meeting of
Shareholders.

Item 14 - Principal Accountant Fees and Services

         Information regarding principal accountant fees and services is
incorporated by reference from the section entitled "Audit Firm Fee Summary" in
our Proxy Statement for the 2005 Annual Meeting of Shareholders.


                                       58
<PAGE>



Item 15 - Exhibits, Financial Statement Schedules .

         (a)(1) Financial Statements. The following financial statements and
supplementary data are included in Item 8 of this annual report.

<TABLE>
<CAPTION>

                                                                                      Form 10-K Page
                                                                                      --------------
<S>                                                                                    <C>
Financial Statements
Report of Independent Public Auditors, Dixon Hughes PLLC, dated March 18, 2005              27

Consolidated Balance Sheets as of December 31, 2004 and 2003                                28

Consolidated  Statements  of  Operations  for the years ended  December 31, 2004,           29
2003 and 2002

Consolidated  Statements of Comprehensive Income for the years ended December 31,           30
2004, 2003 and 2002

Consolidated  Statements of Shareholders' Equity for the years ended December 31,           31
2004, 2003 and 2002

Consolidated  Statements  of Cash Flows for the years ended  December  31,  2004,           32
2003 and 2002

Notes to Consolidated Financial Statements                                                  33

</TABLE>

         (a)(2) Financial Statement Schedules. All applicable financial
statement schedules required under Regulation S-X have been included in the
Notes to Consolidated Financial Statements.

         (a)(3) Exhibits. The following exhibits are filed as part of this
annual report.

<TABLE>
<CAPTION>
              Exhibit No.                 Description of Exhibit
              -----------                 ---------------------------------------------------------------------------------
<S>                                       <C>
               2(1)                       Agreement and Plan of Reorganization
                                          and Merger by and between Four Oaks
                                          Bank & Trust Company and Four Oaks
                                          Fincorp, Inc. dated February 24, 1997
               3.1                        Articles  of  Incorporation  of Four Oaks  Fincorp,  Inc.  including  Articles of
                                          Amendment to Articles of Incorporation
               3.2(1)                     Bylaws of Four Oaks Fincorp, Inc.
               4(1)                       Specimen of Certificate for Four Oaks Fincorp, Inc. Common Stock
               10.1(2)*                   Employment Agreement with Ayden R. Lee, Jr.
               10.2(2)*                   Severance Compensation Agreement with Ayden R. Lee, Jr.
               10.3(3)*                   Amended and Restated Nonqualified Stock Option Plan
               10.4(3)*                   Amended and Restated Employee Stock Purchase and Bonus Plan
               10.5(4)*                   Amended and Restated Dividend Reinvestment and Stock Purchase Plan
               10.6(5)*                   Four Oaks Bank & Trust Company Supplemental Executive
                                          Retirement Plan
               10.7(6)*                   Employment Agreement with Clifton L. Painter
               10.8(7)*                   Severance Compensation Agreement with Clifton L. Painter
               10.9(8)*                   Executive Employment Agreement with W. Leon Hiatt, III
               10.10(8)*                  Severance Compensation Agreement with W.Leon Hiatt, III
               10.11(8)*                  Executive Employment Agreement with Nancy S. Wise
               10.12(8)*                  Severance Compensation Agreement with Nancy S. Wise
               10.13(9)*                  Form of Stock Option Agreement (Non-Employee Director)
               10.14(9)*                  Form of Stock Option Agreement (Employee)
               10.15*                     Executive Employment Agreement with Jeff D. Pope
               10.16*                     Severance Compensation Agreement with Jeff D. Pope
               21                         Subsidiaries of Four Oaks Fincorp, Inc.
               23                         Consent of Dixon Hughes PLLC
               31.1                       Certification of Chief Executive Officer Pursuant to Rule 13a-14/15d-14 as
                                          Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
               31.2                       Certification of Chief Financial Officer Pursuant to Rule 13a-14/15d-14 as
                                          Adopted  Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
               32.1                       Certification of Chief Executive Officer and Chief Financial Officer
                                          Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the
                                          Sarbanes-Oxley Act of 2002
         -----------------------
            *Management Contract or Compensatory Plan
            (1)     Filed as an exhibit to the Current Report on Form 8-K12G3 filed with the SEC on July 2, 1997
                    and incorporated herein by reference.
            (2)     Filed as an exhibit to the Quarterly Report on Form 10-Q for the period ended June 30, 1997
                    and incorporated herein by reference.
            (3)     Filed as an exhibit to the Quarterly Report on Form 10-Q for the period ended June 30, 2004
                    and incorporated herein by reference.
            (4)     Filed as an exhibit to the Current Report on Form 8-K filed with the SEC on September 9, 2004 and
                    incorporated herein by reference.
            (5)     Filed as an exhibit to the Annual Report on Form 10-KSB for the period ended December 31, 1998 and
                    incorporated herein by reference.
            (6)     Filed as an exhibit to the Annual Report on Form 10-KSB for the period ended December 31, 2001 and
                    incorporated herein by reference.
            (7)     Filed as an exhibit to the Annual Report on Form 10-KSB for the period ended December 31, 2002 and
                    incorporated herein by reference.
            (8)     Filed as an exhibit to the Annual Report on Form 10-KSB for the period ended December 31, 2003 and
                    incorporated herein by reference.
            (9)     Filed as an exhibit to the Current Report on Form 8-K filed with the SEC on March 1, 2005 and
                    incorporated herein by reference.
</TABLE>

(b) See (a)(3) above.

(c) See (a)(2) above.

--------------------------------------------------------------------------------
                                       59



<PAGE>




                                                                 61
                                   SIGNATURES

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

                                     FOUR OAKS FINCORP, INC.

         Date: March 29, 2005        By:  /s/ Ayden R. Lee, Jr.
                                          -------------------------------------
                                          Ayden R. Lee, Jr.
                                          President and Chief Executive Officer

              Pursuant to the requirements of the Securities Exchange Act of
1934, this report has been signed below by the following persons on behalf of
the registrant and in the capacities and on the dates indicated.

         Date: March 29, 2005          /s/ Ayden R. Lee, Jr.
                                       ----------------------------------------
                                       Ayden R. Lee, Jr.
                                       President, Chief Executive Officer
                                       and Director

         Date: March 29, 2005          /s/ Nancy S. Wise
                                       ----------------------------------------
                                       Nancy S. Wise
                                       Executive Vice President and Chief
                                       Financial Officer

         Date: March 29, 2005          /s/ William J. Edwards
                                       ----------------------------------------
                                       William J. Edwards
                                       Director

         Date: March 29, 2005         /s/  Warren L. Grimes
                                       ----------------------------------------
                                       Warren L. Grimes
                                       Director

         Date: March 29, 2005         /s/  Dr. R. Max Raynor, Jr.
                                       ----------------------------------------
                                       Dr. R. Max Raynor, Jr.
                                       Director

         Date: March 29, 2005         /s/  Percy Y. Lee
                                       ----------------------------------------
                                       Percy Y. Lee
                                       Director

         Date: March 29, 2005         /s/  Merwin S. Canaday
                                       ----------------------------------------
                                       Merwin S. Canaday
                                       Director

         Date: March 29, 2005         /s/  Paula C. Bowman
                                       ----------------------------------------
                                       Paula C. Bowman
                                       Director

         Date: March 29, 2005          /s/ William Ashley Turner
                                       ----------------------------------------
                                       William Ashley Turner
                                       Director


                                       60

<PAGE>
                                 EXHIBIT INDEX

<TABLE>
<CAPTION>
              Exhibit No.                 Description of Exhibit
              -----------                 ---------------------------------------------------------------------------------
<S>                                       <C>
               2(1)                       Agreement and Plan of Reorganization
                                          and Merger by and between Four Oaks
                                          Bank & Trust Company and Four Oaks
                                          Fincorp, Inc. dated February 24, 1997
               3.1                        Articles  of  Incorporation  of Four Oaks  Fincorp,  Inc.  including  Articles of
                                          Amendment to Articles of Incorporation
               3.2(1)                     Bylaws of Four Oaks Fincorp, Inc.
               4(1)                       Specimen of Certificate for Four Oaks Fincorp, Inc. Common Stock
               10.1(2)*                   Employment Agreement with Ayden R. Lee, Jr.
               10.2(2)*                   Severance Compensation Agreement with Ayden R. Lee, Jr.
               10.3(3)*                   Amended and Restated Nonqualified Stock Option Plan
               10.4(3)*                   Amended and Restated Employee Stock Purchase and Bonus Plan
               10.5(4)*                   Amended and Restated Dividend Reinvestment and Stock Purchase Plan
               10.6(5)*                   Four Oaks Bank & Trust Company Supplemental Executive
                                          Retirement Plan
               10.7(6)*                   Employment Agreement with Clifton L. Painter
               10.8(7)*                   Severance Compensation Agreement with Clifton L. Painter
               10.9(8)*                   Executive Employment Agreement with W. Leon Hiatt, III
               10.10(8)*                  Severance Compensation Agreement with W.Leon Hiatt, III
               10.11(8)*                  Executive Employment Agreement with Nancy S. Wise
               10.12(8)*                  Severance Compensation Agreement with Nancy S. Wise
               10.13(9)*                  Form of Stock Option Agreement (Non-Employee Director)
               10.14(9)*                  Form of Stock Option Agreement (Employee)
               10.15*                     Executive Employment Agreement with Jeff D. Pope
               10.16*                     Severance Compensation Agreement with Jeff D. Pope
               21                         Subsidiaries of Four Oaks Fincorp, Inc.
               23                         Consent of Dixon Hughes PLLC
               31.1                       Certification of Chief Executive Officer Pursuant to Rule 13a-14/15d-14 as
                                          Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
               31.2                       Certification of Chief Financial Officer Pursuant to Rule 13a-14/15d-14 as
                                          Adopted  Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
               32.1                       Certification of Chief Executive Officer and Chief Financial Officer
                                          Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the
                                          Sarbanes-Oxley Act of 2002
         -----------------------
            *Management Contract or Compensatory Plan
            (1)     Filed as an exhibit to the Current Report on Form 8-K12G3 filed with the SEC on July 2, 1997
                    and incorporated herein by reference.
            (2)     Filed as an exhibit to the Quarterly Report on Form 10-Q for the period ended June 30, 1997
                    and incorporated herein by reference.
            (3)     Filed as an exhibit to the Quarterly Report on Form 10-Q for the period ended June 30, 2004
                    and incorporated herein by reference.
            (4)     Filed as an exhibit to the Current Report on Form 8-K filed with the SEC on September 9, 2004 and
                    incorporated herein by reference.
            (5)     Filed as an exhibit to the Annual Report on Form 10-KSB for the period ended December 31, 1998 and
                    incorporated herein by reference.
            (6)     Filed as an exhibit to the Annual Report on Form 10-KSB for the period ended December 31, 2001 and
                    incorporated herein by reference.
            (7)     Filed as an exhibit to the Annual Report on Form 10-KSB for the period ended December 31, 2002 and
                    incorporated herein by reference.
            (8)     Filed as an exhibit to the Annual Report on Form 10-KSB for the period ended December 31, 2003 and
                    incorporated herein by reference.
            (9)     Filed as an exhibit to the Current Report on Form 8-K filed with the SEC on March 1, 2005 and
                    incorporated herein by reference.
</TABLE>

(b) See (a)(3) above.

(c) See (a)(2) above.
                                       61