SECURITIES AND EXCHANGE COMMISSION
                             Washington, D.C. 20549

                                   FORM 10-KSB

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

                   For the fiscal year ended December 31, 2003

[ ]  TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES  EXCHANGE ACT
     OF 1934

                        Commission file number 000-24675

                       STATE OF FRANKLIN BANCSHARES, INC.
                 (Name of small business issuer in its charter)


       TENNESSEE                                            62-1749121
(State or other jurisdiction of             (I.R.S. Employer Identification No.)
 incorporation or organization)

                             1907 North Roan Street
                          Johnson City, Tennessee 37601
              (Address of principal executive offices and Zip Code)

                    Issuer's telephone number (423)926-3300


Securities registered under Section 12(b) of the Exchange Act:  None
Securities registered under Section 12(g) of the Exchange Act: Common Stock

     Check  whether  the issuer (1) filed all  reports  required  to be filed by
Section 13 or 15(d) of the  Exchange  Act during the past 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 [ ]

     Check if there is no disclosure  of  delinquent  filers in response to Item
405 of  Regulation  S-B  contained  in  this  form,  and no  disclosure  will be
contained,  to the  best of  registrant's  knowledge,  in  definitive  proxy  or
information statements incorporated by reference in Part III of this Form 10-KSB
or any amendment to this Form 10-KSB. [ ]

     The  registrant's  revenues for the twelve  months ended  December 31, 2003
were $16,035,307.

     The  aggregate  market  value  of  the  shares  of  Common  Stock  held  by
nonaffiliates  of the  registrant  as of March 15, 2004 is  approximately  $19.1
million.  (For purposes of this  calculation  only,  all executive  officers and
directors are classified as affiliates.)

Indicate the number of shares outstanding of each of the registrant's classes of
common stock, as of the latest practicable date.  Outstanding at March 15, 2004,
Common Stock, $1.00 par value, 1,465,512 shares.

Documents  Incorporated  by Reference:  Proxy  Statement  related to 2004 Annual
Meeting of Shareholders (Part III hereof).

Transitional Small Business Disclosure Forman (check one):  Yes [ ]  No [X]



<PAGE>

                                     PART I
Item 1.  Description of Business

The Company

     State of Franklin  Bancshares,  Inc.  ("State of Franklin") is a registered
bank holding company  organized under the laws of Tennessee and headquartered in
Johnson City, Tennessee.  State of Franklin Savings Bank (the "Savings Bank") is
a wholly  owned  subsidiary  through  which we conduct our  banking  operations.
References to "State of Franklin" include State of Franklin Bancshares, Inc. and
the Savings  Bank.  On December 31, 2003,  we had  consolidated  total assets of
approximately  $292 million.  State of Franklin Leasing  Corporation is a wholly
owned  subsidiary  of  State  of  Franklin  which  engages  in  equipment  lease
financing.  The Savings  Bank offers  title  services  through its wholly  owned
subsidiary  John Sevier Title  Services,  Inc. (the "Title  Company").  State of
Franklin Real Estate,  Inc. (the "Real Estate  Company") was  incorporated  as a
wholly  owned  subsidiary  of the Savings  Bank for the purpose of selling  real
estate.

     We  believe  we can  present  an  alternative  to recent  mergers  of large
financial  institutions by offering local  ownership,  local decision making and
other personalized services characteristic of local,  community-based  financial
institutions.  The holding company structure provides  flexibility for expansion
of our banking business through acquisition of other financial  institutions and
provision  of  additional   banking-related   services  which  the   traditional
commercial bank may not provide under present laws.

The Savings Bank

     The Savings Bank was incorporated  under the laws of the State of Tennessee
and commenced  business on February 26, 1996, as a  Tennessee-chartered  savings
bank whose deposits are insured by the Federal Deposit  Insurance  Corporation's
(the "FDIC") Bank Insurance Fund. The Savings Bank is regulated by the Tennessee
Department of Financial  Institutions  and the FDIC. The Savings Bank operates a
main office and two branches in Johnson City, Washington County,  Tennessee, and
two branches in Kingsport, Sullivan County, Tennessee. The Savings Bank owns the
Title Company, a Tennessee-chartered  and regulated title insurance company, and
the Real Estate Company

Services

     We provide a wide range of personal and  corporate  banking  services.  Our
principal  business is to accept  demand and savings  deposits  from the general
public and to invest such funds in  residential  mortgage loans and, to a lesser
extent,  in  commercial  and consumer  loans in our market area. We seek savings
deposits and  transaction  accounts from households and businesses by offering a
full range of savings accounts,  retirement and professional accounts,  checking
accounts and time certificates.  We also offer 24-hour automated teller machines
and other financial services.

Markets

     Our customers are primarily  individuals,  households,  and small-to-medium
sized businesses, as well as physicians and other professionals.  We are subject
to substantial  competition,  however,  from other commercial banks, savings and
loan associations,  credit unions and finance companies  operating in Washington
and Sullivan  counties and  elsewhere  in the  Tri-Cities,  Tennessee / Virginia
region. Particularly intense competition for loans and deposits comes from other
financial institutions in our market area.

     In some aspects of our business,  we also compete with credit unions, small
loan companies,  insurance  companies,  mortgage  companies,  finance companies,
brokerage houses and other financial institutions, some of which are not subject
to the same degree of regulation and restriction  that we are, and some of which
have  financial  resources  greater  than ours.  Our future  success will depend
primarily  upon the  difference  between  the cost of our  borrowing  (primarily
interest  paid on deposits and Federal Home Loan Bank  advances) and income from
operations  (primarily  interest  or fees earned on loans and  investments).  We
compete  for  funds  with  other   institutions,   which,  in  most  cases,  are
significantly  larger  than we are and are able to provide a greater  variety of
services than we can. These  competitors may thus obtain deposits at lower rates
of interest.

                                       1

<PAGE>

Net Interest Income

     The following table sets forth weighted average taxable  equivalent  yields
earned by State of Franklin on our earning assets and the weighted average rates
paid on our average  deposits  and other  interest-bearing  liabilities  for the
years indicated, and certain other information:

<TABLE>
<CAPTION>


                                                                2003                             2002
                                                --------------------------------------------------------------------
(Fully taxable equivalent)                                    Interest      Average             Interest     Average
(Dollars in thousands)                          Average        Income/      Yields/  Average     Income/     Yields/
                                                Balance       Expense        Rate    Balance     Expense       Rate
                                                -------       --------      ------  --------    --------     -------
<S>                                             <C>            <C>          <C>     <C>          <C>          <C>

Assets:

Interest-earning assets:

Loans net of unearned income................    $156,002       $10,431      6.69%   $154,043     $11,241      7.30%
Investment securities.......................      83,277         4,079      4.90%     81,365       5,480      6.74%
Other earning assets .......................       5,266           121      2.30%      2,822         113      4.00%
Federal funds sold..........................      25,628           267      1.04%     13,315         210      1.58%
                                                --------        ------      -----   --------     -------      -----
Total interest-earning assets/interest income    270,173        14,898      5.51%    251,545      17,044      6.78%
                                                --------        ------              --------     -------
Cash and due from banks.....................       3,471                               2,418
Other assets................................      10,778                               7,938
 Allowance for loan losses...................     (1,786)                             (1,456)
                                                --------                            --------
    Total...................................    $282,636                            $260,445
                                                ========                            ========
Liabilities and stockholders' equity:

Interest-bearing liabilities:

Interest-bearing checking deposits..........    $ 16,240       $   213      1.31%   $ 10,696      $  203      1.90%
Savings.....................................      76,608         1,392      1.82%     55,897       1,397      2.50%
Money market................................      30,365           524      1.73%     38,370         821      2.14%
Time certificates...........................      79,076         2,309      2.92%     81,834       2,959      3.62%
Borrowed funds..............................      36,913         1,765      4.78%     34,730       1,677      4.83%
Subordinated debentures                            8,000           434      5.43%      8,000         501      6.26%
                                                --------       -------      -----   --------      ------      -----
  Total interest-bearing liabilities/
  interest expense..........................     247,202         6,637      2.68%    229,527       7,558      3.29%
                                                --------       -------      -----   --------      ------      -----
Non-interest bearing demand  deposits.......      11,119                               9,850
Other liabilities...........................         751                                 882
Stockholders' equity........................      23,564                              20,186
                                                --------                            --------
    Total...................................    $282,636                            $260,445
                                                ========                            ========
Net interest earnings.......................                   $ 8,261                            $9,486
                                                               =======                            ======
Net interest on interest-earning assets.....                                3.06%                             3.77%

Return on average assets....................                                 .94%                             1.22%
Return on average equity....................                               11.23%                            15.77%
Cash dividends declared.....................                                  --                                --
Dividend payout ratio.......................                                  --                                --

</TABLE>

                                       2
<PAGE>

     The  following  table  summarizes  changes  in  interest  income,  interest
expense, and the interest rate differential aggregated by the changes in volumes
and rates:

<TABLE>
<CAPTION>

                                                              December 31, 2003               December 31, 2002
                                                                   Versus                          Versus
                                                              December 31, 2002               December 31, 2001
                                                             Increase (Decrease)             Increase (Decrease)
                                                             Change Due to: (1)              Change Due to: (1)
                                                             ------------------              ------------------
    (Dollars in thousands)                               Volume      Rate     Total      Volume     Rate     Total
                                                         ------      ----     -----      ------     ----    ------
    <S>                                                 <C>     <C>         <C>          <C>      <C>       <C>
    Increase (decrease) in: (2)
    Loans, net of unearned income....................   $131    (  $941)    ( $810)      $1,000   ($1,225)  ($225)
    U.S. Treasury and other U.S. government agency
    securities.......................................     94    ( 1,495)    (1,401)       1,352   (   281)  1,071
    Other earning assets.............................     56    (    48)         8           27   (    57)  (  30)
    Federal funds sold...............................    128    (    71)        57           79   (   131)     52)
                                                       -----    --------    -------      ------   --------  ------
       Total interest income.........................    409    ( 2,555)    (2,146)       2,458   ( 1,694)    764
                                                       -----    --------    -------      ------   --------  ------
    Increase (decrease) in: (2)
    Interest-bearing checking deposits...............     73    (    63)        10           59    (    9)     50
    Savings deposits.................................    376    (   381)    (    5)         781    (  318)    463
    Money Market..................................... (  138)   (   159)    (  297)      (  195)   (  966) (1,161)
    Time certificates................................ (   81)   (   569)    (  650)      (  156)   (1,770) (1,926)
    Borrowed funds...................................    104    (    16)    (   88)         374    (   76)    298
    Subordinated Debentures..........................      -    (    67)    (   67)         482         2     484
                                                      -------   --------   --------      -------   ------- -------
        Total interest expense.......................    334    ( 1,255)    (  921)       1,345    (3,137) (1,792)
                                                                           --------                        -------
        Increase (decrease) in net interest income...                      $(1,225)                        $2,556
                                                                           ========                        =======
</TABLE>

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


(1)  Increases  (decreases) are  attributable to volume changes and rate changes
     on the following  basis:  Volume Change equals change in volume times prior
     year rate.  Rate  Change  equals  change in rate times  prior year  volume.
     Changes that are not due solely to volume or rate changes are  allocated to
     volume.

(2)  For  purposes  of this  schedule,  non-accruing  loans are  included in the
     average  balances and tax exempt  income is  reflected on a tax  equivalent
     basis.  As tax exempt income is exempt only for Federal income tax purposes
     and  not  Tennessee  purposes,  tax  equivalent  income  is  based  upon an
     effective  34% tax rate.  Loan fees  included  in  interest  income are not
     material to the presentation.


Liability and Asset Management

     A committee  composed of our officers  and  directors  is  responsible  for
managing  our assets and  liabilities.  The  chairman  of the  committee  is our
Chairman of the Board,  Charles E. Allen,  Jr. The committee  attempts to manage
our asset growth,  liquidity and capital to maximize  income and reduce interest
rate risk. The committee directs our overall acquisition and allocation of funds
and reviews and discusses  our assets and liability  funds budget in relation to
the actual flow of funds. The committee also reviews and discusses:

     -    peer group comparisons,
     -    the ratio of rate-sensitive assets to rate-sensitive liabilities,
     -    the  ratio  of   allowance   for  loan  losses  to   outstanding   and
          nonperforming loans,
     -    expected loan demand,
     -    investment opportunities,
     -    core deposit growth within specific categories,
     -    regulatory changes,
     -    monetary policy adjustments, and
     -    the overall state of the local and national economies.

                                       3

<PAGE>


     The matching of assets and  liabilities is analyzed by examining the extent
to which the  assets  and  liabilities  are  "interest  rate  sensitive"  and by
monitoring  an  institution's  interest  rate  sensitivity  "gap."  An  asset or
liability is said to be interest rate sensitive within a specific time period if
it will mature or reprice within that time period. The interest rate sensitivity
gap is defined as the difference between the amount of  interest-earning  assets
maturing  or  repricing  within  a  specific  time  period  and  the  amount  of
interest-bearing  liabilities  maturing or repricing  within that time period. A
gap is considered  positive when the amount of interest  rate  sensitive  assets
exceeds the amount of interest rate sensitive  liabilities.  A gap is considered
negative  when the amount of interest  rate  sensitive  liabilities  exceeds the
amount of interest rate  sensitive  assets.  During a period of rising  interest
rates, a negative gap would tend to adversely affect net interest income while a
positive gap would tend to result in an increase in net interest income.  During
a period of falling  interest  rates,  a negative gap would tend to result in an
increase in net  interest  income  while a positive  gap would tend to adversely
affect net interest income.

     The  following  table is an interest  sensitivity  profile for the State of
Franklin as of December 31, 2003 and 2002.  The table  represents a static point
in  time  and  does  not  consider  other  variables,  such as  changing  spread
relationships  or interest rate levels.  "Net  repricing  gap" is the difference
between total earning assets and total interest-bearing liabilities repricing in
any given period and  "cumulative  gap" is the sum of the net repricing gap from
period to period.  Interest-bearing  demand,  savings and money  market  account
deposits are presented as repricing in the earliest period presented.


<TABLE>
<CAPTION>
                                                                           December 31, 2003
                                                --------------------------------------------------------------------
                                                               After 3 months    After 12
                                                 Within          within          months           After
                                                3 months       12 months      within 5 years     5 years       Total
                                                --------     --------------   --------------     -------       -----
       <S>                                      <C>             <C>              <C>            <C>         <C>
       (Dollars in thousands)
       Earning assets:
       Loans...........................         $61,947         $ 11,809         $32,902        $ 44,402    $151,060
       Investment securities:
         Available for sale............           3,615           10,181          12,942          36,637      63,375
         Held to maturity..............                                            8,535          25,497      34,032
       Federal funds sold..............          25,040                                                       25,040
       Interest-bearing deposits.......           3,336                                                        3,336
       Federal Home Loan Bank stock....           2,355                                                        2,355
                                                -------         --------         -------        --------    --------
             Total earning assets......         $96,293         $ 21,990         $54,379        $106,536    $279,198
                                                =======         ========         =======        ========    ========

       Interest-bearing liabilities:
       Interest-bearing deposits.......        $140,467         $ 34,848         $34,563                    $209,878
       Repurchase Agreements...........             536                                                          536
       Long-term debt..................               5               25           3,126          33,054      36,210
       Subordinated debentures.........           8,000                                                        8,000
                                               --------                                                     --------
         Total interest-bearing liabilities    $149,008         $ 34,873         $37,689        $ 33,054    $254,624
                                               ========         ========         =======        ========    ========
         Net repricing gap.............        $(52,715)        $(12,883)        $16,690        $ 73,482    $ 24,574

       Rate sensitivity gap:
       Net repricing gap as a percentage
         of total earning assets.......          (18.98)%          (4.64)%          6.01%          26.46%      8.85%
       Cumulative gap..................       $( 52,715)        $(65,598)       $(48,908)       $ 24,574     $24,574
       Cumulative gap as a percentage of
         total earning assets                    (18.98)%         (23.62)%       ( 17.61)%          8.85%      8.85%

</TABLE>

                                       4
<PAGE>
<TABLE>
<CAPTION>

                                                                              December 31, 2002
                                               ----------------------------------------------------------------------
                                                             After 3 months    After 12
                                                 Within          within        months              After
                                                3 months       12 months    within 5 years        5 years       Total
                                                --------       ---------    --------------        --------    -------
      <S>                                       <C>              <C>             <C>             <C>         <C>

      (Dollars in thousands)
      Earning assets:
      Loans............................         $ 36,185         $ 34,567        $61,164         $ 28,437    $160,353
      Investment securities:
        Available for sale.............               18           17,468          7,645           36,898      62,029
        Held to maturity...............                                            1,038           14,700      15,738
      Federal funds sold...............           12,705                                                       12,705
      Interest-bearing deposits........            1,366                                                        1,366
      Federal Home Loan Bank stock.....            2,263                                                        2,263
                                               ---------                                                     --------
             Total earning assets......        $  52,537         $ 52,035        $69,847         $ 80,035    $254,454
                                               =========         ========        =======         ========    ========

      Interest-bearing deposits........        $ 123,328         $ 38,811        $25,347                     $187,486
      Repurchase Agreements............            1,050                                                        1,050
      Long-term debt...................                                                            36,239      36,239
      Subordinated debentures..........           8,000                                                         8,000
                                               --------                                                      --------
        Total interest-bearing liabilities     $132,378         $ 38,811        $25,347          $ 36,239    $232,775
                                             ==========         ========        =======          ========    ========

     Net repricing gap................         $(79,841)        $ 13,224        $44,500          $ 43,796    $ 21,679
     Rate sensitivity gap:
     Net repricing gap as a percentage
         of total earning assets.......          (31.60)%           5.23%         17.61%            17.33%      8.58%
     Cumulative gap....................       $( 79,841)        $(66,617)      $(22,117)         $ 21,679    $ 21,679
     Cumulative gap as a percentage of
       total earning assets............          (31.60)%         (26.36)%       ( 8.75)%            8.58%      8.58%
</TABLE>

                                       5
<PAGE>

Management has made the following assumptions in the above analysis:

(a)  Assets and liabilities are generally  assigned to a period based upon their
     earliest  repricing  period when the repricing is less than the contractual
     maturity.

(b)  Nonaccrual loans are included in the loan category.

(c)  Investment  securities available for sale are currently treated in the same
     manner  as  comparable  securities  in the  investment  securities  held to
     maturity  portfolio in that they are scheduled  according to the earlier of
     their  contractual  maturities or earliest  repricing dates;  however,  the
     maturities of callable agency  securities are scheduled  according to their
     call dates when valued at a premium to par.

(d)  Money  market  deposits  and  savings  deposits  that  have no  contractual
     maturities are scheduled in the within 3 months category.

Deposits

     We offer a full range of depositor  accounts and services to both consumers
and  businesses.  None of these deposits were brokered.  Our primary  sources of
funds are interest-bearing  deposits. The following table sets forth our deposit
structure at December 31, 2003 and 2002 (in thousands).


                                                          2003          2002
                                                       -------        -------
Non interest-bearing deposits:
Individuals, partnerships and corporations.......     $ 10,654        $ 9,433
Certified and official checks....................        1,460          1,921
                                                        ------        -------
Total non interest-bearing deposits..............       12,114         11,354
Interest-bearing deposits:
Interest-bearing demand accounts.................       45,062         48,798
Savings accounts.................................       84,622         63,943
Certificates of deposit, less than $100,000......       59,909         55,356
Certificates of deposit, greater than $100,000...       20,285         19,389
                                                       -------        -------
Interest-bearing deposits........................      209,878        187,486
                                                       -------        -------
Total deposits...................................     $221,992       $198,840
                                                      ========       ========

     The  following  table  shows,  by category,  the  weighted  average rate on
deposits and the average amount of deposits for the periods indicated:
<TABLE>
<CAPTION>

                                                                       December 31,
                                                     -----------------------------------------------
                                                             2003                        2002
                                                     ------------------          -------------------
<S>                                                  <C>       <C>               <C>        <C>
 (Dollars in thousands)
 Non interest-bearing  deposits................      0.00%     $ 11,119          0.00%      $  9,850
 Savings deposits..............................      1.82%       76,608          2.50%        55,897
 Money market deposits ........................      1.72%       30,365          2.14%        38,370
 Time deposits.................................      2.92%       79,076          3.62%        81,834
 Interest-bearing demand deposits..............      1.31%       16,240          1.90%        10,696
                                                               --------                     --------
          Total deposits.......................                $213,408                     $196,647
                                                               ========                     ========
</TABLE>

     At  December  31,  2003 and  2002,  time  deposits  greater  than  $100,000
aggregated  approximately  $20.3 million and $19.4  million,  respectively.  The
following table  indicates,  as of December 31, 2003 and 2002, the dollar amount
of  deposits  of  $100,000  or more by the time  remaining  until  maturity  (in
thousands):

<TABLE>
<CAPTION>

                                            2003                                           2002
                                            ----                                           ----
                                              1 Year                                          1 Year
                       3 Months   3 to 12     through                3 Months     3 to 12     through
                       or less    Months      5 years    Total       or less      Months      5 years   Total
                       -------    ------      -------    -----       -------      ------     --------  --------
<S>                    <C>        <C>         <C>        <C>         <C>          <C>          <C>      <C>

Time certificates      $2,511     $8,895      $8,879     $20,285     $3,050       $8,791      $7,548    $19,389
</TABLE>

                                       6
<PAGE>

Assets

     Our  management  considers  many  criteria  in managing  assets,  including
creditworthiness,  diversification and structural characteristics,  maturity and
interest rate sensitivity.  The following table sets forth our earning assets by
category at December 31, 2003 and 2002.


            (In Thousands)                            2003            2002
            --------------                            ----            ----
      Investment securities:
        Available for sale.....................    $ 63,375       $ 61,214
        Held to maturity.......................      34,032         15,738
      Short-term interest-bearing deposits.....       3,336          1,366
      Federal funds sold.......................      25,040         12,705
      Federal Home Loan Bank stock.............       2,355          2,263
        Loans:
          Real estate..........................     119,617        119,710
          Commercial and other.................      31,687         40,889
                                                   --------       --------
            Total loans........................     151,304        160,599
          Less unearned income.................         244            246
                                                   --------       --------
          Loans, net of unearned income........     151,060        160,353
                                                   --------       --------
         Total earning assets .................    $279,198       $253,639
                                                   ========       ========
Investment Portfolio

     For a  description  of  the  composition  of  the  carrying  value  of  our
investment  portfolio  at  December  31,  2003  and  2002,  see  Note  11 to the
Consolidated Financial Statements attached hereto.

         The following table presents the maturity distribution of the amortized
cost and estimated market value of our investment portfolio at December 31, 2003
and 2002. The weighted average tax equivalent yields on these instruments are
presented based on final maturity.
<TABLE>
<CAPTION>

                                                            2003                                   2002
                                                            ----                                   ----
                                            Amortized    Estimated      Weighted      Amortized    Estimated     Weighted
                                               Cost     Market Value  Average Yield     Cost     Market Value  Average Yield
                                            ---------   ------------  -------------   ---------  ------------  -------------
<S>                                           <C>         <C>            <C>      <C>            <C>

(Dollars in thousands)

Held to maturity
----------------
Obligations of U.S. Government agencies:
  Due after 1 year but within 5 years......  $ 5,068      $ 5,076        3.11%    $    --        $   --            --
  Due after 5 years but within 10years.....    3,978        3,898        3.87%      1,017         1,019         5.45%
  Due after 10 years but within 15 years...       --           --           --      2,503         2,519         5.19%
  Due after 15 years but within 20 years...      257          250        7.02%         --            --            --
  Due after 20 years.......................       --           --           --      1,841         1,872         4.45%

Mortgage backed securities:
  Due after 5 years but within 10 years....    6,504        6,483        3.44%      1,120         1,137         5.65%
  Due after 10 years but within 15 years...    3,188        3,194        3.31%      2,940         2,961         6.07%
  Due after 15 years but within 20 years...      862          868        2.28%         --            --            --
  Due after 20 years.......................    4,920        4,888        3.33%      1,611         1,622         4.37%

Municipal securities:
  Due within 1 year........................      406          407        2.12%         --            --            --
  Due after 1 year but within 5 years......    1,304        1,299        3.44%         --            --            --
  Due after 10 years but within 15 years...      430          448        5.65%         --            --            --

Corporate securities:
  Due after 1 year but within 5 years .....    2,323        2,369        3.84%      1,039         1,087         5.24%
  Due after 5 years but within 10 .........    1,087        1,124        4.36%        500           481         7.23%
  Due after 20 years.......................    3,705        3,970        8.30%      3,167         2,963         8.37%
                                             -------     --------        -----    -------      --------         -----
  Total held to maturity...................  $34,032     $ 34,274        4.01%    $15,738      $ 15,661         5.70%
                                             =======     ========                 =======      ========
</TABLE>

                                       7
<PAGE>
<TABLE>
<CAPTION>

 Available for sale:
 ------------------

 Obligations of U.S. Government agencies:

<S>                                           <C>          <C>           <C>      <C>             <C>           <C>

  Due within 1 year......................     $2,031       $2,037        2.07%    $    --         $  --            --
  Due after 1 year but within 5 years....      1,022        1,032        3.00%        911           914         3.02%
  Due after 10 years but within 15 years.         --           --           --      2,041         2,030         4.59%
  Due after 15 years but within 20 years.         --           --           --      2,151         2,119         4.61%
  Due after 20 years.....................         --           --           --        813           815         2.06%

Mortgage backed securities:
  Due after 1 year but within 5 years....        364          365        3.03%         --            --            --
  Due after 5 years but within 10 years..      1,065        1,094        3.75%        492           519         7.77%
  Due after 10 years but within 15 years.      1,320        1,337        4.17%         --            --            --
  Due after 20 years.....................      1,227        1,236        2.80%         --            --            --

Municipal securities:
  Due within 1 year .....................        130          131        6.35%        125           126         6.28%
  Due after 1 year but within 5 years....      1,399        1,476        5.93%        550           585         6.68%
  Due after 5 years but within 10 years..      4,823        5,072        6.44%      3,629         3,764         6.19%
  Due after 10 years but within 15 years.      9,767       10,324        6.85%     10,834        11,183         6.70%
  Due after 15 years but within 20.......      3,026        3,199        7.46%      4,029         4,151         7.50%
  Due after 20 years.....................      2,021        2,020        6.78%      2,163         2,132         8.01%

Corporate securities:
  Due after 1 year but within 5 years....      1,367        1,400        3.70%      1,406         1,461         3.70%
  Due after 5 years but within 10 years..      4,488        4,561        5.82%      4,447         4,432         5.86%
  Due after 10 years but within 15 years.      2,100        2,112        7.25%      2,100         2,007         7.25%
  Due after 20 years.....................      1,730        1,878        8.30%      1,733         1,775         8.31%

Equity securities (preferred stock
 in U.S. government agencies):
 Callable within 1 year..................     21,056       18,156        3.07%     17,935        17,342         5.05%
 Callable after 1 year but within 5 years      4,414        4,572        7.58%      4,431         4,715         7.55%
 Callable after 5 years but within 10 years    1,000        1,030        7.93%      1,000         1,080         7.88%


Other securities:

 Due after 20 years.....................         318          343        3.14%         15            18         0.00%
                                             -------      -------                 -------       -------
  Total available for sale..............     $64,668      $63,375        5.14%    $60,805       $61,168         5.34%
                                             =======      =======                 =======       =======
</TABLE>

Investment Policy

     Our investment  portfolio policy is designed to provide guidelines by which
the funds not  otherwise  needed to meet loan demand of our market area can best
be invested to meet fluctuations in the loan demand and deposit  structure.  Our
investment officer,  Chairman Allen, seeks to balance the market and credit risk
against the potential  investment return,  make investments  compatible with the
pledging  requirements of our deposits of public funds, and maintain  compliance
with  regulatory  investment  requirements.  The  Investment  Policy is reviewed
annually by the Directors. Chairman Allen reports monthly to the Directors.

Loan Portfolio

     The  following  table  sets  forth  the  composition  of our loan and lease
portfolio and loans held for sale at December 31, 2003 and 2002.


                                                       2003             2002
                                                --------------    --------------
     (In Thousands)
     Real estate loans:
     Construction and land development..........    $ 21,974         $ 19,017
     Secured by residential properties..........      82,431           85,797
     Commercial real estate loans...............      14,968           14,896
                                                    --------         --------
       Total real estate loans..................     119,373          119,710
     Commercial and industrial loans and leases.      28,140           29,714
     Installment loans..........................       3,547           10,929
     Other consumer loans.......................           0                0
     All other loans............................           0                0
                                                    --------         ---------
       Total loans..............................    $151,060         $160,353
                                                    ========         ========

                                       8

<PAGE>

The following  tables set forth the  maturities of the loan and lease  portfolio
and  its   sensitivity   to  interest   rate   changes  at  December  31,  2003:

<TABLE>
<CAPTION>


                                                      One Year       One Through           Over
     (In Thousands)                                    or Less        Five Years     Five Years          Total
                                                       -------        ----------     ----------          -----
<S>                                                   <C>                  <C>          <C>           <C>
     Real estate construction loans.....              $ 21,974             $  --        $    --       $ 21,974
     Commercial and industrial loans....                 2,621            24,617            902         28,140
     All other loans....................                 7,626            64,604         28,716        100,946
                                                      --------            ------         ------        -------
       Total loans......................              $ 32,221           $89,221        $29,618       $151,060
                                                       =======            ======         ======        =======
</TABLE>

     The  sensitivity  to  interest  rate  changes  of that  portion of our loan
portfolio that matures after one year is set forth below.

     Real estate and commercial and industrial  loans maturing after one year as
of December 31, 2003 (in thousands):

       Fixed rate...........................................   $ 13,590
       Floating rate........................................    101,702

       Other loans maturing after one year:

       Fixed rate...........................................      2,591
       Floating rate........................................        956
                                                               --------
               Total loans maturing after one year.........    $118,839
                                                               ========


Lending Policy

     While the  ultimate  authority  to  approve  loans  rests with our Board of
Directors,  lending authority is delegated by the Directors to our loan officers
and loan  committees,  each of whom may make a  limited  amount of  secured  and
unsecured  loans to a single  borrower or related  group of  borrowers.  Lending
limits of individual  officers are documented in the respective  personnel files
and are reviewed annually by the Directors.  Loan officers discuss with a senior
officer any loan request which exceeds their individual  lending limit. The loan
must have the joint approval from the originating  officer and a senior officer.
Our President and Chief Executive  Officer of the Savings Bank has the authority
to approve  first  mortgages  for  one-to-four  family  residential  loans which
conform to the  guidelines  of the Farmers  Home  Administration,  the  Veterans
Administration,  and the  Tennessee  Housing  Development  Authority,  and other
conventional investors in any amount.

     Our Lending Policy provides written  guidelines for lending  activities and
is reviewed at least annually by the Directors.  The Directors  recognize  that,
from time to time,  it is in State of  Franklin's  best interest to deviate from
the  established,  written  credit policy and have  established  guidelines  for
granting exceptions to the policy.  Situations in which such exceptions might be
granted include the waiving of requirements  for independent  audited  financial
statements when a comfort level with respect to the financial  statements of the
borrower can be otherwise  obtained;  and when it is desirable to meet the terms
offered by a  competitor.  All  exceptions  granted are  documented  in the loan
committee's minutes.

     State of Franklin's  primary  business lies in making real estate  mortgage
loans in the market area. Real estate loans made outside the market area must be
in compliance with the exception-to-policy guidelines. Lending activities in the
real estate area tend to fall into the four general categories of:

     o    acquisition and development,

     o    construction,

     o    permanent financing, and

     o    home equity.

     As a general rule, we seek to maintain  loan-to-collateral  value ratios of
at least 80% of the actual purchase price or the appraised  value,  whichever is
less. This limit is reduced for certain types of real estate loans in conformity
to industry and regulatory guidelines.  The following standards,  established by
inter-agency guidelines by the federal bank regulators, including the FDIC, went
into effect on March 19, 1993:


                                       9
<PAGE>

                                                             Maximum  Allowable
             Loan Category                                   Loan-to-Value Ratio
             -------------                                   -------------------

         Land                                                         65%
         Land development                                             75%
         Owner-occupied commercial                                    75%
         Construction
              Commercial, multifamily (1) and other nonresidential    80%
                  1-4 family residential                              85%
         Improved property                                            85%
         Owner-occupied 1-4 family and home equity (2)                85%
         --------------------------------------

          (1)  Multifamily construction includes condominiums and cooperatives.

          (2)  A  loan-to-value  limit has not been  established  for  permanent
               mortgage  or home  equity  loans or  owner-occupied,  1-4  family
               residential   property.   However,  for  any  such  loan  with  a
               loan-to-value  ratio that equals or exceeds  90% at  origination,
               appropriate  credit  enhancement  in the form of either  mortgage
               insurance or readily marketable collateral is required.

Loan Review and Nonperforming Assets

     We have an  internal  loan  review  system to  determine  deficiencies  and
corrective action to be taken. Loans are graded as follows:

     Class 1. Prime loans based upon liquid  collateral  with adequate margin or
supported by strong financial statement of recent date.  Character and repayment
ability of borrower are excellent and  unquestioned.  Position of company in its
industry and in its community is excellent.  High liquidity,  minimum risk, good
ratios, low handling cost.

     Class 2.  Desirable  loans of somewhat  less stature than Class 1, but with
strong  financial  statements,  and/or  secured by strong  collateral  position.
Probability of serious financial deterioration is unlikely.

     Class 3. Satisfactory  loans of average or mediocre  strength;  having some
deficiency or vulnerability  to changing  economic or industry  conditions,  but
currently  collectible.  Secured loans lacking in margin or liquidity.  Loans to
individuals,  perhaps  supported  in dollars  of net worth but whose  supporting
assets are illiquid.  Sometimes used as a temporary  classification for untested
borrowers or where information is incomplete.

     Class 4. First  classification  that has  relevancy  to bank  examiners.  A
warning  classification  which portrays one or more  deficiencies that cannot be
tolerated  even  in the  short  run.  Regulatory  classification  "Other  Assets
Especially Mentioned."

     Class 5.  Substandard  credits  for  their  steadiness  or other  deficient
nature.   Company  or  individual  loans  with  no  evident  future,  which  are
unfavorable,  affecting  loan-to-deposit ratio or cost of funds. Heavy leveraged
accounts, with no immediate relief or compensating features.  Accounts requiring
attention of loan officer due to lack of borrower cooperation.

     Class 6. Doubtful credits with weaknesses  demanding full attention of loan
officer.  Collection  or  liquidation  in full is highly  questionable.  Serious
problems exist to the point where a partial loss of principal is likely.

     Class 7. Loans  where an  element of  probable  loss is  present.  Critical
credits requiring  immediate and drastic action. Loan should probably be charged
off. Bank examiners will probably classify such loans as "Loss."

     Loans graded "5", "6" or "7" will  automatically  be referred to management
for  inclusion on our "watch  list." We also employ an outside  bank  consulting
firm to perform an independent annual loan review.

     Nonperforming  loans are placed on  non-accrual  basis of accounting if (i)
there is deterioration in the financial condition of the borrower;  (ii) payment
in full of principal or interest is not expected; or (iii) principal or interest
has been in default for 90 days or more,  unless the  obligation is well secured
and in the process of collection.  The three categories of  nonperforming  loans
are  non-accrual  status  loans,  renegotiated  debt,  and loans in  Chapter  13
bankruptcy unless a repayment schedule is adopted that pays out the loan.

     At December  31,  2003 State of Franklin  had  non-accrual  loans  totaling
$3,212,689  and no  restructured  loans or leases nor loans or leases 90 days or
more past due and still  accruing.  We have  increased  the  provision  for loan
losses during 2003 to cover  anticipated  losses associated with non-accrual and
past due loans.

                                       10
<PAGE>


State of Franklin has no loans to foreign  borrowers and we are not aware of any
additional  problems that would  significantly  increase the amount or number of
problem loans in the coming months.

Credit Risk Management and Reserve for Loan and Lease Losses

     Credit  risk  and  exposure  to loss  are  inherent  parts  of the  banking
business.  Management  seeks to manage and minimize these risks through its loan
and investment policies and loan review procedures.  Management  establishes and
continually reviews lending and investment criteria and approval procedures that
it believes reflect the risk sensitive  nature of our business.  The loan review
procedures  are set to monitor  adherence  to the  established  criteria  and to
ensure that on a continuing  basis such  standards are enforced and  maintained.
Management's  objective in establishing  lending and investment  standards is to
manage  the risk of loss and  provide  for  income  generation  through  pricing
policies.  To effect this policy,  management meets weekly to review and approve
loans and meets monthly to review investments.

     The loan  portfolio is regularly  reviewed and  management  determines  the
amount of loans to be  charged-off.  In  addition,  such factors as our previous
loan loss experience,  prevailing and anticipated economic conditions,  industry
concentrations  and the overall  quality of the loan  portfolio are  considered.
While  management  uses available  information to recognize  losses on loans and
real estate owned,  future  additions to the allowance may be necessary based on
changes in economic conditions. In addition,  various regulatory agencies, as an
integral part of their examination  process,  periodically review the allowances
for losses on loans and real  estate  owned.  Such  agencies  may  require us to
recognize additions to the allowances based on their judgments about information
available at the time of their  examinations.  In addition,  any loan, lease, or
portion  thereof  which is  classified  as a "loss" by  regulatory  examiners is
charged-off.

     The reserve for loan and lease losses is increased by provisions charged to
operating  expense.  The reserve is reduced by charging off loans or portions of
loans  at the  time  they are  deemed  by  management  to be  uncollectible  and
increased  when  loans or  leases  previously  charged  off are  recovered.  The
resulting reserve for loan and lease losses is viewed by management as a single,
unallocated  reserve  available  for all loans or  leases.  Rules  and  formulas
relative to the  adequacy  of the  reserve,  although  useful as  guidelines  to
management,  are not rigidly applied.  The reserve for loan and lease losses was
$1,870,279  at year end 2003, or 1.24% of loans and leases  outstanding,  net of
unearned  income and  excluding  loans held for sale,  compared to $1,563,320 or
..99% at year end 2002. During 2003, net charge-offs and recoveries were $137,589
compared to $489,514  during 2002.  Management  does not foresee any events that
will  significantly  increase  loan losses in the coming  months.  The following
table presents data related to State of Franklin's consolidated reserve for loan
and lease losses for the years ended December 31, 2003 and 2002.


                                                        2003             2002
                                                    -------------  -------------
(Dollars in thousands)

Balance at beginning of period..................         $1,563        $1,474

Charge offs:
  Commercial ...................................             --            18
  Real estate mortgage..........................             --           466
  Installment loans to individuals..............             73             6
  Lease financing...............................             65            --
                                                         ------        ------
Recoveries:
  Commercial ...................................             --            --
  Real estate mortgage..........................             --            --
  Installment loans to individuals..............             --            --
  Lease financing...............................             --            --
                                                         ------        ------
Less: Net charge offs...........................            138           490

Additions to reserve charged to operations......            445           579
                                                         ------        ------
Balance at end of period........................         $1,870        $1,563
                                                         ======         =====

Ratio of net charge offs during the period
to average loans and leases outstanding
during the period...............................          0.09%         0.32%
Average allowance for loan and lease losses
to average total loans and leases...............          1.14%         0.95%

                                       11
<PAGE>

     At December 31, 2003 and 2002,  the allowance for loan and lease losses was
allocated as follows:
<TABLE>
<CAPTION>

                                                         2003                                 2002
                                                         ----                                 ----

          (Dollars in thousands)
                                                        Percent of loans in each             Percent of loans in each
                                                 Amount category to total loans      Amount   category to total loans
                                                 ------ -----------------------      ------  ------------------------
<S>                                                <C>           <C>                <C>              <C>

     Commercial..........................          $561           30%               $  469           30%
     Real estate mortgage................           935           50%                  860           55%
     All other ..........................           374           20%                  234           15%
                                                   ----          ----               ------          ----
        Total............................        $1,870          100%               $1,563          100%
                                                  =====          ====               ======          ====
</TABLE>

     The  allocation of the allowance is presented  based in part on evaluations
of past history and composition of the loan  portfolio.  Since these factors are
subject to change,  the current  allocation of the allowance is not  necessarily
indicative of the breakdown of future losses.

     The   following   table  sets  forth   information   with  respect  to  our
nonperforming loans on the dates indicated.  Accrual of interest is discontinued
when there is reasonable doubt as to the full, timely collections of interest or
principal.  When a loan becomes  contractually  past due 90 days with respect to
interest or principal,  it is reviewed and a determination is made as to whether
it should be placed on non-accrual  status. When a loan is placed on non-accrual
status,  all interest  previously  accrued but not collected is reversed against
current period interest income.  Income on such loans is then recognized only to
the extent that cash is received and where the future collection of principal is
probable. Interest accruals are resumed on such loans only when they are brought
fully  current with respect to principal  and interest and when, in the judgment
of management,  the loans are estimated to be fully  collectible as to principal
and interest.  Restructured  loans are those loans on which concessions in terms
have been granted  because of a  borrower's  financial  difficulty.  Interest is
generally accrued on such loans in accordance with the new terms.

Nonperforming assets (Dollars in thousands):                 December 31,
                                                    ----------------------------
                                                         2003          2002
                                                    -------------- -------------
    Non-accrual loans............................     $ 3,213       $ 1,104
    Restructured loans...........................          --            --
    Other loans past due 90 days or more to
      principal or interest payments.............          --            --
    Nonperforming loans as a percentage of net
      loans before allowance for loan losses.....        2.13%        0.70%
    Allowance for loan losses as a percentage
      of nonperforming loans.....................          68%         142%

Capital Resources/Liquidity

     Of primary  importance  to  depositors,  creditors  and  regulators  is the
ability to have  readily  available  funds  sufficient  to repay fully  maturing
liabilities.  Our liquidity,  represented by cash and cash due from banks,  is a
result of our operating,  investing and financing activities. In order to insure
funds are available at all times, we devote resources to projecting on a monthly
basis the amount of funds which will be required and maintain relationships with
a diversified customer base so funds are accessible.  Liquidity requirements can
also be met through  short-term  borrowings  or the  disposition  of  short-term
assets which are generally matched to correspond to the maturity of liabilities.

     Although we have no formal liquidity  policy, in the opinion of management,
its liquidity levels are considered adequate. We are not subject to any specific
liquidity  requirements  imposed by regulatory orders.  Management  believes its
liquidity ratios meet or exceed regulatory guidelines.  Management does not know
of any  trends or demands  which are  reasonably  likely to result in  liquidity
increasing or decreasing in any material manner.

     The following table sets forth liquidity ratios for the periods indicated:

                                                     2003              2002
                                              ----------------- ----------------

     Average loans and leases to average
     deposits...............................         73.1%            78.3%


                                       12
<PAGE>
Impact of Inflation and Changing Prices

     The consolidated  financial statements and related  consolidated  financial
data presented  herein have been prepared in accordance with generally  accepted
accounting  principles  which require the measurement of financial  position and
operating results in terms of historical dollars without considering the changes
in the relative  purchasing  power of money over time and due to inflation.  The
impact of inflation on our operations is reflected in increased operating costs.
Unlike most  industrial  companies,  virtually all of our assets and liabilities
are  monetary in nature.  As a result,  interest  rates have a more  significant
impact on our  performance  than the  effects  of general  levels of  inflation.
Interest  rates do not  necessarily  move in the same  direction  or in the same
magnitude as the price of goods and services.

Capital Adequacy

     Capital  adequacy refers to the level of capital  required to sustain asset
growth over time and to absorb losses. Our management's objective is to maintain
a level of  capitalization  that is sufficient  to take  advantage of profitable
growth opportunities while meeting regulatory requirements.  This is achieved by
improving   profitability  through  effectively  allocating  resources  to  more
profitable businesses,  improving asset quality,  strengthening service quality,
and  streamlining  costs. The primary measures used by management to monitor the
results of these  efforts  are the ratios of average  equity to average  assets,
average tangible equity to average  tangible  assets,  and average equity to net
loans.

     Capital guidelines require the maintenance of an amount of capital based on
risk-adjusted assets so that categories of assets with potentially higher credit
risk will require more capital backing than assets with lower risk. In addition,
financial  institutions  and their  holding  companies  are required to maintain
capital  to  support,  on  a  risk-adjusted  basis,  certain  off-balance  sheet
activities such as loan commitments.

     The capital guidelines classify capital into two tiers, referred to as Tier
I and Tier II. Under risk-based capital requirements,  total capital consists of
Tier I capital which is generally common  stockholders' equity less goodwill and
Tier II capital  which is primarily a portion of the  allowance  for loan losses
and certain  qualifying  debt  instruments.  In determining  risk-based  capital
requirements,  assets  are  assigned  risk-weights  of  0%  to  100%,  depending
primarily on the regulatory  assigned levels of credit risk associated with such
assets.   Off-balance   sheet  items  are  considered  in  the   calculation  of
risk-adjusted  assets through conversion factors  established by the regulators.
The framework for calculating risk-based capital requires financial institutions
to meet the regulatory minimums of 4% Tier I and 8% total risk-based capital and
prepare a leveraged computation comparing Tier I capital to total average assets
less goodwill.

Our consolidated capital ratios are set forth below.

                                                    December 31,   December 31,
                                                        2003          2002
                                                        ----          ----
    (Dollars in thousands)
    Capital:
    Tier I capital:

              Stockholders' common equity............  $24,491        $22,622
              Qualifying interest in subordinated
              debentures .............................   7,860          7,406
              Less unrealized gain (loss) on AFS
              securities .............................  (  798)           252
              Less unrealized loss on equity securities  1,658            151
              Less disallowed intangibles.............     140            188
                                                       -------        -------
                         Total Tier I capital.........  31,351         29,437
    Tier II capital:
              Qualifying interest in subordinated
              debentures .............................     140            594
              Qualifying allowance for loan losses....   1,870          1,563
                                                       -------        -------
                         Total capital................  33,361         31,594

     Risk-adjusted assets............................. 190,660        191,359
     Quarterly average assets......................... 294,881        265,666

     Ratios:
     Tier I capital to risk-adjusted assets...........   16.46%         15.38%
     Tier II capital to risk-adjusted assets..........     .98%           .82%
     Total capital to risk-adjusted assets............   17.52%         16.51%
     Leverage-- Tier I capital to quarterly average
      assets less disallowed intangibles.............    10.63%         11.08%

     On December  31, 2003 and 2002,  we exceeded  the  regulatory  minimums and
qualified as a well-capitalized institution under the regulations.

                                       13
<PAGE>
Supervision and Regulation

General.

     As a Tennessee-chartered,  federally-insured savings bank, the Savings Bank
is subject to extensive  regulation.  Lending  activities and other  investments
must  comply with  various  statutory  and  regulatory  requirements,  including
prescribed minimum capital standards.  The Savings Bank is regularly examined by
the FDIC and the  Tennessee  Department  of  Financial  Institutions  and  files
periodic  reports  concerning its activities and financial  conditions  with its
regulators.  The Savings Bank's  relationship  with  depositors and borrowers is
also  regulated  to a great extent by both federal law and the laws of the State
of  Tennessee,  especially  in such matters as the ownership of accounts and the
form and content of mortgage documents.

     Federal  and state  banking  laws and  regulations  govern all areas of the
operation of the Savings Bank, including reserves,  loans,  mortgages,  capital,
issuance of  securities,  payment of dividends  and  establishment  of branches.
Federal and state bank  regulatory  agencies also have the general  authority to
limit the dividends  paid by insured banks if such payments  should be deemed to
constitute  an unsafe and unsound  practice.  Both the  Tennessee  Department of
Financial  Institutions  and the FDIC have the  authority  to impose  penalties,
initiate  civil and  administrative  actions  and take other  steps  intended to
prevent banks from engaging in unsafe or unsound practices.

Tennessee Supervision and Regulation
------------------------------------

     As a  Tennessee-chartered  savings  bank,  the  Savings  Bank is subject to
various state laws and regulations  which limit the amount that can be loaned to
a  single  borrower,  the  type  of  permissible  investments,   and  geographic
expansion,  among other things.  The Savings Bank must submit an application and
receive the  approval of the  Tennessee  Department  of  Financial  Institutions
before   opening  a  new  branch  office  or  merging  with  another   financial
institution.  The  Commissioner  of the  Department has the authority to enforce
state laws and  regulations  by ordering a director,  officer or employee of the
Savings  Bank to cease and desist from  violating a law or  regulation  and from
engaging in unsafe or unsound banking practices.

     The Savings Bank is  chartered  under the Savings  Bank  Chartering  Act of
1991. The Tennessee Department of Financial Institutions has not yet promulgated
any regulations  governing the operation of savings banks.  However, the Savings
Bank Act  contains  a "parity  provision"  that  authorizes  the  Department  to
promulgate  regulations  authorizing  savings  banks to make any  investment  or
engage in any  activity  that is  permissible  for  federally-chartered  savings
banks, subject to the same limitations applicable to federally-chartered savings
bank, upon the  Commissioner's  determination that  Tennessee-chartered  savings
banks would be at a competitive disadvantage absent such authorization.

Federal Regulation
------------------

     Deposit  Insurance.  Our  deposit  accounts  are  insured by the FDIC up to
applicable  limits  by the Bank  Insurance  Fund.  The Bank  Insurance  Fund was
designated as an insurance fund pursuant to the Financial  Institutions  Reform,
Recovery and Enforcement Act of 1989. As insurer,  the FDIC issues  regulations,
conducts  examinations,  requires the filing of reports and generally supervises
and regulates the  operations of  state-chartered  banks that are not members of
the Federal  Reserve  System.  FDIC approval is required  prior to any merger or
consolidation   involving  state,  nonmember  banks,  or  the  establishment  or
relocation of an office  facility  thereof.  FDIC  supervision and regulation is
intended  primarily  for the  protection of  depositors  and the FDIC  insurance
funds.

     Pursuant to the Federal Deposit Insurance Act, as amended, all Bank Insured
Fund-insured banks must pay semiannual insurance assessments to recapitalize the
Bank Insurance Fund to a 1.25% of insured  deposits  ratio.  In August 1995, the
FDIC  substantially  reduced deposit  insurance  premiums for  well-capitalized,
well-managed Bank Insurance  Fund-insured  institutions to the lowest assessment
rate of 4 basis points per $100 of assessable deposits.  The Bank Insurance Fund
premium  reduction  became  effective in September  1995. Any insured bank which
does not operate in accordance with or conform to FDIC regulations, policies and
directives may be sanctioned for non-compliance. For example, proceedings may be
instituted against any insured bank or any director, officer or employee of such
bank who engages in unsafe and unsound  practices,  including  the  violation of
applicable laws and regulations. The FDIC has the authority to terminate deposit
insurance pursuant to procedures established for that purpose.

     At December  31, 2003,  our deposit base for purposes of FDIC  premiums was
$228 million.  We paid FDIC  insurance  premiums of $30,832 in 2001,  $34,474 in
2002, and $33,573 in 2003.


                                       14
<PAGE>


     Prompt Corrective Action. Under Section 38 of the Federal Deposit Insurance
Act, as amended,  each federal  banking agency is required to implement a system
of prompt  corrective  action for institutions  which it regulates.  The federal
banking agencies have promulgated substantially similar regulations to implement
this system of prompt corrective action.  Under the regulations,  an institution
shall be deemed to be:

          o    "well  capitalized" if it has a total risk-based capital ratio of
               10.0% or more,  has a Tier 1 risk-based  capital ratio of 6.0% or
               more, has a Tier 1 leverage  capital ratio of 5.0% or more and is
               not  subject to  specified  requirements  to meet and  maintain a
               specific capital level for any capital measure;

          o    "adequately  capitalized"  if it has a total  risk-based  capital
               ratio of 8.0% or more, a Tier 1 risk-based  capital ratio that is
               4.0% or more, or a Tier 1 leverage  capital ratio that is 4.0% or
               more;

          o    "undercapitalized"  if it has a total risk-based capital ratio of
               less than 8.0%,  a Tier 1 risk-based  capital  ratio that is less
               than 4.0% or a Tier 1  leverage  capital  ratio that is less than
               4.0% (3.0% under certain circumstances);

          o    "significantly  undercapitalized"  if it has a  total  risk-based
               capital ratio that is less than 6.0%, a Tier 1 risk-based capital
               ratio that is less than 3.0% or a Tier 1 leverage  capital  ratio
               that is less than 3.0%; and

          o    "critically  undercapitalized"  if it  has a  ratio  of  tangible
               equity to total assets that is equal to or less than 2.0%.

     Section  38 of the  Federal  Deposit  Insurance  Act and  the  implementing
regulations  also provide that a federal banking agency may, after notice and an
opportunity  for  a  hearing,  reclassify  a  well-capitalized   institution  as
adequately capitalized and may require an adequately capitalized  institution or
an undercapitalized institution to comply with supervisory actions as if it were
in the next lower category if the institution is an unsafe or unsound  condition
or  engaging  in an  unsafe or  unsound  practice.  (The FDIC may not,  however,
reclassify  a   significantly   undercapitalized   institution   as   critically
undercapitalized).

     An institution generally must file a written capital restoration plan which
meets specified  requirements,  as well as performance  guaranty by each company
that controls the  institution,  with the  appropriate  federal  banking  agency
within 45 days of the date that the institution  receives notice or is deemed to
have  notice  that it is  undercapitalized,  significantly  undercapitalized  or
critically  undercapitalized.  Immediately  upon becoming  undercapitalized,  an
institution  shall become subject to the provisions of Section 38 of the Federal
Deposit  Insurance  Act,  which set forth various  mandatory  and  discretionary
restrictions on its operations.

     Standards  for Safety and  Soundness.  The Federal  Deposit  Insurance  Act
requires the federal banking  regulatory  agencies to prescribe,  by regulation,
standards for all insured depository institutions relating to:

          o    internal  controls,   information   systems  and  internal  audit
               systems;

          o    loan documentation;

          o    credit underwriting;

          o    interest rate risk exposure;

          o    asset growth; and

          o    compensation, fees and benefits.

The federal banking agencies have adopted regulations and Interagency Guidelines
Prescribing Standards for Safety and Soundness to implement safety and soundness
standards  required by the Federal Deposit  Insurance Act. These  Guidelines set
forth the safety and soundness  standards that the federal banking  agencies use
to identify  and  address  problems at insured  depository  institutions  before
capital becomes  impaired.  The agencies also adopted asset quality and earnings
standards which are part of these Guidelines. Under the regulations, if the FDIC
determines  that we fail to meet any standards  prescribed by these  Guidelines,
the agency may require us to submit to the agency an acceptable  plan to achieve
compliance with the standard,  as required by the Federal Deposit Insurance Act.
The final regulations  establish deadlines for the submission and review of such
safety and soundness compliance plans.


                                       15
<PAGE>


     Capital  Requirements.  The FDIC's minimum capital standards  applicable to
FDIC-regulated banks and savings bank require the most highly-rated institutions
to meet a "Tier 1" leverage capital ratio of at least 3.0% of total assets. Tier
1 (or "core capital")  consists of common  stockholders'  equity,  noncumulative
perpetual  preferred stock and minority  interests in consolidated  subsidiaries
minus all  intangible  assets other than limited  amounts of purchased  mortgage
servicing rights and certain other accounting adjustments.  All other banks must
have a Tier 1  leverage  ratio of at least  100-200  basis  points  above the 3%
minimum. The FDIC capital regulations  establish a minimum leverage ratio of not
less  than 4% for  banks  that  are not  highly  rated  or are  anticipating  or
experiencing significant growth.

     FDIC capital  regulations  require  higher  capital  levels for banks which
exhibit  more than a moderate  degree of risk or exhibit  other  characteristics
which necessitate that higher than minimum levels of capital be maintained.  Any
insured  bank with a Tier 1  capital  to total  assets  ratio of less than 2% is
deemed to be  operating in an unsafe and unsound  condition  pursuant to Section
8(a) of the Federal Deposit  Insurance Act unless the insured bank enters into a
written  agreement,  to which  the  FDIC is a  party,  to  correct  its  capital
deficiency.  Insured banks  operating  with Tier 1 capital  levels below 2% (and
which have not entered  into a written  agreement)  are subject to an  insurance
removal action.  Insured banks operating with lower than the prescribed  minimum
capital levels generally will not receive approval of applications  submitted to
the FDIC. Also,  inadequately  capitalized state nonmember banks will be subject
to such administrative action as the FDIC deems necessary.

     FDIC regulations also require that savings banks meet a risk-based  capital
standard.  The risk-based  capital  standard  requires the  maintenance of total
capital (which is defined as Tier 1 capital and Tier 2 or supplementary capital)
to risk weighted assets of 8% and Tier 1 capital to risk-weighted  assets of 4%.
In determining the amount of risk-weighted  assets, all assets, plus certain off
balance sheet items, are multiplied by a risk-weight of 0% to 100%, based on the
risks  the FDIC  believes  are  inherent  in the  type of  asset  or  item.  The
components of Tier 1 capital are equivalent to those  discussed  above under the
3% leverage  requirement.  The components of mandatory  convertible  securities,
term  subordinated  debt,  intermediate-term  preferred  stock and allowance for
possible  loan and lease  losses.  Allowance  for possible loan and lease losses
includable  in  supplementary  capital  is  limited  to a  maximum  of  1.25% of
risk-weighted   assets.   Overall,   the  amount  of  capital   counted   toward
supplementary capital cannot exceed 100% of Tier 1 capital. The FDIC includes in
its evaluation of a bank's capital adequacy an assessment of risk-based  capital
focusing  principally  on  broad  categories  of  credit  risk.  No  measurement
framework for  assessing  the level of a bank's  interest rate risk exposure has
been codified but, effective board and senior management  oversight of the banks
tolerance for interest rate risk is required.

     The  FDIC  has  adopted  the  Federal  Financial  Institutions  Examination
Council's  recommendation  regarding  the  adoption of  Statement  of  Financial
Accounting  Standard No. 115,  "Accounting  for Certain  Investments in Debt and
Equity  Securities."  Specifically,  the agencies determined that net unrealized
holding gains or losses on available for sale debt and equity  securities should
not be included when calculating core and risk-based capital ratios.

     FDIC  capital   requirements  are  designated  as  the  minimum  acceptable
standards for banks whose overall  financial  condition is fundamentally  sound,
which are well-managed and have no material or significant  financial  weakness.
The FDIC capital  regulations  state that,  where the FDIC  determines  that the
financial history or condition,  including  off-balance  sheet risk,  managerial
resources and/or the future earnings prospects of a bank are not adequate and/or
a bank has a significant  volume of assets classified  substandard,  doubtful or
loss or otherwise  criticized,  the FDIC may determine that the minimum adequate
amount  of  capital  for  that  bank  is  greater  than  the  minimum  standards
established in the regulation.

     We believe  that,  under the  current  regulations,  the  Savings  Bank has
sufficient  capital to meet its minimum capital  requirements.  However,  events
beyond the  control of the  Savings  Bank,  such as a downturn in the economy in
areas  where the  Savings  Bank has most of its loans,  could  adversely  affect
future earnings and,  consequently,  the ability of the Savings Bank to meet its
capital requirements.

                                       16
<PAGE>

     Activities and Investments of Insured  State-Chartered Banks. Section 24 of
the Federal Deposit  Insurance Act, as amended,  generally limits the activities
and equity investments of FDIC-insured,  state-chartered banks to those that are
permissible  for  national  banks.   Under   regulations   dealing  with  equity
investments,  an insured  state bank  generally  may not directly or  indirectly
acquire or retain any equity investment of a type, or in an amount,  that is not
permissible  for a national bank. An insured state bank is not prohibited  from,
among other things,

     (1)  acquiring or retaining majority interest in a subsidiary,

     (2)  investing as a limited  partner in a  partnership  the sole purpose of
          which  is  direct  or   indirect   investment   in  the   acquisition,
          rehabilitation  or new  construction of a qualified  housing  project,
          provided that such limited partnership investment may not exceed 2% of
          the bank's total assets,

     (3)  acquiring  up to 10% of the  voting  stock of a  company  that  solely
          provides or reinsures  directors',  trustees' and officers'  liability
          insurance  coverage or bankers' blanket bond group insurance  coverage
          for insured depository institutions, and

     (4)  acquiring or retaining the voting  shares of a depository  institution
          if certain requirements are met.


     State law also provides that the Savings Bank may invest in any  investment
permissible by federally  chartered  savings banks,  subject to the restrictions
for such entities.

     FDIC regulations  implementing  Section 24 of the Federal Deposit Insurance
Act  provide  that  an  insured  state-chartered  bank  may  not,  directly,  or
indirectly  through a subsidiary,  engage as "principal" in any activity that is
not  permissible  for a national bank unless the FDIC has  determined  that such
activities  would pose no risk to the insurance fund of which it is a member and
the bank is in compliance with applicable regulatory capital  requirements.  Any
insured  state-chartered  bank or savings bank directly or indirectly engaged in
any  activity  that  is  not  permitted  for a  national  bank  must  cease  the
impermissible activity.

     Loans-to-One-Borrower.  The aggregate amount of loans that we are permitted
to make under  applicable  regulations  to any one borrower,  including  related
entities, is the greater of 25% of unimpaired capital with Board approval. Based
on the Savings Bank's capitalization of $20.6 million, our loans-to-one borrower
limit is approximately $5.1 million.

     Federal Reserve System. In 1980, Congress enacted legislation which imposed
Federal  Reserve  requirements  on all  depository  institutions  that  maintain
transaction accounts or non-personal time deposits. These reserves may be in the
form of cash or non-interest-bearing  deposits with the regional Federal Reserve
Bank. NOW accounts and other types of accounts that permit payments or transfers
to third  parties fall within the  definition  of  transaction  accounts and are
subject to these reserve requirements,  as are any non-personal time deposits at
a bank.

     Community  Reinvestment  Act. We are also subject to the  provisions of the
Community  Reinvestment Act of 1977, which requires the appropriate federal bank
regulatory  agency,  in connection  with its regular  examination  of a bank, to
assess the bank's record in meeting the credit needs of the  community  serviced
by the bank,  including low and moderate  income  neighborhoods.  The regulatory
agency's  assessment  of the  bank's  record is made  available  to the  public.
Further, such assessment is required of any bank which has applied,  among other
things, to establish a new branch office that will accept deposits,  relocate an
existing  office or merge or  consolidate  with, or acquire the assets or assume
the liabilities of, a federally regulated financial institution.  As a component
of its Community  Reinvestment  Act outreach,  we have  instituted an affordable
home  loan  program  for  first-time  home  buyers  and low to  moderate  income
borrowers.  We also offer  Tennessee  Housing  Development  Authority,  Veterans
Administration and Federal Home Administration loans.

     Interstate  Banking.  On September 29, 1994, the Federal government enacted
the  Riegle-Neal  Interstate  Banking and Branching  Efficiency Act of 1994. The
provisions  of this Act became  effective on September  29, 1995,  at which time
eligible  bank  holding  companies  in any state were  permitted,  with  Federal
Reserve  approval,  to acquire  organizations  in any other state.  As such, all
existing regional  compacts and substantially all existing regional  limitations
on interstate  acquisitions of banking organizations have been eliminated.  This
Act also removed  substantially  all of the existing  prohibitions on interstate
branching by banks. On and after June 1, 1997, a bank operating in any state may
establish one or more branches within any other state without the  establishment
of a separate banking structure within the other state.

                                       17
<PAGE>

     Under the  Tennessee  Bank Reform Act of 1996 that  amended  the  Tennessee
Banking Act, the acquisition of Tennessee  banks and bank holding  companies by,
and mergers  with,  out-of-state  banks and bank holding  companies is permitted
with the prior approval of the  Department  subject to the  requirements  of the
Act. An amendment to the Bank Reform Act of 1996,  effective June 1, 1997,  also
permits  Tennessee  state banks and savings  banks,  with prior  approval of the
Department of Financial  Institutions,  to operate branches outside the state of
Tennessee. Although this legislation has the potential to increase the number of
competitors  in our market  place,  we cannot  predict the actual impact of such
legislation  on our  competitive  position.  Out-of-state  banks may not,  under
current Tennessee law, branch de novo into Tennessee nor may out-of-state  banks
or bank holding companies enter Tennessee through "branch-only" acquisition.

Change in Control Restrictions
------------------------------

     Statutory  Provisions.  The Change in Bank Control Act requires the written
consent  of the  FDIC be  obtained  prior to any  person  or  company  acquiring
"control" of a  state-chartered  savings  bank.  Tennessee law also requires the
prior written  consent of the  Department of Financial  Institutions  to acquire
control of a Tennessee-chartered savings bank. Upon acquiring control, a company
will be deemed to be a bank holding  company and must  register with the Federal
Reserve.  Conclusive  control is presumed to exist if,  among other  things,  an
individual  or company  acquires more than 25% of any class of our voting stock.
Rebuttable  control  is  presumed  to exist if,  among  other  things,  a person
acquires more than 10% of any class of voting stock and the issuer's  securities
are registered  under Section 12 of the  Securities  Exchange Act of 1934 or the
person would be the single largest stockholder.  Restrictions  applicable to the
operations of a bank holding  company and conditions  that may be imposed by the
Federal  Reserve in  connection  with its approval of a company to become a bank
holding  company may deter  companies from seeking to obtain control of State of
Franklin.

     Other. While not directly  restricting  efforts to acquire control of State
of Franklin,  certain other  characteristics  of our organization may discourage
attempts  to acquire  control  of us. Our  By-Laws  provide  that  approximately
one-third of our Board of Directors  are elected  each year,  thereby  making it
more difficult for a potential  acquirer to gain control of State of Franklin by
electing  the members of the Board of  Directors  than it would be if  directors
were elected at more frequent  intervals or if a greater percentage of directors
were elected at any one time.

     The  restrictions  contained  in the  Change  of Bank  Control  Act and the
regulations  promulgated  thereunder  will apply to  acquisitions  of the common
stock  in the  offering.  In  addition,  as a  result  of  all of the  foregoing
restrictions on acquisitions,  State of Franklin is a less attractive target for
a  "takeover"  attempt than other  less-highly  regulated  companies  generally.
Accordingly, these restrictions might deter offers to purchase State of Franklin
which  stockholders may consider to be in their best interests,  and may make it
more difficult to remove incumbent management.

Regulation of Bank Holding Companies
------------------------------------

     We are subject to  regulation  by the Federal  Reserve and are  required to
file with the Federal Reserve annual reports and other information regarding our
business operations and the business operations of our subsidiaries. We are also
subject to examination by the Federal Reserve and are required to obtain Federal
Reserve  approval  prior to  acquiring,  directly or  indirectly,  ownership  or
control of voting shares of any bank if, after such acquisition,  we will own or
control, directly or indirectly,  more than 5% of the voting stock of such bank.
In addition, pursuant to the provisions of the Bank Holding Company Act of 1956,
as amended, and regulations  promulgated by the Federal Reserve thereunder,  the
bank holding company is only able to engage in, or own or control companies that
engage in,  activities deemed by the Federal Reserve to be so closely related to
banking as to be a proper incident thereto.

Dividends
---------

     The Board of Directors may determine  whether dividends on the common stock
will be declared and paid,  taking into  consideration  our  operating  results,
financial condition,  tax considerations,  future capital requirements and other
relevant  factors.  The Directors may also declare a non-cash dividend if, after
considering  the above factors,  it appears  prudent to do so. The Directors are
not,  however,  obligated  to pay any such  dividend  and will  only do so if it
appears to be in the best  interest of State of Franklin.  The  Directors do not
anticipate that a dividend will be paid in the foreseeable future.

     Tennessee law requires that  dividends be paid only from retained  earnings
(or undivided  profits),  except that dividends may be paid from capital surplus
with the prior,  written  consent of the  Department of Financial  Institutions.
Tennessee laws  regulating  savings banks require  certain  charges  against and
transfers from an  institution's  undivided  profits  account  before  undivided
profits can be made available for the payment of dividends.

                                       18
<PAGE>

Monetary Policy
---------------

     We,  like other  depository  institutions,  are  affected  by the  monetary
policies  implemented by the Federal Reserve.  The Federal Reserve has the power
to restrict or expand the money supply through open market operations, including
the purchase and sale of  government  securities  and the  adjustment of reserve
requirements.  These actions may result in  significant  fluctuations  in market
interest rates, which could adversely affect our operations, such as our ability
to make loans and attract deposits, as well as market demand for loans.

Capital Adequacy
----------------

     See "Capital Adequacy" above for a discussion of bank regulatory  agencies'
capital adequacy requirements.

Recent Legislation
------------------

     Bills  are  presently  pending  before  the  United  States  Congress,  and
additional  bills  may be  introduced  in the  future  in the  Congress  and the
Tennessee General Assembly,  to alter the structure,  regulation and competitive
relationships of the nation's financial institutions.

     In October 2001, the USA Patriot Act of 2001 was enacted in response to the
terrorist  attacks in New York,  Pennsylvania and Washington D.C. which occurred
on  September  11,  2001.  The Patriot Act is intended to  strengthen  U.S.  law
enforcement's and the intelligence  communities' abilities to work cohesively to
combat terrorism on a variety of fronts. The potential impact of the Patriot Act
on financial  institutions  of all kinds is  significant  and wide ranging.  The
Patriot Act contains sweeping anti-money  laundering and financial  transparency
laws and imposes various  regulations,  including standards for verifying client
identification  at  account  opening,  and rules to  promote  cooperation  among
financial  institutions,  regulators and law enforcement entities in identifying
parties that may be involved in terrorism or money laundering.

     On October  28,  2003,  President  George W. Bush signed into law the Check
Clearing for the 21st Century Act, also known as Check 21. The new law, which is
not  effective  until  October 28, 2004,  gives  "substitute  checks," such as a
digital  image of a check  and  copies  made  from that  image,  the same  legal
standing as the original paper check. Some of the major provisions include:

     o    Allows check truncation without making it mandatory;

     o    Demands that every financial institution communicate to accountholders
          in writing a description of its substitute  check  processing  program
          and their rights under the law;

     o    Legalizes  substitutions  for and replacements of paper checks without
          agreement from consumers;

     o    Keeps in place  the  previously  mandated  electronic  collection  and
          return of checks between  financial  institutions only when individual
          agreements are in place;

     o    Cautions that when  accountholder's  request  verification,  financial
          institutions   must  produce  the  original  check  (or  a  copy  that
          accurately  represents the original) and demonstrate  that the account
          debit was accurate and valid; and

     o    Requires  recrediting of funds to an individual's  account on the next
          business day after a consumer  proves the  financial  institution  has
          erred.

     This new  legislation  will likely have a dramatic  impact on bank  capital
spending  as  many  financial   institutes   assess  whether   technological  or
operational  changes are necessary to stay competitive and take advantage of the
new opportunities presented by Check 21.

                                       19
<PAGE>

     The  Gramm-Leach-Bailey  Financial  Modernization  Act of 1999 permits bank
holding   companies   meeting  certain   management,   capital,   and  community
reinvestment  act  standards  to  engage  in a  substantially  broader  range of
non-banking   activities   than  permitted   previously,   including   insurance
underwriting and merchant banking activities. The Act repeals sections 20 and 32
of the Glass  Steagall Act,  permitting  affiliations  of banks with  securities
firms and registered investment companies.  The Act authorizes financial holding
companies,  permitting banks to be owned by security firms,  insurance companies
and merchant banking  companies and visa-versa.  Some of these  affiliations are
also permissible for bank subsidiaries.  The Act gives the Federal Reserve Board
authority to regulate financial holding  companies,  but provides for functional
regulation of subsidiary activities.

     The Gramm-Leach-Bailey  Financial Modernization Act also modifies financial
privacy and community  reinvestment  laws. The new financial privacy  provisions
generally  prohibit  financial  institutions  such as  State  of  Franklin  from
disclosing  non-public  personal  financial  information to third parties unless
customers  have  the  opportunity  to opt out of the  disclosure.  The Act  also
magnifies  the  consequences  of a bank  receiving  a less  than a  satisfactory
community  reinvestment  act  rating,  by  freezing  new  activities  until  the
institution achieves a better community reinvestment act rating.

Employees

     At  December  31,  2003,  we had a total of 63  employees  with 50 of those
employed on a full-time basis.

Item 2. Description of Property

     We operate at five  locations  with our  principal  office  located at 1907
North Roan Street, Johnson City, Washington County,  Tennessee. The Savings Bank
owns the land and the approximately 36,000 square foot building at our principal
office,  8,000 feet of which is leasable space. This property serves as the main
office of the Savings  Bank.  The Savings Bank also operates  branch  offices at
3300 Browns Mill Road and 612 West Walnut Street,  Johnson City, Tennessee;  and
240 West Center Street and 4409 Fort Henry Drive,  Kingsport,  Sullivan  County,
Tennessee.  The Savings Bank owns the land and the  buildings in both  Kingsport
locations. The West Walnut branch is also owned by the Savings Bank. The Savings
Bank  leases  the  Browns  Mill Road  office  from  Allen and  Allen,  a general
partnership.  Charles E. Allen, Jr., chairman and chief financial officer of the
Savings Bank,  and Charles E. Allen,  Sr., M.D., a director of the Savings Bank,
are principals of Allen and Allen.  The lease was negotiated at arm's length and
was approved by the Tennessee Department of Financial Institutions and the FDIC.
Rent for the 2,625 square foot building for the next three years will be $46,536
annually.  Effective  April 1, 2004,  the Real  Estate  Company  entered  into a
three-year lease with the partnership for a 4,000 square foot office facility at
3300 Browns Mill Road. The annual lease payments will be $53,964. Lease payments
for the  Savings  Bank and the Real  Estate  Company  at the  Browns  Mill  Road
locations include taxes, insurance and maintenance costs.

     All  facilities  operated by the Savings Bank have  improvements  including
drive-through tellers, vaults, night depository and certain facilities have safe
deposit boxes.

Item 3.  Legal Proceedings

     There are no pending  legal  proceedings  to which  State of  Franklin is a
party or of which any of our  properties  are  subject  that are  expected to be
material;  nor are there material  proceedings known to us to be contemplated by
any  governmental  authority;  nor are there material  proceedings  known to us,
pending or  contemplated,  in which any  director,  officer or  affiliate or any
principal  security holder of State of Franklin,  or any associate of any of the
foregoing, is a party or has an interest adverse to State of Franklin.

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

     None.


                                     PART II

Item 5. Market for Common Equity and Related Stockholder Matters

     There is no established  public  trading  market for our common stock.  Our
management  is aware that isolated  transactions  in the common stock occur from
time to time. There is no significant likelihood that any market will develop in
the  future.  There  has  been  isolated  trading  of  the  common  stock  where
shareholders  wishing to transfer shares would do so in individually  negotiated
transactions. The following table shows a range of high and low sales prices, to
the best of management's knowledge, for our common stock.

                                       20
<PAGE>


                                                          High             Low
2002:
     First Quarter....................................  $16.20            $16.20
     Second Quarter...................................   18.00             18.00
     Third Quarter....................................   18.00             18.00
     Fourth Quarter...................................   18.00             18.00
2003:
     First Quarter....................................  $18.00            $18.00
     Second Quarter...................................   20.00             18.00
     Third Quarter....................................   20.00             19.50
     Fourth Quarter...................................   22.50             20.00

     There were 1,104  holders of record of the common  stock as of December 31,
2003.

     On December 18, 2001, we issued  debentures to State of Franklin  Statutory
Trust I (the "Trust"),  a business trust subsidiary of ours. The Trust purchased
the  debentures  with the proceeds from the sale of trust  preferred  securities
issued  by the  Trust  in a  private  placement.  We  guaranteed  the  preferred
securities. The proceeds from the sale of the debentures will be used to support
our current capital position  allowing for future growth.  For more information,
see  notes  1,  4,  and 13 to the  Consolidated  Financial  Statements  included
elsewhere in this report.

     State of Franklin currently intends to retain its earnings, if any, for use
in the  business  and does not  anticipate  paying  any  cash  dividends  in the
foreseeable  future.  The board of directors cannot predict when such dividends,
if any, will ever be made. The payment of dividends,  if any, shall at all times
be subject to the payment of expenses,  the  maintenance  of reasonable  working
capital and risk reserves, and minimum capitalization requirements for banks.

Item 6. Management's Discussion and Analysis or Plan of Operation

General

     The   following   discussion   and   analysis  is  intended  to  assist  in
understanding the financial  condition and the results of operations of State of
Franklin.   References  to  "State  of  Franklin"   include  State  of  Franklin
Bancshares, Inc. and State of Franklin Savings Bank.


FOR THE YEAR ENDED  DECEMBER  31, 2003  COMPARED TO THE YEAR ENDED  DECEMBER 31,
2002

EARNINGS REVIEW

     Total net income of State of Franklin for the year ended  December 31, 2003
was  $2,645,445,  a decrease of $538,686  under the year ended December 31, 2002
total net  income of  $3,184,141.  Earnings  per  share  was $1.77  compared  to
earnings per share of $2.16 in 2002.  Return on average assets was 0.94% and the
return on average equity was 11.23% for the year ended December 31, 2003.

     Operating  results in 2003 reflected  lower net interest  income and higher
noninterest  income.  Net  interest  income of $7.6  million  for the year ended
December 31, 2003 was 12.0% under the 2002 period.  During 2003, average earning
assets  grew  10%  while  average  interest  bearing   liabilities  and  capital
securities also grew 10% over the same period a year ago. The 2003 provision for
possible loan losses was $444,548.  Noninterest  income increased  $387,287,  or
27%,  with other fees and service  charges,  net gains on loans  sold,  and real
estate sales  commission  primarily  responsible  for the increase over the year
ended  December  31,  2002.  Noninterest  expense was $5.5  million for the 2003
period, a slight decrease under $5.6 million for 2002

Net Interest Income and Margin

     Net interest  income  declined $1.1 million for the year ended December 31,
2003 to $7.6 million  compared to $8.7  million for the year ended  December 31,
2002.  The decrease in net interest  income was due to a $2 million  decrease in
interest income while interest  expense  declined  $940,000.  With interest rate
declines in recent years, deposits generally repriced faster than rates on loans
and investments. Consequently, much of the

                                       21
<PAGE>


reduction  in deposit  cost  occurred  in 2002 while the  reduction  in interest
income from  earning  assets  occurred in 2003.  During  2003,  the rate paid on
average interest-bearing liabilities decreased 61 basis points to 2.68% compared
to a 155 basis point  reduction  in 2002.  During 2003,  the taxable  equivalent
yield on earning  assets  declined 126 basis points to 5.51%  compared with a 90
basis point reduction  during 2002. As a result the net interest margin declined
71 basis points to 3.06% in 2003 compared to 3.77% in 2002.

     During 2003,  average earning assets  increased $18.6 million,  or 7%, over
2002 due primarily to a $12.3 million increase in average fed funds sold, a $2.3
million increase in interest-bearing demand balances, a $1.9 million increase in
investments,  and a $2.0 million  increase in average  loans.  Growth in average
assets during 2003 was funded mainly through a $16.8 million increase in average
deposits and a $2.0 million  increase in average Federal Home Loan Bank ("FHLB")
advances.

Provision for Loan Losses

     During 2003,  the provision for possible loan and lease losses was $444,548
compared to $578,979 in 2002. There were $202,325 in net charge-offs during 2003
and $489,514 in 2002. The allowance for possible loan losses  represented  1.24%
of total  loans,  net of mortgage  loans  held-for-sale,  at December  31, 2003,
compared to 0.99% at December 31, 2002.

Provision for Income Taxes

     For the year ended  December 31, 2003,  the  provision for income taxes was
$758,430 compared to $760,430 in 2002, a decline of $2,000. Provision for income
taxes  decline  only  slightly,  even though  income  before  income tax decline
$540,696,  due mainly to declining  interest rates and the resulting lower level
of income from the  adjustable  rate agency  preferred  stocks  which is 70% tax
exempt for corporations.

Noninterest Income

     State of Franklin's noninterest income was $1,816,268 during the year ended
December  31,  2003,  an increase of  $387,287 or 27% over the  comparable  2002
period.  The  increase was  attributable  to increases in other fees and service
charges,  net gains on loans sold, real estate sales commissions,  and insurance
commissions of $78,430, $452,001, $114,310, and $8,218, respectively. Offsetting
part of the increases was a $259,313  decline in realized gain on securities and
a $6,359 decline in rental income

Noninterest Expense

     Noninterest  expense totaled  $5,549,929 for the period ending December 31,
2003, a decrease of $12,411 from the same period in 2002. Noninterest expense to
average  assets was 1.96% for the period  ending  December 31, 2003  compared to
2.14%  for the same  period  a year  ago.  Compensation  and  related  benefits,
occupancy expense,  advertising, and data processing expense increased $249,861,
$61,321,  $2,751 and $9,674,  respectively.  Furniture and equipment expense and
other operating expenses declined $61,644 and $274,374, respectively.

BALANCE SHEET REVIEW

     State of  Franklin  places an  emphasis  on an  integrated  approach to our
balance sheet  management.  Significant  balance sheet  components of investment
securities,  loans and sources of funds are managed in an integrated manner with
the management of interest rate risk,  liquidity and capital.  These  components
are examined below.

Investment Securities

     Investment  securities  totaled  $97.4  million at December 31,  2003.  The
investment  portfolio at year end consisted of $12.4 million in debt  securities
issued  by the U.S. Government  or Federal  Agencies,  $19.5 million in mortgage
backed  securities,  $24.4 million in  securities  issued by state,  county,  or
municipalities,   $17.1  million  in  corporate  securities,  $23.7  million  in
preferred  stock  issued by  Federal  Agencies,  and  $343,200  in other  equity
securities.


                                       22
<PAGE>


     At December 31, 2003, securities categorized as available-for-sale  totaled
$63.4  million  while the  held-to-maturity  securities  totaled  $34.0  million
compared  to  $61.2   million  in   available-for-sale   and  $15.7  million  in
held-to-maturity   at  December   31,   2002.   At  December   31,   2003,   the
held-to-maturity   portfolio  had  $242,614  in   unrealized   gains  while  our
available-for-sale  securities  had net  unrealized  losses of $1,292,497 due to
changes in market  rates.  Due to the credit  quality of these  investments,  no
realized losses are expected.

Loans

     Loans  outstanding  totaled  $151.1  million at  December  31,  2003.  This
represented  an decrease of 6% from the December 31, 2002  outstanding  loans of
$160.4  million.  First  mortgage loans were $49.7 million at December 31, 2003,
compared  with $57.2 million at December 31, 2002, a decline of 13%. Real estate
construction  lending  totaled  $21.8  million and $18.6 million at December 31,
2003 and 2002,  respectively.  Commercial  loans  declined  to $63.2  million at
December 31, 2003 from $66.4  million at December 31,  2002.  Consumer  loans at
December  31,  2003,  decreased to $13.1  million  compared to $13.8  million at
December 31, 2002.

Non-Performing Assets

     Nonaccrual  loans and leases  totaled  $3,213,000  at December 31, 2003 and
$1,104,000  at December 31,  2002.  There were no loans past due 90 days or more
and still accruing at December 31, 2003 and December 31, 2002. The allowance for
possible  loan and lease losses was  $1,870,279  and  $1,563,320 at December 31,
2003 and 2002, respectively. Management believes the allowance for possible loan
and lease losses is adequate to provide for potential loan losses.

Deposits

     Total deposits at December 31, 2003 of $222 million, reflect an increase of
$23.2  million or a 12%  increase  from  $198.8  million at December  31,  2002.
Non-interest bearing demand deposits totaled $12.1 million at December 31, 2003,
an increase of $761,000 or 7% from December 31, 2002.  Interest bearing deposits
increased $22.4 million to $209.9 million at December 31, 2003.

Capital

     Equity capital at December 31, 2003 was $24.5 million,  an increase of $1.9
million from $22.6  million at December  31,  2002.  Tier 1 capital for State of
Franklin  increased  $2 million to $31.4  million.  At December  31,  2003,  all
capital  ratios  were in  excess  of the  regulatory  minimums,  with  State  of
Franklin's  Tier 1, total  risk-based and leverage  ratio of 16.46%,  17.52% and
10.63%, respectively.

     On December 18, 2001, we issued  debentures to State of Franklin  Statutory
Trust I (Trust),  a business trust  subsidiary of ours. The Trust  purchased the
debentures with the proceeds from the sale of trust preferred  securities issued
by the Trust in a private placement. We guaranteed the preferred securities. For
more  information,  see  notes  1,  4,  and  13 to  the  Consolidated  Financial
Statements  included  elsewhere in this report.  The capital  levels of State of
Franklin  as of  December  31,  2003  include  adjustment  for the  subordinated
debentures issued in December of 2001, subject to certain  limitations.  Federal
Reserve guidelines limit the amount of cumulative preferred securities which can
be included in Tier 1 capital to 25% of total Tier 1 capital. As of December 31,
2003,  approximately  $7.9 million of $8 million of debentures  were included as
Tier 1 capital of State of Franklin with the remaining $100,000 included as Tier
2 capital, component of total risk-based capital.

Liquidity

     The purpose of liquidity  management  is to ensure that there is sufficient
cash  flow to  satisfy  demands  for  credit,  deposit  withdrawals,  and  other
corporate needs.  Traditional  sources of liquidity include asset maturities and
growth in core  deposits.  Other sources of funds such as securities  sold under
agreements  to  repurchase,   negotiable   certificates  of  deposit  and  other
liabilities   are  sources  of  liquidity   which  State  of  Franklin  has  not
significantly  used.  State of Franklin  had unused  sources of liquidity in the
form of unused  federal  funds lines of credit and a line of credit for the FHLB
of Cincinnati totaling $62.0 million at December 31, 2003.


                                       23
<PAGE>


Effects of Inflation and Changing Prices

         The consolidated financial statements and related financial data
presented herein have been prepared in accordance with generally accepted
accounting principles, which require the measurement of financial position and
operating results in terms of historical dollars, without considering changes in
relative purchasing power over time due to inflation.

         Unlike most industrial companies, virtually all of the assets and
liabilities of a financial institution are monetary in nature. As a result,
interest rates generally have a more significant impact on a financial
institution's performance than does the effect of inflation. In the current
interest rate environment, the liquidity and maturity structures of State of
Franklin's assets and liabilities are critical to maintenance of acceptable
performance levels.


















                                       24
<PAGE>


Item 7. Financial Statements

The consolidated financial statements of State of Franklin Bancshares,  Inc. are
set forth below.





                       State of Franklin Bancshares, Inc.
                             JOHNSON CITY, TENNESSEE

                              INDEX TO AUDIT REPORT

                           December 31, 2003 and 2002

          Audited Consolidated Financial Statements:

          Independent Auditor's Report                                        26

          Consolidated Statements of Financial Condition                      27

          Consolidated Statements of Income                                   28

          Consolidated Statements of Changes in Stockholders' Equity          29

          Consolidated Statements of Cash Flows                            30-31

          Notes to Consolidated Financial Statements                       32-49

          Statement of Management Responsibility                              50



                                       25
<PAGE>





                              BAYLOR AND BACKUS
D.G. LEONARD, CPA     CERTIFIED PUBLIC ACCOUNTANTS  E.N. BACKUS, CPA (1907-1971)
R.F. VANHOY, CPA                                     T.E. HULSE, CPA (1927-1975)
T.S. JOHNSON, CPA        409 EAST WATAUGA AVENUE    E.R. BAYLOR, CPA (1894-1982)
G.L. FREEMAN, CPA          P.O. BOX 1736           A.C. NICKELL, CPA (1921-1983)
J.M. WOODY, CPA     JOHNSON CITY, TENNESSEE 37605 W.E. MORELOCK, CPA (1927-1985)
D.M. MCVEY, CPA           (423) 282-9000         H.L. SIENKNECHT, CPA(1917-1990)




                          INDEPENDENT AUDITOR'S REPORT



To the Stockholders and
the Board of Directors
State of Franklin Bancshares, Inc.
Johnson City, Tennessee

We have audited the accompanying  consolidated statements of financial condition
of State of Franklin Bancshares, Inc. (a Tennessee corporation) and subsidiaries
as of December 31, 2003 and 2002,  and the related  consolidated  statements  of
income,  changes in  stockholders'  equity  and cash  flows for the years  ended
December 31, 2003, 2002 and 2001. These  consolidated  financial  statements are
the  responsibility  of State of Franklin  Bancshares,  Inc.'s  management.  Our
responsibility  is  to  express  an  opinion  on  these  consolidated  financial
statements based on our audits.

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

In our opinion, the consolidated  financial statements referred to above present
fairly, in all material  respects,  the financial  position of State of Franklin
Bancshares,  Inc. and  subsidiaries  as of December  31, 2003 and 2002,  and the
results of their  operations  and their cash flows for the years ended  December
31, 2003,  2002 and 2001 in  conformity  with  accounting  principles  generally
accepted in the United States.



/s/ Baylor and Backus

BAYLOR AND BACKUS
Certified Public Accountants

Johnson City, Tennessee

March 26, 2004





MEMBERS OF  AMERICAN  INSTITUTE  OF  CERTIFIED  PUBLIC  ACCOUNTANTS  & TENNESSEE
SOCIETY OF CERTIFIED PUBLIC ACCOUNTANTS


                                       26

<PAGE>

State of Franklin Bancshares, Inc.
Consolidated Statements of Financial Condition
December 31, 2003 and 2002


<TABLE>
<CAPTION>

                                                                            2003                    2002
                                                                        ------------          ------------
                                     Assets
                                     ------
<S>                                                                     <C>                   <C>

Cash and Due from Banks                                                    3,764,363             5,751,547
Federal Funds Sold                                                        25,040,000            12,705,000
Short-Term Interest-Bearing Deposits                                       3,336,670             1,365,722
                                                                        ------------          ------------
   Total Cash and Cash Equivalents                                        32,141,033            19,822,269
                                                                        ------------          ------------
Investments - Held-To-Maturity
  (Estimated Market 2003 - $34,274,290 and 2002 - $15,660,614)            34,031,676            15,738,303
Investments - Available-for-Sale                                          63,375,496            61,213,653
Loans Held for Sale                                                          413,179             2,447,752

Loans and Leases Receivable                                              150,646,605           157,905,134
  Less: Allowance for Loan and Lease Loss                               (  1,870,279)         (  1,563,320)
                                                                        ------------          ------------
Loans and Leases Receivable, Net                                         148,776,326           156,341,814
                                                                        ------------          ------------

Accrued Interest Receivable, Net                                           1,366,640             1,502,448
Land, Buildings and Equipment at Cost Less
  Accumulated Depreciation of $2,091,874 in 2003
  and $1,673,027 in 2002                                                   6,218,358             5,760,767
Prepaid Expense and Accounts Receivable                                      108,260               200,598
FHLB Stock                                                                 2,354,800             2,263,100
Stock in Service Bureau at Cost                                              815,009               815,009
Other Real Estate Owned and Repossessed Property                           1,171,919             1,321,575
Trust Preferred Placement Fee, Net                                           140,000               188,000
Deferred Tax Assets, Net                                                   1,141,342               416,903
                                                                        ------------          ------------
         Total Assets                                                    292,054,038           268,032,191
                                                                        ============          ============


                      Liabilities and Stockholders' Equity
                      ------------------------------------

Liabilities:

Interest-Free Deposits                                                    12,114,590            11,354,070
Interest-Bearing Deposits                                                209,877,896           187,485,817
Advances by Borrowers for Taxes and Insurance                                103,632               115,191
Accrued Interest on Deposits                                                 141,757               184,365
Accounts Payable and Accrued Expenses                                        404,720               838,163
Repurchase Agreements                                                        536,419             1,049,781
FHLB Long-Term Advances                                                   36,210,071            36,238,709
Deferred Credits on REO                                                      173,996               144,338
                                                                        ------------          ------------
Total Liabilities                                                        259,563,081           237,410,434
                                                                        ------------          ------------
Guaranteed Preferred Beneficial Interest in
     Subordinated Debentures                                               8,000,000             8,000,000
                                                                        ------------          ------------
Stockholders' Equity:

Common Stock, $1.00 Par Value,
  Authorized: 10,000,000 Shares; Issued: 1,465,512 Shares
    at December 31, 2003 and at December 31, 2002                          1,465,512             1,465,512
Paid-In Capital                                                           14,251,461            14,251,461
Accumulated Other Comprehensive Income                                  (    797,592)              252,107
Retained Earnings                                                         10,356,571             7,711,127
Less: Employee Stock Ownership                                          (    784,995)         (  1,058,450)
                                                                        ------------          ------------
Total Stockholders' Equity                                                24,490,957            22,621,757
                                                                        ------------          ------------
         Total  Liabilities and Stockholders' Equity                     292,054,038           268,032,191
                                                                        ============          ============
</TABLE>

The  accompanying  notes  are an  integral  part of the  consolidated  financial
statements.

                                       27
<PAGE>

State of Franklin Bancshares, Inc.
Consolidated Statements of Income
For the Years Ended December 31, 2003, 2002, and 2001


<TABLE>
<CAPTION>


                                                                     2003             2002              2001
                                                           --------------   --------------      ------------
<S>                                                            <C>              <C>               <C>

Interest Income
     Interest on Loans                                         10,431,443       11,240,780        11,466,414
     Other Interest Income                                      3,787,596        4,973,991         4,184,974
                                                              -----------      -----------       -----------

         Total Interest Income                                 14,219,039       16,214,771        15,651,388
                                                               ----------       ----------        ----------

Interest Expense
     Interest on Deposits                                       4,437,705        5,380,118         7,953,344
     Other Interest Expense                                     2,199,250        2,177,742         1,396,049
                                                              -----------       ----------       -----------

         Total Interest Expense                                 6,636,955        7,557,860         9,349,393
                                                              -----------       ----------       -----------

Net Interest Income before Provision for Loan Losses            7,582,084        8,656,911         6,301,995
Provision for Loan Losses                                     (   444,548)     (   578,979)     (    589,902)
                                                              -----------      -----------      ------------

         Net Interest Income after Provision for Loan Losses    7,137,536        8,077,932         5,712,093
                                                              -----------      -----------       -----------

Other Income
     Other Fees and Service Charges                               540,166          461,736           426,630
     Net Gain on Loans Sold                                       820,419          368,418           227,598
     Realized Gain on Securities                                      460          259,772               --
     Real Estate Sales Commission Income                          290,014          175,704               --
     Insurance Commission Income                                   80,139           71,921            42,073
     Rental Income, Net                                            85,070           91,429            79,907
                                                              -----------      -----------      ------------

         Total Other Income                                     1,816,268        1,428,980           776,208
                                                              -----------      -----------      ------------

Other Expenses
     Compensation and Related Benefits                          2,729,560        2,479,700         1,831,580
     Occupancy Expenses                                           462,727          401,406           338,670
     Furniture and Equipment Expenses                             383,880          445,524           343,994
     Advertising                                                  194,490          191,739           137,069
     Data Processing Expense                                      529,743          520,068           431,070
     Other                                                      1,249,529        1,523,904           866,792
                                                              -----------      -----------      ------------

         Total Other Expenses                                   5,549,929        5,562,341         3,949,175
                                                              -----------      -----------      ------------

Income before Income Taxes                                      3,403,875        3,944,571         2,539,126
Provision for Income Taxes                                   (    758,430)    (    760,430)     (    581,715)
                                                             ------------     ------------      ------------

Net Income                                                      2,645,445        3,184,141         1,957,411
                                                             ============     ============      ============



Basic Earnings per Share                                            1.90             2.31              1.42
                                                                    ====             ====              ====

Diluted Earnings per Share                                          1.77             2.16              1.36
                                                                    ====             ====              ====
</TABLE>

The  accompanying  notes  are an  integral  part of the  consolidated  financial
statements.

                                       28
<PAGE>

State of Franklin Bancshares, Inc.
Consolidated Statements of Changes in Stockholders' Equity
For the Years Ended December 31, 2003, 2002, and 2001

<TABLE>
<CAPTION>
                                                                            Accumulated
                                                                              Other                    Employee
                                                   Common     Paid-In      Comprehensive   Retained      Stock-
                                                   Stock       Capital       Income        Earnings    Ownership      Total
                                                  -------     --------     -------------   --------    ---------      ------
<S>                                              <C>         <C>                <C>        <C>        <C>
Balance at December 31, 2000                     1,465,512   14,251,461         89,677     2,569,574  (1,151,623)   17,224,601
                                                                                                                    ----------
ESOP Shares Allocated                                   --           --             --            --      61,529        61,529
                                                                                                                    ----------
Comprehensive Income
   Other Comprehensive Income,
     Net of Tax:
     Unrealized Gains on Securities
       Available-For-Sale:
       Unrealized Holding Losses
         Arising During the Period
           (Net of $251,218 Income Tax Benefit)         --           --       (401,015)           --          --    (  401,015)
       Less: Reclassification Adjustment
           (Net of $34,746 Income Tax Benefit)          --           --       ( 56,691)           --          --    (   56,691)
                                                                                                                    -----------
                                                                                                                     ( 457,706)

Net Income                                              --           --             --     1,957,411          --     1,957,411
                                                                                           ----------
          Total Comprehensive Income                    --           --             --            --          --     1,499,705
                                                 ---------   ----------       ---------   ----------- -----------   -----------
Balance at December 31, 2001                     1,465,512   14,251,461       (368,029)    4,526,985  (1,090,094)   18,785,835
                                                                                                                    -----------

ESOP Shares Allocated                                   --           --             --            --      31,644        31,644
                                                                                                                    -----------
Comprehensive Income
   Other Comprehensive Income,
     Net of Tax:
     Unrealized Gains on Securities
       Available-For-Sale:
       Unrealized Holding Gains
         Arising During the Period
           (Net of $321,852 Income Tax)                 --           --        527,249            --          --       527,249
       Less: Reclassification Adjustment
           (Net of $57,659 Income Tax)                  --           --         92,886            --          --        92,886
                                                                                                                    -----------
                                                                                                                       620,135

Net Income                                              --           --             --     3,184,141          --     3,184,141
                                                                                                                    -----------

         Total Comprehensive Income                     --           --             --            --          --     3,804,276
                                               -----------   ----------     ----------    ----------   ----------   -----------
Balance at December 31, 2002                     1,465,512   14,251,461        252,106     7,711,126   (1,058,450)  22,621,755
                                                                                                                    -----------
ESOP Shares Allocated                                   --           --             --            --      273,455      273,455
                                                                                                                    -----------
Comprehensive Income
   Other Comprehensive Income,
     Net of Tax:
     Unrealized Gains on Securities
       Available-For-Sale:
       Unrealized Holding Gains
         Arising During the Period
           (Net of $656,269 Income Tax Benefit)         --           --     (1,057,399)           --          --    (1,057,399)
       Less: Reclassification Adjustment
           (Net of $4,780 Income Tax)                   --           --          7,701            --          --         7,701
                                                                                                                    -----------
                                                                                                                    (1,049,698)

Net Income                                              --           --             --     2,645,445          --     2,645,445

         Total Comprehensive Income                     --           --             --            --          --     1,595,747
                                               -----------   ----------     ----------    ----------   ---------    -----------
Balance at December 31, 2003                     1,465,512   14,251,461     (  797,592)   10,356,571   ( 784,995)   24,490,957
                                               ===========   ==========     ==========    ==========   =========    ==========

</TABLE>

The  accompanying  notes  are an  integral  part of the  consolidated  financial
statements.

                                       29
<PAGE>

State of Franklin Bancshares, Inc.
Consolidated Statements of Cash Flows
For the Years Ended December 31, 2003, 2002, and 2001


<TABLE>
<CAPTION>

                                                                     2003                 2002                 2001
                                                           --------------       --------------       --------------
<S>                                                          <C>                   <C>                  <C>
Cash Flows from Operating Activities
Net Income                                                      2,645,445            3,184,141            1,957,411
Items Not Affecting Cash and Cash Equivalents:
   Depreciation                                                   421,502              520,473              379,945
   (Increase) Decrease in Accrued Interest                        135,808          (   138,168)             178,163
   Deferred Tax Assets                                         (   91,645)         (   104,430)          (  169,678)
   Provisions for Loan Losses                                     444,548              578,979              589,902
   (Increase) Decrease in Prepaid Expenses
     and Accounts Receivable                                       92,338          (    80,951)          (   42,268)
   Increase (Decrease) in Interest Payable                     (   42,608)               4,468           (    8,511)
   Increase (Decrease) in Accounts Payable
     and Accrued Expenses                                      (  433,443)             417,379              124,396
   Increase (Decrease) in Deferred Loan Fees, Net              (    2,635)             105,497               20,323
   Realized (Gain) on Securities                               (      460)         (   259,772)                 --
Discount Accretion                                             (  165,632)         (   534,407)          (  487,399)
Amortization Expense                                              649,620              113,753                  --
Increase in Deferred Gain on Sale of REO                           37,936                  --                   --
   Earned ESOP Shares                                             273,455               31,644              105,528
   FHLB Stock Dividends                                        (   91,700)         (   101,400)          (  137,200)
   (Increase) Decrease in Loans Available-For-Sale              2,034,573              100,618           (2,283,448)
                                                             ------------        -------------          ------------

       Net Cash Provided  by Operating Activities               5,907,102            3,837,824              227,164
                                                             ------------         ------------          ------------


Cash Flows from Investing Activities
Purchase of Held-to-Maturity Investments                      (36,457,514)         (21,376,120)         ( 9,676,728)
Purchase of Available-for-Sale Investments                    (14,014,267)         (13,475,457)         (42,792,458)
Proceeds from Maturities of Held-to-Maturity Investments        8,495,000            8,835,000           14,000,000
Proceeds from Sale of Available-for-Sale Investments                   --              655,517                   --
Proceeds from Maturities of Available-for-Sale Investments      5,932,581           12,484,105           17,490,740
Principal Payments on Mortgage-Backed Securities
  Available-for-Sale                                           13,451,963           10,244,598                  --
(Increase) Decrease in Loans Receivable, Net                    7,283,952          (20,107,511)         ( 3,582,986)
Purchases of Premises and Equipment                           (   879,093)         (   942,110)         (   303,191)
Purchase of FHLB Stock                                                 --                   --          (   500,000)
                                                           --------------        --------------         ------------

       Net Cash Used by Investing Activities                  (16,187,378)         (23,681,978)         (25,364,623)
                                                           --------------        --------------         ------------


</TABLE>





                                (continued...)



                                       30
<PAGE>

State of Franklin Bancshares, Inc.
Consolidated Statements of Cash Flows
For the Years Ended December 31, 2003, 2002, and 2001

<TABLE>
<CAPTION>


                                                                       2003               2002                2001
                                                               ------------        -----------         -----------
<S>                                                            <C>                 <C>                 <C>
Cash Flows from Financing Activities
Net Increase (Decrease) in Deposits                              23,152,599        ( 1,297,187)         38,054,684
Net Increase (Decrease) in Advances by Borrowers
  for Taxes and Insurance                                      (     11,559)            15,777         (     7,821)
Net Increase (Decrease) in Repurchase Agreements               (    513,362)         1,049,781                  --
    Net proceeds from the issuance of guaranteed preferred
  beneficial interests in subordinated debentures                        --                 --           7,760,000
  Proceeds from FHLB Advances                                            --          6,013,060          21,995,733
    Repayment of FHLB Advances                                 (     28,638)       (    15,346)        (15,661,417)
Repayment of Debt                                                        --                 --         (   571,637)
                                                               ------------        -----------         -----------

       Net Cash Provided by Financing Activities                 22,599,040          5,766,085          51,569,542
                                                               ------------        -----------         -----------

       Net Increase (Decrease) in Cash and Cash Equivalents      12,318,764        (14,078,069)         26,432,083

Cash and Cash Equivalents at Beginning of Period                 19,822,269         33,900,338           7,468,255
                                                               ------------        -----------         -----------

       Cash and Cash Equivalents at End of Period                32,141,033         19,822,269          33,900,338
                                                               ============        ===========         ===========



Supplemental Schedule of Noncash Investing and Financing Activities:

Increase (Decrease) in Unrealized Gain on Securities
   Available-For-Sale, Net of Deferred Tax Liability           (  1,049,699)           620,136         (   504,400)
                                                               ============        ===========         ===========
   Acquisition of Real Estate Property through
   Foreclosure of Related Loans                                   1,152,919          1,321,575             449,988
                                                               ============        ===========         ===========
Origination of Mortgage Loans to Finance
   the Sale of Foreclosed Real Estate                               452,800          1,191,348                  --
                                                               ============        ===========         ===========


Supplemental Disclosures of Cash Flow Information:

Cash Paid During the Period for:

     Taxes                                                        1,381,742          1,369,167             714,077
                                                               ============        ===========         ===========

     Interest                                                     6,679,563          7,553,392           9,357,904
                                                               ============        ===========         ===========
</TABLE>




The  accompanying  notes  are an  integral  part of the  consolidated  financial
statements.


                                       31
<PAGE>


State of Franklin Bancshares, Inc.
Notes to Consolidated Financial Statements
For the Years Ended December 31, 2003, 2002, and 2001

Note 1 Summary of Significant Accounting Policies
------ ------------------------------------------

     Incorporation and Operations

     State of Franklin  Savings  Bank (the  "Savings  Bank"),  headquartered  in
     Johnson City, Tennessee, was incorporated on February 15, 1996, and was the
     first  Tennessee  Chartered  Stock  Savings  Bank  under the  Savings  Bank
     Chartering  Act of  1991  (the  "Savings  Bank  Act").  State  of  Franklin
     Bancshares,  Inc. (the  "Company") was  incorporated  under the laws of the
     State of Tennessee  for the purpose of becoming the holding  company of the
     Savings Bank. The  stockholders  of the Savings Bank exchanged their shares
     for the shares of the  Company,  whereby the  Savings  Bank became a wholly
     owned subsidiary of the Company. State of Franklin Leasing Corporation (the
     "Leasing Corp") was  incorporated  under the laws of the State of Tennessee
     for the purpose of lease  financing.  State of Franklin  Real Estate,  Inc.
     (the "Real Estate  Company")  was  incorporated  for the purpose of selling
     real estate.  The Real Estate Company and John Sevier Title services,  Inc.
     (the "Title  Company") are wholly owned  subsidiaries  of the Savings Bank.
     The leasing Corp is a wholly owned subsidiary of the Company.

     In  December  2001,  the  Company  issued  debentures  to State of Franklin
     Statutory  Trust  I (the  "Trust"),  a  business  trust  subsidiary  of the
     Company. The Trust purchased the debentures with the proceeds from the sale
     of trust preferred  securities issued by the Trust in a private  placement.
     The Company guaranteed the preferred  securities.  The documents  governing
     these  securities,  including the Indenture under which the debentures were
     issued,  restrict the Company's right to pay a dividend on its common stock
     under certain circumstances,  prohibits the issue of any class of common or
     preferred  stock senior to the  debentures  during their term, and give the
     holders of the  preferred  securities  preference on  liquidation  over the
     holders of the Company's  common stock.  Specifically,  the Company may not
     declare  or pay a cash  dividend  on its  common  stock  if (a) an event of
     default  has  occurred as defined in the  Indenture,  (b) the Company is in
     default  under its  Guarantee,  or (c) the Company has  exercised its right
     under the  debentures  and the preferred  securities to extend the interest
     payment period.  In addition,  if any of these conditions have occurred and
     until  they  are  cured,  the  Company  is  restricted  from  redeeming  or
     purchasing  any  shares of its  common  stock  except  under  very  limited
     circumstances.  The Company's net consolidated  principal  obligation under
     the debentures,  the preferred securities, and the Guarantee is $8,000,000.
     The securities are redeemable at par after December 2006.

     The principal  business of the Savings Bank is to accept  savings  deposits
     from the general  public and to invest such funds in  residential  mortgage
     loans and, to a lesser extent,  consumer and commercial  loans. The Savings
     Bank provides a wide variety of financial  services to its  customers.  The
     Savings Bank's primary market area is Washington and Sullivan  Counties and
     their immediate vicinity in Tennessee.  The Savings Bank has three branches
     in Johnson City, Tennessee, and two branches in Kingsport, Tennessee.

     A summary of significant accounting policies of the Company follows:

     Basis of Financial Statement Presentation

     The consolidated  financial  statements include the accounts of the Company
     and  its   subsidiaries.   All   significant   intercompany   accounts  and
     transactions have been eliminated. The consolidated financial statements of
     the  Company  have been  prepared in  conformity  with  generally  accepted
     accounting principles and reflect the accrual method of accounting.

     In preparing the consolidated financial statements,  management is required
     to make  estimates  and  assumptions  that affect the  reported  amounts of
     assets  and  liabilities  as of  the  date  of the  consolidated  financial
     statements  and the reported  amounts of revenues  and expenses  during the
     reporting  period.  Actual  results could differ  significantly  from those
     estimates.

     Material estimates that are particularly  susceptible to significant change
     relate  to the  determination  of the  allowance  for  losses  on loans and
     leases,  the valuation of  foreclosed  real estate and deferred tax assets.
     Management believes the allowance for loan and lease losses is adequate.

     While  management uses available  information to recognize losses on loans,
     future  additions to the  allowances  may be necessary  based on changes in
     local economic conditions. In addition, regulatory agencies, as an integral
     part of their examination  process,  periodically review the Savings Bank's
     allowances  for losses on loans and leases.  Such  agencies may require the
     Savings  Bank to  recognize  additions  to the  allowance  based  on  their
     judgments  about  information  available  to  them  at the  time  of  their
     examination.  A substantial  portion of the Savings Bank's loans is secured
     by real estate in local markets.  Accordingly,  the ultimate collectibility
     of  a  substantial   portion  of  the  Savings  Bank's  loan  portfolio  is
     susceptible to changes in local market conditions.

     Cash and Cash Equivalents

     Cash and highly liquid  investments with maturities of three months or less
     when  purchased are  considered  cash and cash  equivalents.  Cash and cash
     equivalents  consist  primarily of cash and due from banks,  federal  funds
     sold, and short term interest  bearing  deposits.  Cash and cash equivalent
     balances   maintained  at  correspondent   institutions  are  monitored  by
     management to minimize the risk associated with a concentration of funds at
     a single  institution.  Risks  associated with  concentration  of funds are
     regulated under Regulation F governing interbank liabilities.  In addition,
     the bank maintains an internal  policy  limiting the risk.  Compliance with
     the policy is monitored monthly by management and reported quarterly to the
     Board of Directors.

                                       32
<PAGE>


State of Franklin Bancshares, Inc.
Notes to Consolidated Financial Statements
For the Years Ended December 31, 2003, 2002, and 2001

Note 1 Continued

     Land, Buildings and Equipment

     Land is carried  at cost.  Buildings  and  equipment,  including  leasehold
     improvements,  are  carried  at cost and are being  depreciated  over their
     estimated useful lives on the straight-line method. Repairs and maintenance
     items are expensed and  improvements  are  capitalized.  Upon retirement or
     sale, any gain or loss will be charged to operations.

     Loans Receivable

     Loans  receivable  are  stated  at  unpaid  principal  balances,  less  the
     allowance for loan losses and net deferred loan origination fees.  Mortgage
     loans  held for sale are held at the lower of cost or  market  value in the
     aggregate.  Net  unrealized  losses,  if  any,  are  recognized  through  a
     valuation  allowance  by charges  to income.  The  accrual of  interest  on
     mortgage,  commercial, and other personal loans is discontinued at the time
     the loan is 90 days delinquent unless the credit is well-secured and in the
     process of  collection.  In all cases,  loans are placed on  nonaccrual  or
     charged-off  at an earlier date if  collection  of principal or interest is
     considered doubtful.

     All  interest  accrued  but not  collected  for  loans  that are  placed on
     nonaccrual or charged off is reversed against interest income. The interest
     on these loans is accounted  for on a cash-basis or  cost-recovery  method,
     until  qualifying  for a return to accrual.  Loans are  returned to accrual
     status when all the principal and interest  amounts  contractually  due are
     brought current and future payments are reasonably assured.

     Loan origination and commitment fees, as well as certain direct origination
     costs,  are deferred and amortized as a yield  adjustment over the lives of
     the related loans using the interest method.  Amortization of deferred loan
     fees is discontinued when a loan is placed on nonaccrual status.

     The  allowance  for  loan  losses  is  maintained  at  a  level,  which  in
     management's  judgment, is adequate to absorb credit losses inherent in the
     loan  portfolio.  Management's  periodic  evaluation of the adequacy of the
     allowance is based on the Savings Bank's past loan loss  experience,  known
     and inherent risks in the portfolio, adverse situations that may affect the
     borrower's ability to repay,  estimated value of any underlying collateral,
     and current economic conditions. The allowance for loan losses is increased
     by a provision for loan losses,  which is charged to expense, and decreased
     by charge-offs (net of recoveries).

     Investment and Mortgage-Backed Securities

     The  Company is subject to  Statement  of  Financial  Accounting  Standards
     ("SFAS") No. 115,  Accounting  for Certain  Investments  in Debt and Equity
     Securities.  Accordingly,  investment  and  mortgage-backed  securities are
     categorized    as   either    held-to-maturity,    trading    account    or
     available-for-sale securities.

     Held-to-maturity  securities are bonds,  notes and debentures for which the
     Savings  Bank has the  positive  intent and ability to hold to maturity and
     are  reported  at  cost,  adjusted  for  premiums  and  discounts  that are
     recognized in interest  income using the interest method over the period to
     maturity.

     Trading account  securities are investments  held principally for resale in
     the near term and  mortgage-backed  securities held for sale in conjunction
     with mortgage  banking  activities.  Trading  account  securities  would be
     recorded  at their  fair  values.  Unrealized  gains and  losses on trading
     account  securities  would be included  immediately  in other  income.  The
     Savings Bank has no securities in this classification at year end.

     Available-for-sale  securities  consist of bonds,  notes,  debentures,  and
     certain  equity  securities  not  classified  as trading  securities  or as
     held-to-maturity  securities.  The change in  unrealized  holding gains and
     losses,  net of tax, on  available-for-sale  securities  are  reported as a
     separate component of other comprehensive  income until realized.  Realized
     gains  (losses)  on  available-for-sale  securities  are  included in other
     income (expense) and, when applicable,  are reported as a  reclassification
     adjustment, net of tax, in other comprehensive income.

     Gains  and  losses  on  the  sale  of  available-for-sale   securities  are
     determined using the  specific-identification  method.  The amortization of
     premiums and the accretion of discounts are  recognized in interest  income
     using  methods  approximating  the  interest  method  over  the  period  to
     maturity.

     Declines   in  the  fair   value   of   individual   held-to-maturity   and
     available-for-sale   securities  below  their  cost  that  are  other  than
     temporary  would have resulted in write-downs of the individual  securities
     to their fair  value.  No  write-downs  have been  included  in earnings as
     realized losses.

     Federal Home Loan Bank Stock

     Federal  Home  Loan  Bank  ("FHLB")  stock  is a  required  investment  for
     institutions that are members of the FHLB system.  The required  investment
     in the common stock is  recalculated  annually and based on a predetermined
     formula.  FHLB stock is carried at cost on the  consolidated  statements of
     financial  condition.  At December 31, 2003,  the bank owned  $2,354,800 in
     FHLB stock and the minimum  required  investment was  $1,812,000.  State of
     Franklin  Bancshares,  Inc. Notes to Consolidated  Financial Statements For
     the Years Ended December 31, 2003, 2002, and 2001
                                       33
<PAGE>
State of Franklin Bancshares, Inc.
Notes to Consolidated Financial Statements
For the Years Ended December 31, 2003, 2002, and 2001

Note 1 Continued

     Foreclosed Real Estate

     Foreclosed  real estate  includes  both  formally  foreclosed  property and
     in-substance  foreclosed property.  In-substance  foreclosed properties are
     those  properties for which the institution has taken physical  possession,
     regardless of whether formal  foreclosure  proceedings have taken place. At
     the time of foreclosure, foreclosed real estate is recorded at the lower of
     the  carrying  amount or fair value less cost to sell,  which  becomes  the
     property's new basis.  Any  write-downs  based on the asset's fair value at
     date of  acquisition  are charged to the allowance  for loan losses.  After
     foreclosure,  these assets are carried at the lower of their new cost basis
     or fair value less cost to sell.  Costs incurred in maintaining  foreclosed
     real  estate  and  subsequent  adjustments  to the  carrying  amount of the
     property are included in income (loss) on foreclosed real estate.  Required
     development  costs associated with foreclosed  property under  construction
     are  capitalized  and included in  determining  the  estimated net realized
     value of the property, which is reviewed periodically,  and any write-downs
     are charged against current earnings as market adjustments.

     Income Taxes

     Income taxes are provided for the tax effects of the transactions  reported
     in the consolidated financial statements and consist of taxes currently due
     plus deferred taxes related  primarily to differences  between the basis of
     available-for-sale  securities  and allowance for loan losses for financial
     and income tax reporting. the deferred tax assets and liabilities represent
     the future tax return consequences of those differences,  which will either
     be taxable or deductible  when the assets and  liabilities are recovered or
     settled.  Deferred tax assets and  liabilities  are reflected at income tax
     rates  applicable  to the  period  in which  the  deferred  tax  assets  or
     liabilities are expected to be realized or settled.  As changes in tax laws
     or rates are  enacted,  deferred  tax assets and  liabilities  are adjusted
     through the provision for income taxes.

     Dividends

     In determining  whether dividends will be declared on the Common Stock, the
     Board of Directors will take into account the Company's  operating results,
     financial  condition,  tax  considerations,  future  capital  and cash flow
     requirements,  and other  relevant  factors.  The Company's  right to pay a
     dividend  might be  restricted  under  certain  circumstances  by documents
     governing the December,  2001,  issuance of the trust preferred  securities
     and debentures as previously noted under the "Incorporation and Operations"
     section of Note 1.

     Tennessee law requires that  dividends be paid only from retained  earnings
     (or  undivided  profits),  except that  dividends  may be paid from capital
     surplus  with the prior  written  consent of the  Tennessee  Department  of
     Financial  Institutions.  Tennessee laws  regulating  savings banks require
     certain  charges  against and  transfers  from an  institution's  undivided
     profits  account  before  undivided  profits can be made  available for the
     payment of dividends.

     Reclassifications

     In instances where  required,  amounts  reported in prior years'  financial
     statements  included  herein  have  been  reclassified  to  put  them  on a
     comparable  basis  to  the  amounts  reported  in  the  December  31,  2003
     consolidated financial statements.

Note 2 Land, Buildings and Equipment

     A summary of the cost of fixed assets at December  31, 2003,  2002 and 2001
     are summarized as follows:

<TABLE>
<CAPTION>
                                                                 2003                 2002                  2001
                                                              ---------            ---------             ---------
         <S>                                                  <C>                  <C>                   <C>
         Land                                                 1,580,000            1,580,000             1,450,000
         Buildings and Leasehold Improvements                 4,030,608            3,457,883             3,040,756
         Furniture, Fixtures and Equipment                    2,699,624            2,395,911             2,091,976
                                                              ---------            ---------             ---------
                                                              8,310,232            7,433,794             6,582,732
         Less: Accumulated Depreciation                       2,091,874            1,673,027             1,263,552
                                                              ---------            ---------             ---------

                                                              6,218,358            5,760,767             5,319,180
                                                              =========            =========             =========
</TABLE>

                                       34
<PAGE>

State of Franklin Bancshares, Inc.
Notes to Consolidated Financial Statements
For the Years Ended December 31, 2003, 2002, and 2001

Note 3 Loans and Leases Receivable

     Loans and leases  receivable at December 31, 2003, 2002 and 2001 consist of
the following:

<TABLE>
<CAPTION>

                                                                          2003              2002              2001
                                                                      ------------     ------------      ------------
<S>                                                                   <C>              <C>               <C>

              First Mortgage Loans                                      49,702,608       57,183,220        53,102,998
              Construction Loans                                        21,817,058       18,579,725        15,014,967
              Consumer Loans                                            13,070,617       13,679,529        12,536,061
              Participation Loans, Net                                     458,452          481,399           503,354
              Commercial Loans                                          63,208,012       66,392,958        56,028,216
              Credit Line Advances                                       1,185,167          519,020           710,137
              Direct Finance Leases                                      1,550,376        1,459,185         1,342,242
                                                                      ------------     ------------      ------------

                Gross Loans and Leases Receivable                      150,992,290      158,295,036       139,237,975
                                                                      ------------     ------------      ------------

              Less:
                Undisbursed Portion of Loans in Process               (    101,875)    (    143,455)     (      6,694)
                Net Deferred Loan Origination Fees                    (    243,810)    (    246,447)     (    140,949)
                Accumulated General Loan and Lease Loss Allowance     (  1,870,279)    (  1,563,320)     (  1,473,855)
                                                                      ------------     ------------      -------------

                                                                      (  2,215,964)    (  1,953,222)     (  1,621,498)
                                                                      ------------     ------------      -------------

              Loans and Leases Receivable - Net                        148,776,326      156,341,814       137,616,477
                                                                      ============     ============      ============

</TABLE>

     An analysis of the allowance for loan and lease losses is as follows:


<TABLE>
<CAPTION>

                                                                           2003             2002             2001
                                                                      -------------    -------------    -------------
<S>                                                                   <C>               <C>             <C>
                Balance - Beginning of Period                            1,563,320        1,473,855         1,062,511
                Provision for Losses                                       444,548          578,979           589,902
                Actual Loan and Lease Losses                          (    137,589)    (    489,514)    (     178,558)
                                                                      -------------    -------------    --------------

                Balance - End of Period                                  1,870,279        1,563,320         1,473,855
                                                                     ==============    =============     =============
</TABLE>


     The gross amount of  participation  loans  serviced by the Savings Bank was
     $916,883  at  December  31,  2003,  $962,371  at  December  31,  2002,  and
     $1,006,596 for year ending December 31, 2001.

     At December 31, 2003 the Company had non-accrual  loans and leases totaling
     $3,213,000  which  included   $121,000  in  impaired  loans  compared  with
     $1,104,000  and  $112,000,  respectively,  at December  31, 2002. A loan is
     impaired when, based on current information and events, it is probable that
     the Company  will be unable to collect all  amounts  due  according  to the
     contractual  agreement.  The total  allowance for loan losses  allocated to
     impaired loans was $66,000 at December 31, 2003 and $56,000 at December 31,
     2002. No interest  income on impaired  loans was recognized for the periods
     ending  December  31, 2003 and 2002.  The Company had no loans or leases 90
     days or more  past due and  still  accruing  and no  restructured  loans at
     December 31, 2003.


Note 4 Supervision and Regulation

General

     As a  Tennessee-chartered  federally insured savings bank, the Savings Bank
     is  subject  to  extensive   regulation.   Lending   activities  and  other
     investments must comply with various statutory and regulatory requirements,
     including  prescribed  minimum  capital  standards.  The  Savings  Bank  is
     regularly  examined by the FDIC and the  Tennessee  Department of Financial
     Institutions  and files  periodic  reports  concerning  its  activities and
     financial  condition with its regulators.  The Savings Bank's  relationship
     with  depositors  and borrowers also is regulated to a great extent by both
     federal  law and the laws of the  State of  Tennessee,  especially  in such
     matters as the  ownership  of savings  accounts and the form and content of
     mortgage documents.

     Federal  and state  banking  laws and  regulations  govern all areas of the
     operation  of the  Savings  Bank,  including  reserves,  loans,  mortgages,
     capital, issuance of securities,  payment of dividends and establishment of
     branches.  Federal and state bank regulatory agencies also have the general
     authority to limit the  dividends  paid by insured  banks if such  payments
     should be deemed to constitute an unsafe and unsound practice.  The primary
     federal  regulator of the Savings Bank,  the FDIC,  has authority to impose
     penalties,  initiate civil and administrative  actions and take other steps
     intended to prevent banks from engaging in unsafe or unsound practices.

                                       35

<PAGE>



State of Franklin Bancshares, Inc.
Notes to Consolidated Financial Statements
For the Years Ended December 31, 2003, 2002, and 2001

Note 4 Continued

     Tennessee  law permits  the Savings  Bank to become a member of the Federal
     Reserve System or the FHLB system. The Savings Bank is a member of the FHLB
     of Cincinnati.  The FHLB of Cincinnati  functions as a central reserve bank
     that provides credit for member institutions. The Savings Bank, as a member
     of the FHLB of Cincinnati,  is required to own capital stock in the FHLB of
     Cincinnati. Provided certain standards related to creditworthiness continue
     to be met,  the Savings  Bank will be  authorized  to apply for  additional
     advances on the  security  of such stock and on certain of its  residential
     mortgage  loans  and  other  assets  (principally,   securities  which  are
     obligations  of, or guaranteed by, the United  States).  The Savings Bank's
     current advances from FHLB are disclosed in Note 8.

     Tennessee Supervision and Regulation

     As a  Tennessee-chartered  savings  bank,  the  Savings  Bank is subject to
     various state laws and regulations that limit the amount that can be loaned
     to a single borrower, the type of permissible  investments,  and geographic
     expansion,  among other things. The Savings Bank must submit an application
     and receive  the  approval of the  Department  before  opening a new branch
     office or merging with another financial  institution.  The Commissioner of
     the Department (the "Commissioner") has the authority to enforce state laws
     and regulations by ordering a director,  officer or employee of the Savings
     Bank to cease and desist from  violating a law or regulation and unsafe and
     unsound banking practices.

     Federal Regulation

     The Company is subject to  regulation  by the Federal  Reserve Bank ("FRB")
     and is required to file annual reports with the FRB. The Company is subject
     to  examination  by the FRB and is required to obtain FRB approval prior to
     acquiring, directly or indirectly,  ownership or control of more than 5% of
     the voting stock of a bank.  The Company is only able to engage in, own, or
     control companies that engage in activities closely related to banking.

     The Savings  Bank was  approved  by the FDIC to have its  deposit  accounts
     insured up to applicable  limits by the Bank  Insurance  Fund.  The BIF was
     designated  as an insurance  fund  pursuant to the  Financial  Institutions
     Reform,  Recovery and Enforcement Act of 1989 ("FIRREA").  As insurer,  the
     FDIC issues  regulations,  conducts  examinations,  requires  the filing of
     reports  and  generally   supervises   and  regulates  the   operations  of
     state-chartered  banks that are not members of the Federal  Reserve System.
     FDIC approval is required  prior to any merger or  consolidation  involving
     state,  nonmember  banks, or the  establishment  or relocation of an office
     facility thereof. FDIC supervision and regulation is intended primarily for
     the protection of depositors and the FDIC insurance funds.

     Any  insured  bank that does not operate in  accordance  with or conform to
     FDIC   regulations,   policies  and   directives   may  be  sanctioned  for
     noncompliance.  For  example,  proceedings  may be  instituted  against any
     insured bank or any director, officer, or employee of such bank who engages
     in unsafe and unsound practices, including the violation of applicable laws
     and regulations.  The FDIC has the authority to terminate deposit insurance
     pursuant  to  procedures  established  for that  purpose.  Failure  to meet
     minimum capital requirements can initiate certain mandatory---and  possibly
     additional discretionary---actions by regulators that, if undertaken, could
     have a direct material effect on the Savings Bank's  financial  statements.
     Under capital adequacy  guidelines and the regulatory  framework for prompt
     corrective  action,  the Savings Bank must meet specific capital guidelines
     that  involve   quantitative   measures  of  the  Savings   Bank's  assets,
     liabilities,  and  certain  off-balance-sheet  items  as  calculated  under
     regulatory  accounting  practices.  The Savings Bank's capital  amounts and
     classification are also subject to qualitative  judgments by the regulators
     about components, risk weightings, and other factors.

     Quantitative  measures established by regulation to ensure capital adequacy
     require the Savings Bank to maintain  minimum amounts and ratios (set forth
     in the table below) of Total  Risk-Based  and Tier 1 capital (as defined in
     the regulations) to risk-weighted  assets (as defined),  and Tier 1 capital
     (as defined) to average  assets (as defined).  Management  believes,  as of
     December  31,  2003,  that the  Savings  Bank  meets all  capital  adequacy
     requirements to which it is subject.

     As of  December  31,  2003,  the  most  recent  notification  from the FDIC
     categorized  the  Savings  Bank as  well-capitalized  under the  regulatory
     framework for prompt  corrective  action.  The "prompt  corrective  action"
     regulations  established  five categories of depository  institutions:  (1)
     well-capitalized,  (2) adequately capitalized,  (3) under-capitalized,  (4)
     significantly under-capitalized, and (5) critically under-capitalized. Each
     category relates to the level of capital for the depository institution.  A
     "well-capitalized"   institution   meets  the  minimum  level  required  by
     regulation (i.e.,  total risk-based capital ratio of 10% or greater, a Tier
     1 risk-based  capital ratio of 6% or greater and a leverage  ratio of 5% or
     greater).  To be  categorized  as  well-capitalized,  the Savings Bank must
     maintain minimum total risk-based,  Tier 1 risk-based,  and Tier 1 leverage
     ratios as set forth in the table.  There are no  conditions or events since
     that notification  that management  believes have changed the institution's
     category.

     The  capital  levels  of  the  Company  as of  December  31,  2003  include
     adjustment  for the  subordinated  debentures  issued in  December of 2001,
     subject to certain limitations. Federal Reserve guidelines limit the amount
     of cumulative  preferred securities which can be included in Tier 1 capital
     to 25% of total Tier 1 capital.  As of  December  31,  2003,  approximately
     $7,900,000  of the  $8,000,000  of the  debentures  were included as Tier 1
     capital of the  Company  with the  remaining  $100,000  included  as Tier 2
     capital, component of total risk-based capital.


                                       36
<PAGE>


State of Franklin Bancshares, Inc.
Notes to Consolidated Financial Statements
For the Years Ended December 31, 2003, 2002, and 2001

Note 4   Continued
<TABLE>
<CAPTION>

         The capital ratios for the Savings Bank are as follows:                              For Capital
                                                                                           Adequacy Purposes
                                                                                             And To Be Well
                                                                                           Capitalized Under
                                                                                           Prompt Corrective
                                                                        Actual             Action Provisions
                                                                   -------------------     --------------------
             In Thousands                                            Amount     Ratio        Amount      Ratio
         ------------------------                                  -------------------     --------------------
         <S>                                                       <C>          <C>         <C>           <C>
         As of December 31, 2003:

                Total Risk-Based Capital (to Risk-Weighted Assets) 23,498       12.35%      >19,021       10.0%
                                                                                            -
                Tier 1 Capital (to Risk-Weighted Assets)           21,923       11.53%      >11,413        6.0%
                                                                                            -
                Tier 1 Capital (to Adjusted Total Assets)          21,923        7.48%      >14,649        5.0%
                                                                                            -

         As of December 31, 2002:

                Total Risk-Based Capital (to Risk-Weighted Assets) 21,928       11.49%      >19,085       10.0%
                                                                                            -
                Tier 1 Capital (to Risk-Weighted Assets)           20,441       10.71%      >11,451        6.0%
                                                                                            -
                Tier 1 Capital (to Adjusted Total Assets)          20,441        7.74%      >13,213        5.0%
                                                                                            -



         The capital ratios for the Company are as follows:                                  For Capital
                                                                                           Adequacy Purposes
                                                                                             And To Be Well
                                                                                           Capitalized Under
                                                                                           Prompt Corrective
                                                                        Actual             Action Provisions
                                                                   -------------------     --------------------
             In Thousands                                            Amount     Ratio        Amount      Ratio
         ------------------------                                  -------------------     --------------------
         As of December 31, 2003:

                Total Risk-Based Capital (to Risk-Weighted Assets) 33,361       17.52%      >19,066       10.0%
                                                                                            -
                Tier 1 Capital (to Risk-Weighted Assets)           31,351       16.46%      >11,440        6.0%
                                                                                            -
                Tier 1 Capital (to Adjusted Total Assets)          31,351       10.63%      >14,744        5.0%
                                                                                            -

         As of December 31, 2002:

                Total Risk-Based Capital (to Risk-Weighted Assets) 31,594       16.51%      >19,136       10.0%
                                                                                            -
                Tier 1 Capital (to Risk-Weighted Assets)           29,437       15.38%      >11,482        6.0%
                                                                                            -
                Tier 1 Capital (to Adjusted Total Assets)          29,437       11.08%      >13,283        5.0%
                                                                                            -

</TABLE>


Note 5 Employee and Director Benefit Plans
------ -----------------------------------

     Employee Stock Ownership Plan

     The company has an employee  stock  ownership  plan (the  "ESOP") for those
     employees who meet the  eligibility  requirements of the plan. The ESOP was
     established in 1997. The ESOP currently has two loans  established  for the
     purpose of purchasing shares in the Company for the plan.

     In November 2001, the ESOP loans were  consolidated  into a seven year term
     loan from the  Company in the amount of  $1,071,093  with a fixed  interest
     rate of 6.00%.  Note  payments  are  $15,218 per month for 83 months plus a
     final  principal  payment  of  $24,092.  The note  balance  outstanding  at
     December 31, 2003 was $784,995.  In November 2001, the Company also granted
     a $300,000 line of credit to the ESOP for the purchase of additional shares
     of stock in the  Company as it becomes  available.  The  interest  rate for
     balances  outstanding  on the line of credit  is 6% with a five year  term.
     Interest  is  paid  monthly  with  principal  payments  made as  funds  are
     available.  At December 31, 2003, no balances were outstanding for advances
     on the line of credit.

     Shares owned by the ESOP at December 31, 2003 totaled 171,148.  ESOP shares
     are  maintained  in a suspense  account  until  released  and  allocated to
     participants'  accounts. The release of shares from the suspense account is
     based on the principal paid in the year in proportion to the


                                       37
<PAGE>


State of Franklin Bancshares, Inc.
Notes to Consolidated Financial Statements
For the Years Ended December 31, 2003, 2002, and 2001

Note 5   Continued
------

     total of  current  year  and  remaining  outstanding  debt.  Allocation  of
     released shares to participants' accounts is done as of December 31. Shares
     allocated and remaining in suspense were as follows:



                                                         December 31,
                                                  2003                   2002
                                            ----------               -----------
Number of Shares
    Released and Allocated                      77,857                  62,665
    Suspense                                    70,811                  86,003

Fair Value
    Released and Allocated                   1,557,140               1,127,970
    Suspense                                 1,416,220               1,548,054

     The expense  recorded by the  Company is based on cash  contributed  to the
     ESOP during the year in amounts determined by the Board of Directors,  plus
     the excess of fair value of shares  released and allocated  over the ESOP's
     cost of  those  shares.  The  Company's  contributions  to the  ESOP are as
     follows:


                                                          December 31,

                                                 2003                  2002
                                            ---------              -----------

     Compensation Expense                     408,370                 330,000
     Contributions                            408,370                 330,000

     No dividends  have been declared on the Company's  stock.  If dividends are
     paid, the ESOP administrators will determine whether dividends on allocated
     and  unallocated  shares  will be used  for  debt  service.  Any  allocated
     dividends  used will be replaced with common stock of equal value.  For the
     purpose of computing  earnings per share,  all ESOP shares  committed to be
     released are considered outstanding.

     The released  Company  stock will be allocated to employees  based on their
     salaries.  Generally,  all employees who work over 1,000 hours are eligible
     for the plan  after one year of  service.  Employees  will be vested  after
     seven years of service.  This plan includes a 401(k)  feature that began in
     1998,  which  allows  employees  to defer up to 15% of their  salary and is
     matched  by the  Company  up to 6%. In  addition,  the  Company  may make a
     discretionary contribution to the ESOP.

     Stock Option Plans

     On December 21, 1996,  the Board of Directors  approved a stock option plan
     for outside  directors  and  management.  The plan provided for issuance of
     State of Franklin common stock at a price equal to its fair market value at
     the date of the grant.  The options  began  vesting over a five year period
     beginning  in 1997 and 1998.  The  vested  portion  of the  options  can be
     exercised at any time. There is no termination date on the options,  but in
     the event of death,  the estate must  exercise  the options  within  twelve
     months.  If the individual  leaves the service of the Company,  the options
     must be exercised  within three months,  although this  requirement  may be
     waived by the board.  If the Company is sold or merged,  the options become
     100% vested.

     Under the plan 34,000  additional  stock options were granted to management
     and  employees on October 15, 1999.  These options vest over five years and
     expire after ten years. There are significant restrictions imposed based on
     continued employment.

     Additional  stock options were granted to directors and  management at fair
     market  value  during the years  2000,  and 2001 with terms the same as the
     original  options.  During 2002 and 2003,  options  granted were 42,219 and
     27,826 shares, respectively.  All options granted in 2003 expire at the end
     of ten years. 7,000 shares granted in 2002 and 7,000 shares granted in 2003
     to outside  directors  were fully  vested when  issued.  The other terms of
     these additional options are the same as the terms of the original options.

     Options granted during 2002 and 2003 are summarized as follows:





<TABLE>
<CAPTION>

                                                                     Awarded And                 Weighted Average
                                                                     Unexercised      Vested       Exercise Price
                                                                      Options        Options          Per Share
                                                                     -----------   -----------   ----------------
<S>                                             <C>                     <C>           <C>                <C>

     December 31, 2002

     Options Granted - Outside Directors        January 1, 2002          76,014        59,918            $11.62
                                                During 2002               7,000         7,000            $16.20
     Options Granted - Management/Employees     January 1, 2002         182,166       146,344            $11.64
                                                During 2002              35,219            --            $16.93
                                                                     -----------   ----------    ----------------

            Total Options Outstanding           December 31, 2002       300,399       213,262            $12.36
                                                                     ==========    ==========

</TABLE>

                                       38
<PAGE>

State of Franklin Bancshares, Inc.
Notes to Consolidated Financial Statements
For the Years Ended December 31, 2003, 2002, and 2001

Note 5   Continued
------

<TABLE>
<CAPTION>

                                                                     Awarded And                Weighted Average
                                                                     Unexercised      Vested     Exercise Price
                                                                      Options        Options       Per Share
                                                                     -----------   ----------   -------------
<S>                                             <C>                    <C>            <C>            <C>
          December 31, 2003

        Options Granted - Outside Directors     January 1, 2003         83,014         75,833        $12.00
                                                During 2003              7,000          7,000        $18.00
        Options Granted - Management/Employees  January 1, 2003        217,385        167,594        $12.50
                                                During 2003             20,826             --        $18.88
                                                                       -------        -------

                 Total Options Outstanding      December 31, 2003      328,225        250,427        $12.89
                                                                       =======        =======        ======
</TABLE>


     The  Savings  Bank  accounts  for these  plans  under APB  Opinion  No. 25,
     Accounting for Stock Issued to Employees,  under which no compensation cost
     has been recognized.  Statement of Financial  Accounting  Standard No. 123,
     Accounting  for  Stock-based   Compensation,   ("SFAS  No.  123")  requires
     compensation cost to be calculated by the fair value based method. However,
     it is not  possible to estimate  the fair value of the options at the grant
     date. Therefore, the estimates of compensation cost have been determined by
     the intrinsic value based method.


Note 6 Deposits

     Savings deposit balances are summarized as follows:

<TABLE>
<CAPTION>

                                            December 31, 2002                      December 31, 2002
                                    ------------------------------           ------------------------------
                                     Average                                  Average
                                      Rate      Amount     Percent             Rate       Amount     Percent
                                    --------   -------     -------           -------   -----------   -------
<S>                                    <C>   <C>            <C>              <C>       <C>           <C>


     Passbook                          1.75   84,622,380    38.12            2.04       63,942,676     2.16
     Interest-Free Checking              --   12,114,590     5.46              --       11,354,070     5.71
     NOW                               1.17   18,753,775     8.45            1.50       13,425,042     6.75
     Money Market Deposit              1.47   26,308,635    11.85            1.71       35,372,704    17.79
                                             -----------   ------                      -----------   ------

                                             141,799,380    63.88                      124,094,492    62.41
                                             -----------   ------                      -----------   ------

    Fixed Term Certificate Accounts
      Balances $100,000 or Greater     2.84   20,284,510     9.14            3.31       19,388,917     9.75
      Balances Less than $100,000      2.66   59,908,596    26.98            3.08       55,356,478    27.84
                                             -----------   ------                      -----------   ------
                                              80,193,106    36.12                       74,745,395    37.59
                                             -----------   ------                      -----------   ------

                                             221,992,486   100.00                      198,839,887   100.00
                                             ===========   ======                      ===========   ======
</TABLE>


The contractual  maturity of certificate accounts at December 31, 2003 and 2002,
is as follows:



             Year Ending December 31, 2003         Year Ending December 31, 2002
             -----------------------------         -----------------------------
               2004             45,642,644           2003            49,359,359
               2005             21,464,822           2004            11,390,081
               2006              6,379,826           2005            11,253,040
               2007              2,937,998           2006               737,993
               2008 and After    3,767,816           2007 and After   2,004,922
                               -----------                           -----------
                                80,193,106                           74,745,395
                               ===========                           ===========

Note 7 Accrued Interest Receivable, Net


                                                   2003                  2002
                                                ---------             ----------

Loans
   (net of allowance for uncollected interest)    590,148               747,126
Investment Securities                             768,113               746,774
Cash and Due from Banks                             8,379                 8,548
                                                ---------             ---------
                                                1,366,640             1,502,448
                                                =========             =========
                                       39
<PAGE>


State of Franklin Bancshares, Inc.
Notes to Consolidated Financial Statements
For the Years Ended December 31, 2003, 2002, and 2001

Note 8 Federal Home Loan Bank Advances

The contractual maturity of FHLB advances at December 31, 2003 is as follows:

     2004            29,617                    2009              33,799
     2005            30,410                    2010           8,034,703
     2006            31,224                    2011          19,035,632
     2007            32,059                    2012           5,036,586
     2008         3,032,917                    2013 and after   913,124

     Convertible  fixed rate advances were  $35,000,000  for both periods ending
     December 31, 2003 and 2002.  The  convertible  fixed rate  advances have an
     original  maturity  of 10 years with an option held by FHLB to convert to a
     variable  rate  tied to  3-month  LIBOR  beginning  1 to 3 years  from  the
     original issue date. If converted to a variable rate the bank maintains the
     option to pay off the  advance or continue  at the  variable  rate over the
     original  contractual  maturity of the advance. CRA mortgage match advances
     are amortized over a 30-year period and totaled  $1,210,071 at December 31,
     2003 and $1,238,709 at December 31, 2002. The average rate on FHLB advances
     was 4.85% at both December 31, 2003 and 2002.

     The  Savings  Bank  pledges as  collateral  for these  borrowings  selected
     qualifying  mortgage  loans (as defined)  under an agreement with the FHLB.
     Loans pledged at December 31, 2003 and 2002 were approximately  $54,315,000
     and $54,360,000, respectively.

Note 9 Noninterest Expense

     For periods  ended  December 31, 2003,  2002,  and 2001,  occupancy  rental
     expense was $85,142, $75,498, and $38,762; auto rental expense was $16,724,
     $19,909,  and $19,909;  and equipment  rental  expense was $3,755,  $1,678,
     $1,667, respectively.

     No advertising was capitalized for the periods end December 31, 2003, 2002,
     or 2001. All  advertising was expensed as services were performed and costs
     were incurred.

     Other noninterest expense amounts are summarized as follows for the periods
     ended December 31, 2003, 2002 and 2001:

<TABLE>
<CAPTION>
                                                                2003          2002             2001
                                                             ---------      ---------        --------
<S>                                                           <C>            <C>              <C>
Other Noninterest Expense:
  Insurance Expense                                             49,614        104,086          49,342
  Professional Expenses and Supervisory Examinations           299,077        311,660         134,063
  Office Supplies and Postage                                  156,128        139,011         127,699
  Telephone                                                    130,814        157,747          87,853
  Director Fees                                                159,252        126,686          86,150
  Other Operating Expenses                                     454,644        684,714         381,685
                                                             ---------      ---------         -------
                                                             1,249,529      1,523,904         866,792
                                                             =========      =========         =======
</TABLE>

Note 10 Related Party Transactions

     The Savings Bank has granted loans to its executive officers and directors.
     Management  believes  that such loans were made in the  ordinary  course of
     business with normal credit terms,  including interest rates and collateral
     and do not represent more than a normal risk of  collection.  Loan balances
     to  executive  officers and  directors at December 31, 2003,  2002 and 2001
     were as follows:
<TABLE>
<CAPTION>

                                                                 2003          2002           2001
                                                             ---------    -----------       ---------
<S>                                                          <C>           <C>             <C>

Loan Balances at the Beginning of the Period                 2,381,392      1,743,756       1,788,928
New Loans                                                    2,610,748        901,497       1,278,794
Repayments                                                  (1,156,896)    (  263,861)     (1,323,966)
                                                             ---------     ----------       ---------

Loan Balances at the End of the Period                       3,835,244      2,381,392       1,743,756
                                                             =========      =========       =========
</TABLE>

     Executive  officers and  directors  have lines of credit that have not been
     used in the amount of  $858,923,  $498,636,  and  $613,240 at December  31,
     2003, 2002, and 2001, respectively.

     Two individuals,  one a director and the other an officer and director, are
     also  partners  in  a  partnership  in  which  the  following   significant
     transaction occurred:

     The Savings Bank and the Real Estate  Company  lease office space at Browns
     Mill Road in Johnson City from the partnership.  The monthly lease payments
     for the Savings Bank branch location were $3,372 from March 1, 2003 through
     February 28, 2006 with an option to renew for an additional  three years at
     $3,878 per month.  Effective April 1, 2004, the Real Estate Company entered
     into a three-year  lease with the  partnership.  The monthly lease payments
     are $4,497 through March 31, 2007 with an option to renew for an additional
     three years at $5,170 per month.  In addition,  the Savings Bank,  the Real
     Estate  Company,  and the  Leasing  Company  lease  storage  space from the
     partnership  on a  month-to-month  basis.  The total lease payments for the
     additional storage space are $2,010 per month.


                                       40
<PAGE>
State of Franklin Bancshares, Inc.
Notes to Consolidated Financial Statements
For the Years Ended December 31, 2003, 2002, and 2001

Note 11 Investment Securities

     The amortized cost and fair value of investment securities held-to-maturity
     and  available-for-sale  at  December  31,  2003 and 2002,  by  contractual
     maturity,  are shown below.  Expected  maturities  differ from  contractual
     maturities because issuers may have the right to call or prepay obligations
     without call or prepayment penalties.

               December 31, 2003:
               -----------------
<TABLE>
<CAPTION>
                                                                                      Gross           Gross     Estimated
                                                                   Amortized        Unrealized     Unrealized     Market
                                                                     Cost             Gains           Losses      Value
                                                                   ----------      ---------      ----------    ---------
             <S>                                                    <C>              <C>           <C>         <C>
             Available-for-Sale:

                United States Government Agency Securities Maturing:
                   Within one year                                  2,030,774          5,864              --    2,036,638
                   After one year but within five years             1,022,169          9,988              --    1,032,157

                Mortgage Backed Securities Maturing:
                   After one year but within five years               363,538          1,580              --      365,118
                   After five years but within ten years            1,064,873         29,274              --    1,094,147
                   After ten years but within fifteen years         1,319,685         17,100              --    1,336,785
                   After twenty years                               1,227,535          8,943              --    1,236,478

                 Municipal Securities Maturing:
                   Within one year                                    130,000            819              --      130,819
                   After one year but within five years             1,398,810         77,226              --    1,476,036
                   After five years but within ten years            4,823,565        248,696              --    5,072,261
                   After ten years but within fifteen years         9,766,877        557,543              --   10,324,420
                   After fifteen years but within twenty years      3,025,933        172,956              --    3,198,889
                   After twenty years                               2,021,070         40,869          42,314    2,019,625

                Corporate Securities Maturing:
                   After one year but within five years             1,367,263         32,716              --    1,399,979
                   After five years but within ten years            4,487,738         73,035              16    4,560,757
                   After ten years but within fifteen years         2,100,000         11,640              --    2,111,640
                   After twenty years                               1,730,047        148,350              --    1,878,397

                Equity Securities (Preferred Stock in
                   U.S. Government Agencies):
                   Callable within one year                        21,055,811             --       2,899,811   18,156,000
                   Callable after 1 year but within five years      4,414,150        158,000              --    4,572,150
                   Callable after five years but within ten years   1,000,000         30,000              --    1,030,000

                Other
                   After twenty years                                 318,155         25,045              --      343,200
                                                                   ----------      ---------       ---------   ----------
                          Total Available-for-Sale                 64,667,993      1,649,644       2,942,141   63,375,496
                                                                   ==========      =========       =========   ==========

             Held-to-Maturity:

                United States Government Agency Securities Maturing:
                   After one year but within five years             5,067,937          8,183              --    5,076,120
                   After five years but within ten years            3,977,933          9,040          89,045    3,897,928
                   After fifteen years but within twenty years        257,345             --           7,051      250,294

                Mortgage Backed Securities Maturing:
                   After five years but within ten years            6,503,942          5,187          25,641    6,483,488
                   After ten years but within fifteen years         3,187,836          8,956           2,685    3,194,107
                   After fifteen years but within twenty years        862,403          5,385              --      867,788
                   After twenty years                               4,919,759          9,982          41,536    4,888,205

                 Municipal Securities Maturing:
                   Within one year                                    406,349            571              --      406,920
                   After one year but within five years             1,303,406            386           5,115    1,298,677
                   After ten years but within fifteen years           429,979         18,128              --      448,107

                Corporate Securities Maturing:
                   After one year but within five years             2,323,341         45,505              --    2,368,846
                   After five years but within ten years            1,086,789         41,987           5,363    1,123,413
                   After twenty years                               3,704,657        281,562          15,822    3,970,397
                                                                  -----------     ----------       ---------   ----------
                          Total Held-to-Maturity                   34,031,676        434,872         192,258   34,274,290
                                                                  ===========     ==========       =========   ==========
</TABLE>

                                       41
<PAGE>
State of Franklin Bancshares, Inc.
Notes to Consolidated Financial Statements
For the Years Ended December 31, 2003, 2002, and 2001

Note 11 Continued
-------
               December 31, 2002:
               -----------------
<TABLE>
<CAPTION>
                                                                                   Gross          Gross       Estimated
                                                                   Amortized     Unrealized     Unrealized     Market
                                                                     Cost          Gains          Losses        Value
                                                                   ----------    ---------       ----------  ----------
<S>                                                              <C>            <C>                <C>       <C>
             Available-for-Sale:
                United States Government Agency Securities Maturing:
                   After one year but within five years             910,567         3,785               --      914,352
                   After ten years but within fifteen years       2,041,062        30,486           41,357    2,030,191
                   After fifteen years but within twenty years    2,150,849            --           32,429    2,118,420
                   After twenty years                               812,902         2,128               --      815,030

                U S Agency Collateralized Mortgage Obligations:
                   After five years but within ten years            492,329        26,866               --      519,195

                 Municipal Securities Maturing:
                   Within one year                                  125,000           756               --      125,756
                   After one year but within five years             550,000        35,414               --      585,414
                   After five years but within ten years          3,628,939       139,211            3,654    3,764,496
                   After ten years but within fifteen years      10,833,870       350,387              932   11,183,325
                   After fifteen years but within twenty years    4,028,838       137,481           15,240    4,151,079
                   After twenty years                             2,163,297         7,044           38,151    2,132,190

                Corporate Securities Maturing:
                   After one year but within five years           1,406,115        24,812               --    1,430,927
                   After five years but within ten years          4,447,251         8,700           23,886    4,432,065
                   After ten years but within fifteen years       2,100,000            --           93,706    2,006,294
                   After twenty years                             1,733,311        41,197               --    1,774,508

                Equity Securities (Preferred Stock in
                   U.S. Government Agencies):
                   Callable within one year                      17,935,131        29,869          623,000   17,342,000
                   Callable after 1 year but within five years    4,430,582       284,548               --    4,715,130
                   Callable after five years but within ten years 1,000,000        80,000               --    1,080,000

                Other
                   After twenty years                                15,075         2,895               --       17,970
                                                                 ----------     ---------  ----------------------------
                          Total Available-for-Sale               60,805,118     1,205,579          872,355   61,138,342
                                                                 ==========     =========       ==========   ==========
             Held-to-Maturity:

                United States Government Agency Securities Maturing:
                   After five years but within ten years          1,017,058         1,672               --    1,018,730
                   After ten years but within fifteen years       2,503,325        15,729               --    2,519,054
                   After twenty years                             1,840,956        30,983               --    1,871,939

                U.S. Agency Collateralized Mortgage Obligations:
                   After five years but within ten years          1,120,476        16,282               --    1,136,758
                   After ten years but within fifteen years       2,940,106        28,906            7,873    2,961,139
                   After twenty years                             1,610,561        14,798            3,177    1,622,182

                Corporate Securities Maturing:
                   After one year but within five years           1,038,776        47,726               --    1,086,502
                   After five years but within ten years            500,490            --           19,460      481,030
                   After twenty years                             3,166,555            --          203,275    2,963,280
                                                               ------------     ---------       ----------   ----------
                          Total Held-to-Maturity                 15,738,303       156,096          233,785   15,660,614
                                                               ============     =========       ==========   ==========
</TABLE>

     Securities  called from investment  securities  available-for-sale  for the
     periods  ended  December  31,  2003,   2002,  and  2001  were   $5,932,581,
     $8,923,573,  and $0,  respectively,  resulting  in  gross  gains  of  $274,
     $259,772,  and  $0,  respectively.  Gross  realized  gains  from  calls  on
     held-to-maturity  securities for the periods ended December 31, 2003, 2002,
     and 2001 were $8,495,000,  $2,041,000,  and $0, respectively,  resulting in
     gross gains of $186, $3,465, and $0, respectively.

     Securities   sold  under  agreement  to  repurchase  are  offered  to  cash
     management  customers as an automated,  collateralized  investment account.
     Under these  transactions,  securities are delivered to the  counterparty's
     custody  account.  Securities held in custody accounts at December 31, 2003
     and 2002 totaled $2,030,774 and $2,503,325, respectively.

                                       42
<PAGE>

State of Franklin Bancshares, Inc.
Notes to Consolidated Financial Statements
For the Years Ended December 31, 2003, 2002, and 2001

Note 12 Commitments
------- -----------

     In the normal course of business,  the Savings Bank has various outstanding
     commitments  and  contingent  liabilities  that  are not  reflected  in the
     accompanying  consolidated financial statements.  The principal commitments
     of the Savings Bank are as follows:
<TABLE>
<CAPTION>

                                                           December 31, 2003                         December 31, 2002
                                               ---------------------------------------   ---------------------------------------
                                                   Fixed       Variable                      Fixed      Variable
                                                     Rate         Rate         Total          Rate         Rate         Total
                                               ----------     ----------    ----------    ----------    ----------    ----------
    <S>                                        <C>            <C>           <C>           <C>           <C>           <C>

    Mortgage Loans to Originate                        --      1,700,520     1,700,520            --       853,715       853,715
    Construction Loans                                 --     11,466,084    11,466,084            --    10,632,480    10,632,480
    Unsecured Lines of Credit                          --        599,809       599,809            --       378,544       378,544
    Overdraft Protection Accounts                 418,710             --       418,710       454,330            --       454,330
    Home Equity Lines of Credit                        --      5,341,397     5,341,397            --     4,844,727     4,844,727
    Commercial Loans                            1,663,219      9,133,999    10,797,218       715,143     4,642,537     5,357,680
                                               -----------    -----------   ----------    ----------   -----------    ----------
                                                2,081,929     28,241,809    30,323,738     1,169,473    21,352,003    22,521,476
                                               ===========    ===========   ==========    ==========   ============   ==========
</TABLE>


     Commitments under standby letters of credit totaled approximately  $212,000
     and $919,000 December 31, 2003 and 2002, respectively.  The amount and type
     of  collateral  obtained,  if deemed  necessary  by the  Savings  Bank upon
     extension of credit,  varies and is based on management's credit evaluation
     of the counterparty.

     At December  31,  2003,  the Savings  Bank had an unused line of credit for
     funds  purchases  and daylight  overdrafts  with one bank.  The line totals
     $2,000,000  and has a variable  interest  rate based on the lending  bank's
     daily  federal  funds rate.  The Savings Bank also has  available  lines of
     credit with the FHLB in the amount of $60,000,000.

     The Savings Bank is engaged in the sale of mortgage  loans on the secondary
     market.  These loans are sold  outright and are not serviced by the Savings
     Bank.  Loans originated for sale are under contract from the time the loans
     are closed and are held at cost on the general  ledger.  The  Savings  Bank
     turns these loans within a one to two week period.  The gain on the sale of
     these mortgage loans is as follows:

                                    2003              2002             2001
                                 ------------     -------------    -------------

      Selling Price              51,490,655        27,651,336       18,333,321
      Less: Carrying Value       50,493,861        27,141,803       17,985,843
        Loan Cost                   176,375           141,115          119,880
                                 ------------     -------------     ------------

      Net Gain on Loans Sold        820,419           368,418          227,598
                                 ============     =============     ============

     At December 31, 2003,  2002,  and 2001, the Savings Bank had mortgage loans
     committed  to  be  sold  totaling  $413,179,  $2,447,752,  and  $2,548,370,
     respectively.  Commitments  to originate  loans to be sold on the secondary
     market were  $5,116,152,  $8,397,051,  and $1,968,281 at December 31, 2003,
     2002, and 2001, respectively.

     The Savings Bank leases office space at the Browns Mill Road, Johnson City,
     branch  location  under an operating  lease which is scheduled to expire on
     February  28,  2006 with an option to renew and  extend for  another  three
     years.  The Real Estate  Company  also leases  office space near the Browns
     Mill Road,  Johnson City,  branch  location which extends through March 31,
     2007 with an option to renew for an  additional  3 years.  The Savings Bank
     has one  automobile  lease that  expires in April 2006.  In  addition,  the
     Savings Bank and the Real Estate  Company lease storage space at the Browns
     Mill Road, Johnson City,  location under a month-to-month  operating lease.
     Management  expects as  operating  leases  expire in the  normal  course of
     business, they will be renewed or replaced by leases on other properties at
     current market rental rates at the time of renewal.

     Approximate  minimum  future  rentals to be paid under the  cancelable  and
     noncancelable  leases for five years subsequent to December 31, 2003 are as
     follows:




                                             Noncancelable           Cancelable
 Years Ended                                   Leases -               Leases -
              December 31,                 Building & Auto            Building
              -------------                ---------------          ------------

                 2004                            102,216               20,370
                 2005                            105,803               24,120
                 2006                             64,500               24,120
                 2007                             13,491               24,120
                 2008                                 --               24,120
                                                --------             --------
           Total Minimum Future Rentals          286,010              116,850
                                                ========             ========


                                       43
<PAGE>

State of Franklin Bancshares, Inc.
Notes to Consolidated Financial Statements
For the Years Ended December 31, 2003, 2002, and 2001

Note 13 Guaranteed Preferred Beneficial Interest in Subordinated Debentures
------- -------------------------------------------------------------------

     On December 18, 2001, the Company issued $8,248,000 of junior  subordinated
     debentures  to State  of  Franklin  Trust I (the  "Trust"),  a  Connecticut
     business trust wholly owned by the Company.  The Trust (a) sold  $8,000,000
     of Capital Securities  through its underwriters to institutional  investors
     and  upstreamed  the  proceeds to the  Company  and (b) issued  $248,000 of
     Common  Securities to the Company.  Both of these  Securities have the same
     terms and conditions as the junior subordinated debentures.  The sole asset
     of the Trust is the $8,248,000 of junior subordinated  debentures issued by
     State of Franklin Bancshares.  The Company has, through various contractual
     arrangements,  fully  and  unconditionally  guaranteed  all of the  Trust's
     obligations  with  respect  to  the  Capital   Securities.   These  capital
     securities  are  presented in the  Consolidated  Statements of Condition as
     "Guaranteed  Preferred Beneficial Interest in Subordinated  Debentures" and
     qualify as Tier 1 capital,  subject to certain  limitations as discussed in
     Note 4. The securities are redeemable at par after December 2006 and have a
     final  maturity in December  2031.  The interest is payable  quarterly at a
     floating rate equal to 3-month LIBOR plus 3.6%.  There is a five-year  rate
     cap of 12.5%. The interest  distributions are payable on March 18, June 18,
     September 18, and December 18. The first distribution was paid on March 18,
     2002. A $240,000 placement cost associated with the Capital Securities will
     be  amortized  over five years  using the level yield  method.  The Capital
     Securities will be used to support the Company's  current capital  position
     allowing for future growth.

Note 14 Fair Value of Financial Instruments
------- -----------------------------------

The fair value of  financial  instruments  is  disclosed to comply with SFAS No.
107, Disclosure about Fair Value of Financial Instruments.  The following tables
present estimates of fair value for the Savings Bank's financial  instruments at
December 31, 2003 and 2002:

<TABLE>
<CAPTION>
                                                                                     Carrying              Fair
                                                                                       Amount              Value
                                                                                    -----------         -----------
         <S>                                                                        <C>                 <C>
         December 31, 2003:

         Financial Assets:
              Cash and Cash Equivalents                                              32,141,033          32,141,033
              Investment Securities                                                  97,407,172          97,649,786
              Loans                                                                 151,059,784         151,854,497
              Accrued Interest Receivable                                             1,366,640           1,366,640

         Financial Liabilities:
              Deposits                                                              221,992,486         222,615,134
              Advance Payments by Borrowers for Taxes and Insurance (Escrows)           103,632             103,632
              Accrued Interest on Deposits                                              141,757             141,757
              FHLB Advances                                                          36,210,071          37,843,293
              Preferred Beneficial Interest in Subordinated Debentures                8,000,000           8,000,000

         December 31, 2002:

         Financial Assets:
              Cash and Cash Equivalents                                              19,887,689          19,887,689
              Investment Securities                                                  77,766,965          77,689,276
              Loans                                                                 160,352,886         160,766,407
              Accrued Interest Receivable                                             1,502,448           1,502,448

         Financial Liabilities:
              Deposits                                                              198,839,887         199,093,130
              Advance Payments by Borrowers for Taxes and Insurance (Escrows)           115,191             115,191
              Accrued Interest on Deposits                                              184,365             184,365
              FHLB Advances                                                          36,238,709          37,386,934
              Preferred Beneficial Interest in Subordinated Debentures                8,000,000           8,000,000

</TABLE>

     The  carrying   amounts  in  the  preceding   table  are  included  in  the
     consolidated   statements  of  financial  condition  under  the  applicable
     captions.  The  contract or  notional  amounts of the  Company's  financial
     instruments  with  off-balance-sheet  risk are  disclosed  in Note  13.  No
     derivatives were held by the Company. It is not practicable to estimate the
     fair value of Federal  Home Loan Bank stock  because it is not  marketable.
     The  carrying  amount  of  that  investment  is  reported  at  cost  in the
     consolidated statements of financial condition.

                                       44
<PAGE>


State of Franklin Bancshares, Inc.
Notes to Consolidated Financial Statements
For the Years Ended December 31, 2003, 2002, and 2001

Note 14  Continued
-------

The following  describes the assumptions and methodologies used to calculate the
fair value for financial instruments.

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

     Floating Rate Loans:  Floating rate 1-4 family  residential  mortgage loans
     reprice periodically and will lag movements in market rates. The fair value
     for floating rate mortgage loans is calculated by  discounting  future cash
     flows to their present  value.  Future cash flows,  consisting of principal
     payments,  interest payments,  and repricings,  are discounted with current
     Savings Bank prices for similar  instruments  applicable  to the  remaining
     maturity. Prepayment assumptions based on historical prepayment speeds have
     been  applied  to  the  1-4  family  residential   floating  rate  mortgage
     portfolio.

     Fixed Rate Loans and Leases: The fair value for fixed rate loans and leases
     is calculated  by  discounting  future cash flows to their  present  value.
     Future cash flows,  consisting of both principal and interest payments, are
     discounted  with  current  Savings  Bank  prices  for  similar  instruments
     applicable  to the  remaining  maturity.  Prepayment  assumptions  based on
     historical  prepayment  speeds have been applied to the fixed rate mortgage
     and installment loan portfolios.

     Allowance for Loan Losses:  The fair value of the allowance for loan losses
     is approximated by the book value. Additionally,  the credit exposure known
     to  exist in the loan  portfolio  is  embodied  in the  allowance  for loan
     losses.

     Cash and Cash Equivalents:  The fair value of cash and cash equivalents are
     approximated by the book value.

     Investment Securities: Market quotes, when available, are used for the fair
     value of investment securities.

     Defined Maturity Deposits:  The fair value for defined maturity deposits is
     calculated by discounting future cash flows to their present value.  Future
     cash  flows,  consisting  of both  principal  and  interest  payments,  are
     discounted with Savings Bank prices for similar  instruments  applicable to
     the  remaining  maturity.  For  the  purpose  of this  disclosure,  defined
     maturity  deposits  include  all  certificates  of  deposit  and other time
     deposits.

     Undefined Maturity Deposits:  The fair value of undefined maturity deposits
     is required by the  statement  to equal the book value.  For the purpose of
     this  disclosure,  undefined  maturity  deposits  include demand  deposits,
     checking interest accounts, savings accounts, and money market accounts.

     Long-Term  Debt: The fair value of long-term debt  instruments  and Federal
     Home  Loan  Bank  advances  is  estimated  using  a  discounted  cash  flow
     calculation, based on current rates for similar debt.

     Limitations:  The  foregoing  fair value  estimates  are made at a specific
     point in time, based on pertinent  market data and relevant  information on
     the  financial  instrument.  These  estimates do not include any premium or
     discount that could result from an offer to sell, at one time,  the Savings
     Bank's  entire  holdings of a particular  financial  instrument or category
     thereof.  Since no market exists for a  substantial  portion of the Savings
     Bank's financial  instruments,  fair value estimates were necessarily based
     on  judgments  with respect to future  expected  loss  experience,  current
     economic  conditions,  risk  assessments of various  financial  instruments
     involving a myriad of individual  borrowers,  and other factors.  Given the
     innately   subjective   nature  of  these  estimates,   the   uncertainties
     surrounding  them and the  matters  of  significant  judgment  that must be
     applied,  these fair value estimations cannot be calculated with precision.
     Modifications in such assumptions could meaningfully alter these estimates.
                                       45
<PAGE>

State of Franklin Bancshares, Inc.
Notes to Consolidated Financial Statements
For the Years Ended December 31, 2003, 2002, and 2001

Note 14 Continued
-------

     Since  these  fair  value  approximations  were  made  solely  for  on- and
     off-balance  sheet financial  instruments,  no attempt was made to estimate
     the value of  anticipated  future  business  and the value of  nonfinancial
     statement  assets and liabilities.  Other important  elements which are not
     deemed to be  financial  assets  or  liabilities  include  the value of the
     Savings  Bank's  existing core deposit base,  premises and  equipment,  and
     goodwill.  Further,  certain tax implications related to the realization of
     the  unrealized  gains and losses could have a substantial  impact on these
     fair  value  estimates  and  have  not  been  incorporated  into any of the
     estimates.


Note 15  Federal Income Tax
-------  ------------------

     A  reconciliation  between the effective  income tax expense or benefit and
     the amount computed by multiplying the projected  statutory  federal income
     tax  rate for the  period  ended  December  31,  2003,  2002 and 2001 is as
     follows:


<TABLE>
<CAPTION>

                                                                          2003            2002               2001
                                                                       ---------        ---------          --------
         <S>                                                           <C>             <C>              <C>

         Computed "Expected" Federal Tax                               1,157,318        1,287,474           822,759
         Effect of State Taxes                                           146,026          104,203            78,703
         Tax Exempt Interest                                          (  305,978)      (  290,720)       (  143,941)
         FHLMC  Dividends                                             (  176,389)      (  283,036)       (  275,903)
         Miscellaneous Other                                          (   62,547)      (   57,491)          100,097
                                                                     -----------      -----------        ----------

         Provision for Income Taxes                                      758,430          760,430           581,715
                                                                     ===========      ===========        ==========

         Current Income Tax Expense                                      832,041          850,535           702,598
         Deferred Income Tax (Benefit)                               (    73,611)     (    90,105)       (  120,883)
                                                                     -----------      -----------        ----------

         Provision for Income Taxes                                      758,430          760,430           581,715
                                                                     ===========      ===========        ==========

         Deferred Tax Assets and Liabilities:

         Due to Reserve for Loan and Lease Losses                        850,903          742,108           586,997
         Due to Unrealized Losses on Investments                         494,897                -           251,391
                                                                      ----------      -----------        ----------
              Deferred Tax Assets                                      1,345,800          742,108           838,388
                                                                      ----------      -----------        ----------

         Due to FHLB Dividends                                       (   204,458)     (   169,274)       (  128,451)
         Due to Unrealized Gains on Investments                                       (   155,931)
                                                                     -----------      -----------        ----------
              Deferred Tax Liabilities                               (   204,458)     (   325,205)       (  128,451)
                                                                      ----------      -----------        ----------

         Deferred Tax Assets and Liabilities                           1,141,342          416,903           709,937
                                                                      ==========      ===========        ==========
</TABLE>


     In  assessing  the   realizability  of  the  related  deferred  tax  asset,
     management  considers  whether it is more likely than not that some portion
     or all of the  deferred  tax  asset  will  not be  realized.  The  ultimate
     realization  of deferred tax assets is dependent  upon the existence of, or
     generation  of,  taxable  income  in  the  periods  which  those  temporary
     differences  are  deductible.  Management  considers the  projected  future
     taxable income and tax planning strategies in making this assessment. Based
     upon the  projection  for future  taxable income over the periods which the
     deferred tax asset is deductible, at December 31, 2003, management believes
     it is more likely than not that the Savings  Bank will realize the benefits
     of these deductible differences.


Note 16  Comprehensive Income
-------  --------------------

     In June of 1997, the Financial  Accounting Standards Board issued Statement
     of  Financial  Accounting  Standards  No. 130,  (SFAS No.  130),  Reporting
     Comprehensive  Income. This statement  established  standards for reporting
     and  displaying  comprehensive  income and its components in a basic set of
     financial statements.  the purpose of reporting  comprehensive income is to
     report a measure of all  changes in equity of an  enterprise  that  results
     from recognized  transactions and other economic events of the period other
     than transactions with owners in their capacity as owners.

     Comprehensive  income is  defined  as the  change  in equity of a  business
     enterprise   during  a  period  from  transactions  and  other  events  and
     circumstances  from  nonowner  sources.  It includes  all changes in equity
     during a period  except  those  resulting  from  investments  by owners and
     distributions to owners.

                                       46
<PAGE>

State of Franklin Bancshares, Inc.
Notes to Consolidated Financial Statements
For the Years Ended December 31, 2003, 2002, and 2001


Note 16  Continued
-------  ----------

     Reclassification  adjustments  are made to avoid counting in  comprehensive
     income  items that are  displayed  as part of net income for a period  that
     also  had been  displayed  as part of other  comprehensive  income  in that
     period or earlier periods. For example, gains on investment securities that
     were  realized and  included in net income of the current  period that also
     had been included in other comprehensive income as unrealized holding gains
     in  the  period  in  which  they  arose  must  be  deducted  through  other
     comprehensive income of the period in which they are included in net income
     to avoid including them in comprehensive income twice.

Note 17  Legal Proceedings
-------  ----------------

     The  Company  and its  subsidiaries  are  periodically  involved  in  legal
     proceedings that are generally incidental to their businesses.  At December
     31,  2003,  there were no legal  proceedings  that were  expected to have a
     material impact on the Company's financial statements.


Note 18  Earnings Per Share
-------  ------------------

     Statement  of  Financial  Accounting  Standards  No. 128 ("SFAS No.  128"),
     Earnings Per Share, is effective for fiscal years ending after December 15,
     1997.  This  statement  presents  standards for  computing  and  presenting
     earnings  per share  ("EPS")  and applies to entities  with  publicly  held
     common stock or potential  common stock.  SFAS No. 128 simplifies  previous
     standards for computing EPS and makes them comparable to international  EPS
     standards.   It  replaces  the   presentation   of  primary  EPS  with  the
     presentation  of basic EPS. Basic EPS excludes  dilution and is computed by
     dividing income  available to common  stockholders by the  weighted-average
     number of common shares  outstanding  for the period.  Diluted EPS reflects
     the potential dilution that could occur if securities or other contracts to
     issue  common  stock were  exercised  or  converted  into  common  stock or
     resulted in the  issuance of common  stock that then shared in the earnings
     of the entity. Diluted EPS is computed similarly to fully diluted EPS.

         Earnings per Share Computation:
<TABLE>
<CAPTION>
                                                                      2003               2002               2001
                                                                   ---------           ---------          ---------
<S>                                                                <C>                 <C>                <C>


         Net Income                                                2,645,445           3,184,141          1,957,411
         Average Basic Shares Outstanding                          1,388,782           1,379,713          1,374,709

         Basic Earnings Per Share                                       1.90                2.31               1.42
                                                                        ====                ====               ====


         Net Income                                                2,645,445           3,184,141          1,957,411

         Average Basic Shares Outstanding                          1,388,782           1,379,713          1,374,709
         Dilutive Effect Due to Stock Options                        105,526              93,444             65,572
                                                                  ----------           ---------          ---------

         Average Shares Outstanding, as Adjusted                   1,494,308           1,473,157          1,440,281

         Diluted Earnings Per Share                                     1.77                2.16               1.36
                                                                        ====                ====               ====

</TABLE>

Note 19  Condensed Parent Company Only Financial Statements
-------  --------------------------------------------------
<TABLE>
<CAPTION>

         Statement of Financial Position                             December 31,               December 31,
                                                                        2003                       2002
                                                                    ------------               ------------
<S>                                                                   <C>                       <C>

                  Assets:

         Cash and Cash Equivalents                                     8,522,421                 8,853,128
         Investments - Available-for-Sale                                343,200                    17,970
         Investment in State of Franklin Leasing                         585,204                   704,553
         Investment in State of Franklin Savings Bank                 22,782,742                20,843,815
         Investment in State of Franklin Statutory Trust I               248,000                   248,000
         Interest Receivable                                               9,818                    12,823
         Trust Preferred Placement Cost, net of amortization             140,000                   188,000
         Accrued Tax Benefit                                             130,943                    18,165
                                                                     -----------               -----------
                Total Assets                                          32,762,328                30,886,454
                                                                     ===========               ===========

</TABLE>



                                       47
<PAGE>

State of Franklin Bancshares, Inc.
Notes to Consolidated Financial Statements
For the Years Ended December 31, 2003, 2002, and 2001


Note 19  Continued
------


<TABLE>
<CAPTION>

                                                                                   December 31,         December 31,
                                                                                           2003                2002
                                                                                   ------------        ------------
<S>                                                                                 <C>                 <C>
         Liabilities:

         Accounts Payable and Accrued Expenses                                          13,780              15,588
         Deferred Tax Liability                                                          9,590               1,109


                Total Liabilities                                                       23,370              16,697
                                                                                    ----------          ----------

         Guaranteed Preferred Beneficial Interest
             In Subordinated Debentures                                              8,248,000           8,248,000
                                                                                    ----------         -----------

         Stockholders' Equity:

         Common Stock, $1.00 Par Value,
            Authorized: 10,000,000 Shares; Issued: 1,465,512 Shares                   1,465,512          1,465,512
         Paid-In Capital                                                             14,251,461         14,251,461
         Accumulated Other Comprehensive Income                                     (   797,592)           252,107
         Retained Earnings                                                           10,356,572          7,711,127
         Less: Employee Stock Ownership                                             (   784,995)       ( 1,058,450)
                                                                                     ----------        -----------

                Total Stockholders' Equity                                           24,490,958          22,621,757
                                                                                     ----------         -----------

                    Total Liabilities and Stockholders' Equity                       32,762,328          30,886,454
                                                                                     ==========          ==========
</TABLE>




<TABLE>
<CAPTION>


         Statement of Income                                                       Period Ended         Period Ended
                                                                                   December 31,         December 31,
                                                                                           2003                 2002
                                                                                   ------------         ------------
<S>                                                                                 <C>                 <C>


         Interest Income                                                                190,063             225,878

         Interest Expense                                                           (   433,863)        (   500,713)
         Other Operating Expenses                                                   (   142,881)        (   119,733)
                                                                                    ------------        ------------

         Income (Loss) before Income Taxes and Equity
           in Undistributed Earnings of Subsidiaries                                (   386,681)        (   394,568)
         Provision for Income Taxes (Benefit)                                       (   149,179)        (   147,981)
                                                                                    ------------        ------------
             Income (Loss) before Equity in Undistributed Earnings of Subsidiaries  (   237,502)        (   246,587)

         Equity in undistributed Earnings of Subsidiaries                             2,882,947           3,430,728
                                                                                    ------------        ------------
         Net Income                                                                   2,645,445           3,184,141
                                                                                    ============        ============

</TABLE>




                                       48




<PAGE>


State of Franklin Bancshares, Inc.
Notes to Consolidated Financial Statements
For the Years Ended December 31, 2003, 2002, and 2001

Note 19  Continued
-------
<TABLE>
<CAPTION>


         Statement of Cash Flows                                                   Period Ended          Period Ended
                                                                                    December 31,          December 31,
                                                                                         2003                 2002
                                                                                 -----------------     ---------------
         <S>                                                                        <C>                 <C>

         Cash Flows from Operating Activities
                Net Income                                                            2,645,445           3,184,141
                Items Not Affecting Cash and Cash Equivalents:
                  Equity in Undistributed Earnings of Subsidiaries                  ( 2,882,947)        ( 3,430,728)
                  (Increase) in Accrued Tax Benefit                                 (   112,778)        (    18,165)
                  Decrease in Deferred Tax                                                   --               3,099
                  Increase (Decrease) in Accounts Payable                           (     1,807)              1,594
                  Amortization Expense                                                   48,000              48,000
                  Earned ESOP Shares                                                    273,455              31,644
                  (Increase) Decrease in Accounts Receivable                              3,005         (     7,409)
                                                                                    ------------        ------------

                    Net Cash (Used) by Operating Activities                         (    27,627)        (   187,824)
                                                                                    ------------        ------------

         Cash Flows from Investing Activities
                Purchase of Available-for-Sale Investments                          (   303,080)        (    15,075)
                Proceeds from Sale of Available-for-Sale Investments                         --             514,297
                                                                                    ------------        ------------

                    Net Cash Provided (Used) by Investing Activities                (   303,080)            499,222
                                                                                    ------------        ------------

                    Net Increase (Decrease) in Cash and Cash Equivalents            (   330,707)            311,398

         Cash and Cash Equivalents at Beginning of Period                             8,853,128           8,541,730
                                                                                    ------------        ------------

                    Cash and Cash Equivalents at End of Period                        8,522,421           8,853,128
                                                                                    ============        ============

</TABLE>








                                       49

<PAGE>



STATE OF
FRANKLIN
BANCSHARES, INC.

Statement of Management Responsibility
--------------------------------------

The management of State of Franklin  Bancshares,  Inc. and its  subsidiaries  is
responsible  for the  preparation,  content and  integrity  of the  consolidated
financial  statements and all other information  included in this annual report.
The consolidated financial statements, which include management's best estimates
where judgment is required,  are prepared in accordance with generally  accepted
accounting principles applied on a consistent basis and meet the requirements of
the appropriate regulatory agencies.

The Company has established and maintains a system of internal controls designed
to provide  reasonable  assurance as to the  integrity  and  reliability  of the
consolidated  financial  statements and related  information,  the protection of
assets and customer deposits from material loss or misuse,  and the detection of
fraudulent  financial  reporting.  The  Company's  system of  internal  controls
includes  written  policies and procedures,  proper  delegation of authority and
organizational  division  of  responsibilities,  and the careful  selection  and
training of qualified personnel.

Management  recognizes that the cost of a system of internal controls should not
exceed the  benefits  derived  and that  there are  inherent  limitations  to be
considered in the potential  effectiveness  of any system.  However,  management
believes that the system of internal  controls  provides  reasonable  assurances
that financial  transactions are recorded  properly to permit the preparation of
reliable consolidated financial statements.

Management  also  recognizes  its  responsibility  for  conducting the Company's
affairs in an ethical and socially  responsible  manner.  This responsibility is
characterized  and  reflected  in key policy  statements  covering,  among other
subjects,  proper  conduct  of  business  practices.  The  Company  maintains  a
systematic  program to  communicate,  review and  assess  compliance  with these
policies.

The Audit  Committee of the Board of Directors  has the  responsibility  for the
recommendation of the independent  certified public accountants for the Company.
The Board of Directors, through its audit committee, is responsible for ensuring
that both management and the independent  certified public  accountants  fulfill
their respective  responsibilities with regard to the financial statements.  The
independent   certified  public  accountants  have  free  access  to  the  Audit
Committee.

The Company's  consolidated financial statements have been audited by Baylor and
Backus.  Their  responsibility  is  to  express  an  opinion  on  the  Company's
consolidated  financial  statements and, in performing  their audit, to evaluate
the Company's internal control system to the extent they deem necessary in order
to issue an opinion  on the  Company's  consolidated  financial  statements.  As
described further in their report, their opinion is based on their audits, which
were conducted in accordance with generally  accepted auditing  standards and is
believed by them to provide a reasonable basis for their opinion.


/s/ Charles E. Allen, Jr.                      /s/ Randal R. Greene
Charles E. Allen, Jr.                          Randal R. Greene

Chairman of the Board of Directors             President
  and Chief Executive Officer


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

1907 North Roan Street  -  P.O.  Box 940 - Johnson  City,  Tennessee  37605-0940
(423) 926-3300 - Facsimile (423) 232-4448

                                       50
<PAGE>

Item 8.  Changes  In  and  Disagreements  with  Accountants  on  Accounting  and
         Financial Disclosure

         None

Item 8A. Controls and Procedures

     (a) Evaluation of Disclosure  Controls and Procedures.  State of Franklin's
Chief Executive  Officer and its President  (principal  accounting and financial
officer) have evaluated the  effectiveness  of the design and operation of State
of Franklin's  disclosure  controls and  procedures  (as defined in Exchange Act
Rule  13a-14(c)) as of the last day of the period covered by this report.  Based
on that evaluation, the Chief Executive Officer and the President have concluded
that State of Franklin's  disclosure  controls and  procedures  are effective to
ensure that  material  information  relating  to State of Franklin  and State of
Franklin's  consolidated  subsidiaries  is made known to such officers by others
within these entities,  particularly during the period this quarterly report was
prepared, in order to allow timely decisions regarding required disclosure.

     (b)  Changes in  Internal  Controls.  There  have not been any  significant
changes  in State of  Franklin's  internal  controls  or in other  factors  that
occurred  during  the last  fiscal  quarter  covered  by this  report  that have
materially  affected or are reasonably  likely to materially affect our internal
control over financial reporting.


                                    PART III

Item 9. Directors, Executive Officers, Promoters and Control Persons

     Except  as set  forth  below,  the  information  required  by this  item is
incorporated by reference to the sections entitled  "Incumbent  Directors (Terms
Expiring  2005),"  "Incumbent   Directors  (Terms  Expiring  2005),"  "Incumbent
Directors (Terms Expiring 2006)," "Information about the Board of Directors" and
"Section 16(a) Beneficial Ownership Reporting Compliance" of State of Franklin's
Proxy Statement related to its 2004 Annual Meeting of Shareholders.

Audit Committee Financial Expert

     Our Board of Directors has determined that Audit Committee  members Cameron
E.  Perry,  Vance W.  Cheek and  Steven K.  Gross are each  qualified  as "audit
committee  financial  experts," as defined under the rules of the Securities and
Exchange   Commission.   Each  of  our  audit  committee  financial  experts  is
independent.

Code of Ethics

     We have  adopted a code of ethics  that  applies to our senior  management,
including our chief  executive  officer,  vice president  (principal  accounting
officer) and persons performing similar functions.  Copies of our code of ethics
are available  without charge upon written request directed to Charles E. Allen,
Jr., 1907 North Roan Street, P.O. Box 940, Johnson City, Tennessee 37605-0940.

Item 10. Executive Compensation.

     This item is incorporated by reference to the section entitled
"Executive Compensation" of State of Franklin's Proxy Statement related to its
2004 Annual Meeting of Shareholders.

Item 11. Security Ownership of Certain Beneficial Owners and Management

     This item is  incorporated  by reference to the section  entitled "State of
Franklin Stock Ownership" of State of Franklin's Proxy Statement  related to its
2004 Annual Meeting of Shareholders.

Item 12.  Certain Relationships and Related Transactions

     This  item  is   incorporated   by  reference   to  the  section   entitled
"Transactions  with  Executive  Officers,  Directors  and  Others"  of  State of
Franklin's Proxy Statement related to its 2004 Annual Meeting of Shareholders.


                                       51
<PAGE>

Item 13.  Exhibits and Reports on Form 8-K

(1) Exhibits

  Exhibit No.       Description

    3.1*    Charter of State of Franklin Bancshares, Inc.

    3.2*    Bylaws of State of Franklin Bancshares, Inc.

     21     Subsidiaries of State of Franklin Bancshares, Inc.

     22     Consent of Baylor and Backus

   31.1     Certification of Randal R. Greene,  President  of State of  Franklin
            Bancshares, Inc., Pursuant to Section 302 of the Sarbanes-Oxley  Act
            of 2002.

   31.2     Certification of Charles E. Allen, Jr., the  Chief Executive Officer
            of State of  Franklin  Bancshares,  Inc.,  Pursuant  to  Section 302
            of the Sarbanes-Oxley Act of 2002.

   32.1     Certification of Randal R. Greene, President  of  State of  Franklin
            Bancshares, Inc., Pursuant to Section 906 of the Sarbanes-Oxley  Act
            of 2002.

   32.2     Certification of Charles E. Allen, Jr., the Chief Executive  Officer
            of State of  Franklin  Bancshares,  Inc.,  Pursuant  to  Section 906
            of the Sarbanes-Oxley Act of 2002.

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

   *        Incorporated   herein   by  reference  to   the   Registrant's  Form
            10-KSB,  filed  with  the  Securities  and  Exchange  Commission  on
            March 28, 1999 (File number 000-24675).


     (2)  Reports on Form 8-K
          -------------------


     No reports on Form 8-K were filed  during the quarter  ended  December  31,
2003.

Item 14. Principal Accountant Fees and Services

     This item is incorporated by reference to the section  entitled  "Principal
Accountant Fees and Services" of State of Franklin's Proxy Statement  related to
its 2004 Annual Meeting of Shareholders.

                                       52

<PAGE>

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


                                       STATE OF FRANKLIN BANCSHARES, INC.


                                       By: /s/ Charles E. Allen, Jr.
                                          --------------------------------------
                                          Charles E. Allen, Jr.
                                          Chairman of the Board

                                          Date: March 29, 2004

     In accordance  with the  requirements  of the Exchange Act, this report has
been signed below by the following  persons on behalf of the  registrant  and in
the capacities and on the dates indicated.
<TABLE>
<CAPTION>

         Signature                           Capacity                                                 Date
         ----------                          --------                                               -------
<S>                                 <C>                                                          <C>
/s/ Charles E. Allen, Jr.
---------------------------         Chairman of the Board, Director                               March 29, 2004
Charles E. Allen, Jr.               (principal executive, financial, and accounting officer)


/s/ Randal R. Greene
---------------------------         President, Director                                           March 29, 2004
Randal R. Greene

/s/ Stephen Gross
---------------------------         Director                                                      March 29, 2004
Stephen Gross

/s/ Donald R. Jeanes
---------------------------         Director                                                      March 29, 2004
Donald R. Jeanes

/s/ Henry J. Williams, M.D.
---------------------------         Director                                                      March 29, 2004
Henry J. Williams, M.D.

/s/ Kenneth E. Cutshall, M.D.
---------------------------         Director                                                      March 29, 2004
Kenneth E. Cutshall, M.D.

/s/ Charles E. Allen, Sr.
---------------------------         Director                                                      March 29, 2004
Charles E. Allen, Sr.

/s/ Richard S. Venable
----------------------------        Director                                                      March 29, 2004
Richard S. Venable

/s/ Verrill M. Norwood, Jr.
----------------------------        Director                                                      March 29, 2004
Verrill M. Norwood, Jr.

/s/ Cameron E. Perry
-----------------------------       Director                                                      March 29, 2004
Cameron E. Perry

/s/ Vance W. Cheek
-----------------------------       Director                                                      March 29, 2004
Vance W. Cheek

/s/ Alan R. Hubbard
-----------------------------       Director                                                      March 29, 2004
Alan R. Hubbard

</TABLE>


                                       53