FORM 10-KSB

                       SECURITIES AND EXCHANGE COMMISSION
                             Washington, D.C. 20549


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

                   For the fiscal year ended December 31, 2002


[ ] 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
         (State or other jurisdiction of incorporation or organization)

                                   62-1607709
                      (I.R.S. Employer Identification No.)


                             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. [X]

     The  registrant's  revenues for the twelve  months ended  December 31, 2002
were $17,643,751.

     The  aggregate  market  value  of  the  shares  of  Common  Stock  held  by
nonaffiliates  of the  registrant  as of March 15, 2003 is  approximately  $19.3
million.  (For purposes of this  calculation  only,  all executive  officers and
directors are classified as affiliates.)

The number of shares  outstanding of the  registrant's  Common  Stock, $1.00 par
value, as of March 15, 2003 was 1,465,512 shares.

Documents  Incorporated  by Reference:  Proxy  Statement  related to 2003 Annual
Meeting of Shareholders.




<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.  On
December 31,  2002,  we had  consolidated  total  assets of  approximately  $268
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.  In  early  2002,  State  of  Franklin  Real  Estate,  Inc.  was
incorporated as a 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
(generally  known as 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  John  Sevier  Title  Services,   Inc.,  a
Tennessee-chartered and regulated title insurance company, and State of Franklin
Real Estate, Inc.

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 certain  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>

                                                             2002                               2001
                                                --------------------------------------------------------------------
(Fully taxable equivalent)                                  Interest      Average               Interest     Average
(Dollars in thousands)                          Average      Income/      Yields/    Average     Income/     Yields/
                                                Balance      Expense       Rate      Balance     Expense      Rate
                                                --------------------------------------------------------------------
Assets:

Interest-earning assets:
<S>                                             <C>            <C>          <C>     <C>          <C>          <C>

Loans net of unearned income................    $154,043       $11,241      7.30%   $140,343     $11,466      8.17%
Investment Securities.......................      81,365         5,480      6.74%     61,282       4,409      7.19%
Other earning assets .......................       2,822           113      4.00%      2,150         143      6.65%
Federal funds sold..........................      13,315           210      1.58%      8,286         262      3.16%
                                                --------       -------      -----   --------     -------      -----
    Total interest-earning assets/interest
income......................................     251,545        17,044      6.78%    212,061      16,280      7.68%
                                                --------       -------      -----   --------     -------      -----
Cash and due from banks.....................       2,418                               3,038
Other assets................................       7,938                               6,993
Allowance for loan losses...................   (   1,456)                          (   1,245)
                                                --------                            --------
    Total...................................    $260,445                            $220,847
                                                ========                            ========
Liabilities and stockholders' equity:

Interest-bearing liabilities:

Interest-bearing checking deposits..........     $10,696         $ 203      1.90%     $7,580       $ 153      2.02%
Savings.....................................      55,897         1,397      5.50%     24,643         934      3.79%
Money Market................................      38,370           821      2.14%     47,453       1,982      4.18%
Time certificates...........................      81,834         2,959      3.62%     86,156       4,885      5.67%
Borrowed funds..............................      34,730         1,677      4.83%     26,988       1,379      5.11%
Subordinated Debentures                            8,000           501      6.26%        307          17      5.54%
                                                --------        ------      -----    -------       -----      -----
     Total interest-bearing liabilities/
interest expense............................     229,527         7,558      3.29%    193,127       9,350      4.84%
                                                --------        ------      -----    -------       -----      -----
Non-interest bearing demand  deposits.......       9,850                               9,074
Other liabilities...........................         882                                 825
Stockholders' equity........................      20,186                              17,821
                                                --------                            --------
    Total...................................    $260,445                            $220,847
                                                ========                            ========
Net interest earnings.......................                    $9,486                            $6,930
                                                                ======                            ======
Net interest on interest-earning assets.....                                3.77%                             3.27%
Return on average assets....................                                1.22%                             0.89%
Return on average equity....................                               15.77%                            10.98%
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, 2002             December 31, 2001
                                                                   Versus                          Versus
                                                              December 31, 2001               December 31, 2000
                                                             Increase (Decrease)             Increase (Decrease)
                                                             Change Due to: (1)              Change Due to: (1)
                                                             -------------------             -------------------
(Dollars in thousands)                               Volume      Rate       Total   Volume     Rate      Total
                                                     ------      ----       -----   ------     ----      -----
Increase (decrease) in: (2)
<S>                                                  <C>        <C>       <C>        <C>      <C>       <C>

Loans, net of unearned income....................    $1,000     ( $1,225) (  $225)   $1,083   (  $568)     $515
U.S. Treasury and other U.S. government agency
  securities.....................................     1,352     (    281)   1,071     1,513       101     1,614
Other earning assets ............................        27     (     57) (    30)       43   (    10)       33
Federal funds sold...............................        79     (    131) (    52)      234   (    26)      208
                                                     ------      --------   ------   ------    -------   ------

         Total interest income...................     2,459     (  1,695)     764     2,872   (   502)    2,370
                                                     ------      --------   ------   ------    -------   ------

Increase (decrease) in: (2)
Interest-bearing checking deposits...............        59     (      9)      50        23   (     2)       21
Savings deposits.................................       781     (    318)     463        55   (   226)  (   171)
Money Market.....................................   (   195)    (    966) ( 1,161)    1,042   (   219)      823
Time certificates................................   (   156)    (  1,770) ( 1,926)      174   (   343)  (   169)
Borrowed funds...................................       374     (     76)     298       437   (   218)      219
Subordinated Debentures..........................       482            2      484        17        --        17
                                                     ------       ------   ------   -------   -------   -------
         Total interest expense..................     1,344     (  3,136) ( 1,792)    1,748    (1,008)      740
                                                                           -------                      -------
Increase (decrease) in net interest income.......                        $  2,556                       $ 1,630
                                                                           =======                      =======
</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  Bancshares  as of December 31, 2002 and 2001.  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, 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                                                     58
Federal Home Loan Bank stock..                2,263                                                  2,263
                                            -------                                               --------
     Total earning assets.....              $52,537       $52,035       $69,847      $80,035      $254,454
                                            =======       ========      ========     =======      ========
Interest-bearing liabilities:
Interest-bearing deposits.....             $123,328       $38,811       $25,347                   $187,486
Repurchase Agreements.........                1,050                                                  1,050
Long-term debt................                                                        30,241        30,241
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>

                                       4
<PAGE>


<TABLE>
<CAPTION>

                                                                      December 31, 2001
                                            -----------------------------------------------------------------
                                                         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.........................              $33,755        $11,572       $39,219      $ 57,093      $141,639
Investment securities:
     Available for sale.......                  794                       17,531        45,456        63,780
     Held to maturity.........                                             1,963         7,714         9,677
Federal funds sold............               28,590                                                   28,590
Interest-bearing deposits.....                   58                                                       58
Federal Home Loan Bank stock..                2,161                                                    2,161
                                            -------                                                 --------
        Total earning assets.               $65,358        $11,572       $58,713      $110,263      $245,905
                                            =======        =======       =======      ========      ========

Interest-bearing liabilities:
Interest-bearing deposits.....             $157,056        $20,658       $ 3,890      $    317      $181,921
Long-term debt................                                                          30,241        30,241
Subordinated debentures.......                8,000                                                    8,000
                                           --------                                                 --------
Total interest-bearing liabilities         $165,056        $20,658       $ 3,890      $ 30,558      $220,162
                                           ========        =======       =======      ========      ========

Net repricing gap.............             $(99,698)       $(9,086)      $54,823      $ 79,705      $ 25,744

Rate sensitivity gap:
Net repricing gap as a percentage
    of total earning assets....             (40.87)%        (3.72)%        22.47%       32.67%        10.55%
Cumulative gap................             $(99,698)     $(108,784)     $(53,961)      $25,744       $25,744
Cumulative gap as a percentage of
    total earning assets                    (40.87)%       (44.59)%      (22.12)%       10.55%        10.55%
</TABLE>


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.

                                       5
<PAGE>

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, 2002 and 2001 (in thousands).


                                                           2002          2001
                                                        --------      --------
     Non interest-bearing deposits:
     Individuals, partnerships and corporations.......  $  9,433      $ 17,027
     Certified and official checks....................     1,921         1,189
                                                        --------      --------
     Total non interest-bearing deposits..............    11,354        18,216


     Interest-bearing deposits:
     Interest-bearing demand accounts.................    48,798        54,533
     Savings accounts.................................    63,943        41,603
     Certificates of deposit, less than $100,000......    55,356        63,547
     Certificates of deposit, greater than $100,000...    19,389        22,238
                                                        --------      --------
       Total interest-bearing deposits................   187,486       181,921
                                                        --------      --------
       Total deposits.................................  $198,840      $200,137
                                                        ========      ========


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

                                                       December 31,
                                            -----------------------------------
                                                 2002                2001
                                            ------------         --------------
     (Dollars in thousands)
     Non interest-bearing  deposits.....  0.00%   $ 9,850       0.00%    $9,074
     Savings deposits...................  2.50%    55,897       3.79%    24,643
     Money market deposits .............  2.14%    38,370       4.18%    47,453
     Time deposits......................  3.62%    81,834       5.67%    86,156
     Interest-bearing  demand deposits..  1.90%    10,696       2.02%     7,580
                                                 --------              --------
             Total deposits.............         $196,647              $174,906
                                                 ========              ========


     At  December  31,  2002 and  2001,  time  deposits  greater  than  $100,000
aggregated  approximately  $19.4 million and $22.2  million,  respectively.  The
following table  indicates,  as of December 31, 2002 and 2001, the dollar amount
of  deposits  of  $100,000  or more by the time  remaining  until  maturity  (in
thousands):
<TABLE>
<CAPTION>

                                            2002                                           2001
                                            ----                                           ----
                                               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      $3,050     $8,791      $7,548     $19,389     $4,128       $15,589      $2,521     $22,238
</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, 2002 and 2001.

         (In Thousands)                               2002            2001
                                                      ----            ----
         Investment securities:
          Available for sale..................      $ 62,029      $ 63,780
          Held to maturity....................        15,738         9,677
         Short-term interest-bearing deposits.         1,366            58
         Federal funds sold...................        12,705        28,590
         Federal Home Loan Bank stock.........         2,263         2,162
         Loans:
          Real estate.........................       119,710        95,708
          Commercial and other................        40,889        46,072
                                                    --------      --------
           Total loans........................       160,599       141,780
          Less unearned income................           246           141
                                                    --------      --------
         Loans, net of unearned income........       160,353       141,639
                                                    --------      --------
         Total earning assets ................      $254,454      $245,906
                                                    ========      ========
Investment Portfolio

     For a  description  of  the  composition  of  the  carrying  value  of  our
investment  portfolio  at  December  31,  2002  and  2001,  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, 2002
and 2001. The weighted  average tax equivalent  yields on these  instruments are
presented based on final maturity.

<TABLE>
<CAPTION>

                                                                2002                                    2001
                                                                ----                                    ----
                                              Amortized    Estimated     Weighted    Amortized    Estimated     Weighted
                                                Cost     Market Value  Average Yield    Cost    Market Value  Average Yield
                                                ----     ------------  -------------    ----    ------------  -------------
(Dollars in thousands)
Held to maturity:
----------------
<S>                                          <C>           <C>              <C>     <C>           <C>            <C>

Obligations of U.S. Government agencies:
 Due after 5 years but within 10 years.....  $  1,017      $  1,019         5.45%   $    834      $    833        6.38%
 Due after 10 years but within 15..........     2,503         2,519         5.19%      4,491         4,451        6.54%
 Due after 20 years........................     1,841         1,872         4.45%         --            --           --

U.S.Agency Collateralized Mortgage Obligations
 Due after 1 year but within 5 years.......        --           --            --      1,963         1,963        6.52%
 Due after 5 years but within 10 years.....     1,120         1,137         5.65%     2,389         2,389        5.59%
 Due after 10 years but within 15 years....     2,940         2,961         6.07%        --            --           --
 Due after 20 years........................     1,611         1,622         4.37%        --            --           --

Corporate Securities:
 Due after 1 year but within 5 years.......     1,039         1,087         5.24%        --            --           --
 Due after 5 year but within 10 years......       500           481         7.23%        --            --           --
 Due after 20 years........................     3,167         2,963         8.37%        --            --           --
                                             --------      --------                --------      --------
  Total held to maturity...................  $ 15,738      $ 15,661         5.70%  $  9,677      $  9,636        6.29%
                                             ========      ========                ========      ========

Available for sale:
-------------------
Obligations of U.S. Government agencies:
 Due after 1 year but within 5 years ......  $    911      $    914         3.02%  $    --       $    --           --
 Due after 5 years but within 10 years.....        --            --           --     6,888         7,070         6.71%
 Due after 10 years but within 15 years....     2,041         2,030         4.59%    1,230         1,204         6.42%
 Due after 15 years but within 20 years....     2,151         2,119         4.61%    3,369         3,428         7.79%
 Due after 20 years........................       813           815         2.06%    1,084         1,032         7.80%

U.S. Agency Collateralized Mortgage Obligations:
 Due after 5 years but within 10 years.....       492           519         7.77%      290           290         6.51%

                                       7
<PAGE>

Municipal Securities:

 Due within 1 year .......................    $   125       $   126         6.28%  $   120       $   121         5.98%
 Due after 1 year but within 5 years......        550           585         6.68%      530           545         6.22%
 Due after 5 years but within 10 years....      3,629         3,765         6.19%    2,109         2,095         5.96%
 Due after 10 years but within 15 years...     10,834        11,183         6.70%   10,888        10,615         6.40%
 Due after 15 years but within 20 years...      4,029         4,151         7.50%    5,090         4,863         7.12%
 Due after 20 years.......................      2,163         2,132         8.01%    1,508         1,448         7.16%

Corporate Securities:
 Due after 1 year but within 5 years......      1,406         1,461         3.70%       --            --            --
 Due after 5 year but within 10 years.....      4,447         4,432         5.86%    3,000         2,912         7.00%
 Due after 10 year but within 15 years....      2,100         2,007         7.25%    2,100         1,990         7.25%
 Due after 20 years.......................      1,733         1,775         8.31%    1,743         1,723         8.26%

Equity Securities (Preferred Stock
 In U S Government Agencies):
 Callable within 1 year...................     17,935        17,342         5.05%       --            --           --
 Callable after 1 year but within 5 years.      4,431         4,715         7.55%   17,000        16,986         7.23%
 Callable after 5 year but within 10 years      1,000         1,080         7.88%    5,933         5,894         8.03%

Other Securities:
 Due within 1 year ......................          --            --           --       674           674         3.27%

 Due after 20 years......................         830           908         0.00%      815           890         0.00%
                                              -------       -------                -------       -------
  Total available for sale...............     $61,620       $62,029         5.27%  $64,371       $63,780         6.92%
                                              =======       =======                =======       =======
</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, 2002 and 2001.

                                                     2002              2001
                                               --------------    --------------
(In Thousands)
Real estate loans:
 Construction and land development...........      $ 19,017       $ 14,668
 Secured by residential properties...........        85,797         72,903
 Commercial real estate loans................        14,896          8,137
                                                   --------       --------
  Total real estate loans....................       119,710         95,708
Commercial and industrial loans and leases...        29,714         26,780
Installment loans............................        10,929         19,091
Other consumer loans.........................             0              0
All other loans..............................             0             60
                                                   --------       --------
  Total loans................................      $160,353       $141,639
                                                   ========       ========

    The following tables set forth the maturities of the loan portfolio and its
sensitivity to interest rate changes at December 31, 2002:

<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...............    $ 19,017         $    --        $    --      $ 19,017
Commercial and industrial loans.......... ...      11,146          14,324          4,244        29,714
All other loans..............................      24,145          61,492         25,985       111,622
                                                 --------         -------        -------      --------
 Total loans.................................    $ 54,308         $75,816        $30,229      $160,353
                                                 ========         =======        =======      ========
</TABLE>

                                       8
<PAGE>

     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, 2002 (in thousands):

     Fixed rate...........................................         $27,941
     Floating rate........................................          56,945

     Other loans maturing after one year:

     Fixed rate...........................................          14,811
     Floating rate........................................           6,348
                                                                  --------
              Total loans maturing after one year.........        $106,045
                                                                  ========

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:

                                                             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.

                                       9
<PAGE>
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,  2002,  State of Franklin had  non-accrual  loans  totaling
$1,104,000 and no restructured  loans.  State of Franklin had no loans or leases
90 days or more  past due and still  accruing  at  December  31,  2002.  We have
increased the provision for loan losses during 2002 to cover anticipated  losses
associated with  non-accrual and past due loans.  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
                                       10
<PAGE>

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
$1,563,320  at year end 2002, or 0.99% of loans and leases  outstanding,  net of
unearned  income and  excluding  loans held for sale,  compared to $1,473,855 or
1.06% at year end  2001.  During  2002,  net  charge-offs  and  recoveries  were
$489,514.  Management  does not  foresee  any  events  that  will  significantly
increase loan losses in the coming  months.  The following  table  presents data
related to the Company's  consolidated reserve for loan and lease losses for the
years ended December 31, 2002 and 2001.

                                                        2002           2001
                                                   -------------  -------------
(Dollars In thousands)
Balance at beginning of period..................        $1,474        $1,063
Charge offs:
Commercial .....................................            18            30
Real estate mortgage............................           466           150
Installment loans to individuals................             6             1
                                                        ------        ------
Recoveries:
 Commercial ....................................            --             2
 Real estate mortgage...........................            --            --
 Installment loans to individuals...............            --            --
                                                        ------        ------
Net Charge offs.................................           490           179
Additions to reserve charged to operations......           579           590
                                                        ------        ------
Balance at end of period........................        $1,563        $1,474
                                                        ======        ======

Ratio of net charge offs during the period to average
loans and leases outstanding during the period..          0.32%         0.13%
Average allowance for loan and lease losses to
average total loans and leases..................          0.95%         0.89%


     At December 31, 2002 and 2001,  the allowance for loan and lease losses was
allocated as follows:


<TABLE>
<CAPTION>

                                                           2002                                 2001
                                                           ----                                 ----
(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..................    $469               30%                    $442               30%
     Real estate mortgage........     860               55%                     811               55%
     All other ..................     234               15%                     221               15%
                                   ------              ----                  ------              ----
      Total......................  $1,563              100%                  $1,474              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.

                                       11
<PAGE>

     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.
<TABLE>
<CAPTION>

        Nonperforming assets (Dollars in thousands):                                                December 31,
                                                                                   ----------------------------------------
                                                                                           2002                 2001
                                                                                   ------------------      ----------------
<S>                                                                                        <C>               <C>
     Non-accrual loans..................................................................   $1,104            $2,840
     Restructured loans.................................................................       --                --
     Other loans past due 90 days or more to principal or interest payments.............       --               881
     Nonperforming loans as a percentage of net loans before allowance for loan losses..     0.70%             2.04%
     Allowance for loan losses as a percentage of nonperforming loans...................     1.42%               52%

</TABLE>

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:


                                                          2002           2001
                                                       ----------     ----------
Average loans and leases to average deposits..........    78.3%          80.2%


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.

                                       12

<PAGE>

     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,
                                                        2002               2001
                                                        ----               ----
     (Dollars in thousands)
     Capital:
    Tier I capital:
       Stockholders' common equity....................$ 22,622          $18,786
       Qualifying interest in subordinated debentures.   7,406            6,295
       Less unrealized gain (loss) on AFS securities..     252            ( 336)
       Less unrealized loss on equity securities......     151               --
       Less disallowed intangibles....................     188              236
                                                       -------          -------
            Total Tier I capital......................  29,437           25,181

     Tier II capital:
       Qualifying interest in subordinated debentures.     594            1,705
       Qualifying allowance for loan losses...........   1,563            1,474
                                                       -------          -------
            Total capital.............................  31,594           28,360
     Risk-adjusted assets............................. 191,359          166,708
     Quarterly average assets......................... 265,666          233,494

     Ratios:

     Tier I capital to risk-adjusted assets..........   15.38%            15.10%
     Tier II capital to risk-adjusted assets.........    0.82%             0.88%
     Total capital to risk-adjusted assets...........   16.51%            17.01%
     Leverage-Tier I capital to quarterly average
     assets less  disallowed intangibles.............   11.08%            10.78%

     On December  31, 2002 and 2001,  we exceeded  the  regulatory  minimums and
qualified as a well-capitalized institution under the regulations.

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.

                                       13
<PAGE>

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, 2002,  our deposit base for purposes of FDIC  premiums was
$205 million.  We paid FDIC  insurance  premiums of $27,840 in 2000,  $30,832 in
2001, and $34,474 in 2002.

     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%.

                                       14
<PAGE>

     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.

     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.
                                       15

<PAGE>

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.

     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.
                                       16

<PAGE>

     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.

     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.

                                       17
<PAGE>

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

     During  the  first  three  years of the  Savings  Bank's  operation  it was
precluded   from  declaring  and  paying   dividends  in  accordance   with  the
requirements of the Tennessee Department of Financial Institutions. Except for a
$5,000  dividend  paid by the  Savings  Bank  to  State  of  Franklin  to  cover
organizational  expenses,  which was  approved by the  Department  of  Financial
Institutions,  earnings  generated  from the  operation of the Savings Bank have
been used to finance the growth of the Savings  Bank.  The effect of the special
one-time dividend was eliminated through consolidating entries.

     Following the  mandatory  initial  three-year  moratorium on the payment of
dividends  imposed by  regulatory  authorities,  the Board of Directors  may now
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.  The  Department
generally  prohibits a newly chartered  institution from paying dividends during
its first three years of operation without the Department's prior approval.

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.

     The  Federal  Deposit  Insurance  Corporation's  Improvement  Act  of  1991
("FDICIA"),  permitted the Bank  Insurance  Fund (the "BIF") to borrow up to $30
billion from the U.S. Treasury (to be repaid through deposit insurance  premiums
over 15 years) and permitted the BIF to borrow working  capital from the Federal
Financing Bank in an amount up to 90 percent of the value of the assets the FDIC
has acquired from failed banks, which it is estimated would yield  approximately
$40 billion in working  capital.  The bill followed a year-long effort initiated
by the Bush Administration to enact major banking legislation. Virtually none of
the Administration's  major systemic proposals,  including nationwide interstate
banking and  branching  or ownership of  financial  institutions  by  commercial
entities,  were  included in the final  bill.  However,  a number of  additional
pervasive supervisory measures, some of which are described below, were included
in the FDICIA.  The effect of these measures will be to a great extent dependent
on the manner in which bank regulatory authorities choose to enforce regulations
which have been recently issued pursuant to the FDICIA.

                                       18
<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,  2002,  we had a total of 65  employees  with 53 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, 10,000 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.  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 $40,464  annually.  This
amount includes taxes, insurance and maintenance costs.

     All facilities 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.

                                       19
<PAGE>

                                     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.  To the best of  management's  knowledge  of  transactions  in the
Common Stock of State of Franklin  Bancshares  during 2002,  prices  ranged from
$16.20 to $18.00 per share.

     There were 1,130  holders of record of the Common  Stock as of December 31,
2002.

     On December 18, 2001, we issued  debentures to State of Franklin  Statutory
Trust I (Trust),  a business  trust  subsidiary of State of Franklin.  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 and 4 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/or State of Franklin Savings Bank.


FOR THE YEAR ENDED  DECEMBER  31, 2002  COMPARED TO THE YEAR ENDED  DECEMBER 31,
2001 EARNINGS REVIEW

     Total net income of State of Franklin for the year ended  December 31, 2002
was $3,184,141,  an increase of $1,226,730 over the year ended December 31, 2001
total net  income of  $1,957,411.  Earnings  per  share  was $2.16  compared  to
earnings per share of $1.36 in 2001.  Return on average assets was 1.22% and the
return on average equity was 15.77% for the year ended December 31, 2002.

     Operating  results  in  2002  reflected  higher  net  interest  income  and
noninterest  income.  Net  interest  income of $8.7  million  for the year ended
December 31, 2002 was up 37% over the 2001 period.  During 2002, average earning
assets  grew  19%  while  average  interest  bearing   liabilities  and  capital
securities also grew 19% over the same period a year ago. The 2002 provision for
possible loan losses was $578,979.  Noninterest  income increased  $652,772,  or
84%, with net gains on loans sold, realized gains on securities, and real estate
sales  commission  primarily  responsible  for the increase  over the year ended
December 31, 2001.  Noninterest expense was $5.6 million for the 2002 period, an
increase of 41% over the previous year,  resulting  from increased  salaries and
benefits,  equipment,   occupancy,   advertising,  data  processing,  and  other
operating expenses.

Net Interest Income and Margin

     Net  interest  income  increased  $2.4  million  or 37% for the year  ended
December  31, 2002 to $8.7  million  compared to $6.3 million for the year ended
December 31, 2001.  Growth in average  loans  remained  relatively  low at $13.7
million, or 10%, primarily due to lower interest rates and refinancing  activity
moving loans into the secondary  market.  Average  investments  increased  $20.1
million,  or 33%. Growth in the investment  portfolio came mainly from purchases
of U.S.  government agency  securities.  The taxable equivalent yield on earning
assets declined 90 basis points to 6.78% during 2002.

     Average deposits increased by 12% or $21.7 million to $196.6 million during
2002   compared   to  $174.9   million  in  2001.   The  rate  paid  on  average
interest-bearing  liabilities  decreased  155 basis points during the year ended
December 31, 2002 to 3.29%.  Consequently,  the taxable  equivalent net interest
margin based on average earning assets increased 50 basis points to 3.77% during
2002 compared to 3.27% during the prior year ended December 31, 2001.

                                       20
<PAGE>

Provision for Loan Losses

     During the year ended  December 31, 2002,  the  provision for possible loan
losses was  $578,979.  There were  $489,514 in net  charge-offs  during the year
ended  December 31, 2002 and $178,558 for the year ended  December 31, 2001. The
allowance  for possible  loan losses  represented  0.99% of total loans,  net of
mortgage  loans  held-for-sale,  at  December  31,  2002,  compared  to 1.06% at
December 31, 2001.

Provision for Income Taxes

     For the year ended  December 31, 2002,  the  provision for income taxes was
$760,430,  an increase of $178,715 from 2001.  The increase was primarily due to
an increase in the level of taxable income.

Noninterest Income

     State of Franklin's noninterest income was $1,428,980 during the year ended
December  31,  2002,  an increase of  $652,772 or 84% over the  comparable  2001
period.  The  increase was  attributable  to increases in other fees and service
charges, net gains on loans sold, realized gain on securities, real estate sales
commissions,  insurance  commissions,  and rental  income of $35,106,  $140,820,
$259,772, $175,704, $29,848, and $11,522, respectively.

Noninterest Expense

     Noninterest  expense  totaled  $5,562,341  million  for the  period  ending
December 31, 2002, an increase of  $1,613,166,  or 41%.  Noninterest  expense to
average  assets was 2.14% for the period  ending  December 31, 2002  compared to
1.79% for the same  period a year ago.  Compensation  and  related  benefits  of
$2,479,700  accounted  for 45% of the  total  noninterest  expense  compared  to
$1,831,580 or 46% for the year ended December 31, 2001. Occupancy, furniture and
equipment,  advertising, data processing, and other operating expenses increased
$62,736, $101,530, $54,670, $88,998, and $652,772, 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  $77.8  million at December 31,  2002.  The
investment  portfolio at year end consisted of $11.2 million in debt  securities
issued by the U. S.  Government  or Federal  Agencies,  $6.2  million in Federal
Agency collateralized  mortgage obligations,  $21.9 million in securities issued
by state, county, or municipalities, $5.6 million in corporate securities, $23.1
million in  preferred  stock issued by Federal  Agencies,  and $908,000 in other
equity securities.

     At December 31, 2002, securities categorized as available-for-sale  totaled
$62 million while the held-to-maturity securities totaled $15.7 million compared
to $63.8 million in  available-for-sale  and $9.7 million in held-to-maturity at
December 31, 2001. At December 31, 2002,  the  available-for-sale  portfolio had
net  unrealized  gains of $408,535  while our  held-to-maturity  securities  had
$77,689 in unrealized  losses due to changes in market rates.  Due to the credit
quality of these investments, no realized losses are expected.

Loans

     Loans  outstanding  totaled  $160.4  million at  December  31,  2002.  This
represented an increase of 13% from the December 31, 2001  outstanding  loans of
$141.6  million.  First  mortgage loans were $57.2 million at December 31, 2002,
compared  with $54.6  million at December  31,  2001.  Real estate  construction
lending  totaled  $29.2 million and $20.2 million at December 31, 2002 and 2001,
respectively.  Commercial loans increased to $66.4 million at December 31, 2002,
an  increased  19% from $56  million at December  31,  2001.  Consumer  loans at
December 31,  2002,  increased to $13.7  million,  or 9%, over $12.5  million at
December 31, 2001.

                                       21
<PAGE>

Non-Performing Assets

     Nonaccrual loans totaled  $1,104,000 at December 31, 2002 and $2,840,000 at
December 31, 2001.  There were no loans past due 90 days or more at December 31,
2002 and $881,000 at December  31, 2001.  The  allowance  for possible  loan and
lease  losses was  $1,563,320  and  $1,473,855  at  December  31, 2002 and 2001,
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, 2002 of $198.8 million, reflect a decline of
$1.3 million or a 1% decrease  from $200.1  million at December  31,  2001.  The
decline was due in part to higher than normal  transaction  balances at December
31, 2001,  and less  competitive  rates in local markets.  Non-interest  bearing
demand  deposits  totaled $11.4 million at December 31, 2002, a decrease of $6.9
million or 38% from December 31, 2001.  Interest bearing deposits increased $5.6
million to $187.5 million at December 31, 2002.

Capital

     Equity capital at December 31, 2002 was $22.6 million,  an increase of $3.8
million from $18.8  million at December 31, 2001.  Our Tier 1 capital  increased
$4.2 million to $29.4 million.  At December 31, 2002, all capital ratios were in
excess of the  regulatory  minimums,  with  State of  Franklin's  Tier 1,  total
risk-based and leverage ratio of 15.38%, 16.51% and 11.08%, respectively.

     On December 18, 2001, we issued  debentures to State of Franklin  Statutory
Trust I (Trust),  a business  trust  subsidiary of State of Franklin.  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  and  4  to  the
Consolidated Financial Statements included elsewhere in this report. The capital
levels of State of Franklin as of December 31, 2002 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, 2002,  approximately  $7.4 million of $8 million of
debentures  were  included as Tier 1 capital of the Company  with the  remaining
$600,000 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
Federal Home Loan Bank of Cincinnati totaling $62 million at December 31, 2002.

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.

                                       22
<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, 2002 and 2001

                   Audited Consolidated Financial Statements:

                   Independent Auditor's Report                               24

                   Consolidated Statements of Financial Condition             25

                   Consolidated Statements of Income                          26

                   Consolidated Statements of Changes in Stockholders' Equity 27

                   Consolidated Statements of Cash Flows                   28-29

                   Notes to Consolidated Financial Statements              30-46

                   Statement of Management Responsibility                     47


                                       23

<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, 2002 and 2001,  and the related  consolidated  statements  of
income,  changes in  stockholders'  equity  and cash  flows for the years  ended
December 31, 2002, 2001 and 2000. 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, 2002 and 2001,  and the
results of their  operations  and their cash flows for the years ended  December
31, 2002,  2001 and 2000 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, 2003










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

                                       24
<PAGE>

State of Franklin Bancshares, Inc.
Consolidated Statements of Financial Condition
December 31, 2002 and 2001

<TABLE>
<CAPTION>

                                                                            2002                  2001
                                                                        ------------          ------------
Assets
<S>                                                                     <C>                   <C>

Cash and Due from Banks                                                    5,751,547             5,252,689
Federal Funds Sold                                                        12,705,000            28,590,000
Short-Term Interest-Bearing Deposits                                       1,365,722                57,649
                                                                          ----------            ----------
   Total Cash and Cash Equivalents                                        19,822,269            33,900,338
                                                                          ----------            ----------
Investments - Held-To-Maturity
  (Estimated Market 2002 - $15,736,381 and 2001 - $9,636,374)             15,738,303             9,676,885
Investments - Available-for-Sale                                          62,028,662            63,780,481
Loans Held for Sale                                                        2,447,752             2,548,370

Loans and Leases Receivable                                              157,905,134           139,090,332
  Less: Allowance for Loan and Lease Loss                               (  1,563,320)         (  1,473,855)
                                                                         -----------           -----------
Loans and Leases Receivable, Net                                         156,341,814           137,616,477
                                                                         -----------           -----------

Accrued Interest Receivable, Net                                           1,502,448             1,364,280
Land, Buildings and Equipment at Cost Less
  Accumulated Depreciation of $1,673,027 in 2002
  and $1,260,895 in 2001                                                   5,760,767             5,319,180
Prepaid Expense and Accounts Receivable                                      200,598               119,647
FHLB Stock                                                                 2,263,100             2,161,700
Other Real Estate Owned and Repossessed Property                           1,321,575               452,988
Trust Preferred Placement Fee, Net                                           188,000               236,000
Deferred Tax Assets, Net                                                     416,903               709,103
                                                                         -----------           -----------

         Total Assets                                                    268,032,191           257,885,449
                                                                         ===========           ===========


Liabilities and Stockholders' Equity

Liabilities:

Interest-Free Deposits                                                    11,354,070            18,216,284
Interest-Bearing Deposits                                                187,485,817           181,920,790
Advances by Borrowers for Taxes and Insurance                                115,191                99,414
Accrued Interest on Deposits                                                 184,365               179,897
Accounts Payable and Accrued Expenses                                        838,163               420,784
Repurchase Agreements                                                      1,049,781                    --
FHLB Long-Term Advances                                                   36,238,709            30,240,995
Deferred Credits on REO                                                      144,338                21,448
                                                                         -----------           -----------

Total Liabilities                                                        237,410,434           231,099,612
                                                                         -----------           -----------

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, 2002 and at December 31, 2001                          1,465,512             1,465,512
Paid-In Capital                                                           14,251,461            14,251,461
Accumulated Other Comprehensive Income                                       252,107          (    368,029)
Retained Earnings                                                          7,711,127             4,526,987
Less: Employee Stock Ownership                                          (  1,058,450)         (  1,090,094)
                                                                         -----------           -----------

Total Stockholders' Equity                                                22,621,757            18,785,837
                                                                         -----------           -----------

         Total Liabilities and Stockholders' Equity                      268,032,191           257,885,449
                                                                         ===========           ===========
</TABLE>

The  accompanying  notes  are an  integral  part of the  consolidated  financial
statements.
                                       25

<PAGE>
State of Franklin Bancshares, Inc.
Consolidated Statements of Income
For the Years Ended December 31, 2002, 2001, and 2000

<TABLE>
<CAPTION>


                                                                     2002             2001              2000
                                                               ----------       ----------        ----------
<S>                                                           <C>              <C>               <C>

Interest Income
Interest on Loans                                              11,240,780       11,466,414        10,951,017
Other Interest Income                                           4,973,991        4,184,974         2,869,360
                                                               ----------       ----------        ----------

         Total Interest Income                                 16,214,771       15,651,388        13,820,377
                                                               ----------       ----------        ----------

Interest Expense
Interest on Deposits                                            5,380,118        7,953,344         7,450,364
Other Interest Expense                                          2,177,742        1,396,049         1,160,101
                                                               ----------       ----------        ----------

         Total Interest Expense                                 7,557,860        9,349,393         8,610,465
                                                               ----------       ----------        ----------

Net Interest Income before Provision for Loan Losses            8,656,911        6,301,995         5,209,912
Provision for Loan Losses                                     (   578,979)     (   589,902)       (  302,609)
                                                               ----------       ----------         ---------

         Net Interest Income after Provision for Loan Losses    8,077,932        5,712,093         4,907,303
                                                               ----------       ----------         ---------

Other Income
Other Fees and Service Charges                                    461,736          426,630           380,476
Net Gain on Loans Sold                                            368,418          227,598            62,597
Realized Gain on Securities                                       259,772              --                 --
Real Estate Sales Commission Income                               175,704              --                 --
Insurance Commission Income                                        71,921           42,073            40,336
Rental Income, Net                                                 91,429           79,907            88,169
                                                               ----------       ----------         ---------

         Total Other Income                                     1,428,980          776,208           571,578
                                                               ----------       ----------         ---------

Other Expenses
Compensation and Related Benefits                               2,479,700        1,831,580         1,572,923
Occupancy Expenses                                                401,406          338,670           304,804
Furniture and Equipment Expenses                                  445,524          343,994           271,897
Advertising                                                       137,069           98,385           191,739
Data Processing Expense                                           520,068          431,070           369,392
Other                                                             866,792          823,670         1,523,904
                                                               ----------       ----------       -----------

         Total Other Expenses                                   5,562,341        3,949,175         3,441,071
                                                               ----------       ----------       -----------

Income before Income Taxes                                      3,944,571        2,539,126         2,037,810
Provision for Income Taxes                                    (   760,430)     (   581,715)     (    658,123)
                                                               ----------       ----------       -----------

Net Income                                                      3,184,141        1,957,411         1,379,687
                                                               ==========       ==========       ===========



Basic Earnings per Share                                            2.31             1.42              1.04
                                                                    ====             ====              ====

Diluted Earnings per Share                                          2.16             1.36              1.00
                                                                    ====             ====              ====
</TABLE>

The  accompanying  notes  are an  integral  part of the  consolidated  financial
statements.
                                       26
<PAGE>
State of Franklin Bancshares, Inc.
Consolidated Statements of Changes in Stockholders' Equity
For the Years Ended December 31, 2002, 2001, and 2000
<TABLE>
<CAPTION>

                                                           Accumulated
                                                             Other                Employee
                                     Common     Paid-In  Comprehensive  Retained  Stock-
                                     Stock      Capital      Income     Earnings  Ownership      Total
                                   ----------  --------  -------------  --------- ---------   ----------
<S>                                <C>        <C>          <C>         <C>          <C>      <C>

Balance at December 31, 1999       1,301,519  12,243,730   (610,238)   1,189,889    (626,615) 13,498,285

Net Proceeds
  from Secondary Stock Offering      163,993   2,007,731         --           --          --   2,171,724
                                                                                              ----------
ESOP Shares Allocated                     --          --         --           --      74,986      74,986
                                                                                              ----------
Additional ESOP Shares Issued             --          --         --           --    (599,994)(   599,994)
                                                                                              ----------
Comprehensive Income
   Other Comprehensive Income,
     Net of Tax:
     Unrealized Gains on Securities
       Available-For-Sale:
       Unrealized Holding Gains
         Arising During the Period
           (Net of $360,563 Income Tax)   --          --    699,915           --          --     699,915

Net Income                                --          --         --    1,379,687          --   1,379,687
                                                                                               ---------

         Total Comprehensive Income       --          --         --           --          --   2,079,602
                                   ---------  ----------    -------    ---------   ---------  ----------
Balance at December 31, 2000       1,465,512  14,251,461     89,677    2,569,576  (1,151,623) 17,224,603
                                                                                              ----------
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 $278,776 Income Tax)   --          --   (401,015)          --          -- (   401,015)
       Less: Reclassification Adjustment
           (Net of $34,746 Income Tax)    --          --   ( 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)   4,526,987  (1,090,094) 18,785,837
                                                                                              ----------

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    7,711,128  (1,058,450) 22,621,757
                                   =========  ==========   ========    =========   =========  ==========
</TABLE>
The  accompanying  notes  are an  integral  part of the  consolidated  financial
statements.
                                       27
<PAGE>

State of Franklin Bancshares, Inc.
Consolidated Statements of Cash Flows
For the Years Ended December 31, 2002, 2001, and 2000
<TABLE>
<CAPTION>


                                                                              2002              2001               2000
                                                                   ---------------    --------------     --------------
<S>                                                                   <C>                <C>               <C>
Cash Flows from Operating Activities
  Net Income                                                             3,184,141          1,957,411         1,379,686
  Items Not Affecting Cash and Cash Equivalents:
  Depreciation                                                             520,473            379,945           275,989
  (Increase) Decrease in Accrued Interest                             (    138,168)           178,163      (    271,004)
  Deferred Tax Assets                                                 (    104,430)      (    169,678            74,874)
  Provisions for Loan Losses                                               578,979            589,902           302,609
  (Increase) Decrease in Prepaid Expenses
    and Accounts Receivable                                           (     80,951)      (     42,268)              528
  Increase (Decrease) in Interest Payable                                    4,468       (      8,511)           92,674
  Increase (Decrease) in Accounts Payable
    and Accrued Expenses                                                   417,379            124,396      (    192,242)
  Increase in Deferred Loan Fees, Net                                      105,497             20,323            48,072
  Realized (Gain) on Securities                                       (    259,772)                --                --
  Discount Accretion                                                  (    420,654)      (    487,399)           62,403)
  Earned ESOP Shares                                                        31,644            105,528            74,986
  FHLB Stock Dividends                                                (    101,400)      (    137,200)     (    106,800)
  (Increase) Decrease in Loans Available-For-Sale                          100,618          2,283,448)          188,640
                                                                        ----------          ----------       ----------

       Net Cash Provided  by Operating Activities                        3,837,824            227,164         1,655,861
                                                                        ----------          ----------       ----------


Cash Flows from Investing Activities
  Purchase of Held-to-Maturity Investments                            ( 21,376,120)      (  9,676,728)               --
  Purchase of Available-for-Sale Investments                          ( 13,475,457)      ( 42,792,458)     ( 17,658,492)
  Proceeds from Maturities of Held-to-Maturity Investments               8,835,000         14,000,000                --
  Proceeds from Sale of Available-for-Sale Investments                     655,517                 --           504,171
  Proceeds from Maturities of Available-for-Sale Investments            12,484,105         17,490,740         1,002,305
  Principal Payments on Mortgage-Backed Securities
    Available-for-Sale                                                  10,244,598                 --                --
  (Increase) in Loans Receivable, Net                                 ( 20,107,511)      (  3,582,986)     ( 21,813,918)
  Purchases of Premises and Equipment                                 (    942,110)      (    303,191)     (  1,613,680)
  Purchase of FHLB Stock                                                        --       (    500,000)               --
                                                                       -----------         -----------       ----------

       Net Cash Used by Investing Activities                          ( 23,681,978)      ( 25,364,623)     ( 39,579,614)
                                                                       ------------       -----------        ----------

                                 (continued...)

                                       28
<PAGE>

State of Franklin Bancshares, Inc.
Consolidated Statements of Cash Flows
For the Years Ended December 31, 2002, 2001, and 2000

                                                                         2002               2001               2000
                                                                     -----------          ----------        -----------

Cash Flows from Financing Activities
  Net Increase (Decrease) in Deposits                                 (1,297,187)         38,054,684         29,844,764
  Net Increase (Decrease) in Advances by Borrowers
   for Taxes and Insurance                                                15,777         (     7,821)      (     10,137)
  Net Increase in Repurchase Agreements                                1,049,781                  --                 --
  Issuance of Common Stock, Net                                               --                  --          2,171,724
  ESOP Shares Purchased                                                       --                  --       (    599,994)
  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         10,813,972
  Repayment of FHLB Advances                                          (   15,346)        (15,661,417)                --
  Repayment of Debt                                                           --         (   571,637)      (     54,978)
                                                                     -----------          ----------         ----------

       Net Cash Provided by Financing Activities                       5,766,085          51,569,542         42,165,351
                                                                     -----------          ----------         ----------

       Net Increase (Decrease) in Cash and Cash Equivalents          (14,078,069)         26,432,083          4,241,598

Cash and Cash Equivalents at Beginning of Period                      33,900,338           7,468,255          3,226,657
                                                                     -----------          ----------         ----------

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


Supplemental Schedule of Noncash Investing and Financing Activities:

Increase (Decrease) in Unrealized Gain on Securities
   Available-For-Sale, Net of Deferred Tax Liability                     620,136         (   504,400)      (    699,916)
                                                                     ===========          ==========        ============
Acquisition of Real Estate Property through
   Foreclosure of Related Loans                                        1,321,575             449,988                 --
                                                                     ===========          ==========        ============
Origination of Mortgage Loans to Finance
   the Sale of Foreclosed Real Estate                                  1,191,348                  --                 --
                                                                     ===========          ==========        ============

Supplemental Disclosures of Cash Flow Information:

   Cash Paid During the Period for:

     Taxes                                                             1,369,167             714,077          1,162,389
                                                                     ===========        ============        ===========

     Interest                                                          7,553,392           9,357,904          8,517,791
                                                                     ===========        ============        ===========
</TABLE>


The  accompanying  notes  are an  integral  part of the  consolidated  financial
statements.
                                       29
<PAGE>
State of Franklin Bancshares, Inc.
Notes to Consolidated Financial Statements
For the Years Ended December 31, 2002, 2001, and 2000

Note 1    Summary of Significant Accounting Policies
------
          Incorporation and Operations

          State of Franklin  Bancshares,  Inc.  (Company) was incorporated under
          the laws of the State of  Tennessee  for the purpose of  becoming  the
          holding company of State of Franklin  Savings Bank (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
          (Leasing  Corp.)  was  incorporated  under  the  laws of the  State of
          Tennessee for the purpose of lease financing.  In early 2002, State of
          Franklin Real Estate,  Inc. (Real Estate Company) was incorporated for
          the purpose of selling real estate.  The Real Estate  Company and John
          Sevier  Title  Services,  Inc. are wholly  owned  subsidiaries  of the
          Savings  Bank.  The Leasing Corp is a wholly owned  subsidiary  of the
          Company.

          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 (Savings Bank Act). The Savings Bank's application to the Federal
          Deposit  Insurance   Corporation  (FDIC)  to  obtain  federal  deposit
          insurance  for the  Savings  Bank's  deposit  accounts  under the Bank
          Insurance  Fund (BIF) was approved on February 9, 1996.  The Tennessee
          Department of Financial Institutions (Department) approved the Savings
          Bank's registration on February 15, 1996.

          The  Savings  Bank's  initial  stock  offering  of 610,000  shares was
          completely subscribed. All shares were purchased as of March 31, 1996,
          the end of the initial offering period.

          A private placement offering was conducted in 1997 with 501,280 shares
          of  subscribed  common  stock sold for $11 per share.  The date of the
          offering  was April 7, 1997,  expiring on September  30,  1997.  Total
          proceeds  received  related  to the  offering  were  $5,495,380  and a
          receivable  of  $18,700  was due from  Individual  Retirement  Account
          transfers at December 31, 1997. Expenses relating to the offering were
          $83,079.  the net proceeds of $5,431,001  were used to provide capital
          to support future operations.

          A second  private  placement  offering began on November 17, 1999. The
          Company  offered up to 370,370  shares at an offering  price of $13.50
          per  share.  The Board of  Directors  had the  option  to  extend  the
          offering to a maximum of 555,555 shares. The offering expired June 30,
          2000. 275,085 shares were sold through the expiration date, generating
          gross proceeds of $3,713,648.  Expenses  associated  with the offering
          totaled $124,277.

          On December  18,  2001,  State of  Franklin  Bancshares,  Inc.  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 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.

          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.

          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
                                       30
<PAGE>
State of Franklin Bancshares, Inc.
Notes to Consolidated Financial Statements
For the Years Ended December 31, 2002, 2001, and 2000

Note 1    Continued
------

          Savings  Bank's  allowances  for losses on loans.  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 for the
          purposes of the consolidated  statements of cash flows.  Cash and cash
          equivalents  consist  primarily of cash and due from banks and federal
          funds  sold.   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.

          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.  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.
                                       31
<PAGE>

State of Franklin Bancshares, Inc.
Notes to Consolidated Financial Statements
For the Years Ended December 31, 2002, 2001, and 2000

Note 1   Continued
------

          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 Federal  Home Loan Bank  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,
          2002, the bank owned $2,263,100 in FHLB stock and the minimum required
          investment was $2,024,500.

          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,
          2002 consolidated financial statements.

Note 2    Land, Buildings and Equipment
          -----------------------------

Fixed assets at December 31, 2002, 2001 and 2000 are summarized as follows:

<TABLE>
<CAPTION>

                                                                  2002                 2001                 2000
                                                              ---------            ---------             ---------
<S>                                                           <C>                  <C>                   <C>


         Land                                                 1,580,000            1,450,000             1,450,000
         Buildings and Leasehold Improvements                 3,457,883            3,040,756             2,941,388
         Furniture, Fixtures and Equipment                    2,395,911            2,091,976             1,888,152
                                                              ---------            ---------             ---------
                                                              7,433,794            6,582,732             6,279,540
         Less: Accumulated Depreciation                       1,673,027            1,263,552               883,607
                                                              ---------            ---------            ----------

                                                              5,760,767            5,319,180             5,395,933
                                                              =========            =========             =========
</TABLE>
                                       32
<PAGE>
State of Franklin Bancshares, Inc.
Notes to Consolidated Financial Statements
For the Years Ended December 31, 2002, 2001, and 2000

Note 3    Loans and Leases Receivable
------

Loans and leases  receivable at December 31, 2002,  2001 and 2000 consist of the
following:

<TABLE>
<CAPTION>
                                                                              2002            2001              2000
                                                                         -----------      -----------       -----------
<S>                                                                       <C>              <C>               <C>

              First Mortgage Loans                                        57,183,220       54,554,665        54,716,151
              Construction Loans                                          29,225,436       20,163,050        24,454,126
              Consumer Loans                                              13,679,529       12,536,061        10,204,760
              Participation Loans, Net                                       481,399          503,354           533,676
              Commercial Loans                                            66,392,958       56,028,216        50,931,829
              Credit Line Advances                                           519,020          710,137           392,295
              Direct Finance Leases                                        1,459,185        1,342,242         1,461,095
                                                                         -----------      -----------       -----------
                Gross Loans and Leases Receivable                        168,940,747      145,837,725       142,693,932
                                                                         -----------      -----------       -----------
              Less:
                Undisbursed Portion of Loans in Process               (   10,789,166)  (    6,606,444)   (    6,418,089)
                Net Deferred Loan Origination Fees                    (      246,447)  (      140,949)   (      120,626)
                Accumulated General Loan and Lease Loss Allowance     (    1,563,320)  (    1,473,855)   (    1,062,511)
                                                                       -------------    -------------     -------------
                                                                      (   12,598,933)  (    8,221,248)   (    7,601,226)
                                                                        ------------    -------------     -------------
              Loans and Leases Receivable - Net                          156,341,814      137,616,477       135,092,706
                                                                         ===========      ===========       ===========
</TABLE>
An analysis of the allowance for loan and lease losses is as follows:

<TABLE>
<CAPTION>
                                                                            2002            2001              2000
                                                                      --------------   --------------   --------------
<S>                                                                  <C>              <C>               <C>
                Balance - Beginning of Period                              1,473,855        1,062,511           810,303
                Provision for Losses                                         578,979          589,902           302,609
                Actual Loan and Lease Losses                         (       489,514) (       178,558)  (        50,401)
                                                                      --------------   --------------   ---------------
                Balance - End of Period                                    1,563,320        1,473,855         1,062,511
                                                                       =============    =============     =============
</TABLE>

The gross amount of  participation  loans serviced by State of Franklin  Savings
Bank was  $962,371 at December 31, 2002,  $1,006,596  at December 31, 2001,  and
$1,067,240 for year ending December 31, 2000.

At December 31, 2002 the Company had non-accrual loans totaling $1,104,000 which
included  $112,000 in impaired loans. 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 Company had
no  loans  or  leases  90 days or  more  past  due  and  still  accruing  and no
restructured loans at December 31, 2002.

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 Department 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.

                                       33
<PAGE>

State of Franklin Bancshares, Inc.
Notes to Consolidated Financial Statements
For the Years Ended December 31, 2002, 2001, and 2000

Note 4    Continued
------

          Tennessee  law  permits  the  Savings  Bank to  become a member of the
          Federal  Reserve  System or the  Federal  Home Loan Bank  System.  The
          Savings Bank is a member of the Federal Home Loan Bank 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 (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,  2002,  that the
          Savings Bank meets all capital  adequacy  requirements  to which it is
          subject.

          As of December 31, 2002,  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, 2002  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,
          2002,  approximately  $7,400,000 of the  $8,000,000 of the  debentures
          were  included  as Tier 1 capital of the  Company  with the  remaining
          $600,000  included as Tier 2 capital,  component  of total  risk-based
          capital.
                                       34
<PAGE>

State of Franklin Bancshares, Inc.
Notes to Consolidated Financial Statements
For the Years Ended December 31, 2002, 2001, and 2000

Note 4    Continued
------

The capital ratios for State of Franklin Savings Bank are as follows:
<TABLE>
<CAPTION>

                                                                                           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, 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%
                                                                                        -

         As of December 31, 2001:

            Total Risk-Based Capital (to Risk-Weighted Assets) 18,680       11.25%      >16,602       10.0%
                                                                                        -
            Tier 1 Capital (to Risk-Weighted Assets)           17,244       10.39%      > 9,961        6.0%
                                                                                        -
            Tier 1 Capital (to Adjusted Total Assets)          17,244        7.44%      >11,588        5.0%
                                                                                        -
</TABLE>

The capital ratios for State of Franklin  Bancshares,  Inc. are as follows:
<TABLE>
<CAPTION>

                                                                                         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, 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%
                                                                                        -


          As of December 31, 2001:

             Total Risk-Based Capital (to Risk-Weighted Assets) 28,392       17.03%     >16,671       10.0%
                                                                                        -
             Tier 1 Capital (to Risk-Weighted Assets)           25,224       15.13%     >10,003        6.0%
                                                                                        -
             Tier 1 Capital (to Adjusted Total Assets)          25,224       10.80%     >11,675        5.0%
                                                                                        -
</TABLE>

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

          Employee Stock Ownership Plan

          The  Company  has an employee  stock  ownership  plan (ESOP) for those
          employees who meet the eligibility  requirements of the plan. The ESOP
          was  established  and funded for 1997.  On February  28,  1998,  5,236
          shares of the  Savings  Bank with a fair value of $57,600  were issued
          for the 1997  contribution.  The Savings Bank stock was  exchanged for
          Company stock as discussed in Note 1.

          During the third quarter of 1998, the ESOP borrowed  $700,000 from the
          Company and used the funds to purchase  63,636  shares of common stock
          of the Company at $11 per share.  Note  payments were $8,218 per month
          for ten years with a fixed  interest rate of 7.25%.  The note balances
          outstanding  at December 31, 2000 and 1999 were $571,637 and $626,615,
          respectively. A related loan was granted for the purpose of leveraging
          the ESOP in the amount of $700,000 with similar terms and collaterized
          with stock.  The note  balances  outstanding  at December 31, 2000 and
          1999 were $571,637 and $626,615, respectively.

          On June 30, 2000,  the ESOP borrowed an  additional  $599,994 from the
          Company and used the funds to  purchase  44,444  additional  shares of
          common stock of the Company at $13.50 per share.  Note  payments  were
          $7,280  per month for ten years with a fixed  interest  rate of 8.00%.
          The note balance outstanding at December 31, 2000 was $579,985.

                                       35
<PAGE>

State of Franklin Bancshares, Inc.
Notes to Consolidated Financial Statements
For the Years Ended December 31, 2002, 2001, and 2000

Note 5    Continued
------    ---------

          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, 2002 was $919,450.  In November 2001, the
          Company 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,  2002,  the
          outstanding balance advanced on the line of credit was $139,000.

          Shares owned by the ESOP at December 31, 2002  totaled  167,848.  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 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,
                                                       2002               2001
                                                 ------------        -----------
          Number of Shares
              Released and Allocated                  62,665              43,654
              Suspense                                86,003              88,814
          Fair Value
              Released and Allocated               1,127,970             707,195
              Suspense                             1,548,054           1,438,787

          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
          contribution to the ESOP are as follows:


                                                             December 31,
                                                      2002                2001
                                                   ---------           ---------
          Compensation Expense                       330,000             264,000
          Contributions                              330,000             264,000

          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.  A total of 91,500 shares,
          15% of the original stock offering,  were initially granted under this
          plan. The exercise price of the options was set at $10 per share.  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.

          Additional  stock options for 75,192 shares at an $11 exercise  price,
          60,546 shares at a $13.50 exercise price, and 2,500 shares at a $16.20
          exercise price were granted to directors and management under the plan
          during 1998, 2000, and 2001,  respectively.  During 2002,  options for
          27,982 shares with an exercise  price of $16.20 and 14,237 shares with
          an  exercise  price of  $18.00  were  granted.  7,000 of these  shares
          granted in 2002 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.

          Under  the plan  34,000  additional  stock  options  were  granted  to
          management  and employees on October 15, 1999 at an exercise  price of
          $13.50. These options vest over five years and expire after ten years.
          There  are  significant   restrictions   imposed  based  on  continued
          employment.
                                       36
<PAGE>
State of Franklin Bancshares, Inc.
Notes to Consolidated Financial Statements
For the Years Ended December 31, 2002, 2001, and 2000

Note 5   Continued
------   ---------
<TABLE>
<CAPTION>
                                                          Awarded  And                      Weighted Average
                                                          Unexercised           Vested      Exercise Price
                                                            Options             Options        Per Share
                                                          ------------         --------     ----------------
December 31, 2001
<S>                                                            <C>              <C>               <C>
Options Granted-Outside Directors       January 1, 2001         73,514           49,707           $11.46
                                            During 2001          2,500               --           $16.20
Options Granted-Management/Employees    January 1, 2001        182,166          109,910           $11.64
                                            During 2001             --               --
                                                               -------          -------
    Total Options Outstanding           December 31, 2001      258,180          159,617           $11.63
                                                               =======          =======
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>
     The State of  Franklin  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, 2001
                                                  ------------------------------           ------------------------------
                                                  Average                                   Average
                                                  Rate       Amount      Percent            Rate        Amount    Percent
                                                  ----     ----------   --------            ----    ----------      -----
              <S>                                 <C>      <C>             <C>              <C>    <C>             <C>
              Passbook                            2.04     63,942,676      32.16            2.60    41,603,020      20.79
              Interest-Free Checking               --      11,354,070       5.71             --     18,216,284       9.10
              NOW                                 1.50     13,425,042       6.75            2.00     8,512,548       4.26
              Money Market Deposit                1.71     35,372,704      17.79            2.21    46,020,212      22.99
                                                         ------------    -------                   -----------     ------
                                                          124,094,492      62.41                   114,352,064      57.14
                                                          -----------    -------                   -----------     ------
              Fixed Term Certificate Accounts
                Balances $100,000 or Greater      3.31     19,388,917       9.75            4.45    22,237,766      11.11
                Balances Less than $100,000       3.08     55,356,478      27.84            4.32    63,547,244      31.75
                                                          -----------    -------                   -----------     ------
                                                           74,745,395      37.59                    85,785,010      42.86
                                                          -----------    -------                   -----------     ------
                                                          198,839,887     100.00                   200,137,074     100.00
                                                          ===========     ======                   ===========     ======
</TABLE>

The contractual  maturity of certificate accounts at December 31, 2002 and 2001,
is as follows:

    Year Ending December 31, 2002            Year Ending December 31, 2001
    -----------------------------            -----------------------------
     2003             49,359,359               2002            77,330,432
     2004             11,390,081               2003             5,968,854
     2005             11,253,040               2004             1,323,611
     2006                737,993               2005             1,162,113
     2007 and After    2,004,922               2006 and After          --
                      ----------                                ---------
                      74,745,395                               85,785,010
                      ==========                               ==========
                                       37
<PAGE>
State of Franklin Bancshares, Inc.
Notes to Consolidated Financial Statements
For the Years Ended December 31, 2002, 2001, and 2000

Note 7   Accrued Interest Receivable, Net
------   --------------------------------
<TABLE>
<CAPTION>
                                                                                   2002                 2001
                                                                               ---------             ---------
<S>                                                                              <C>                   <C>
         Loans (net of allowance for uncollected interest)                       747,126               736,968
         Investment Securities                                                   746,774               627,238
         Cash and Due from Banks                                                   8,548                    74
                                                                               ---------             ---------
                                                                               1,502,448             1,364,280
                                                                               =========             =========
Note 8   Federal Home Loan Bank Advances
------   -------------------------------
         Advances  from FHLB are  summarized  as follows for the periods  ended
         December 31, 2002 and 2001:
         Contractual Maturity                                                     2002                  2001
         --------------------                                                  ---------             ---------
         Convertible Fixed Rate (Within 10 Years)                             35,000,000            30,000,000
         Matched-Funding (30-Year Amortizing)                                  1,238,709               240,995
          Weighted Average Rate                                                     4.85%                 4.95%
</TABLE>
          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.

          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, 2002 and 2001 were  approximately
          $54,360,000 and $45,370,000, respectively.

Note  9  Other Noninterest Expense
-------  -------------------------

          Other  noninterest  expense  amounts are summarized as follows for the
          periods ended December 31, 2002, 2001 and 2000:
<TABLE>
<CAPTION>
                                                                                2002            2001            2000
                                                                             ---------        -------         -------
<S>                                                                            <C>            <C>             <C>

          Other Noninterest Expense:
               Insurance Expense                                               104,086         49,342          56,591
                    Professional Expenses and Supervisory Examinations         311,660        134,063         141,214
               Office Supplies and Postage                                     139,011        127,699         136,832
               Telephone                                                       157,747         87,853          89,058
               Director Fees                                                   126,686         86,150          67,200
               Other                                                           684,714        381,685         332,775
                                                                             ---------        -------         -------
                                                                             1,523,904        866,792         823,670
                                                                             =========        =======         =======
</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, 2002, 2001 and 2000 were as follows:
<TABLE>
<CAPTION>
                                                                                2002           2001              2000
                                                                           -----------     ----------       ----------
<S>                                                                        <C>             <C>             <C>
             Loan Balances at the Beginning of the Period                    1,743,756      1,788,928       2,702,537
             New Loans                                                         901,497      1,278,794         898,963
             Repayments                                                    (   263,861)    (1,323,966)     (1,812,572)
                                                                            ----------      ---------       ---------
             Loan Balances at the End of the Period                          2,381,392      1,743,756       1,788,928
                                                                             =========      =========       =========
</TABLE>


          Executive  officers and  directors  have lines of credit that have not
          been  used in the  amount  of  $498,636,  $613,240,  and  $781,127  at
          December 31, 2002, 2001, and 2000, 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  leases the Browns Mill Office in Johnson  City
               from the partnership. The monthly lease payments were $2,932 from
               September 1, 1999 through  February 28, 2003.  Effective March 1,
               2003  the  Bank  entered  into a new  three-year  lease  with the
               partnership.  The monthly  lease  payments will be $3,372 with an
               option to renew for an additional three years at 3,878 per month.

                                       38

<PAGE>
State of Franklin Bancshares, Inc.
Notes to Consolidated Financial Statements
For the Years Ended December 31, 2002, 2001, and 2000

Note 11   Investment Securities
-------   ---------------------

          The   amortized   cost  and  fair  value  of   investment   securities
          held-to-maturity and available-for-sale at December 31, 2002 and 2001,
          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.
<TABLE>
<CAPTION>
          December 31, 2002:                                                        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                               830,084         78,206              --        908,290
                                                                 ----------      ---------         -------     ----------

                          Total Available-for-Sale               61,620,127      1,280,890         872,355     62,028,662
                                                                 ==========      =========         =======     ==========

             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>
                                       39
<PAGE>

State of Franklin Bancshares, Inc.
Notes to Consolidated Financial Statements
For the Years Ended December 31, 2002, 2001, and 2000

Note 11   Continued
-------   ---------

<TABLE>
<CAPTION>


         December 31, 2001:                                                         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 five years but within ten years          6,887,788        182,113              --      7,069,901
                   After ten years but within fifteen years       1,229,796             --          26,021      1,203,775
                   After fifteen years but within twenty years    3,369,059        163,867         104,876      3,428,050
                   After twenty years                             1,083,563             --          51,443      1,032,120

                U S Agency Collateralized Mortgage Obligations:
                   After five years but within ten years            290,460             --              --        290,460

                 Municipal Securities Maturing:
                   Within one year                                  120,000            557              --        120,557
                   After one year but within five years             530,000         15,421              --        545,421
                   After five years but within ten years          2,109,345         21,290          35,783      2,094,852
                   After ten years but within fifteen years      10,888,272         14,161         287,117     10,615,316
                   After fifteen years but within twenty years    5,089,607             --         226,247      4,863,360
                   After twenty years                             1,507,983             --          59,685      1,448,298

                Equity Securities (Preferred Stock in
                   U S Government Agencies):
                   Callable after 1 year but within five years   17,000,000         62,610          77,028     16,985,582
                   Callable after five years but within ten years 5,933,450         28,000          67,201      5,894,249

                Other
                   Within one year                                  673,487             --              --        673,487
                   After five years but within ten years          3,000,000             --          87,733      2,912,267
                   After ten years but within fifteen years       2,100,000             --         110,284      1,989,716
                   After twenty years                             2,558,474         75,311          20,714      2,613,071
                                                                 ----------        -------       ---------     ----------

                          Total Available-for-Sale               64,371,284        563,330       1,154,132     63,780,482
                                                                 ==========        =======       =========     ==========


             Held-to-Maturity:

                United States Government Agency Securities Maturing:
                   After five years but within ten years            834,541             --           1,266        833,275
                   After ten years but within fifteen years       4,490,647             --          39,244      4,451,403

                U S Agency Collateralized Mortgage Obligations:
                   After one year but within five years           1,962,981             --              --      1,962,981
                   After five years but within ten years          2,388,716             --              --      2,388,716
                                                                 ----------        -------       ---------     ----------

                          Total Held-to-Maturity                  9,676,885             --          40,510      9,636,375
                                                                 ==========        =======       =========     ==========
</TABLE>


          Gross   realized   gains   from   calls   on   investment   securities
          available-for-sale  for the periods ended December 31, 2002, 2001, and
          2000 were  $8,923,573,  $0, and $0,  respectively,  resulting in gross
          gains of $259,772, $0, and $0, respectively. Gross realized gains from
          calls on  held-to-maturity  securities  for the periods ended December
          31, 2002,  2001, and 2000 were $2,041,000,  $0, and $0,  respectively,
          resulting in gross gains of $3,465, $0, 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, 2002  totaled  $2,503,325.  No  securities  were held in
          custody accounts for the periods ending December 31, 2001 and 2000.

                                       40
<PAGE>

State of Franklin Bancshares, Inc.
Notes to Consolidated Financial Statements
For the Years Ended December 31, 2002, 2001, and 2000

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

          In the normal course of business,  State of Franklin  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, 2002                            December 31, 2001
                                       --------------------------------------     ----------------------------------------
                                           Fixed        Variable                      Fixed       Variable
                                            Rate          Rate         Total           Rate         Rate           Total
                                       ---------     -----------  -----------     ----------    -----------    -----------
<S>                                     <C>          <C>           <C>               <C>         <C>           <C>

         Mortgage Loans to Originate          --        853,715       853,715             --      4,147,789      4,147,789
         Construction Loans                   --     10,632,480    10,632,480          9,000      6,590,750      6,599,750
         Unsecured Lines of Credit            --        378,544       378,544             --        415,255        415,255
         Overdraft Protection Accounts   454,330             --       454,330        400,928             --        400,928
         Home Equity Lines of Credit          --      4,844,727     4,844,727             --      2,707,566      2,707,566
         Commercial Loans                715,143      4,642,537     5,357,680             --      6,782,053      6,782,053
                                       ---------     ----------    ----------        -------     ----------     ----------

                                       1,169,473     21,352,003    22,521,476        409,928     20,643,413     21,053,341
                                       =========     ==========    ==========        =======     ==========     ==========
</TABLE>


          Commitments  under  standby  letters of credit  totaled  approximately
          $919,182  and $75,000  December 31, 2002 and 2001,  respectively.  The
          amount and type of  collateral  obtained,  if deemed  necessary by the
          Bank upon  extension  of credit,  varies and is based on  management's
          credit evaluation of the counterparty.

          At December  31,  2002,  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  Federal  Home  Loan Bank 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 Bank turns these loans  within a one to two week  period.
          The gain on the sale of these mortgage loans is as follows:
<TABLE>
<CAPTION>

                                                                      2002               2001              2000
                                                                   ----------        ----------        ---------
<S>                                                                <C>               <C>               <C>
               Selling Price                                       27,651,336        18,333,321        7,359,346
               Less: Carrying Value                                27,141,803        17,985,843        7,244,050
                         Loan Cost                                    141,115           119,880           52,699
                                                                   ----------        ----------        ---------

               Net Gain on Loans Sold                                 368,418           227,598           62,597
                                                                   ==========        ==========        =========
</TABLE>
          At December 31, 2002,  2001,  and 2000,  the Savings Bank had mortgage
          loans  committed  to be  sold  totaling  $2,447,752,  $2,548,370,  and
          $264,922,  respectively.  Commitments to originate loans to be sold on
          the  secondary  market were  $8,397,051,  $1,968,281,  and $486,384 at
          December 31, 2002, 2001, and 2000, 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. State of Franklin Real Estate leases office space
          at State  of  Franklin  Road,  Johnson  City,  which  extends  through
          February 28, 2005.  The Savings  Bank has two  automobile  leases that
          expire on April 4, 2003 and July 8, 2003. The Savings Bank also leases
          storage space at the Browns Mill Road,  Johnson City,  branch 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, 2002
          are as follows:

                                             Noncancelable          Cancelable
          Years Ended                           Leases-               Leases-
          December 31,                      Building & Auto         Building
          ------------                      ---------------         ----------
             2003                                88,342               1,680
             2004                                80,080               1,680
             2005                                47,067               1,680
             2006                                 6,744               1,680
             2007                                     0               1,680
                                                -------               -----
   Total Minimum Future Rentals                 222,233               8,400
                                                =======               =====
                                       41
<PAGE>
State of Franklin Bancshares, Inc.
Notes to Consolidated Financial Statements
For the Years Ended December 31, 2002, 2001, and 2000

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

     On December 18, 2001, State of Franklin Bancshares,  Inc. 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, 2002 and 2001:

<TABLE>
<CAPTION>
                                                                                        Carrying            Fair
                                                                                         Amount             Value
     December 31, 2002:                                                               ----------        ------------
     -----------------
<S>                                                                                 <C>                 <C>
         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

      December 31, 2001:
      -----------------

         Financial Assets:
              Cash and Cash Equivalents                                              33,900,338          33,900,338
              Investment Securities                                                  72,567,046          71,860,422
              Loans                                                                 141,638,702         143,527,223
              Accrued Interest Receivable                                             1,364,280           1,364,280

         Financial Liabilities:
              Deposits                                                              200,137,074         200,779,922
              Advance Payments by Borrowers for Taxes and Insurance (Escrows)            99,414              99,414
              Accrued Interest on Deposits                                              179,897             179,897
              FHLB Advances                                                          30,240,995          30,884,560
              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.

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

                                       42
<PAGE>
State of Franklin Bancshares, Inc.
Notes to Consolidated Financial Statements
For the Years Ended December 31, 2002, 2001, and 2000

Note 14   Continued
-------   ---------

          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.

          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.

                                       43
<PAGE>

State of Franklin Bancshares, Inc.
Notes to Consolidated Financial Statements
For the Years Ended December 31, 2002, 2001, and 2000

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, 2002,  2001 and 2000
         is as follows:

<TABLE>
<CAPTION>
                                                                          2002             2001               2000
                                                                     ------------       ---------         ----------
         <S>                                                        <C>                <C>                <C>
         Computed "Expected" Federal Tax                               1,287,474          822,759           663,626
         Effect of State Taxes                                           104,203           78,703            56,740
         Tax Exempt Interest                                        (    290,720)      (  143,941)        (   6,760)
         FHLMC  Dividends                                           (    283,036)      (  275,903)        (  53,322)
         Miscellaneous Other                                        (     57,491)         100,097         (   2,161)
                                                                     -----------        ----------         --------
         Provision for Income Taxes                                      760,430          581,715           658,123
                                                                     ===========        ==========         ========
         Current Income Tax Expense                                      850,535          702,598           721,546
         Deferred Income Tax (Benefit)                              (     90,105)      (  120,883)        (  63,423)
                                                                     -----------        ---------          --------
         Provision for Income Taxes                                      760,430          581,715           658,123
                                                                     ===========        =========          ========

         Deferred Tax Assets and Liabilities:

         Due to Reserve for Loan and Lease Losses                        742,108          586,997           403,754
         Due to Unrealized Losses on Investments                                          251,391
         Miscellaneous Other                                                                                 38,841
            Deferred Tax Assets                                          742,108          838,388           442,595
                                                                       ---------        ---------          --------
         Due to FHLB Dividends                                        (  169,274)      (  128,451)        (  77,147)
         Due to Unrealized Gains on Investments                       (  155,931)                         (  51,633)
                                                                       ---------        ---------          --------
              Deferred Tax Liabilities                                (  325,205)      (  128,451)        ( 128,780)
                                                                       ---------        ---------          --------
         Deferred Tax Assets and Liabilities                             416,903          709,937           313,815
                                                                       =========         ========          ========
</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, 2002, 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.

          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, 2002, there were no legal  proceedings that were expected
          to have a material impact on the Company's financial statements.

                                       44
<PAGE>
State of Franklin Bancshares, Inc.
Notes to Consolidated Financial Statements
For the Years Ended December 31, 2002, 2001, and 2000

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>

                                                                     2002                2001                2000
                                                                  ----------          ----------        ------------
<S>                                                                <C>                  <C>               <C>
         Net Income                                                3,184,141           1,957,411          1,379,687

         Average Basic Shares Outstanding                          1,379,713           1,374,709          1,329,958

         Basic Earnings Per Share                                       2.31                1.42               1.04
                                                                        ====                ====               ====
         Net Income                                                3,184,141           1,957,411          1,379,687

         Average Basic Shares Outstanding                          1,379,713           1,374,709          1,329,958
         Dilutive Effect Due to Stock Options                         93,444              65,572             42,873
                                                                 -----------          ----------        -----------
         Average Shares Outstanding, as Adjusted                   1,473,157           1,440,281          1,372,831

         Diluted Earnings Per Share                                     2.16                1.36               1.00
                                                                        ====                ====               ====
</TABLE>

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

         Statement of Financial Position                                            December 31,           December 31,
                                                                                         2002                 2001
                                                                                   --------------         -------------
<S>                                                                                  <C>                 <C>

         Assets:

         Cash and Cash Equivalents                                                    8,853,128           8,541,730
         Investments - Available-for-Sale                                                17,970             514,297
         Investment in State of Franklin Leasing                                        704,553             623,724
         Investment in State of Franklin Savings Bank                                20,843,815          16,828,873
         Investment in State of Franklin Statutory Trust I                              248,000             248,000
         Interest Receivable                                                             12,823               5,414
         Trust Preferred Placement Cost, net of amortization                            188,000             236,000
         Accrued Tax Benefit                                                             18,165                  --
         Deferred Tax Assets                                                                 --               3,099
                                                                                     ----------          ----------

                Total Assets                                                         30,886,454          27,001,137
                                                                                     ==========          ==========

         Liabilities:

         Accounts Payable and Accrued Expenses                                           15,588              13,993
         Deferred Tax Liability                                                           1,109                  --
                                                                                     ----------          ----------
               Total Liabilities                                                         16,697              13,993
                                                                                     ----------          ----------

         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                                         252,107            (414,722)
         Retained Earnings                                                            7,711,127           4,526,987
         Less: Employee Stock Ownership                                              (1,058,450)         (1,090,094)
                                                                                     ----------          ----------

                Total Stockholders' Equity                                           22,621,757          18,739,144
                                                                                     ----------          ----------

                    Total Liabilities and Stockholders' Equity                       30,886,454          27,001,137
                                                                                     ==========          ==========
</TABLE>
                                       45
<PAGE>


State of Franklin Bancshares, Inc.
Notes to Consolidated Financial Statements
For the Years Ended December 31, 2002, 2001, and 2000

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

         Statement of Income

                                                                                     Period Ended       Period Ended
                                                                                     December 31,        December 31,
                                                                                         2002               2001
                                                                                    ------------       -------------
<S>                                                                                 <C>                <C>
         Interest Income                                                                225,878              69,969
         Interest Expense                                                           (   500,713)       (     17,184)
         Other Operating Expenses                                                   (   119,733)       (     74,144)
                                                                                     ----------         -----------

         Income (Loss) before Income Taxes and Equity
           in Undistributed Earnings of Subsidiaries                                (   394,568)       (     21,359)
         Provision for Income Taxes (Benefit)                                       (   147,981)       (      8,108)
                                                                                     ----------         ------------

         Income (Loss) before Equity in Undistributed Earnings of Subsidiaries      (   246,587)             13,251)

         Equity in undistributed Earnings of Subsidiaries                             3,430,728           1,970,662
                                                                                      ---------           ---------

         Net Income                                                                   3,184,141           1,957,411
                                                                                      =========           =========


         Statement of Cash Flows                                                     Period Ended       Period Ended
                                                                                     December 31,        December 31,
                                                                                         2002                2001
                                                                                     ------------       ------------
         Cash Flows from Operating Activities
                Net Income                                                            3,184,141           1,957,411
                Items Not Affecting Cash and Cash Equivalents:
                      Equity in Undistributed Earnings of Subsidiaries              ( 3,430,728)         (1,970,662)
                      (Increase) in Accrued Tax Benefit                             (    18,165)                 --
                      Decrease in Deferred Tax                                            3,099                  --
                Increase in Accounts Payable                                              1,594              12,274
                Amortization Expense                                                     48,000               4,000
                Earned ESOP Shares                                                       31,644              61,529
                (Increase) in Accounts Receivable                                   (     7,409)         (    5,414)
                                                                                     ----------           ---------

                    Net Cash Provided by Operating Activities                       (   187,824)             59,138
                                                                                     -----------          ---------

         Cash Flows from Investing Activities
                Purchase of Available-for-Sale Investments                          (    15,075)         (   19,835)
                Proceeds from Sale of Available-for-Sale Investments                    514,297                  --
                Investment in Subsidiary                                                     --          (  248,000)
                                                                                     ----------           ---------

                    Net Cash Provided (Used) by Investing Activities                    499,222          (  267,835)
                                                                                     ----------           ---------

         Cash Flows from Financing Activities
                Net proceeds from the issuance of guaranteed preferred
                beneficial interests in subordinated debentures                              --           8,008,000
                Repayments of Debt                                                           --         (   571,637)
                                                                                   ------------           ---------

                    Net Cash Provided by Financing Activities                                --           7,436,363
                                                                                   ------------           ---------

                    Net Increase in Cash and Cash Equivalents                           311,398           7,227,666

         Cash and Cash Equivalents at Beginning of Period                             8,541,730           1,314,064
                                                                                      ---------           ---------

                    Cash and Cash Equivalents at End of Period                        8,853,128           8,541,730
                                                                                      =========           =========

</TABLE>
                                       46

<PAGE>

[GRAPHIC OMITTED]


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

                                       47
<PAGE>

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

          None


                                    PART III

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

     This item is incorporated by reference to the sections entitled  "Incumbent
Directors (Terms Expiring 2004),"  "Incumbent  Directors (Terms Expiring 2003),"
"Information  about  the  Board of  Directors"  and  "Section  16(a)  Beneficial
Ownership  Reporting  Compliance" of State of Franklin's Proxy Statement related
to its 2003 Annual Meeting of Shareholders.

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 2003 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
2003 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 2003 Annual Meeting of Shareholders.

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
         99.1**            Certification  Pursuant  to  18  U.S.C. Section 1350,
                           as  adopted pursuant  to Section 906 of the Sarbanes-
                           Oxley  Act  of  2002, signed by Randal R. Greene, the
                           President of  State  of  Franklin Bancshares, Inc. on
                           March 31, 2003.
         99.2**            Certification  Pursuant  to 18  U.S.C.  Section 1350,
                           as  adopted pursuant to Section 906 of the  Sarbanes-
                           Oxley  Act of 2002, signed  by Charles E. Allen, Jr.,
                           the  Chief  Executive  Officer  of  State of Franklin
                           Bancshares, Inc. on March 31, 2003.

         -------------------
         *        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).
         **       A  signed  original  of  this  written  statement  required by
                  Section 906 has been provided to State of Franklin Bancshares,
                  Inc. and will be retained by State of Franklin Bancshares,Inc.
                  and furnished to the Securities and Exchange Commission or its
                  staff upon request.

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

     No reports on Form 8-K were filed  during the quarter  ended  December  31,
2002.

                                       48
<PAGE>

Item 14.  Controls and Prodecures

     (a) Evaluation of Disclosure  Controls and Procedures.  The Company's Chief
Executive  Officer and its President  have  evaluated the  effectiveness  of the
design and operation of the Company's  disclosure  controls and  procedures  (as
defined  in  Exchange  Act Rule  13a-14(c))  as of a date  within 90 days of the
filing  date of this  quarterly  report.  Based on that  evaluation,  the  Chief
Executive Officer and the President have concluded that the Company's disclosure
controls  and  procedures  are  effective  to ensure that  material  information
relating to the  Company and the  Company'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 the  Company's  internal  controls  or in other  factors  that could
significantly affect these controls subsequent to the date of their evaluation.



                                       49
<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.
                                              ----------------------------------
                                                     Chairman of the Board
                                                     Date: March 31, 2003

     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 31, 2003
    Chares E. Allen, Jr.          (principal executive, financial, and accounting officer)

/s/ Randal R. Greene
----------------------------       President, Director                                       March 31, 2003
    Randal R. Greene

/s/ Steven Gross
----------------------------       Director                                                  March 31, 2003
    Steven Gross

/s/ Donald R. Jeanes
----------------------------       Director                                                  March 31, 2003
    Donald R. Jeanes

/s/ Henry J. Williams, M.D.
----------------------------       Director                                                  March 31, 2003
    Henry J. Williams, M.D.

/s/ Kenneth E. Cutshall, M.D.
----------------------------       Director                                                  March 31, 2003
    Kenneth E. Cutshall, M.D.

/s/ Charles E. Allen, Sr.
----------------------------       Director                                                  March 31, 2003
    Charles E. Allen, Sr.

/s/ Richard S. Venable
----------------------------       Director                                                  March 31, 2003
    Richard S. Venable

/s/ Verrill M. Norwood, Jr.
----------------------------       Director                                                  March 31, 2003
    Verrill M. Norwood, Jr.

/s/ Cameron E. Perry
----------------------------       Director                                                  March 31, 2003
    Cameron E. Perry

/s/ Vance W. Cheek
----------------------------       Director                                                  March 31, 2003
    Vance W. Cheek

/s/ Alan R. Hubbard
----------------------------       Director                                                  March 31, 2003
    Alan R. Hubbard
</TABLE>

                                       50
<PAGE>



                                  Certification
                         Pursuant to Section 302 of the
                           Sarbanes-Oxley Act of 2002

I, Randal R. Greene, certify that:

     1.   I have reviewed this annual report on Form 10-KSB of State of Franklin
          Bancshares, Inc. ("State of Franklin");

     2.   Based on my knowledge,  this annual report does not contain any untrue
          statement  of a  material  fact  or  omit to  state  a  material  fact
          necessary to make the statements  made, in light of the  circumstances
          under which such  statements were made, not misleading with respect to
          the period covered by this annual report; and

     3.   Based on my knowledge,  the financial statements,  and other financial
          information  included in this  annual  report,  fairly  present in all
          material respects the financial  condition,  results of operations and
          cash flows of State of Franklin as of, and for, the periods  presented
          in this annual report.

     4.   The registrant's  other certifying  officers and I are responsible for
          establishing  and maintaining  disclosure  controls and procedures (as
          defined in Exchange  Act Rules  13a-14 and 15d-14) for the  registrant
          and we have:

          a)   designed such  disclosure  controls and procedures to ensure that
               material  information  relating to the registrant,  including its
               consolidated  subsidiaries,  is made known to us by others within
               those  entities,  particularly  during  the  period in which this
               annual report is being prepared;

          b)   evaluated  the  effectiveness  of  the  registrant's   disclosure
               controls and  procedures as of a date within 90 days prior to the
               filing date of this annual report (the "Evaluation Date"); and

          c)   presented  in  this  annual  report  our  conclusions  about  the
               effectiveness of the disclosure  controls and procedures based on
               our evaluation as of the Evaluation Date;

     5.   The registrant's other certifying officers and I have disclosed, based
          on our most recent  evaluation,  to the registrant's  auditors and the
          audit  committee  of  registrant's  board  of  directors  (or  persons
          performing the equivalent function):

          a)   all  significant  deficiencies  in the  design  or  operation  of
               internal  controls which could adversely  affect the registrant's
               ability to record,  process,  summarize and report financial data
               and have  identified for the  registrant's  auditors any material
               weaknesses in internal controls; and

          b)   any fraud,  whether or not material,  that involves management or
               other employees who have a significant  role in the  registrant's
               internal controls; and

     6.   The  registrant's  other  certifying  officers and I have indicated in
          this annual report  whether or not there were  significant  changes in
          internal controls or in other factors that could significantly  affect
          internal   controls   subsequent  to  the  date  of  our  most  recent
          evaluation,   including   any   corrective   actions  with  regard  to
          significant deficiencies and material weaknesses.



Date:  March 31, 2003                        /s/ Randal R. Greene
                                             -----------------------------------
                                             Randal R. Greene
                                             President


<PAGE>


                                  Certification
                         Pursuant to Section 302 of the
                           Sarbanes-Oxley Act of 2002

I, Charles E. Allen, Jr., certify that:

     1.   I have reviewed this annual report on Form 10-KSB of State of Franklin
          Bancshares, Inc. ("State of Franklin");

     2.   Based on my knowledge,  this annual report does not contain any untrue
          statement  of a  material  fact  or  omit to  state  a  material  fact
          necessary to make the statements  made, in light of the  circumstances
          under which such  statements were made, not misleading with respect to
          the period covered by this annual report; and

     3.   Based on my knowledge,  the financial statements,  and other financial
          information  included in this  annual  report,  fairly  present in all
          material respects the financial  condition,  results of operations and
          cash flows of State of Franklin as of, and for, the periods  presented
          in this annual report.

     4.   The registrant's  other certifying  officers and I are responsible for
          establishing  and maintaining  disclosure  controls and procedures (as
          defined in Exchange  Act Rules  13a-14 and 15d-14) for the  registrant
          and we have:

          a)   designed such  disclosure  controls and procedures to ensure that
               material  information  relating to the registrant,  including its
               consolidated  subsidiaries,  is made known to us by others within
               those  entities,  particularly  during  the  period in which this
               annual report is being prepared;

          b)   evaluated  the  effectiveness  of  the  registrant's   disclosure
               controls and  procedures as of a date within 90 days prior to the
               filing date of this annual report (the "Evaluation Date"); and

          c)   presented  in  this  annual  report  our  conclusions  about  the
               effectiveness of the disclosure  controls and procedures based on
               our evaluation as of the Evaluation Date;

     5.   The registrant's other certifying officers and I have disclosed, based
          on our most recent  evaluation,  to the registrant's  auditors and the
          audit  committee  of  registrant's  board  of  directors  (or  persons
          performing the equivalent function):

          a)   all  significant  deficiencies  in the  design  or  operation  of
               internal  controls which could adversely  affect the registrant's
               ability to record,  process,  summarize and report financial data
               and have  identified for the  registrant's  auditors any material
               weaknesses in internal controls; and

          b)   any fraud,  whether or not material,  that involves management or
               other employees who have a significant  role in the  registrant's
               internal controls; and

     6.   The  registrant's  other  certifying  officers and I have indicated in
          this annual report  whether or not there were  significant  changes in
          internal controls or in other factors that could significantly  affect
          internal   controls   subsequent  to  the  date  of  our  most  recent
          evaluation,   including   any   corrective   actions  with  regard  to
          significant deficiencies and material weaknesses.



Date:  March 31, 2003                        /s/ Charles E. Allen, Jr.
                                             -----------------------------------
                                             Charles E. Allen, Jr.
                                             Chief Executive  Officer (principal
                                             executive, accounting and financial
                                             officer)