---



UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549



FORM 10-Q

(Mark One)

[X]       Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange
             Act of 1934 For the quarterly
period ended September 30, 2001

[  ]       
Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange
             Act of 1934

Commission file number 000-28496

Community Financial Group, Inc.

|Tennessee                       | 62-1626938                       
|------------------------------- | ---------------------------------
|(State or other jurisdiction of | (IRS Employer Identification No.)
|incorporation or organization)  |                                  

401 Church Street, Suite 200
Nashville, Tennessee 37219-2213



(615) 271-2000
(Registrant's telephone number, including area code)________________________



Securities registered pursuant to Section 12(b) of the Act:
None

Securities registered pursuant to Section 12(g) of the Act:

Common Stock, par value $6.00 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.  Yes [x]
No [  ].

As of
November 8, 2001, the number of outstanding shares of Common Stock, par value $6.00 per share was
3,080,045.

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COMMUNITY FINANCIAL GROUP, INC. AND SUBSIDIARIES
INDEX

|Part I  |                                                                                                      | PAGE
|------- | ---------------------------------------------------------------------------------------------------- | ----
|Item 1  | Financial Information                                                                                |     
|        | Unaudited
      Consolidated Balance Sheets                                                          | 1   
|        | Unaudited
      Consolidated Statements of Income                                                    | 2   
|        | Unaudited
      Consolidated Statements of Shareholders' Equity and Other Comprehensive
      Income | 3   
|        | Unaudited
      Consolidated Statements of Cash Flows                                                | 4   
|        | Notes to
      Consolidated Financial Statements                                                     | 5   
|        |                                                                                                      |     
|Item 2  | Management's Discussion and Analysis of
      Financial Condition and Results of Operations          | 10  
|        |                                                                                                      |     
|Item 3  | Quantitative and Qualitative Disclosures
      About Market Risk                                     | 24  
|        |                                                                                                      |     
|Part II | Other Information                                                                                    | 28  
|        |                                                                                                      |     
|        | Signatures                                                                                           | 29  
|        |                                                                                                      |     



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PART I



FINANCIAL
INFORMATION



Item 1. Financial Statements





















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COMMUNITY FINANCIAL GROUP, INC. AND SUBSIDIARIESCONSOLIDATED BALANCE SHEETS
(In thousands, except share data)
(Unaudited)

|                                                                                                                                                                                        | September 30,
      2001 |  | December 31,
      2000
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | ------------------------ |  | -----------------------
|ASSETS                                                                                                                                                                                  |                          |  |                        
|Cash and due from banks                                                                                                                                                                 | $   
      13,272        |  | $     10,738           
|Federal funds sold and other temporary
      investments                                                                                                                                | 5,000                    |  | 8,300                  
|Investment securities available-for-sale                                                                                                                                                | 126,230                  |  | 62,775                 
|Residential mortgages available-for-sale                                                                                                                                                | 1,919                    |  | --                     
|Loans and leases held for investment (net of
      unearned income of $2,745 at 
          September 30, 2001 and $2,886 at December 31, 2000)                                          |                          |  |                        
|Commercial loans                                                                                                                                                                        | 122,941                  |  | 103,245                
|Commercial leases                                                                                                                                                                       | 15,417                   |  | 14,734                 
|Real estate - mortgage loans                                                                                                                                                            | 110,756                  |  | 86,943                 
|Real estate - construction loans                                                                                                                                                        | 41,875                   |  | 37,899                 
|Consumer loans                                                                                                                                                                          | 33,256                   |  | 27,747                 
|Loans and leases, net of unearned income                                                                                                                                                | 324,245                  |  | 270,568                
|Less: allowance for loan and lease losses                                                                                                                                               | (4,895)                  |  | (4,622)                
|Total net loans and leases held for investments                                                                                                                                         | 319,350                  |  | 265,946                
|Premises and equipment, net                                                                                                                                                             | 3,814                    |  | 3,471                  
|Accrued interest receivable and other assets                                                                                                                                            | 3,729                    |  | 3,390                  
|Total assets                                                                                                                                                                            | $ 
      473,314         |  | $ 354,620              
|                                                                                                                                                                                        | ========                 |  | =======                
|LIABILITIES AND SHAREHOLDERS' EQUITY                                                                                                                                                    |                          |  |                        
|Deposits:                                                                                                                                                                               |                          |  |                        
|Noninterest-bearing                                                                                                                                                                     | $ 
      33,830          |  | $   27,866             
|NOW accounts                                                                                                                                                                            | 32,810                   |  | 21,074                 
|Money market accounts                                                                                                                                                                   | 93,988                   |  | 91,447                 
|Time deposits less than $100,000                                                                                                                                                        | 99,250                   |  | 70,636                 
|Time deposits greater than $100,000                                                                                                                                                     | 79,625                   |  | 62,013                 
|Total deposits                                                                                                                                                                          | 339,503                  |  | 273,036                
|Federal Home Loan Bank and other borrowings                                                                                                                                             | 89,000                   |  | 36,236                 
|Accounts payable and accrued liabilities                                                                                                                                                | 5,034                    |  | 3,067                  
|Total liabilities                                                                                                                                                                       | 433,537                  |  | 312,339                
|Commitments and contingencies (Note
      J)                                                                                                                                            | --                       |  | --                     
|Shareholders' equity:                                                                                                                                                                   |                          |  |                        
|Common stock, $6 par value; authorized 50,000,000 shares; issued and
      outstanding
                 shares
      3,097,380 at September 30, 2001 and 3,425,850 at December 31, 2000 | 18,584                   |  | 20,555                 
|Additional paid-in capital                                                                                                                                                              | 10,804                   |  | 13,507                 
|Retained earnings                                                                                                                                                                       | 9,034                    |  | 8,159                  
|Accumulated other comprehensive income, net of tax                                                                                                                                      | 1,355                    |  | 60                     
|Total shareholders' equity                                                                                                                                                              | 39,777                   |  | 42,281                 
|Total liabilities and shareholders' equity                                                                                                                                              | $ 
      473,314         |  | $  354,620             
|                                                                                                                                                                                        | ========                 |  | ========               









See accompanying notes to consolidated financial statements

-1-

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COMMUNITY FINANCIAL GROUP, INC. AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF INCOME(In thousands, except share data)
(Unaudited)



|                                                          | Three Months Ended
      September 30, |  | Nine
      Months Ended
      September 30,
|--------------------------------------------------------- | -------------------------------------- |  | -------------------------------------------
|                                                          | 2001                                   |  | 2000                                       
|Interest income:                                          |                                        |  |                                            
|Interest and fees on loans                                | $     
      6,705                     |  | $  
      6,030                            
|Federal funds sold and other temporary investments        | 177                                    |  | 38                                         
|Interest on investment securities:                        |                                        |  |                                            
|U.S. government agency obligations                        | 1,643                                  |  | 1,185                                      
|States and political subdivisions, tax-exempt             | 39                                     |  | 29                                         
|Other securities                                          | 100                                    |  | 128                                        
|Total interest income                                     | 8,664                                  |  | 7,410                                      
|Interest expense:                                         |                                        |  |                                            
|Interest bearing demand deposits                          | 1,060                                  |  | 1,382                                      
|Time deposits less than $100,000                          | 1,406                                  |  | 824                                        
|Time deposits greater than $100,000                       | 997                                    |  | 1,167                                      
|Federal Home Loan Bank and other borrowings               | 986                                    |  | 246                                        
|Federal funds purchased                                   | 1                                      |  | 105                                        
|Total interest expense                                    | 4,450                                  |  | 3,724                                      
|Net interest income                                       | 4,214                                  |  | 3,686                                      
|Provision for loan losses                                 | 658                                    |  | 360                                        
|Net interest income after provision for loan
      losses | 3,556                                  |  | 3,326                                      
|Noninterest income:                                       |                                        |  |                                            
|Service charges on deposit accounts                       | 309                                    |  | 220                                        
|Investment center income                                  | 387                                    |  | 407                                        
|Mortgage origination fees                                 | 175                                    |  | --                                         
|Gain/(Loss) on sale of investment securities, net         | 3                                      |  | --                                         
|Other noninterest income                                  | 90                                     |  | 85                                         
|Total noninterest income                                  | 964                                    |  | 712                                        
|Noninterest expense:                                      |                                        |  |                                            
|Salaries and employee benefits                            | 1,905                                  |  | 1,550                                      
|Occupancy                                                 | 441                                    |  | 360                                        
|Advertising                                               | 95                                     |  | 52                                         
|Audit, tax and accounting                                 | 98                                     |  | 63                                         
|Data processing                                           | 123                                    |  | 39                                         
|Other noninterest expense                                 | 491                                    |  | 651                                        
|Total noninterest expense                                 | 3,153                                  |  | 2,715                                      
|Income before provision for income taxes                  | 1,367                                  |  | 1,323                                      
|Provision for income taxes                                | 522                                    |  | 523                                        
|Net income                                                | $     
      845                       |  | $     
      800                           
|                                                          | =======                                |  | =======                                    
|Earnings per common share:                                |                                        |  |                                            
|Basic                                                     | $    
      0.26                       |  | $    
      0.23                           
|Diluted                                                   | $    
      0.26                       |  | $    
      0.23                           
|Weighted average shares outstanding:                      |                                        |  |                                            
|Basic                                                     | 3,232,018                              |  | 3,519,105                                  
|Diluted                                                   | 3,253,558                              |  | 3,521,445                                  





See accompanying notes to consolidated financial statements

-2-

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COMMUNITY FINANCIAL GROUP, INC.  AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
AND
OTHER COMPREHENSIVE INCOME

NINE MONTHS ENDED
SEPTEMBER 30, 2001 AND 2000
(In thousands, except share data)
(Unaudited)

|                                                       | Common Stock
  Shares     
  At Par | Additional
  Paid-in

  Capital | Retained

  Earnings | Accumulated
    Other
  Comprehensive
  Income(loss)

  net of tax |                    | Total
|------------------------------------------------------ | ----------------------------------- | ------------------------------- | -------------------- | ------------------------------------------------------------------ | ------------------ | -----
|Balance at January 1, 2000                             | 3,923,640                           | $ 
    23,542                   | $   
    17,381      | $    
    7,379                                                    | $      (987)       |      
|Comprehensive income:                                  |                                     |                                 |                      |                                                                    |                    |      
|Net income                                             | --                                  | --                              | --                   | 2,483                                                              | --                 |      
|Other
    comprehensive loss                           | --                                  | --                              | --                   | --                                                                 | 275                |      
|Total comprehensive income                             | --                                  | --                              | --                   | --                                                                 | --                 |      
|Issuance of common stock                               | 77,478                              | 465                             | 298                  | --                                                                 | --                 |      
|Repurchase of common stock                             | (535,000)                           | (3,210)                         | (3,957)              | --                                                                 | --                 |      
|Cash dividends                                         | --                                  | --                              | --                   | (1,892)                                                            | --                 |      
|Balance at
    September 30, 2000                      | 3,466,118                           | $  20,797                       | $   
    13,722      | $    
  7,970                                                      | $       
    (712) |      
|                                                       | ========                            | =======                         | ========             | ========                                                           | ========           |      
|                                                       |                                     |                                 |                      |                                                                    |                    |      
|Balance at January 1, 2001                             | 3,425,850                           | $ 
    20,555                   | $13,507              | $     8,159                                                        | $          
  60   |      
|Comprehensive income:                                  |                                     |                                 |                      |                                                                    |                    |      
|Net income                                             | --                                  | --                              | --                   | 2,559                                                              | --                 |      
|Other
      comprehensive loss                         | --                                  | --                              | --                   | --                                                                 | 1,295              |      
|Total comprehensive
                     
      income | --                                  | --                              | --                   | --                                                                 | --                 |      
|Issuance of common stock                               | 10,300                              | 62                              | 73                   | --                                                                 | --                 |      
|Repurchase of common stock                             | (338,770)                           | (2,033)                         | (2,776)              | --                                                                 | --                 |      
|Cash dividends                                         | --                                  | --                              | --                   | (1,684)                                                            | --                 |      
|Balance at
      September
    30, 2001                | 3,097,380                           | $ 
    18,584                   | $   
    10,804      | $     
    9,034                                                   | $       1,355      |      
|                                                       | ========                            | ========                        | ========             | ========                                                           | ========           |      
|                                                       |                                     |                                 |                      |                                                                    |                    |      
|                                                       |                                     |                                 |                      |                                                                    |                    |      
|                                                       |                                     |                                 |                      |                                                                    |                    |      













See accompanying notes to consolidated financial statements

-3-

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COMMUNITY FINANCIAL GROUP, INC.  AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)

|                                                                                                                                           | Nine
      Months Ended
      September 30,
|------------------------------------------------------------------------------------------------------------------------------------------ | -------------------------------------------
|                                                                                                                                           | 2001                                       
|Cash flows from operating activities:                                                                                                      |                                            
|Interest
      received                                                                                                                    | $  
      24,736                           
|Fees
      received                                                                                                                        | 2,545                                      
|Interest
      paid                                                                                                                        | (11,771)                                   
|Cash
      paid to suppliers and associates                                                                                                | (10,202)                                   
|Net cash provided by operating activities                                                                                                  | 5,308                                      
|Cash flows from investing activities:                                                                                                      |                                            
|Maturities of securities available for sale                                                                                                | 16,294                                     
|Sales of
      securities available for sale                                                                                               | 11,698                                     
|Purchases of securities available for sale                                                                                                 | (88,772)                                   
|Loans
      and leases originated by customers, net                                                                                        | (57,258)                                   
|Capital
      expenditures                                                                                                                 | (867)                                      
|Net cash provided by investing activities                                                                                                  | (118,905)                                  
|Cash flows from financing activities:                                                                                                      |                                            
|Net
      increase in demand deposits, NOW and money market accounts                                                                       | 20,240                                     
|Net
      increase in certificates of deposit                                                                                              | 46,184                                     
|Repayment of advance from Federal Home Loan Bank                                                                                           | (31,686)                                   
|Advances
      from the Federal Home Loan Bank and other borrowings                                                                        | 84,451                                     
|Net
      proceeds from issuance of common stock                                                                                           | 135                                        
|Repurchase of common stock                                                                                                                 | (4,809)                                    
|Cash
      dividends paid                                                                                                                  | (1,684)                                    
|Net cash provided by financing activities                                                                                                  | 112,831                                    
|Net (decrease) increase in cash and cash
      equivalents                                                                                 | (766)                                      
|Cash and cash equivalents at beginning of
      period                                                                                     | 19,038                                     
|Cash and cash equivalents at end of period                                                                                                 | $  
      18,272                           
|                                                                                                                                           | =======                                    
|Reconciliation of net income to net cash
      provided by operating activities:                                                           |                                            
|Net income                                                                                                                                 | 2,559                                      
|Adjustments to
      reconcile net income to net cash provided by operating activities:                                                    |                                            
|(Gain)/loss on sale of investment securities                                                                                               | (34)                                       
|Depreciation and amortization                                                                                                              | 524                                        
|Provision for loan losses                                                                                                                  | 1,600                                      
|Provision for deferred taxes                                                                                                               | (505)                                      
|Gain on sale of foreclosed assets                                                                                                          | (97)                                       
|Stock dividend income                                                                                                                      | (172)                                      
|Changes in assets and
      liabilities:                                                                                                   |                                            
|Decrease/(increase) in accrued interest receivable and other assets                                                                        | 307                                        
|Increase in accounts payable and accrued liabilities                                                                                       | 1,126                                      
|Net cash provided by
      operating activities                                                                                            | $   
      5,308                           
|                                                                                                                                           | =======                                    
|Supplemental
      Disclosure                                                                                                              |                                            
|Non Cash Transactions:                                                                                                                     |                                            
|Change in unrealized gain/(loss) on securities available for sale and
                 
      derivative financial instruments, net of tax | $    1,295                                 
|Cash paid for:                                                                                                                             |                                            
|Income taxes                                                                                                                               | $    2,166                                 





See accompanying notes to consolidated financial statements

-4-

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

> Community Financial Group, Inc. ("CFGI" or the "Company") was incorporated as a Tennessee Corporation on December 13, 1995 to become a bank holding company pursuant to Section 3(a)(1) of the Bank Holding Company Act of 1956, as amended, for the Bank of Nashville (the "Bank"). On April 30, 1996, the Company executed a plan of exchange with the Bank, whereby CFGI became the holding company of the Bank. The Bank is a state-chartered bank incorporated in 1989 under the laws of the state of Tennessee. The Bank owns 100% of the stock of
> TBON-Mooreland Joint Venture, LLC ("TBON Title"), a title agency, and has a majority interest in Machinery Leasing Company of North America, Inc. ("TBON Leasing").
> The unaudited consolidated financial statements include the accounts of
> CFGI, the Bank, and its subsidiaries TBON Title and TBON Leasing, the operations of which are collectively referred herein as the Company. All material intercompany accounts and transactions have been eliminated in the consolidation.

> The accompanying unaudited consolidated financial statements were prepared in accordance with general practices within the banking industry,
> accounting principles generally accepted in the United States of America for interim financial information and with the instructions for Form 10-Q. In the opinion of management, the unaudited consolidated financial statements reflect all adjustments, consisting only of normal and recurring adjustments, necessary to present fairly the Company's consolidated financial position at
> September 30, 2001; the Company's consolidated results of operations for the three and
> nine months ended September 30, 2001 and September 30, 2000; the consolidated statements of shareholders' equity and comprehensive income for the
> nine months ended September 30, 2001 and September 30, 2000; and, the consolidated
> statements of cash flows for the
> nine months ended September 30, 2001 and September 30, 2000. Interim period results are not necessarily indicative of results of operations or cash flows for a full-year period. The December 31, 2000 consolidated balance sheet was derived from audited financial statements but does not include all disclosures required by accounting principles generally accepted in the United States of America for complete consolidated financial statements.
> The interim unaudited consolidated financial statements and notes thereto, should be read in conjunction with the Company's annual report on Form 10-K for the year-ended December 31, 2000.



B.   
INVESTMENT SECURITIES

> Securities with an aggregate fair market value of
> $96.5 million at September 30, 2001, were pledged to secure public deposits, Federal Home Loan Bank borrowings and for other purposes as required or permitted by law.



C.   
RESIDENTIAL MORTGAGE LOANS

> Residential mortgage loans
>   available for sale are reflected on the balance sheet at lower of cost or market.
>   The market value used is based on the acquisition price by third party
>   investors.

-5-

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D.   
ALLOWANCE FOR LOAN LOSSES

An analysis of the changes in the allowance for loan and lease losses follows (in thousands):

|                                                              | Three
    Months
    Ended
    September 30, 2001 |  | Nine Months
    Ended
    September 30, 2001
|------------------------------------------------------------- | ------------------------------------------------- |  | --------------------------------------------
|                                                              |                                                   |  |                                             
|Balance, beginning of
    period                              | $  
    4,962                                     |  | $  
  4,622                                 
|Provision charged to
    operations                           | 658                                               |  | 1,600                                       
|Loans charged off                                             | (743)                                             |  | (1,396)                                     
|Recoveries                                                    | 18                                                |  | 69                                          
|Balance, end of period                                        | $  
  4,895                                       |  | $  
  4,895                                 
|                                                              | =========                                         |  | ========                                    
|Allowance ratios are as
    follows:                          |                                                   |  |                                             
|Balance, to loans and leases outstanding, end of period       | 1.51%                                             |  | 1.51%                                       
|Net charge-offs to average loan and lease losses (annualized) | 0.91                                              |  | 0.59                                        

E.    INCOME TAXES

> Actual income tax expense for the three
>   and nine months ended September 30, 2001 and 2000, respectively, differed from "expected" tax expense (computed by applying the U.S. Federal corporate tax rate of 34% to income before
>   provision for income taxes) as follows (in thousands):

|                                          | Three Months Ended
 September 30, | Nine Months
Ended September 30,
|----------------------------------------- | --------------------------------- | -------------------------------
|                                          | 2001                              | 2000                           
|Computed "expected" tax
expense           | $   465                           | $   450                        
|State tax expense, net of federal
benefit | 54                                | 50                             
|Other                                     | 3                                 | 23                             
|Total
income tax expense                  | $   522                           | $   523                        
|                                          | ======                            | ======                         

> Significant temporary differences and carry forwards that give rise to the deferred tax assets and liabilities are as follows (in thousands):

|                                                                                                | As of
September 30, 2001 |  | As of
December 31, 2000
|----------------------------------------------------------------------------------------------- | ------------------------ |  | -----------------------
|Deferred tax assets:                                                                            |                          |  |                        
|Deferred fees, principally due to timing differences in the recognition of
      income         | $    301                 |  | $    278               
|Net operating loss carry forwards                                                               | 218                      |  | 218                    
|Loans, principally due to provision for loan losses                                             | 1,006                    |  | 421                    
|Premises and equipment, principally due to differences in 
     depreciation methods            | 52                       |  | 49                     
|Other                                                                                           | 294                      |  | --                     
|Total gross deferred tax assets                                                                 | 1,871                    |  | 966                    
|                                                                                                |                          |  |                        
|Deferred tax liabilities:                                                                       |                          |  |                        
|Unrealized gain on securities available for sale                                                | (1,029)                  |  | (37)                   
|Discount on investment securities deferred for tax purposes                                     | (91)                     |  | (99)                   
|Leases, principally due to difference in basis acquired and the 
         recognition of income | (226)                    |  | (260)                  
|Federal Home Loan Bank stock dividend and other liabilities                                     | (228)                    |  | (140)                  
|Total gross deferred tax liabilities                                                            | (1,574)                  |  | (536)                  
|Net deferred tax assets                                                                         | $    297                 |  | $     
430             
|                                                                                                | =======                  |  | ========               

-6-

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F.   
EARNINGS PER COMMON SHARE

> The basic earnings per share
>   ratio ("EPS") is computed by dividing net income by the weighted-average number of common shares outstanding during the period. Diluted EPS is computed by dividing net income by the weighted-average number of common shares and potentially dilutive common shares outstanding during the period. The Company had outstanding stock options totaling
>   409,250 and 455,677 shares at September 30, 2001 and September 30, 2000, respectively. The following table is a reconciliation of average shares outstanding used in calculating basic and diluted earnings per share (in thousands, except per share amounts).

|                                            | Three Months EndedSeptember 30, | Nine Months
EndedSeptember 30,
|------------------------------------------- | ------------------------------- | ------------------------------
|                                            | 2001                            | 2000                          
|Net income                                  | $845                            | $800                          
|                                            | =====                           | =====                         
|Weighted-average common shares outstanding  | 3,232                           | 3,519                         
|Dilutive common shares from options         | 22                              | 2                             
|Weighted-average
diluted shares outstanding | 3,254                           | 3,521                         
|                                            | =====                           | =====                         
|Net income per share:                       |                                 |                               
|Basic                                       | $   0.26                        | $   0.23                      
|Diluted                                     | $0.26                           | $   0.23                      
|                                            |                                 |                               

G.    
COMPREHENSIVE INCOME

> During the three and
> nine months ended September 30, 2001 and 2000, the only component of comprehensive income, other than net income, is changes in unrealized gains or losses on investment securities available for sale and derivative financial instruments, net of taxes.



H.    
RECLASSIFICATIONS

> During the first quarter 2001, the Company reclassified its loan portfolio to reflect the business purpose of the loans and reclassified the categorization at December 31, 2000 for comparative purposes. The Company's loan portfolio
>   was historically classified by collateral codes. Such reclassifications do not
>   affect earnings.

-7-

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I.    
NEW ACCOUNTING PRONOUNCEMENTS

> Derivative
>   Financial Instruments. On January 1, 2001, the Company adopted the
>   Financial Accounting Standards Board ("FASB")
>   Statement of Financial Accounting Standards No. 133, Accounting for Derivative
>   Instruments and Hedging Activities, ("SFAS 133"). SFAS 133
>   establishes accounting and reporting standards for derivative instruments and
>   hedging activities. Under the standard, all derivatives must be measured at
>   fair value and recognized as either assets or liabilities in the statement of
>   financial condition. In addition, hedge accounting should only be provided for
>   transactions that meet certain specified criteria. The accounting for changes
>   in fair value (gains and losses) of a derivative is dependent on the intended
>   use of the derivative and its designation. Derivatives may be used to (i)
>   hedge exposure to changes in the fair value of a recognized asset or liability
>   or a firm commitment, referred to as a fair value hedge, (ii) hedge exposure
>   to variable cash flow of forecasted transactions, referred to as a cash flow
>   hedge, or (iii) hedge foreign currency exposure. As of January 1, 2001, the
>   Company had no derivative instruments other than certain investment securities
>   available for sale, which are already recorded at their fair value.
>   Accordingly, the adoption of SFAS 133 did not impact the Company's results
>   of operations, cash flows, or financial position.

> On March 26, 2001, the Company entered into a $10.0 million interest rate swap which matures on October 17, 2008 under which the Company will pay the counterparty a variable rate of three-month LIBOR plus five basis points and will receive a fixed rate of 6.00%. Interest payments are settled and variable rates reset quarterly. The counter party has the option to terminate the swap, in whole or in part, on April 17, 2002 and semi-annually thereafter. Management designated the interest rate swap as a fair value hedge of $10.0 million of brokered time deposits issued by the Company on March 26, 2001. The 6.00% fixed rate, brokered time deposits mature on October 17, 2008 and are callable by the Company on March 26, 2002 and semi-annually thereafter. In the
> third quarter of 2001, the Company recorded an unrealized gain of $42,000 for the market value adjustment on this fair value hedge instrument that was offset by a
> $42,000 increase in the market value of the 6.00% fixed rate, brokered time deposits.
> On May 24, 2001, the Company entered into a $15.0 million interest rate swap agreement which matures on November 25, 2002 under which the Company will pay the counterparty a fixed rate of 4.53% and will receive a variable rate of three-month LIBOR less
> six basis points. Interest payments are settled and variable rates reset quarterly. Management designated the interest rate swap as a cash flow hedge of $15.0 million of $25.0 million in Federal Home Loan Bank advances entered into by the Company on May 24, 2001.
> For the third quarter of 2001, the cash flow hedge of long-term debt resulted in
> a decrease of $194,000 in other comprehensive income, net of taxes of $120,000,
> with a $314,000 offset to unrealized derivative loss.
> On July 19, 2001, the
> Company entered into a $10.0 million interest rate swap agreement which matures
> on October 19, 2002 under which the Company will pay the counterparty a fixed
> rate of 4.205% and will receive a variable rate of three-month LIBOR. Interest
> payments are settled and variable rates reset quarterly. Management designated
> the interest rate swap as a cash flow hedge of $10.0 million in variable rate
> Federal Home Loan Bank advances entered into by the Company on July 19, 2001.
> For the third quarter of 2001, the cash flow hedge of long-term debt resulted in
> a decrease of $101,000 in other comprehensive income, net of taxes of $63,000,
> with a $164,000 offset to unrealized derivative loss.

> The high degree of effectiveness of the Company's derivative financial instruments resulted in no impact to consolidated net income for the three
> and nine months ended September 30, 2001.

> Business Combinations, Goodwill, and Intangible Assets.

The Company is required
to adopt the provisions of SFAS 141 immediately, and SFAS 142 effective January
1, 2002. Furthermore, goodwill and intangible assets determined to have an indefinite
useful life acquired in a purchase business combination will not be amortized, but will
continue to be evaluated for impairment.

SFAS 141 will require
upon adoption of SFAS 142, that the Company evaluate its existing intangible
assets and goodwill that were acquired in a prior purchase business combination,
and to make any necessary reclassifications in order to conform with the new
criteria in SFAS 141 for recognition apart from goodwill. Upon adoption of SFAS
142, the Company will be required to reassess the useful lives and residual
values of all intangible assets acquired, and make any necessary amortization
period adjustments by the end of the first interim period after adoption. In
addition to the extent an intangible asset is identified as having an indefinite
useful life, the Company will be required to test the intangible asset for
impairment in accordance with the provisions of SFAS 142 within the first
interim period. Any impairment loss will be measured as of the date of adoption
and recognized as the cumulative effect of a change in accounting principle in
the first interim period.

In connection with SFAS
142's transitional goodwill impairment evaluation, SFAS 142 will require the
Company to perform an assessment of whether there is an indication that goodwill
(and equity-method goodwill) is impaired as of the date of adoption. To
accomplish this, the Company must identify its reporting units and determine the
carrying value of each reporting unit by assigning the assets and liabilities,
including the existing goodwill and intangible assets, to those reporting units
as of the date of adoption. The Company will then have up to six months from the
date of adoption to determine the fair value of each reporting unit and compare
it to the reporting unit's carrying amount. To the extent a reporting unit's
carrying amount exceeds its fair value, an indication exists that the reporting
unit's goodwill may be impaired and the Company must perform the second step of
the transitional impairment test. In the second step, the Company must compare
the implied fair value of the reporting unit's goodwill, determined by
allocation of the reporting unit's fair value to all of its assets (recognized
and unrecognized) and liabilities in a manner similar to a purchase price
allocation in accordance with SFAS 141, to its carrying amount, both of which
would be measured as of the date of adoption. This second step is required to be
completed as soon as possible, but no later than the end of the year of
adoption. Any transitional impairment loss will be recognized as the cumulative
effect of a change in accounting principle in the Company's statement of
earnings. Any unamortized negative goodwill existing when SFAS 142 is adopted
must be written off as the cumulative effect of a change in accounting
principle.

At September 30, 2001,
the Company had unamortized goodwill of $207,000. As of the date of adoption,
the Company expects to have unamortized goodwill in the amount of $203,000,
which will be subject to the transition provisions of SFAS 141 and 142.
Amortization expense related to goodwill was $11,000 and $14,000 for the nine
months ended September 30, 2001 and the year ended December 31, 2000,
respectively. Because of the extensive effort needed to comply with adopting
SFAS 141 and 142, it is not practicable to reasonably estimate the impact of
adopting these statements on the Company's financial statements at the date of
this report, including whether it will be required to recognize any transitional
impairment losses as the cumulative effect of a change in accounting principle.

> -8-
>   
> 
> Allowance for Loan and Lease Losses. In July 2001, the Office of the Chief Accountant and the Division of Corporation Finance of the Securities and Exchange Commission (the "Commission") released Staff Accounting Bulletin No. 102, ("SAB 102"), Selected Loan Loss Allowance Methodology and Documentation Issues, which provides certain views of the staff on the development, documentation, and application of a systematic loan loss allowance methodology.
> SAB 102 does not change any of the accounting profession's existing rules on
> accounting for loan loss provision or allowances. Rather, SAB 102 draws upon
> existing guidance. Commission rules and interpretations, accounting principles
> generally accepted in the United States of America, and auditing standards
> generally accepted in the United States of America, and explains
> certain views of the staff in applying existing guidance related to loan loss
> allowance methodologies and supporting documentation. SAB 102 is effective
> immediately. The Company does not expect SAB 102 to have a significant impact on
> its financial statements.

> Asset Retirement Obligations. In July 2001, FASB issued
> No. 143 ("SFAS 143"), "Accounting for Asset Retirement
> Obligations". That standard requires entities to record the fair value of a liability for an asset retirement obligation in the period in which it is incurred. When the liability is initially recorded, the entity will capitalize a cost by increasing the carrying amount of the related long-lived asset. Over time, the liability is accreted to its present value each period, and the capitalized cost is depreciated over the useful life of the related asset. Upon settlement of the liability, an entity either settles the obligation for its recorded amount or incurs a gain or loss upon settlement. The standard is effective for fiscal years beginning after
> September 15, 2002, with earlier adoption permitted. The Company has not determined the impact of adopting this standard.
> In August 2001, the
> FASB issued Statement No. 144, Accounting for the Impairment or Disposal of
> Long-Lived Assets ("SFAS 144"), which supersedes both FASB
> Statement No. 121 ("SFAS 121"), Accounting for the Impairment of Long-Lived Assets and for
> Long-Lived Assets to Be Disposed Of and the
> accounting and reporting provisions of APB Opinion No. 30, Reporting the
> Results of Operations - Reporting the Effects of Disposal of a Segment of
> Business, and Extraordinary, Unusual and Infrequently Occurring Events and
> Transactions ("Opinion 30"), for the disposal of a segment of a
> business (as previously defined in that Opinion). SFAS 144 retains the
> fundamental provisions in SFAS 121 for recognizing and measuring impairment
> losses on long-lived assets held for use and long-lived assets to be disposed of
> by sale, while also resolving significant implementation issues associated with
> SFAS 121. For example, SFAS 144 provides guidance on how a long-lived asset that
> is used, as part of a group should be evaluated for impairment, establishes
> criteria for when a long-lived asset is held for sale, and prescribes the
> accounting for a long-lived asset that will be disposed of other than by sale.
> SFAS 144 retains the basic provisions of Opinion 30 on how to present
> discontinued operations in the income statement but broadens that presentation
> to include a component of an entity (rather than a segment of a business). Rather, goodwill is evaluated for impairment under SFAS
> No. 142, Goodwill and Other Intangible Assets.
> The Company is required
> to adopt SFAS 144 no later than the year beginning after December 15, 2001, and
> plans to adopt its provisions for the quarter ending March 31, 2002. Management
> does not expect the adoption of SFAS 144 for long-lived assets held for use to
> have a material impact on the Company's financial statements because the
> impairment assessment under SFAS 144 is largely unchanged from SFAS 121. The
> provisions of the Statement for assets held for sale or other disposal generally
> are required to be applied prospectively after the adoption date to newly
> initiated disposal activities. Therefore, management cannot determine the
> potential effects that adoption of Statement 144 will have on the Company's
> financial statements.



J.     COMMITMENTS AND CONTINGENCIES

> In the normal course of business, there are various commitments outstanding to extend credit, such as the
> funding of undrawn lines of credit or standby letters of credit, which accounting principles generally
> accepted in the United States of America do not require to be recognized in the financial statements. The Company, through
> regular reviews of these arrangements, does not anticipate any material losses as a result of these transactions. At
> September 30, 2001
> and December 31, 2000, the Company had unfunded commitments to extend credit totaling
> $122.1 million and $71.5 million, respectively.
> Additionally, the Company had standby letters of credit of $6.6 million and $5.6 million as of
> September 30, 2001 and December 31, 2000,
> respectively.
> In the normal course of
> business, there are various commitments to sell certain mortgage loans to third
> party investors, residential mortgage loans available for sale are reflected on
> the balance sheet at lower of cost or market. The market value used is based on
> the acquisition price by third party investors.

> The Bank is required to maintain average balances with the Federal Reserve Bank and in vault cash to meet its reserve requirements. The average amount of these balances at the Federal Reserve Bank and vault cash for the three-month period ended
> September 30, 2001, totaled approximately $1.3 million, the required balance at
> September 30, 2001 was $250,000. Management is of the opinion that the vault cash balances maintained are adequate.



-9-

---

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations



Special Cautionary Notice Regarding Forward-Looking Statements

> 

Statements and financial discussion and analysis contained in this report on Form 10-Q and documents incorporated herein by reference that are not historical facts are forward-looking statements made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Any forward-looking statements contained herein describe the future plans, strategies and expectations of Community Financial Group, Inc. and are based on assumptions and involve a number of risks and uncertainties, many of which are beyond the Company's control. The important factors that could cause actual results to differ materially from the results, performance or achievements expressed or implied by the forward-looking statements include, without limitation:

- Changes in interest rates and market prices, which could reduce the Company's net interest margins, asset valuations and expense expectations;
- Changes in the levels of loan prepayments and the resulting effects on the value of the Company's loan portfolio;
- Changes in local economic and business conditions which adversely affect the ability of the Company's customers to transact profitable business with the Company, including the ability of borrowers to repay their loans according to their terms or a change in the value of the related collateral;
- Increased competition for deposits and loans adversely affecting rates and terms;
- The Company's ability to identify suitable acquisition candidates;
- The timing, impact and other uncertainties of the Company's ability to enter new markets successfully and capitalize on growth opportunities;
- Increased credit risk in the Company's assets and increased operating risk caused by a material change in commercial, consumer and/or real estate loans as a percentage of the total loan portfolio;
- The failure of assumptions underlying the establishment of and provisions made to the allowance for loan and lease losses;
- Changes in the availability of funds resulting in increased costs or reduced liquidity;

> Asset levels and changes in the composition of assets and the resulting impact on
>       capital levels and regulatory capital ratios;

> The Company's ability to acquire, operate and maintain cost effective and efficient systems without incurring unexpectedly difficult or expensive but necessary technological changes;

> The loss of senior management or operating personnel and the potential inability to hire qualified personnel at reasonable compensation levels;

> Changes in statutes and government regulations or their interpretations applicable to bank holding companies and our present and future banking and other subsidiaries, including changes in tax requirements and tax
>       rates

- Heightened economic and political uncertainties existing after September 11,
    2001.

> The Company undertakes no obligation to publicly update or otherwise revise any forward-looking statements, whether as a result of new information, future events or otherwise. All written or oral forward-looking statements attributable to the Company are expressly qualified in their entirety by these cautionary statements.

-10-

---

Overview

> Community Financial Group, Inc. is a registered bank holding company under the Federal Reserve Holding Company Act of 1956, as amended. CFGI owns the Bank of Nashville and its subsidiaries. The Bank owns
> TBON-Mooreland Joint Venture, LLC and a majority interest in Machinery Leasing Company of North America, Inc.
> T

> The Bank operates from its main office at 401 Church Street, Nashville, Tennessee as well as three full-service branches located at the Glendale Center in Green Hills, Maryland Farms in Brentwood and Gallatin Road in Hendersonville. The Company has received regulatory approval to establish a fifth branch office in the Cool Springs area which is expected to open during the
> first quarter 2002. In January 2001, the Company expanded its presence in downtown Nashville through the addition
> of
> 11,000 square feet of contiguous space in the building adjacent to its main location. Management plans to continue to seek attractive branch locations to further expand its delivery systems and increase its market share.
> Additional banking services are provided through full-service mobile branches, "Bank-on-Call," which was established in 1996 and has expanded in each subsequent year. Bank-on-Call provides the convenience of "at your door" banking service to customers. Additionally, the Bank has expanded its delivery systems through full-service ATMs, cash dispensers, cash management services, and "Bank-on-Line" Internet banking services. The Company has offered Internet banking services to its consumer clients since early 1999 including a complete array of Net-based banking services for commercial customers comprising basic internet banking, bill payment services as well as full cash management services including ACH origination and wire transfers.
> During the third quarter of 2001, the Company continued the expansion of its leasing business through TBON Leasing and its investment services through the Bank of Nashville Investment Group and its relationship with Legg Mason Financial Partners, Inc.
> ("LMFP"). As of September 30, 2001, the total assets under management
> by the Bank of Nashville Investment Group through LMFP were $298.5 million
> compared with $239.9 million at year-end December 31, 2000. In January 2001, the Company established TBON Mortgage as an operating division of the Bank, primarily to originate and sell, on a servicing released basis, residential mortgages.
> For the three month period ended September 30, 2001, origination volume was $9.3 million, of which
> $600,000 was retained in portfolio, $8.6 million was sold to third party investors, and
> $1.9 million remains available for sale. Origination volume for the nine months
> ended September 30, 2001 was $22.6 million, of which $3.5 million was retained
> in portfolio, $16.3 million was sold to third party investors, and $1.9 million
> remains available for sale.
> Commencing in 1999, the Company approved and implemented
> three stock repurchase plans. As of September 30, 2001, the Company had repurchased a total of
> 1,227,770 shares pursuant to such plans. An additional 77,230 shares remain available for repurchase under the
> third plan that expires December 31, 2001.
>   -11-
>   
> 
> The primary lending focus of the Company is on small and medium-sized
> commercial
> businesses, construction and land development, residential mortgages and consumer loans. The Company offers a variety of commercial lending products including term loans, lines of credit and equipment financing. A broad range of short- to medium-term commercial loans, both collateralized and
> uncollateralized, are made available to businesses for working capital (including inventory and receivables), business expansion (including acquisitions of real estate and improvements) and the purchase of equipment and machinery. The purpose of a particular loan generally determines its structure.
> Generally, the Company's commercial loans are underwritten in the greater Nashville metropolitan area on the basis of the borrower's ability to service such debt from cash flow. As a general practice, the Company takes as collateral a lien on any available real estate, equipment or other assets. Highly liquid or current assets primarily collateralize working capital loans whereas long-term assets primarily collateralize term loans.
> A substantial portion of the Company's real estate loans consists of loans collateralized by real estate and other assets of commercial customers. Additionally, a portion of the Company's residential lending activity consists of the origination of single-family residential mortgage loans collateralized by owner-occupied properties located in the Company's primary market area. The Company offers a variety of mortgage loan products which generally are for terms of five to 30 years. The majority of the residential loans are closed on the Company's books but sold to third party investors on a servicing released basis.
> The Company also provides residential and commercial construction financing to builders and developers. Loans collateralized by single-family residential real estate generally have been originated in amounts of no more than 90% of appraised value. The Company requires mortgage title insurance and hazard insurance in the amount of the loan. Although the contractual loan payment periods for single-family residential real estate loans are generally for a 15 to 30 year period, such loans often remain outstanding for significantly shorter periods than their contractual terms.
> Residential construction financing to builders generally has been originated in amounts not exceeding 80% of appraised value. The Company requires a mortgage title binder and builder's risk insurance in the amount of the loan. The contractual loan payment periods for residential construction loans are generally for a
> nineto twelve month period.
> Consumer loans include automobile, recreational vehicle,
> and boat loans, home equity lines of credit, home improvement and personal loans (collateralized and
> uncollateralized), and deposit account collateralized loans. The terms of these loans typically range from 12 to 120 months and vary based upon the nature of collateral and size of the loan.
>   -12-
>   
> 
> The Company outsources certain non-core competencies. Currently, item processing and imaging functions
> are outsourced to The Intercept Group, Inc. In June 2001, the Company entered upon an agreement with Fiserv
> (Nasdaq: "FISV") a leading technology firm to provide core data and item processing as well as imaging services commencing during the first quarter of 2002. The accounting, financial reporting
> and the internal audit functions have been outsourced to the Nashville-based certified public accounting firm of Kraft
> Bros., Esstman Patton & Harrell, PLLC, an independent member of RSM
> McGladrey, Inc. The relationship with this certified independent public accounting firm provides the Company with access to both the resources of
> a large national accounting and consulting firm while at the same time receiving the individualized attention and fee structure
> provided by a local firm.
> Management is of the opinion that by outsourcing non-core competencies to professional organizations with expertise in their respective field of operations, it can avail itself of professional skills and state-of-the-art systems and technologies that would otherwise not be cost efficient because of economies of scale. The Company believes that these outsourcing agreements have allowed it to remain a customer driven organization, while at the same time continue improving the quality of its management information systems, the timeliness of reports needed by management to run the organization and better control over non-interest expenses.
> During the three months
> ended September 30, 2001, the Company completed the first of four phases related
> to the core system conversion program by implementing a new general ledger
> structure. The new general ledger, together with the data warehousing services
> provided by EarningsInsights, a division of Atlantic Data Services, Inc., (Nasdaq:
> "ADSC"), is expected to facilitate the measurement of profitability by
> branch, business line, account officer, customer relationship and product.
> Management is of the opinion that, over time, the new system should result in
> improved efficiency and enhanced profits. During the third quarter of 2001, the
> Company commenced implementation of the second phase of the core system
> conversion which encompasses an upgrade of the telecommunication systems and an
> increase in bandwidth capacity. The third and fourth phases, including network
> servers and the new core processing system are expected to be operational by the
> first quarter 2002.
> General.
> Net income for the three months ended
> September 30, 2001 and 2000 was $845,000 and $800,000, respectively. Basic and
> Diluted EPS for the three months ended September 30, 2001 were $0.26 compared with $0.23 respectively, for the same
> period in 2000. Net income for the
> nine months ended September 30, 2001 and 2000 increased by $76,000 or 3.1% to
> $2.6 million. Basic and diluted EPS for the nine months ended September 30, 2001 were $0.77 compared with
> $0.68 and $0.67, respectively, for the same period in 2000. 
> At September 30, 2001,
> and December 31, 2000 total assets and net loans were $473.4 million and $319.3 million, respectively, compared with $354.6 million and $265.9 million,
> respectively.
> At September 30, 2001, and December 31, 2000 total liabilities and total shareholders' equity
> were $433.5 million and $39.8 million, respectively, compared with $312.3 million and $42.3 million, respectively, at December 31, 2000.
> For the nine months
> ended September 30, 2001 and 2000, the annualized return on average assets was
> 0.81%  and 1.04%, respectively. The decrease in the return on average assets resulted from
> a greater percentage of investment income on investments securities to total
> interest income which generally have lower yields than loans, and reduced loan yields resulting from
> declining interest rates. The increase in the percent of investment income resulted
> from the leverage strategy in fixed income securities designed to offset the
> decline in interest income on loans and the costs associated with the new core processing system.
> For the nine months ended September 30, 2001 and 2000, the annualized return on average equity was
> 8.33%, and 7.42%, respectively. The increase in annualized return on average equity reflected the Company's increased net income and a reduction in average equity
> resulting from the stock repurchase program.
>   -13-
>   
> 
> Net Interest Income. Net interest income is the principal component of the Company's income stream and represents the difference or spread between interest generated from earning assets and interest paid on interest-bearing liabilities. Fluctuations in interest rates, volume and mix changes in earning assets and, non-interest and interest-bearing liabilities,
> impact net interest income.
> The following table
> presents the dollar amount of changes in interest income and interest expense
> for the major components of interest earning assets and interest-bearing
> liabilities and distinguishes between the increase related to higher outstanding
> balances and changes in interest rates for the three and nine-month periods
> ended September 30, 2001 as compared with the same periods for September 30,
> 2000. For purposes of these tables, changes attributable to both rate and volume
> have been allocated to rate.

|                                                                       | Three
      months ended September 30,  | Nine
      months ended September 30,
|---------------------------------------------------------------------- | --------------------------------------- | -------------------------------------
|                                                                       | 2001
      vs. 2000                     | 2001
      vs. 2000                  
|                                                                       | Increase
      (Decrease) 
      Due to |                                      
|                                                                       | Volume                                  | Rate                                 
|                                                                       | (Dollars
      in thousands)           
|Interest-earning
      assets:                                         |                                         |                                      
|Total
      loans                                                      | $ 
      4,490                          | $ (3,815)                            
|Taxable
      securities                                               | 955                                     | (525)                                
|Tax-exempt securities                                                  | (23)                                    | 33                                   
|Federal
      funds sold and other temporary
            investments   | 182                                     | (43)                                 
|Total increase (decrease) in interest
                   
      income | 5,604                                   | (4,350)                              
|Interest-bearing
      liabilities:                                    |                                         |                                      
|NOW and
      money market accounts                                    | 1,425                                   | (1,747)                              
|Time
      deposits                                                    | 1,409                                   | (997)                                
|Federal
      funds purchased                                          | 297                                     | (401)                                
|FHLB and
      other borrowings                                        | 1,009                                   | (269)                                
|Total increase (decrease) in interest
                  expense        | 4,140                                   | (3,414)                              
|Increase (decrease) in
      net interest income                       | $ 1,464                                 | $  
      (936)                      
|                                                                       | ======                                  | ======                               

> -14-
> 
> 
> 
>   The following tables present the total dollar amount of interest income from average interest-earning assets and the resultant yields, as well as the interest expense on average interest-bearing liabilities, expressed both in dollars and rates for the three and
>   nine-month periods ended September 30, 2001 and 2000. No tax-equivalent adjustments were made and all average balances are yearly average balances. Non-accruing loans have been included in the tables as loans having a zero yield.
>   For the three months
>   ended September 30, 2001 and 2000, net interest margin (net interest income
>   expressed as a percentage of average earning assets) was 3.72% and 4.56%,
>   respectively. The decline in net interest margin resulted from the combined
>   effects of the Company's short-term asset sensitive position and increase in lower
>   yielding investment securities.

|                                                                                           | For
      the three months ended September 30,
|------------------------------------------------------------------------------------------ | ----------------------------------------------
|                                                                                           | 2001                                          
|                                                                                           | Average
      OutstandingBalance              
|ASSETS                                                                                     |                                               
|Interest-earning
      assets:                                                             |                                               
|Total
      loans and leases                                                               | $ 319,923                                     
|Taxable
      securities                                                                   | 111,068                                       
|Tax-exempt securities                                                                      | 2,375                                         
|Federal funds sold and
      other temporary investments                                   | 19,286                                        
|Total interest earning assets                                                              | 452,652                                       
|Less allowance for loan and lease losses                                                   | (5,158)                                       
|Total interest-earning
      assets, net of allowance
          for loan losses            | 447,494                                       
|Non-earning assets                                                                         | 23,743                                        
|TOTAL ASSETS                                                                               | $ 471,237                                     
|                                                                                           | ========                                      
|LIABILITIES AND
       SHAREHOLDERS' EQUITY                                                |                                               
|Interest-bearing
      liabilities:                                                        |                                               
|NOW and
      money market accounts                                                        | 129,240                                       
|Time
      deposits                                                                        | 174,454                                       
|Federal
      funds purchased and securities 
            sold under repurchase agreements | 1,417                                         
|FHLB and
      other borrowings                                                            | 89,005                                        
|Total interest-bearing liabilities                                                         | 394,116                                       
|Noninterest- bearing
      liabilities:                                                    |                                               
|Noninterest-bearing demand deposits                                                        | 33,671                                        
|Other
      liabilities                                                                    | 4,257                                         
|TOTAL LIABILITIES                                                                          | 432,044                                       
|                                                                                           |                                               
|SHAREHOLDERS' EQUITY                                                                       | 39,193                                        
|                                                                                           |                                               
|TOTAL LIABILITIES AND
            SHAREHOLDERS' EQUITY                                     | $ 471,237                                     
|                                                                                           | ========                                      
|NET INTEREST INCOME                                                                        |                                               
|                                                                                           |                                               
|NET INTEREST SPREAD                                                                        |                                               
|                                                                                           |                                               
|NET INTEREST MARGIN                                                                        |                                               
|                                                                                           |                                               

> -15-
> 
> 
> 
> 
>   For the nine months
>   ended September 30, 2001 and 2000, net interest margin (net interest income
>   expressed as a percentage of average earning assets) was 4.03% and 4.60%,
>   respectively. The decline in net interest margin resulted primarily from the
>   Company's short-term asset sensitive position.

|                                                                                           | For
      the nine months ended September 30,
|------------------------------------------------------------------------------------------ | ---------------------------------------------
|                                                                                           | 2001                                         
|                                                                                           | Average
      OutstandingBalance             
|ASSETS                                                                                     |                                              
|Interest-earning
      assets:                                                             |                                              
|Total
      loans and leases                                                               | $ 300,137                                    
|Taxable
      securities                                                                   | 88,338                                       
|Tax-exempt securities                                                                      | 2,363                                        
|Federal funds sold and
      other temporary investments                                   | 11,745                                       
|Total interest earning assets                                                              | 402,584                                      
|Less allowance for loan and lease losses                                                   | (4,950)                                      
|Total interest-earning
      assets, net of allowance
          for loan losses            | 397,633                                      
|Non-earning assets                                                                         | 22,728                                       
|TOTAL ASSETS                                                                               | $ 420,361                                    
|                                                                                           | =======                                      
|LIABILITIES AND
       SHAREHOLDERS' EQUITY                                                |                                              
|Interest-bearing
      liabilities:                                                        |                                              
|NOW and
      money market accounts                                                        | 119,557                                      
|Time
      deposits                                                                        | 157,868                                      
|Federal
      funds purchased and securities 
            sold under repurchase agreements | 1,236                                        
|FHLB and
      other borrowings                                                            | 62,704                                       
|Total interest-bearing liabilities                                                         | 341,365                                      
|Non-interest bearing
      liabilities:                                                    |                                              
|Noninterest-bearing demand deposits                                                        | 31,968                                       
|Other
      liabilities                                                                    | 6,085                                        
|TOTAL LIABILITIES                                                                          | 379,418                                      
|                                                                                           |                                              
|SHAREHOLDERS' EQUITY                                                                       | 40,943                                       
|                                                                                           |                                              
|TOTAL LIABILITIES AND
            SHAREHOLDERS' EQUITY                                     | $ 420,361                                    
|                                                                                           | =======                                      
|NET INTEREST INCOME                                                                        |                                              
|                                                                                           |                                              
|NET INTEREST SPREAD                                                                        |                                              
|                                                                                           |                                              
|NET INTEREST MARGIN                                                                        |                                              
|                                                                                           |                                              

> -16-
> 
> 
>   Management and the Asset Liability Committee of the Board of Directors ("ALCO") continue to review various strategies to enhance net interest income and improve
>   funding. These include but are not limited to the issuance of wholesale and brokered CDs, increased levels of borrowings from the
> FHLB, and the implementation of future leveraging strategies. At September 30, 2001 the Company had
>   $89.0 million in FHLB borrowings compared with $36.2 million at December 31, 2000.
>   During the three months ended
>   September 30, 2001, the Company added $658,000 to the provision for loan and lease losses, compared with
>   $360,000 during the same period of 2000. The increase in the provision is attributable to the
> growth in the loan portfolio and a $1.6 million increase in the level of non-performing assets. There
>   was one $422,000 loan 90 days or more past due and still accruing interest at
>   September 30, 2001. There were no loans 90 days or more past due and still
>   accruing interest at September 30, 2000. Subsequent to quarter-end September 30, 2001, the $422,000
>   reported under the 90 days or more past due and still accruing interest
>   category has been fully repaid.
> Non-Interest Income. For the
> three months ended September 30, 2001, non-interest income increased by $252,000 or
> 35.4% to $964,000 from $712,000 for the same period in 2000. Included in non-interest income for the three months ended
> September 30,
>   2001 was $387,000 investment center income which
>   decreased by $20,000, $309,000 in service charges on deposit accounts which
>   increased by $89,000, and $175,000 in residential mortgages origination fees which resulted from the Residential Mortgage lending division which commenced operations in January 2001.
> For the
> nine-month period ending September 30, 2001, non-interest income increased by
> $687,000 or 34.5% to $2.7 million compared with $2.0 million for the same period
> in 2000. Included in non-interest income for the nine months ended September 30,
> 2001
>   were $960,000 in service charges on
>   deposit accounts, which increased by $307,000, $1.2 million in investment
>   center income, which increased by $67,000 and $305,000 in residential mortgage
>   origination fees. The increase in residential origination income reflects the
>   Company's continued efforts to diversify its sources of non-interest income.
>   Non-Interest Expense. During the three months ended
>   September 30, 2001, non-interest expense increased by $438,000, or 16.1%, to
>   $3.2 million, compared with the same period in 2000. This increase was the result of increases of
>   $355,000 in salaries and employee benefits and $81,000 in occupancy expense resulting from higher salaries and employee benefits and occupancy expense related to the expansion in loan origination and administration staff.
> During the nine-month period ending on
> September 30, 2001 total non-interest expense increased by $1.5 million, or
> 19.6%, compared with the same period of 2000. The increase resulted from a $1.1
> million increase in salaries and employee benefits, and a $117,000 increase in other non-interest expense. The increase in other non-interest expense resulted primarily from higher expenses related to expansion of the Company's accounts receivable financing and residential mortgage lending programs. At
> September 30, 2001, the Company had 104 employees compared with 94 employees at
> September 30, 2000. Plans for the remainder of year 2001 include continued expansion in lending and support areas of the Company's commercial banking activities, expansion of consumer banking services, and further expansion of the Company's investment center services. It is expected that the Company's non-interest expense will also increase during the remainder of 2001 due to
> aforementioned factors and technology investments necessary to enhance the
> Company's product and service delivery capabilities.
> Income Taxes. During the three months ended
> September 30, 2001, the Company recorded provision for income taxes of $522,000, compared with
> $523,000 during the same period in 2000. The effective tax rate for each three-month period was 38.2% and
> 39.5%, respectively. During the first nine months of
> 2001, the Company recorded a provision for income taxes of $1.6 million, compared with
> $1.6 million recorded for the same period of 2000. The effective tax rate for each
> nine-month period was 38.3% and 38.5%, respectively.

-17-

---

FINANCIAL CONDITION

> Total assets at
>   September 30, 2001, were $473.3 million, an increase of $118.6 million, or
>   33.5%, from December 31, 2000. This increase was due to a $53.7 million increase in total loans outstanding and a
>   $63.5 million increase in investment securities.

> Loan Portfolio

|                                          | As
      ofSeptember 30, 2001 | As
      of December 31, 2000
|----------------------------------------- | ----------------------------- | -----------------------------
|                                          | Amount                        |                              
|Commercial                                | (Dollars
      in thousands) 
|Loans                                     | $ 
      122,941              |                              
|Leases                                    | 15,417                        |                              
|Total commercial loans and leases         | 138,358                       |                              
|Real
      estate mortgage:               |                               |                              
|Residential                               | 14,600                        |                              
|Commercial                                | 96,156                        |                              
|Total real estate mortgage                | 110,756                       |                              
|Real
      estate construction:           |                               |                              
|Residential                               | 3,033                         |                              
|Commercial                                | 38,842                        |                              
|Total real estate construction            | 41,875                        |                              
|Consumer                                  | 33,256                        |                              
|Gross
      loans and leases              | 324,245                       |                              
|Less: allowance for loan and lease losses | (4,895)                       |                              
|Net loans and leases                      | $
      319,350               |                              
|                                          | ======                        |                              

> Non-Performing Assets and Impaired Loans.

At September 30, 2001, non-performing assets, including non-accrual loans,
repossessed equipment and other real estate owned, were $2.9 million, compared with $1.3 million at December 31, 2000. The increase in non-performing assets was primarily the result of
four loans placed on non-accrual in the third quarter of 2001 with an aggregate total value of
$650,000 and one loan recorded as 90 days past due but still accruing for
$422,000, which was in the process of collection and was fully repaid subsequent
to September 30, 2001.

At September 30, 2001 and December 31, 2000, loans on nonaccrual status amounted to
$1.8 million and $776,000, respectively. The effect of nonaccrual loans was to reduce interest income by approximately
$90,000 and $318,000, for the three and nine-month periods ended September 30, 2001, respectively, and $219,000
for the year ended December 31,
  2000. At September 30, 2001, there were no material commitments to lend additional funds to customers whose loans were classified as
nonaccrual.

At September 30, 2001, and December 31, 2000, the Company had
14 and eight impaired loans totaling $2.7 million and $985,000, respectively. In addition to allocated reserves to homogenous loan pools, at
September 30, 2001, the Company had $306,000 in specific reserves allocated against
four of the 14 impaired loans. At December 31, 2000, the Company had $96,000 in specific reserve allocated against two of the eight impaired loans.

-18-

---

The following table presents information regarding non-performing assets at the periods indicated

|                                                                            | As
      of 
      September 30, 2001 | As
      of December 31, 2000
|--------------------------------------------------------------------------- | ------------------------------------- | -----------------------------
|                                                                            | Amount                                |                              
|                                                                            | (Dollars
      in thousands)         
|Nonaccrual
      loans                                                      | $ 
      1,808                        |                              
|Accruing loans 90 days
      or more past due                               | 422                                   |                              
|Repossessed equipment                                                       | 638                                   |                              
|Other real estate
      owned                                               | 37                                    |                              
|Total non-performing assets                                                 | $ 
      2,905                        |                              
|                                                                            | ======                                |                              
|Non-performing
      assets to total loans and leases and other real estate | 0.90%                                 |                              
|Non-performing
      assets to total assets                                 | 0.61                                  |                              

> At September 30, 2001, other potential problem loans were
> $1.9 million compared with $429,000 at December 31, 2000. Other potential problem loans consist of loans that are currently not considered non-performing, but where information about possible credit problems has caused the Company to have concerns as to the ability of the borrower to fully comply with present repayment terms. Depending on economic changes and future events, these loans and others, which may not be presently identified, could become future non-performing assets.
> Allowance for Loan and Lease Losses. The allowance for loan and
> lease losses is established through charges to earnings in the form of a provision for loan losses. Management has established an allowance for loan
> and lease losses, which it believes,
> is adequate for estimated losses inherent in the loan portfolio. Based on an evaluation of the loan portfolio, Management presents a quarterly review of the allowance for loan
> and lease losses to the Board of Directors, indicating any change in the allowance since the last review and any recommendations as to adjustments in the allowance. In making its evaluation, Management considers the industry diversification of the
> loan portfolio, the effect of changes in the local real estate market on collateral values, the results of recent regulatory examinations, the effects on the loan portfolio of current economic conditions and their probable impact on borrowers, the amount of charge-offs for the period, the amount of nonperforming loans and related collateral security, delinquency trends, the evaluation of its loan portfolio
> and loan growth by lending staff and credit administration as well as the loan review function and the annual examination of the Company's financial statements by its independent accountants. Charge-offs occur when loans are deemed to be uncollectible in whole or in part.
> The Company follows a loan review program utilizing both Company staff and independent third party consultants to ensure adequate coverage of all credit exposure and to adequately evaluate the credit risk in the loan portfolio. Through the loan review process, the Company maintains an internally classified loan list which, along with the delinquency list of loans, helps Management assess the overall quality of the loan portfolio and the adequacy of the allowance for loan
> and lease losses. Loans classified as "substandard" are those loans with clear and defined weaknesses such as a highly-leveraged position, unfavorable financial ratios, uncertain repayment sources or poor financial condition, which may jeopardize recoverability of the debt.
> Presently, loans classified as "doubtful" are those loans which have characteristics similar to substandard loans but with an increased risk that a loss may occur, or at least a portion of the loan may require a charge-off if liquidated. Although loans classified as substandard do not duplicate loans classified as doubtful, both substandard and doubtful loans include some loans that are delinquent at least 30 days or on nonaccrual status. Loans classified as "loss" are those loans which are in the process of being charged off.
> In addition to the list of delinquent loans and classified loans, the Company maintains a list of criticized or "Special Mention" loans. These loans have marginal quality which represent
> a higher level of credit risk, but not sufficient to warrant adverse classification. A separate "Watch" list is also maintained which further aids the Company in monitoring the loan portfolio. Watch list loans show warning elements where the present status portrays one or more deficiencies that require attention in the short-term or where pertinent ratios of the loan account have weakened to a point where more frequent monitoring is warranted. These loans do not have all of the characteristics of a classified loan (substandard or doubtful) but show weakened elements compared with those of a satisfactory credit. The Company reviews these loans to assist in assessing the adequacy of the allowance for loan
> lease losses.
>   -19-
> 
> 
> 
> 
> Quarterly,the Company
> utilizes a migration analysis to assess the adequacy of the allowance for loans
> and lease losses taking into account the net charge off rates of homogenous loan
> pools over predetermined historical periods. Due to recent deterioration of the
> economy, during the third quarter of 2001, the Company commenced utilizing
> historical charge off rates for the previous eight quarters. The resulting allowance is then subjectively attuned through an analysis
> of criticized, adversely classified and non-homogenous loan pools. Consequently,
> Company's allowance for loan and lease losses reflects both qualitative and
> quantitative estimates of potential credit losses expected over the life of the
> loans within each risk-rating category for each loan pool in the portfolio.
> Additionally, Management establishes specific allowances for loans and leases, which in its
> opinion require reserves different from those allocated through the use of the
> migration analysis. To accomplish this, Management takes into consideration,
> among others, the classification or delinquency status of the loans,
> availability, type and value of supporting collateral, prevalent economic
> conditions and the financial strength of the borrowers and guarantors.
> The allowance for loan
> and leaselosses is comprised of an allocated and unallocated portion. Both portions of the allowance are available to support inherent losses in the portfolios. The allocated allowance is determined for each classification of both performing and nonperforming loans and leases within the portfolios. This methodology includes but is not limited to:
> (i) the application of allowance allocations for commercial, consumer and real estate loans as well as leases and is calculated using the weighted average loss rates over a defined time horizon based upon the analysis of averages of historical net loan charge-offs incurred within the portfolios by credit quality grade; (ii) a detailed review of all adversely criticized,
> nonperforming, and impaired loans and leases to determine if a specific allowance allocation is required on an impaired loan.
> The unallocated allowance is established for loss exposure that exists in the remainder of the portfolios but has yet to be identified and to compensate for the uncertainty in estimating loan losses, including the possibility of changes in risk ratings of credits. The unallocated allowance is based on Management's best efforts in evaluating various conditions, the effects of which are not directly measured in determining the allocated allowance. The evaluation of the inherent loss related to these conditions involves a higher degree of uncertainty because they are not associated with specific problem credits or portfolio segments. The unallocated allowance represents prudent recognition of the fact that allowance estimates, by definition, lack precision.
> At September 30, 2001 and December 31, 2000, the allowance for loan and lease losses aggregated
> $4.9 million and $4.6 million, or 1.51% and 1.71% of total loans, respectively.
> As of September 30, 2001, the allocated and unallocated portions of the
> allowance were $4.0 million and $851,000, respectively. The unallocated portion
> of the reserve represented 17.4% of the total allowance at September 30, 2001
> compared with 23.5% at December 31, 2000. During the third quarter of 2001, the
> impact of the net charge offs and change in historical statistics utilized on
> the migration analysis performed on the loan portfolio resulted in a shift in
> the allowance from the unallocated to the allocated portion of the allowance.
> Due to the subjectivity involved in the determination of the unallocated portion
> of the allowance for loan and lease losses, the relationship of the unallocated
> component to the total allowance may fluctuate from period to period. Presently,
> management is of the opinion that the reserves are appropriate considering the
> current level of loans and leases and overall asset quality reflected in the portfolio.
> Furthermore, while the allowance for loan and lease losses and the amount of the
> provision for loan and lease losses are established on a quarterly basis, given the
> inherent uncertainties of such an estimation process, no assurance can be given
> as to the adequacy or the ultimate amount of the allowance at any future
> date.
>   -20-
> 
> 
> 
> 
> The following table presents an analysis of the allowance for loan and lease losses and other related data:

|                                                                             | As
      of and for the nine
      months ended
      September 30, 2001 |  | As of and for the twelve months ended December 31, 2000
|---------------------------------------------------------------------------- | ------------------------------------------------------------------------ |  | -------------------------------------------------------
|                                                                             | (Dollars
      in thousands)                                            
|Average loans
      outstanding                                              | $
      300,137                                                          |  | $ 235,432                                              
|                                                                             | ========                                                                 |  | ========                                               
|Total loans
      outstanding at end of period                               | $ 
      324,245                                                         |  | $270,568                                               
|                                                                             | ========                                                                 |  | ========                                               
|Allowance for loan and
      lease losses at beginning of period             | $    
      4,622                                                        |  | $    
      4,062                                      
|Provision for loan
      losses                                              | 1,600                                                                    |  | 1,256                                                  
|Charge-offs:                                                                 |                                                                          |  |                                                        
|Commercial loans                                                             | (1,229)                                                                  |  | (678)                                                  
|Commercial leases                                                            | (47)                                                                     |  | (94)                                                   
|Real estate - mortgage                                                       | (77)                                                                     |  | (11)                                                   
|Real estate - construction                                                   | --                                                                       |  | --                                                     
|Consumer and other                                                           | (43)                                                                     |  | (31)                                                   
|Total charge-offs                                                            | (1,396)                                                                  |  | (814)                                                  
|Recoveries:                                                                  |                                                                          |  |                                                        
|Commercial loans                                                             | 23                                                                       |  | 90                                                     
|Commercial leases                                                            | --                                                                       |  | 20                                                     
|Real estate - mortgage                                                       | 14                                                                       |  | --                                                     
|Real estate - construction                                                   | --                                                                       |  | --                                                     
|Consumer and other                                                           | 32                                                                       |  | 8                                                      
|Total recoveries                                                             | 69                                                                       |  | 118                                                    
|Net loan charge-offs                                                         | (1,327)                                                                  |  | (696)                                                  
|Allowance for loan and
      lease losses at end of period                   | $    
      4,895                                                        |  | $    
      4,622                                      
|                                                                             | =======                                                                  |  | =======                                                
|Ratio of allowance to
      end of period total loans                        | 1.51%                                                                    |  | 1.71%                                                  
|Ratio of net loan
      charge-offs to average loans and leases (annualized) | 0.59                                                                     |  | 0.31                                                   
|Ratio of allowance to
      end of period non-performing loans               | 270.74                                                                   |  | 595.62                                                 
|                                                                             |                                                                          |  |                                                        

> Investment Securities.

-21-

---

Deposits. At
September 30, 2001, total deposits increased by $66.5 million, or 24.3%, to
$339.5 million, from $273.0 million at December 31, 2000. The increase in deposits was comprised of a
$17.6 million increase in time deposits greater than $100,000, a $28.6 million increase in time deposits less than $100,000 and
$6.0 million in non-interest-bearing demand deposits, a $11.7 million increase in NOW
accounts and an increase of $2.5 million in money market accounts. The deposit
increase was comprised of $44.0 million in deposits from the Company's market
complemented by $22.5 million in time deposits, with a weighted average life of
38 months, from wholesale sources.

Non-interest-bearing deposits at
September 30, 2001 increased by $6.0 million or 21.4% to $33.8 million from $27.9 million at December 31, 2000. The Company's ratios of
noninterest-bearing demand deposits to total deposits for September 30, 2001 and December 31, 2000 were
9.96% and 10.2%, respectively.

Core deposits, a relatively stable funding base, comprised
67.7% of total deposits at September 30, 2001 and 70.0% at December 31, 2000. Core deposits represent total deposits excluding time deposits greater than $100,000, brokered and wholesale time deposits.
The drop in percentage of core deposits to total deposits is attributable to
$15.2 million in wholesale time deposits, with an average weighted maturity of
37 months, issued during the second quarter of 2001. At September 30, 2001, interest-bearing deposits increased by
$60.5 million or 25% to $305.7 million from $245.2 million at December 31, 2000.

Federal Home Loan Bank and Other Borrowings. At September 30, 2001 the Company had
$89.0 million in FHLB borrowings, with an average interest rate of 4.15% per
annum. Total borrowed funds increased $52.8 million at September 30, 2001 from December 31, 2000. This increase was comprised
of FHLB borrowings, which were utilized in conjunction with the Company's
leverage strategy.

At September 30, 2001 and December 31, 2000, the Company had available for its use
$32.5 million and $38.5 million, respectively, of short term unsecured lines of credit. Such short-term lines serve as a temporary liquidity source for unanticipated loan surges or deposit
drops. These lines facilitate federal funds borrowings and bear a rate that is equal to the current rate for federal funds purchased. There were no amounts outstanding under these lines of credit at
September 30, 2001 and December 31, 2000.

Capital Resources. Shareholder's equity declined by
$2.5 million to $39.8 million at September 30, 2001, from $42.3 million at December 31, 2000. Unrealized gains on securities available for sale were
$1.6 million, net of tax, at September 30, 2001, compared with $60,000, net of tax, at December 31, 2000. The
decrease in shareholders' equity was primarily due to the repurchase of 338,770 shares of common stock repurchased during the
nine months ended September 30, 2001 pursuant to the Company's stock repurchase plans.

At September 30, 2001 total shareholders' equity as a percentage of total assets declined to
8.4% from 11.9%, due to the stock buy-backs, dividends paid, and a 33.5% increase in total assets during the first
nine months of 2001. These factors were partially offset by $2.6 million in net income recorded during the first
nine months of 2001.

The Company reported dividend payments of
$1.7 million during the first nine months of 2001 compared with $1.9 million for the same period in 2000. The total dividend payments during the first
nine months of 2001 and 2000 were $0.51 per share.

-22-

---

The Company's capital ratios continued to exceed all regulatory requirements reflecting a significant amount of excess capital based on industry standards and Federal Deposit Insurance Corporation Improvement Act ("FDICIA") minimum ratios. The following table provides a comparison of the Company's and the Bank's leverage and risk-weighted capital ratios as of
September 30, 2001 to the minimum and well-capitalized regulatory standards:

|                                                                                                                                                          | Minimum
    Required |  | Well
    Capitalized |  | Actual
    Ratio at
    September 30, 2001
|--------------------------------------------------------------------------------------------------------------------------------------------------------- | -------------------- |  | -------------------- |  | ------------------------------------------
|The Company                                                                                                                                               |                      |  |                      |  |                                           
|Leverage ratio                                                                                                                                            | 3.00%(1)             |  | N/A                  |  | 8.11%                                     
|Tier
    1 risk-based capital ratio                                                                                                                       | 4.00                 |  | N/A                  |  | 10.51                                     
|Risk-based capital ratio                                                                                                                                  | 8.00                 |  | N/A                  |  | 11.76                                     
|The Bank                                                                                                                                                  |                      |  |                      |  |                                           
|Leverage ratio                                                                                                                                            | 3.00%(1)             |  | 5.00%                |  | 7.36%                                     
|Tier
    1 risk-based capital ratio                                                                                                                       | 4.00                 |  | 6.00                 |  | 9.49                                      
|Risk-based capital ratio                                                                                                                                  | 8.00                 |  | 10.00                |  | 10.74                                     
|(1) The
    Federal Reserve Board may require the Company to maintain a leverage ratio
    of up to 200 basis points above the
          required minimum

-23-

---

Item 3. Quantitative and Qualitative Disclosures About Market Risk

> As a financial institution, the Company's primary component of market risk is interest rate risk. Ultimately, fluctuations in interest rates will impact liquidity, the level of income and expense recorded on most of the Company's assets and liabilities, and the market value of interest-earning assets and interest-bearing liabilities -- other than those which have a short term to maturity. The Company is not subject to foreign exchange or commodity price risk. The Company does not own any trading assets.
> Interest Rate Risk Management. Interest rate risk is managed by the ALCO in accordance with policies approved by the Company's Board of Directors. The ALCO formulates strategies based on appropriate levels of interest rate risk. In determining the appropriate level of interest rate risk, the ALCO considers the impact on earnings and capital of the current outlook on interest rates, potential changes in interest rates, regional economy, liquidity, business strategies and other factors. The ALCO meets regularly to review, among other things, the sensitivity of assets and liabilities to interest rate changes, the book and market values of assets and liabilities, unrealized gains and losses, purchase and sale activities, commitments to originate loans and the maturities of investments and borrowings. Additionally, the ALCO reviews liquidity, cash flow flexibility, maturities of deposits and consumer and commercial deposit activity. Management uses two methodologies to manage interest rate risk:
> (i) an analysis of relationships between interest-earning assets and interest-bearing liabilities and (ii) an interest rate shock simulation model. The Company has traditionally managed its business to reduce its overall exposure to changes in interest rates, however, under current policies of the Company's Board of Directors, Management has been given some latitude to increase the Company's interest rate sensitivity position within certain limits if, in Management's judgment, it will enhance profitability. As a result, changes in market interest rates may have a greater impact on the Company's financial performance in the future than they have had historically.

The following table provides Management with repricing data within given time frames. The purpose of this information is to assist Management in the elements of pricing and of matching interest sensitive assets with interest sensitive liabilities within time frames. The table indicates that at
September 30, 2001, the Company was asset sensitive up to a 30-day period and had a
negative cumulative GAP for the time periods up to and including one year. With this condition, in a declining rate environment the Company would see deterioration in income for a period up to and including
30 days, with an improving position over the 31 to 365 day period. The Company is aware of this imbalance and has initiated strategies
attempting to minimize the impact of a positive GAP position over the 30-day
period via the use of interest rate swaps and floating rate advances from the
FHLB.

Volumes Subject to
Repricing Within

|                                                                                                  | 0-30Days   | 31-180Days    | 181-365Days   | 1-3Years      | 3-5Years      | 6-10Years     | Greater
than 10Years | Total    
|------------------------------------------------------------------------------------------------- | ---------- | ------------- | ------------- | ------------- | ------------- | ------------- | -------------------- | ---------
|(in
thousands)                                                                                   
|Interest-earning assets:                                                                          |            |               |               |               |               |               |                      |          
|Securities                                                                                        | $    6,816 | $   13,102    | $  15,397     | $ 40,387      | $   21,037    | $   19,547    | $    9,944           | $ 126,230
|Total loans(1)                                                                                    | 171,506    | 16,371        | 14,565        | 66,090        | 49,013        | 6,213         | 487                  | 324,245  
|Due from banks                                                                                    | 945        | --            | --            | --            | --            | --            | --                   | 945      
|Federal funds sold and other
     temporary investments                                           | 5,000      | --            | --            | --            | --            | --            | --                   | 5,000    
|Total interest-earning
                
assets                                                    | $ 184,268  | $   29,473    | $ 29,962      | $ 106,477     | $ 70,050      | $ 25,760      | $ 10,431             | $ 456,420
|                                                                                                  | =======    | =======       | ======        | =======       | ======        | ======        | ======               | =======  
|Interest-bearing liabilities:                                                                     |            |               |               |               |               |               |                      |          
|Money market and
      NOW accounts                                                               | $ 126,798  | $          -- | $          -- | $          -- | $          -- | $          -- | $          --        | $ 126,798
|Time deposits                                                                                     | 11,979     | 46,585        | 76,413        | 23,140        | 10,757        | 10,001        | --                   | 178,875  
|FHLB and other borrowings                                                                         | 10,000     | 25,000        | 14,000        | --            | --            | 40,000        | --                   | 89,000   
|Total
interest-bearing
                 
liabilities                                              | $ 148,777  | $   71,585    | $  166,826    | $   46,280    | $ 21,514      | $   60,002    | $   10,431           | $ 394,673
|                                                                                                  | =======    | =======       | =======       | =======       | =======       | =======       | =======              | =======  
|Period GAP                                                                                        | $   35,490 | $ (42,112)    | $ (60,451)    | $   83,337    | $  59,293     | $ (24,241)    | $ 10,431             | $  61,747
|Cumulative GAP                                                                                    | 35,490     | (6,622)       | (67,073)      | 16,264        | 75,557        | 51,316        | 61,747               |          
|Period GAP to total assets                                                                        | 7.50%      | -8.90%        | -12.77%       | 17.61%        | 12.53%        | -5.12%        | 2.20%                |          
|Cumulative GAP to total
         assets                                                           | 7.50       | -1.40         | -14.17        | 3.44          | 15.96         | 10.84         | 13.05                |          
|Cumulative interest-earning
      assets to cumulative
       interest-bearing
       liabilities | 123.85     | 41.17         | 33.14         | 460.15        | 651.20        | 51.52         | NM                   |          
|                                                                                                  |            |               |               |               |               |               |                      |          
|(1) Excluding $1.9 million in residential
mortgages held for sale.                               

> -24-
> 
> The Company applies an economic value of equity ("EVE") methodology to gauge its interest rate risk exposure as derived from its simulation model. Generally, EVE is the discounted present value of the difference between incoming cash flows on interest-earning assets and other investments and outgoing cash flows on interest-bearing liabilities. The application of the methodology attempts to quantify interest rate risk by measuring the change in the EVE that would result from a theoretical instantaneous and sustained 200 basis point shift in market interest rates.
>   The percentage change
>   in EVE as a result of a 200 basis point decrease in interest rates at
>   September 30, 2001 was 8.7% compared with 5.0% at December 31, 2000. The
>   percentage change in EVE as a result of a 200 basis point increase in interest
>   rates at September 30, 2001 was 9.3% compared with 4.7% at December 31, 2000.
>   Presented below, as of September 30, 2001, is an analysis of the Company's
>   interest rate risk as measured by changes in EVE for parallel shifts of 200
>   basis points in market interest rates:
>   Change in Rates
>       $
>         Change in EVE
>         (In Thousands)
>       % Change in EVE
>       EVE
>         as a % of
>         Present Value of AssetsEVE Ratio
> Change-200
>         bps.
>       $ 
>         1,271
>       2.93
>       8.71
>       19
>         bps.0
>         bps.
>       ---
>       ---
>       8.51
>       ---+200
>         bps.
>       $
>         3,478
>       8.02
>       9.27
>       75 bps.The Company's EVE is most directly affected by the convexity and duration of its investment portfolio. The duration and negative convexity of the Company's investment portfolio produce disproportionate effects on theportfoliovalue
> with changes in interest rates. Convexity measures the percentage of portfolio price appreciation or depreciation relative to a decrease or increase in interest rates. The higher the negative convexity, the greater the decline in the value of a fixed income security as interest rates increase. The Company's investment portfolio is primarily comprised of long-term, fixed income securities, the value of which would be adversely affected in a rising interest rate environment.-25-
> 
> 
> Derivatives.Derivative financial instruments, such as interest rate swaps, options, caps, floors, futures and forward contracts, are components of the Company's risk management profile. The Company may also enter into derivative instruments as a service to banking customers. Where contracts have been created for customers, the Company generally enters into offsetting positions to eliminate the Company's exposure to market risk.
>   On January 1, 2001, the Company adopted SFAS 133. Accordingly, all derivatives are recorded in the financial statements at fair value. Additional information on derivative hedging activity is included in Note
>   I to the consolidated financial statements. The Company monitors its
>   sensitivity to changes in interest rates and may use derivative instruments to
>   hedge this risk.
>   On March 26, 2001, the Company entered into a $10.0 million interest rate swap which matures on October 17, 2008 under which the Company will pay the counterparty a variable rate of three-month LIBOR plus five basis points and will receive a fixed rate of 6.00%. Interest payments are settled and variable rates reset quarterly. The counter party has the option to terminate the swap, in whole or in part, on April 17, 2002 and semi-annually thereafter. Management designated the interest rate swap as a fair value hedge of $10.0 million of brokered time deposits issued by the Company on March 26, 2001. The 6.00% fixed rate, brokered time deposits mature on October 17, 2008 and are callable by the Company on March 26, 2002 and semi-annually thereafter. In the
>   third quarter of 2001, the Company recorded an unrealized gain of $42,000 for the market value adjustment on this fair value hedge instrument that was offset by a
>   $42,000 increase in the market value of the 6.00% fixed rate, brokered time deposits.
> On May 24, 2001, the Company entered into a $15.0 million interest rate swap agreement which matures on November 25, 2002 under which the Company will pay the counterparty a fixed rate of 4.53% and will receive a variable rate of three-month LIBOR less
> six basis points. Interest payments are settled and variable rates reset quarterly. Management designated the interest rate swap as a cash flow hedge of $15.0 million of $25.0 million in
> variable rate Federal Home Loan Bank advances entered into by the Company on May 24, 2001.
> For the third quarter of 2001, the cash flow hedge of long-term debt resulted in
> a decrease of $194,000 in other comprehensive income, net of taxes of $120,000,
> with a $314,000 offset to unrealized derivative loss.
>   On July 19, 2001, the
>   Company entered into a $10.0 million interest rate swap agreement which
>   matures on October 19, 2002 under which the Company will pay the counterparty
>   a fixed rate of 4.205% and will receive a variable rate of three-month LIBOR.
>   Interest payments are settled and variable rates reset quarterly. Management
>   designated the interest rate swap as a cash flow hedge of $10.0 million in
>   variable rate Federal Home Loan Bank advances entered into by the Company on
>   July 19, 2001. For the third quarter of 2001, the cash flow hedge of long-term
>   debt resulted in a decrease of $101,000 in other comprehensive income, net of
>   taxes of $63,000, with a $164,000 offset to unrealized derivative loss.
> -26-
> 
> 
> Liquidity Management.Liquidity involves the Company's ability to raise funds to support asset growth or reduce assets to meet deposit withdrawals and other payment obligations, to maintain reserve requirements and otherwise to operate the Company on an ongoing basis. Liquidity is managed to ensure there is sufficient funding to satisfy demand for credit,
> deposit withdrawals and attractive investment opportunities. A large, stable core deposit base, and a strong capital position are the solid foundation for the Company's liquidity position.
> The Company's liquidity needs are met primarily by financing activities, consisting mainly of core deposits, but also include borrowed funds and cash flows from operations. Customer-based core deposits, the Company's largest and most cost-effective source of funding, accounted for
> 67.7% of total deposits at September 30, 2001 compared to 70.0% at December 31, 2000. Net borrowed funds, which primarily include short-term funds purchased and sold, wholesale and brokered domestic deposits, FHLB and other short term borrowings, were
> $89.0 million at September 30, 2001, compared with $36.2 million at December 31, 2000. Cash flows from operations are also a significant source of liquidity. Net cash from operations primarily results from net income adjusted for noncash items such as depreciation and amortization, provision for loan and lease losses, and deferred tax items.
> Liquidity is strengthened by ready access to a diversified base of wholesale funding sources. These sources include federal funds purchased, securities sold under agreements to repurchase, certificates of deposit, and
> FHLB advances. Liquidity is also available through unpledged loans and securities in the investment portfolio.
>   The Company has a contingency funding plan that stress-tests liquidity needs that may arise from certain events such as rapid loan growth or significant deposit runoff. The plan also provides for continual monitoring of net borrowed funds dependence and available sources of liquidity. Management believes the Company has the funding capacity to meet
>   operational and contingent liquidity needs.
> The Company is eligible for certain borrowing programs through the
> FHLB. Generally, most advances require delivery of eligible securities as collateral. Maturities under these programs range from one day to 20 years. FHLB advances can be particularly attractive as a longer-term funding source to balance interest rate sensitivity and reduce interest rate risk.
> The Company used the FHLB borrowing proceeds to acquire fixed income securities
> in an effort to utilize its leverage capacity and increase earnings and minimize
> the results that a declining rate environment would have on its income stream,
> and to diversify its funding costs.
> At September 30, 2001 and December 31, 2000, the Company had available for its use
> $32.5 million and $38.5 million, respectively, of short-term unsecured lines of credit. Such short-term lines serve as a temporary liquidity source for unanticipated loan and investment surges. These lines facilitate federal funds borrowings and bear a rate that is equal to the current rate for federal funds purchased. At
> September 30, 2001 and December 31, 2000 the Company had no outstanding borrowings under these lines of credit.
> -27-

PART II - OTHER INFORMATION



Item 1.     Legal Proceedings

> Not applicable



Item 2.     Changes in Securities
and Use of Proceeds

> Not applicable

Item 3.     Defaults
Upon Senior Securities

> Not applicable

Item 4.     Submission of Matters To a Vote of Security Holders

> Not applicable

Item 5.     Other Information

> Not applicable

Item 6A.     Exhibits

> ExhibitNumber
> Identification of Exhibit11
> - Computation of Earnings Per Common Share, included as Note (F) to the
>    Interim Consolidated Financial Statements on Page 7 of this Form 10-Q.

Item 6B.    
  Reports on Form 8-K filed during the three months ended September 30,
  2001

> Not
>     applicable



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SIGNATURES



In accordance with the requirements of the Exchange Act, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.



> COMMUNITY FINANCIAL GROUP, INC.
>                             
> Registrant





|                        |                                      
|----------------------- | -------------------------------------
|Date: November 14, 2001 | By:  /s/ J. HUNTER ATKINS            
|                        | J. Hunter Atkins                     
|                        | President and Chief Executive Officer
|                        |                                      
|                        |                                      
|                        |                                      
|Date: November 14, 2001 | By:  /s/ ATTILIO F. GALLI            
|                        | Attilio F. Galli                     
|                        | Chief Financial Officer              
|                       

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