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, 2004

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

                        Commission file number 000-24675

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



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

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

                    Issuer's telephone number (423) 926-3300


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

     Check  whether  the issuer (1) filed all  reports  required  to be filed by
Section 13 or 15(d) of the  Exchange  Act during the past 12 months (or for such
shorter period that the  registrant was required to file such reports),  and (2)
has been  subject to such  filing  requirements  for the past 90 days.
Yes [X]  No [ ]

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

     The  registrant's  revenues for the twelve  months ended  December 31, 2004
were $16,074,960.

     The  aggregate  market  value  of  the  shares  of  Common  Stock  held  by
nonaffiliates  of the  registrant  as of March 15, 2005 is  approximately  $20.8
million.  (For purposes of this  calculation  only,  all executive  officers and
directors are classified as affiliates.)

Indicate the number of shares outstanding of each of the registrant's classes of
common stock, as of the latest practicable date.  Outstanding at March 15, 2005,
Common Stock, $1.00 par value, 1,465,512 shares.

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



<PAGE>
                                     PART I
Item 1. Description of Business

The Company

     State of Franklin  Bancshares,  Inc.  ("State of Franklin") is a registered
bank holding company  organized under the laws of Tennessee and headquartered in
Johnson City, Tennessee.  State of Franklin Savings Bank (the "Savings Bank") is
a wholly  owned  subsidiary  through  which we conduct our  banking  operations.
References to "State of Franklin" include State of Franklin Bancshares, Inc. and
the Savings  Bank.  On December 31, 2004,  we had  consolidated  total assets of
approximately  $297 million.  State of Franklin Leasing  Corporation is a wholly
owned  subsidiary  of  State  of  Franklin  which  engages  in  equipment  lease
financing.  The Savings  Bank offers  title  services  through its wholly  owned
subsidiary  John Sevier Title  Services,  Inc. (the "Title  Company").  State of
Franklin Real Estate,  Inc. (the "Real Estate  Company") was  incorporated  as a
wholly  owned  subsidiary  of the Savings  Bank for the purpose of selling  real
estate.

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

The Savings Bank

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

Services

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

Markets

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

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

                                       2
<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>
                                                           2004                               2003
--------------------------------------------------------------------------------------------------------------------
(Fully taxable equivalent)                                     Interest    Average               Interest    Average
(Dollars in thousands)                          Average        Income/     Yields/   Average     Income/     Yields/
                                                Balance        Expense      Rate     Balance     Expense      Rate
                                                ---------      -------     ------   --------     -------     -------
Assets:
<S>                                             <C>            <C>         <C>      <C>          <C>    <C>

Interest-earning assets:
Loans net of unearned income................    $156,397       $ 9,797      6.26%   $156,002     $10,431      6.69%
Investment securities.......................     104,776         5,159      4.92%     83,277       4,079      4.90%
Other earning assets .......................       5,382           141      2.62%      5,266         121      2.30%
Federal funds sold..........................      22,400           250      1.12%     25,628         267      1.04%
                                                --------       -------              --------     -------
  Total interest-earning assets/interest         288,955        15,347      5.31%    270,173      14,898      5.51%
         income.............................    --------       -------              --------     -------
Cash and due from banks.....................       3,769                               3,471
Other assets................................      12,119                              10,778
Allowance for loan losses...................      (1,784)                             (1,786)
                                                --------                            --------
    Total...................................    $303,059                            $282,636
                                                ========                            ========
Liabilities and stockholders' equity:
Interest-bearing liabilities:
Interest-bearing checking deposits..........     $19,033       $   135       .71%   $ 16,240     $   213      1.31%
Savings.....................................      87,553         1,358      1.55%     76,608       1,392      1.82%
Money market................................      24,891           297      1.19%     30,365         524      1.73%
Time certificates...........................      78,903         2,078      2.63%     79,076       2,309      2.92%
Borrowed funds..............................      45,226         2,053      4.54%     36,913       1,765      4.78%
Subordinated debentures                            8,000           461      5.76%      8,000         434      5.43%
                                                --------       -------      ----    --------     -------      -----
  Total interest-bearing iabilities/interest
         expense............................     263,606         6,382      2.42%    247,202       6,637      2.68%
                                                --------       -------              --------     -------
Non-interest bearing demand  deposits.......      13,890                              11,119
Other liabilities...........................         686                                 751
Stockholders' equity........................      24,877                              23,564
                                                --------                            --------
    Total...................................    $303,059                            $282,636
                                                 =======                             =======
Net interest earnings.......................                   $ 8,965                           $ 8,261
                                                               =======                           =======
Net interest on interest-earning assets.....                                3.10%                             3.06%
Return on average assets....................                                 .94%                              .94%
Return on average equity....................                               11.45%                            11.23%
Cash dividends declared.....................                                   --                                --
Dividend payout ratio.......................                                   --                                --

</TABLE>

     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, 2004               December 31, 2003
                                                                      Versus                          Versus
                                                               December 31, 2003               December 31, 2002
                                                              Increase (Decrease)             Increase (Decrease)
                                                              Change Due to: (1)              Change Due to: (1)
                                                              ------------------              ------------------
       (Dollars in thousands)                               Volume    Rate      Total        Volume   Rate      Total
                                                           -------   -----      -----        ------   -----    -------
    <S>                                                    <C>       <C>       <C>           <C>     <C>        <C>
        Increase (decrease) in: (2)
    Loans, net of unearned income...................          $ 25   ($659)    ( $634)       $131    ($ 941)    ( $810)
    U.S. Treasury and other U.S. government agency
    securities......................................         1,059      21      1,080          94    (1,495)    (1,401)
    Other earning assets ...........................             3      17         20          56    (   48)         8
    Federal funds sold..............................       (    36)     19     (   17)        128    (   71)        57
                                                           -------   -----      ------       -----    ------    ------
                 Total interest income...................    1,051   ( 602)       449         409    (2,555)   ( 2,146)
                                                           -------   -----      ------       -----   ------     ------
</TABLE>

                                      - 3 -
<PAGE>

<TABLE>
<CAPTION>
    <S>                                                   <C>       <C>       <C>        <C>      <C>          <C>
    Increase (decrease) in: (2)
    Interest-bearing checking deposits...............          20   (  98)    (   78)        73   (    63)         10
    Savings deposits.................................         170   ( 204)    (   34)       376   (   381)     (    5)
    Money Market.....................................     (    65)  ( 162)    (  227)    (  138)  (   159)     (  297)
    Time certificates................................     (     5)  ( 226)    (  231)    (   81)  (   569)     (  650)
    Borrowed funds...................................          377  (  89)       288        104   (    16)         88
    Subordinated Debentures..........................            -     27         27          -   (    67)     (   67)
                                                          --------  - -------  ------    ------   --------    --------
             Total interest expense..................          497  (  752)   (  255)       334   ( 1,255)     (  921)
                                                                               ------                         --------
    Increase (decrease) in net interest income.......                         $  704                          $ 1,225
                                                                               ======                         ========
</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.

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

     The  following  table is an interest  sensitivity  profile for the State of
Franklin as of December 31, 2004 and 2003.  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.

                                      -4-
<PAGE>

<TABLE>
<CAPTION>
                                                                       December 31, 2004
                                                --------------- ------------------------------------------------
                                                             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...........................           $75,274       $ 10,464      $ 45,790     $ 33,305      $164,833
      Investment securities:
         Available for sale...........            11,221          4,747        13,315       24,367        53,650
         Held to maturity.............               101          2,158        19,142       28,302        49,703
      Federal funds sold..............             7,130                                                   7,130
      Interest-bearing deposits.......             2,280                                                   2,280
      Federal Home Loan Bank stock....             2,453                                                   2,453
                                                --------       --------      --------     --------      --------
         Total earning assets.........           $98,459       $ 17,369      $ 78,247     $ 85,974      $280,049
                                                ========       ========      ========      =======      ========

      Interest-bearing liabilities:
      Interest-bearing deposits.......          $129,008       $ 38,640      $ 31,137                   $198,785
      Repurchase Agreements...........             1,024                                                   1,024
      Long-term debt..................                 7             23         3,100       43,051        46,181
      Subordinated debentures.........             8,000                                                   8,000
                                                --------       --------      --------     --------      --------
      Total interest-bearing liabilities        $138,039       $ 38,663      $ 34,237     $ 43,051      $253,990
                                                ========       ========      ========      =======      ========
      Net repricing gap...............          $(39,580)      $(21,294)     $ 44,010     $ 42,923      $ 26,059
      Rate sensitivity gap:
      Net repricing gap as a percentage
       of total earning assets........            (14.21)%        (7.65)%       15.80%       15.41%         9.36%
      Cumulative gap..................          $(39,580)      $(60,874)     $(16,864)    $ 26,059      $ 26,059
      Cumulative gap as a percentage of
       total earning assets                       (14.21)%       (21.86)%      ( 6.06)%       9.36%         9.36%

                                                                       December 31, 2003
                                                ----------------------------------------------------------------
                                                             After 3 months  After 12
                                                 Within          within        months         After
                                                3 months       12 months    within 5 years   5 years       Total
                                                --------       ---------    --------------   -------       -----
       (Dollars in thousands)
       Earning assets:
       Loans..........................          $ 61,947       $ 11,809      $ 32,902     $ 44,402      $151,060
       Investment securities:
           Available for sale.........             3,615         10,181        12,942       36,637        63,375
           Held to maturity...........                                          8,535       25,497        34,032
       Federal funds sold.............            25,040                                                  25,040
       Interest-bearing deposits......             3,336                                                   3,336
       Federal Home Loan Bank stock...             2,355                                                   2,355
                                                --------       --------      --------     --------      --------
                 Total earning assets.           $96,293       $ 21,990      $ 54,379     $106,536      $279,198
                                                ========       ========      ========     ========      ========
       Interest-bearing liabilities:
       Interest-bearing deposits......          $140,467       $ 34,848      $ 34,563                   $209,878
       Repurchase Agreements..........               536                                                     536
       Long-term debt.................                 5             25         3,126       33,054        36,210
       Subordinated debentures.......              8,000                                                   8,000
                                                --------       --------      --------     --------      --------
       Total interest-bearing liabilities       $149,008       $ 34,873      $ 37,689     $ 33,054      $254,624
                                                ========       ========      ========     ========      ========
      Net repricing gap.............            $(52,715)      $(12,883)     $ 16,690     $ 73,482      $ 24,574

      Rate sensitivity gap:
      Net repricing gap as a percentage
       of total earning assets......              (18.98)%        (4.64)%        6.01%       26.46%         8.85%
      Cumulative gap................            $(52,715)      $(65,598)     $(48,908)    $ 24,574       $24,574
      Cumulative gap as a percentage of
       total earning assets.........              (18.98)%       (23.62)%     ( 17.61)%       8.85%         8.85%
</TABLE>
                                      -5-

<PAGE>
Management has made the following assumptions in the above analysis:

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

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

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

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

Deposits

     We offer a full range of depositor  accounts and services to both consumers
and  businesses.  None of these deposits were brokered.  Our primary  sources of
funds are interest-bearing  deposits. The following table sets forth our deposit
structure at December 31, 2004 and 2003 (in thousands).

                                                        2004            2003
                                                        ----            ----
Non interest-bearing deposits:
Individuals, partnerships and corporations......   $ 14,108         $ 10,654
Certified and official checks...................      1,263            1,460
                                                   --------         --------
Total non interest-bearing deposits............      15,371           12,114
Interest-bearing deposits:
Interest-bearing demand accounts...............      42,596           45,062
Savings accounts...............................      72,157           84,622
Certificates of deposit, less than $100,000....      61,287           59,909
Certificates of deposit, greater than $100,000.      22,745           20,285
                                                   --------         --------
 Total interest-bearing deposits..............      198,785          209,878

       Total deposits.........................     $214,156         $221,992
                                                   ========         ========

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

                                                     December 31,
                                       -----------------------------------------
                                             2004                   2003
                                       ------------------    -------------------

(Dollars in thousands)
 Non interest-bearing  deposits......  0.00%    $ 13,890     0.00%      $ 11,119
 Savings deposits....................  1.55%      87,553     1.82%        76,608
 Money market deposits ..............  1.19%      24,891     1.73%        30,365
 Time deposits.......................  2.63%      78,903     2.92%        79,076
 Interest-bearing demand deposits....  0.71%      19,033     1.31%        16,240
                                                --------                --------
            Total deposits...........           $224,270                $213,408
                                                ========                ========

     At  December  31,  2004 and  2003,  time  deposits  greater  than  $100,000
aggregated  approximately  $22.7 million and $20.3  million,  respectively.  The
following table  indicates,  as of December 31, 2004 and 2003, the dollar amount
of  deposits  of  $100,000  or more by the time  remaining  until  maturity  (in
thousands):

<TABLE>
<CAPTION>
                                            2004                                            2003
                                            ----                                            ----
                                                1 year                                           1 year
                       3 Months     3 to 12     through                3 Months     3 to 12      through
                       or less      Months      5 years    Total       or less      Months       5 years    Total
                       -------      ------      -------    -----       -------      ------       -------    -----
<S>                      <C>       <C>         <C>        <C>         <C>          <C>          <C>        <C>
Time certificates        $2,630    $12,074     $8,041     $22,745     $2,511       $8,895       $8,879     $20,285
</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, 2004 and 2003.

            (In Thousands)                                 2004            2003
                                                        ---------       --------
            Investment securities:
             Available for sale....................     $ 53,650      $ 63,375
             Held to maturity......................       49,703        34,032
            Short-term interest-bearing deposits...        2,280         3,336
            Federal funds sold.....................        7,130        25,040
            Federal Home Loan Bank stock ..........        2,453         2,355
            Loans:
             Real estate...........................      130,445       119,617
             Commercial and other..................       34,642        31,687
                                                        --------      --------
              Total loans..........................      165,087       151,304
             Less unearned income..................          254           244
                                                        --------      ---------
            Loans, net of unearned income..........      164,833       151,060
                                                        --------      ---------
             Total earning assets .................     $280,049      $279,198
                                                        ========      ========

Investment Portfolio

     For a  description  of  the  composition  of  the  carrying  value  of  our
investment  portfolio  at  December  31,  2004  and  2003,  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, 2004
and 2003. The weighted  average tax equivalent  yields on these  instruments are
presented based on final maturity.
<TABLE>
<CAPTION>
                                                            2004                                   2003
                                                            ----                                   ----
                                            Amortized    Estimated     Weighted   Amortized    Estimated     Weighted
                                               Cost     Market Value   Average       Cost    Market Value  Average Yield
                                                                        Yield
     (Dollars in thousands)
     Held to maturity:
     ----------------
     <S>                                      <C>          <C>           <C>       <C>           <C>             <C>

     Obligations of U.S. Government
      agencies:
       Due after 1 year but within 5yearts..  $ 7,029      $ 6,887        3.41%    $ 5,068       $ 5,076         3.11%
       Due after 5 years but within 10 years       --           --           --      3,978         3,898         3.87%
       Due after 15 years but within 20 years      --           --           --        257           250         7.02%

     Mortgage backed securities:
       Due after 1 years but within 5 years     5,816        5,792        3.68%         --            --            --
       Due after 5 years but within 10 years   11,811       11,813        4.89%      6,504         6,483         3.44%
       Due after 10 years but within 15 years      --           --           --      3,188         3,194         3.31%
       Due after 15 years but within 20 years     534          540        5.31%        862           868         2.28%
       Due after 20 years................       4,125        4,104        3.16%      4,920         4,888         3.33%

     Municipal securities:
       Due within 1 year.................          --           --           --        406           407         2.12%
       Due after 1 year but within 5 years      1,246        1,255        3.44%      1,304         1,299         3.44%
       Due after 5 years but within 10 years      430          439        5.65%         --            --            --
       Due after 10 years but within 15 years     332          331        7.06%        430           448         5.65%
       Due after 20 years................       2,564        2,586        5.35%         --            --            --

     Corporate securities:
       Due within 1 year.................       2,259        2,274        3.86%         --            --            --
       Due after 1 year but within 5 years      7,310        7,344        3.91%      2,323         2,369         3.84%
       Due after 5 years but within 10 years    1,006        1,034        5.05%      1,087         1,124         4.36%
       Due after 20 years................       5,241        5,464        7.43%      3,705         3,970         8.30%
                                                -----        -----                   -----         -----

         Total held to maturity.........      $49,703      $49,864        4.41%    $34,032      $ 34,274         4.01%
                                              =======      =======                 =======      ========
     Available for sale:
     -------------------

     Obligations of U.S. Government
     agencies:

        Due within 1 year................      $1,003      $ 1,003        3.03%    $ 2,031        $2,037         2.07%
        Due after 1 year but within 5 years        --           --           --      1,022         1,032         3.00%
</TABLE>


                                      -7-
<PAGE>
<TABLE>
<CAPTION>
     Mortgage backed securities:
     <S>                                      <C>          <C>            <C>      <C>           <C>             <C>

      Due after 1 year but within 5 years     $   392      $   399        8.74%    $   364       $   365         3.03%
      Due after 5 years but within 10 years     1,586        1,597        4.50%      1,065         1,094         3.75%
      Due after 10 years but within 15 years       --           --          --       1,320         1,337         4.17%
      Due after 20 years................           --           --          --       1,227         1,236         2.80%

     Municipal securities:
      Due within 1 year ...............           135          136        6.49%        130           131         6.35%
      Due after 1 year but within 5 years       1,424        1,483        5.97%      1,399         1,476         5.93%
      Due after 5 years but within 10 years     8,515        8,967        6.55%      4,823         5,072         6.44%
      Due after 10 years but within 15 years    6,662        7,124        7.08%      9,767        10,324         6.85%
      Due after 15 years but within 20 years    3,089        3,275        7.29%      3,026         3,199         7.46%
      Due after 20 years................        1,238        1,243        6.65%      2,021         2,020         6.78%

     Corporate securities:
      Due within 1 year ................        1,328        1,337        3.70%         --            --            --
      Due after 1 year but within 5 years          --           --           --      1,367         1,400         3.70%
      Due after 5 years but within 10 years     3,000        3,059        7.00%      4,488         4,561         5.82%
      Due after 10 years but within 15 years       --           --           --      2,100         2,112         7.25%
      Due after 20 years................        1,730        1,847        8.30%      1,730         1,878         8.30%

     Equity securities (preferred stock
      in U.S. government agencies):
      Callable within 1 year...........        21,066       16,336        2.83%     21,056        18,156         3.07%
      Callable after 1 year but within 5 years  4,414        4,455        7.83%      4,414         4,572         7.58%
      Callable after 5 years but within
       10 years.........................        1,000        1,018        7.93%      1,000         1,030         7.93%

      Other equity securities:

       Due after 20 years................         318          371        3.87%        318           343         3.14%
                                              -------      -------       -----     -------       -------        ------
          Total available for sale.......     $56,901      $53,650        5.28%    $64,668       $63,375         5.14%
                                              =======      =======                 =======       =======
</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, 2004 and 2003.

                                                       2004              2003
                                                --------------    --------------
(In Thousands)
Real estate loans:
Construction and land development.............          $ 27,476       $ 21,974
Secured by residential properties.............            79,139         82,431
Commercial real estate loans..................            23,201         14,968
Total real estate loans.......................           129,816        119,373
Commercial and industrial loans and leases....            31,189         28,140
Installment loans.............................             3,828          3,547
Other consumer loans..........................                --             --
All other loans...............................                --             --
                                                        --------       ---------
          Total loans.........................          $164,833       $151,060
                                                        ========       =========

                                      -8-

<PAGE>

The following  tables set forth the  maturities of the loan and lease  portfolio
and its sensitivity to interest rate changes at December 31, 2004:

                                One Year    One Through       Over
(In Thousands)                  or Less     Five Years     Five Years     Total
                                -------     ----------     ----------  --------
Real estate construction loans  $ 27,476    $       --     $      --   $ 27,476
Commercial and industrial loans.   2,228        24,680         4,281     31,189
All other loans.................   8,830        51,141        46,197    106,168
                                --------    ----------     ---------   --------
 Total loans................... $ 38,534    $   75,821     $  50,478   $164,833
                                ========    ==========     =========   ========

     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, 2004 (in thousands):

     Fixed rate...........................................         $28,882
     Floating rate........................................          94,888

     Other loans maturing after one year:

     Fixed rate...........................................           2,395
     Floating rate........................................             134
                                                                   -------
              Total loans maturing after one year.........        $126,299
                                                                  ========
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.  The loan committee meets weekly and reviews all new loans.

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

     o    acquisition and development,
     o    construction,
     o    permanent financing, and
     o    home equity.

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

                                      -9-
<PAGE>


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

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

(1)  Multifamily construction includes condominiums and cooperatives.

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

Loan Review and Nonperforming Assets
------------------------------------

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

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

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

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

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

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

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

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

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

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

     At December  31,  2004 State of Franklin  had  non-accrual  loans  totaling
$1,260,563  and no  restructured  loans or leases nor loans or leases 90 days or
more past due and still accruing. We blieve the provision for loan losses during
2004 is adequate. We have increased the provision for loan losses during 2003 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.

                                      -10-
<PAGE>

Credit Risk Management and Reserve for Loan and Lease Losses

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

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

     The reserve for loan and lease losses is increased by provisions charged to
operating  expense.  The reserve is reduced by charging off loans or portions of
loans  at the  time  they are  deemed  by  management  to be  uncollectible  and
increased  when  loans or  leases  previously  charged  off are  recovered.  The
resulting reserve for loan and lease losses is viewed by management as a single,
unallocated  reserve  available  for all loans or  leases.  Rules  and  formulas
relative to the  adequacy  of the  reserve,  although  useful as  guidelines  to
management,  are not rigidly applied.  The reserve for loan and lease losses was
$1,601,332  at year end 2004,  or .97% of loans and leases  outstanding,  net of
unearned  income and  excluding  loans held for sale,  compared to $1,870,279 or
1.24% at year end  2003.  During  2004,  net  charge-offs  and  recoveries  were
$206,947  compared  to $137,589  during  2003.  Management  does not foresee any
events that will  significantly  increase loan losses in the coming months.  The
following  table  presents  data  related  to State of  Franklin's  consolidated
reserve  for loan and lease  losses for the years  ended  December  31, 2004 and
2003.

                                                        2004             2003
                                                  -------------    -------------

(Dollars In thousands)

Balance at beginning of period.................         $1,870        $1,563
Charge offs:
  Commercial ..................................             --            --
  Real estate mortgage.........................            179            --
  Installment loans to individuals.............             18            73
  Lease financing..............................             16            65
                                                       -------       -------
                                                           213           138

Recoveries:
  Commercial ..................................             --            --
  Real estate mortgage.........................             --            --
  Installment loans to individuals.............             --            --
  Lease financing..............................              6            --
                                                       -------       -------
                                                             6            --

Less: Net charge offs..........................            207           138
Additions to reserve charged to operations.....         (  62)           445
                                                       -------       -------
Balance at end of period.......................         $1,601        $1,870
                                                       =======       =======
Ratio of net charge offs during the period to
average loans and leases outstanding during
the period....................................           0.13%         0.09%

Average allowance for loan and lease losses
to average total loans and leases.............           1.14%         1.14%

                                      -11-
<PAGE>
At  December  31, 2004 and 2003,  the  allowance  for loan and lease  losses was
allocated as follows:
<TABLE>
<CAPTION>
                                                           2004                                 2003
                                                           ----                                 ----
            (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..........................        $  480           30%                  $  561          30%
     Real estate mortgage................           801           50%                     935          50%
     All other ..........................           320           20%                     374          20%
                                                 ------          ----                  ------         ----
        Total............................        $1,601          100%                  $1,870         100%
                                                 ======          ====                  ======         ====
</TABLE>
     The  allocation of the allowance is presented  based in part on evaluations
of past history and composition of the loan  portfolio.  Since these factors are
subject to change,  the current  allocation of the allowance is not  necessarily
indicative of the breakdown of future losses.

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

Nonperforming assets (Dollars in thousands):                December 31,
                                                    ----------------------------
                                                         2004              2003
                                                    --------------  ------------
Non-accrual loans............................       $ 1,261            $ 3,213
Restructured loans...........................            --                 --
Other loans past due 90 days or more to
  principal or interest payments.............            --                 --
Nonperforming loans as a percentage of net
  loans before allowance for loan losses.....           .77%              2.13%
Allowance for loan losses as a percentage of
  nonperforming loans........................           127%                68%

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:

                                                       2004           2003
                                                  -------------- -------------
Average loans and leases to average deposits.....     69.7%           73.1%

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,
                                                       2004             2003
                                                       ----             ----
(Dollars in thousands)
   Capital:
   Tier I capital:
      Stockholders' common equity.................    $26,274           $24,491
      Qualifying interest in subordinated
        debentures ...............................      8,000             7,860
      Less unrealized gain (loss) on AFS
        securities ...............................    ( 2,006)           (  798)
      Less unrealized loss on equity securities ..      2,851             1,658
      Less disallowed intangibles.................         92               140
                                                     --------          --------
               Total Tier I capital...............     33,337            31,351
   Tier II capital:
       Qualifying interest in subordinated
         debentures ..............................         --               140
       Qualifying allowance for loan losses.......      1,601             1,870
                                                     --------          --------
               Total capital......................     34,938            33,361
   Risk-adjusted assets...........................    208,127           190,660
   Quarterly average assets.......................    298,797           294,881

   Ratios:
   Tier I capital to risk-adjusted assets.........      16.02%            16.46%
   Tier II capital to risk-adjusted assets........        .77%              .98%
   Total capital to risk-adjusted assets..........      16.79%            17.52%
   Leverage -- Tier I capital to quarterly average
     assets less  disallowed intangibles..........      11.16%            10.63%

     On December  31, 2004 and 2003,  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, 2004,  our deposit base for purposes of FDIC  premiums was
$226 million.  We paid FDIC  insurance  premiums of $34,474 in 2002,  $33,573 in
2003, and $34,571 in 2004.

     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. Allowance for possible loan and lease losses includable
in supplementary capital is limited to a maximum of

                                       -15-
<PAGE>

1.25% of  risk-weighted  assets.  Overall,  the amount of capital counted toward
supplementary capital cannot exceed 100% of Tier 1 capital. The FDIC includes in
its evaluation of a bank's capital adequacy an assessment of risk-based  capital
focusing  principally  on  broad  categories  of  credit  risk.  No  measurement
framework for  assessing  the level of a bank's  interest rate risk exposure has
been codified but, effective board and senior management  oversight of the banks
tolerance for interest rate risk is required.

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

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

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

     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 $23.8 million, our loans-to-one borrower
limit is approximately $5.9 million.

                                      -16-

<PAGE>

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

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

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

     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
---------

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

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

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

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

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

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

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

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

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

     On October  28,  2003,  President  George W. Bush signed into law the Check
Clearing for the 21st Century  Act,  also known as Check 21. The new law,  which
was effective  October 28, 2004,  gives  "substitute  checks," such as a digital
image of a check and copies made from that image, the same legal standing as the
original paper check. Some of the major provisions include:


                                      -18-
<PAGE>
     o    Allows check truncation without making it mandatory;

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

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

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

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

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

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

     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,  2004,  we had a total of 68  employees  with 55 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,  5,500 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 has  purchased  property  and is in the process of
constructing  a sixth branch which is scheduled to open in April 2005 located at
4718 North Roan Street in Johnson  City.  The Savings Bank owns the land and the
buildings in both Kingsport  locations.  The West Walnut branch is also owned by
the Savings Bank. The Savings Bank leases the Browns Mill Road office from Allen
and Allen,  a general  partnership.  Charles E. Allen,  Jr.,  chairman and chief
financial  officer of the  Savings  Bank,  and Charles E. Allen,  Sr.,  M.D.,  a
director of the Savings Bank, are  principals of Allen and Allen.  The lease was
negotiated  at arm's  length and was  approved by the  Tennessee  Department  of
Financial Institutions and the FDIC. Rent for the 2,625 square foot building for
the next three years will be $46,536 annually. Effective April 1, 2004, the Real
Estate Company entered into a three-year  lease with the partnership for a 4,000
square foot office  facility at 3300 Browns Mill Road. The annual lease payments
are $53,964.  Lease payments for the Savings Bank and the Real Estate Company at
the Browns Mill Road locations include taxes, insurance and maintenance costs.

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

                                      -19-

<PAGE>
Item 3.  Legal Proceedings

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

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

         None.


                                     PART II

Item 5.  Market for Common Equity and Related Stockholder Matters

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

                                                          High             Low
         2003:
                  First Quarter.......................  $18.00            $18.00
                  Second Quarter......................   20.00             18.00
                  Third Quarter.......................   20.00             19.50
                  Fourth Quarter......................   22.50             20.00
         2004:
                  First Quarter.......................  $20.00            $20.00
                  Second Quarter......................   22.00             20.00
                  Third Quarter.......................   22.00             22.00
                  Fourth Quarter......................   25.00             22.00

     There were 1,083  holders of record of the common  stock as of December 31,
2004.

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

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

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

General

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

                                      -20-

<PAGE>

FOR THE YEAR ENDED  DECEMBER  31, 2004  COMPARED TO THE YEAR ENDED  DECEMBER 31,
2003

EARNINGS REVIEW

     Total net income of State of Franklin for the year ended  December 31, 2004
was  $2,848,000,  an increase of $203,000 over the year ended  December 31, 2003
total net  income of  $2,645,000.  Earnings  per  share  was $1.86  compared  to
earnings per share of $1.77 in 2003.  Return on average assets was 0.94% and the
return on  average  equity  was 11.45%  for the year  ended  December  31,  2004
compared to .94% and 11.23%, respectively for year ended December 31, 2003.

     Operating  results in 2004 reflected  higher net interest  income and lower
noninterest  income.  Net  interest  income of $8.2  million  for the year ended
December 31, 2004 was 8.6% over the 2003 period.  During 2004,  average  earning
assets grew $19.2 million,  or 7.1%, while average interest bearing  liabilities
and capital securities grew $16.8 million,  or 6.8%, over the same period a year
ago.  During 2004,  $62,000 was reversed out of the  provision for possible loan
and lease losses.  Noninterest  income decreased  $357,000,  or 19.7%,  with net
gains on loans sold  primarily  responsible  for the decline from the year ended
December 31, 2003.  Noninterest expense was $6.3 million for the 2004 period, an
increase of $701,000 over $5.6 million for 2003

Net Interest Income and Margin

     Net interest income increased $652,000 for the year ended December 31, 2004
to $8.2 million  compared to $7.6 million for the year ended  December 31, 2003.
The increase in net interest  income was due to a $397,000  increase in interest
income and a $255,000 decline in interest expense. During 2004, the rate paid on
average  interest-bearing  liabilities  decreased 28 basis points to 2.42% while
the taxable  equivalent  yield on earning  assets  declined  23 basis  points to
5.31%. During 2004, the net interest margin increased 4 basis points to 3.10% in
2004 compared to 3.06% in 2003.

     During 2004, average earning assets increased $19.2 million,  or 7.1%, over
2003 due primarily to the net effect of a $22.9 million  increase in investments
and a $3.8  million  decrease in federal  funds sold.  Growth in average  assets
during  2004 was  funded  mainly  through a $11.2  million  increase  in average
deposits and an $8.3 million increase in average Federal Home Loan Bank ("FHLB")
advances.

Provision for Loan Losses

     During 2004,  $62,000 was reversed from the provision for possible loan and
lease losses compared to $445,000  expensed during 2003.  There were $207,000 in
net  charge-offs  during 2004 and $138,000 in 2003.  The  allowance for possible
loan  losses   represented   0.97%  of  total  loans,   net  of  mortgage  loans
held-for-sale, at December 31, 2004, compared to 1.24% at December 31, 2003.

Provision for Income Taxes

     For the year ended  December 31, 2003,  the  provision for income taxes was
$656,000  compared to $758,000 in 2003,  a decline of  $102,000.  Provision  for
income taxes declined,  even though income before income tax increased $101,000,
due mainly to an increase in tax exempt interest on municipal securities.

Noninterest Income

     State of Franklin's noninterest income was $1,459,000 during the year ended
December  31,  2004,  a decrease of $357,000  or 20% under the  comparable  2003
period.  The decrease was  attributable  to declines in net gains on loans sold,
insurance commission income and rental income of $473,000,  $24,000, and $5,000,
respectively.  Other fees and service charges  increased $20,000 and real estate
sales commission income increased $126,000.

Noninterest Expense

     Noninterest  expense totaled  $6,251,000 for the period ending December 31,
2004, an increase of $701,000 from the same period in 2003.  Noninterest expense
to average assets was 2.06% for the period ending  December 31, 2004 compared to
1.96%  for the same  period  a year  ago.  Compensation  and  related  benefits,
occupancy   expense,   furniture  and  equipment  expense,   advertising,   data
processing, and other noninterest expense increased $249,000,  $40,000, $68,000,
$136,000, $76,000, and $132,000, respectively.

                                      -21-
<PAGE>

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  $103.4  million at December 31, 2004.  The
investment  portfolio at year end  consisted of $8.0 million in debt  securities
issued by the U. S.  Government or Federal  Agencies,  $24.3 million in mortgage
backed  securities,  $26.8 million in  securities  issued by state,  county,  or
municipalities,   $22.1  million  in  corporate  securities,  $21.8  million  in
preferred  stock  issued by  Federal  Agencies,  and  $371,000  in other  equity
securities.

     At December 31, 2004, securities categorized as available-for-sale  totaled
$53.7  million  while the  held-to-maturity  securities  totaled  $49.7  million
compared  to  $63.4   million  in   available-for-sale   and  $34.0  million  in
held-to-maturity   at  December   31,   2003.   At  December   31,   2004,   the
held-to-maturity  portfolio  had  $161,000  in net  unrealized  gains  while our
available-for-sale  securities  had net  unrealized  losses of $3,251,000 due to
changes in market  rates.  Due to the credit  quality of these  investments,  no
realized losses are expected.

Loans

     Loans  outstanding  totaled  $164.8  million at  December  31,  2004.  This
represented  an increase of 9% from the December 31, 2003  outstanding  loans of
$151.1  million.  First  mortgage loans were $52.0 million at December 31, 2004,
compared with $49.7 million at December 31, 2003, an increase of 5%. Real estate
construction lending increased 24% to $27.1 million compared to $21.8 million at
December 31, 2003.  Commercial  loans increased to $69.3 million at December 31,
2004 from $63.2  million at December  31, 2003.  Consumer  loans at December 31,
2004, increased to $14.4 million compared to $13.1 million at December 31, 2003.

Non-Performing Assets

     Nonaccrual  loans and leases  totaled  $1,261,000  at December 31, 2004 and
$3,213,000  at December 31,  2003.  There were no loans past due 90 days or more
and still accruing at December 31, 2004 and December 31, 2003. The allowance for
possible  loan and lease losses was  $1,601,000  and  $1,870,000 at December 31,
2004 and 2003, 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, 2004 of $214.2 million, reflect a decline of
$7.8  million  or a 4%  decline  from  $222.0  million  at  December  31,  2003.
Non-interest bearing demand deposits totaled $15.4 million at December 31, 2004,
an increase of $3.3  million or 27% from  December 31,  2003.  Interest  bearing
deposits decreased $11.1 million to $198.8 million at December 31, 2004.

Capital

     Equity capital at December 31, 2004 was $26.3 million,  an increase of $1.8
million from $24.5  million at December  31,  2003.  Tier 1 capital for State of
Franklin  increased  $2.0 million to $33.3  million.  At December 31, 2004,  all
capital  ratios  were in  excess  of the  regulatory  minimums,  with  State  of
Franklin's  Tier 1, total  risk-based and leverage  ratio of 16.02%,  16.79% and
11.16%, respectively.

     On December 18, 2001, we issued  debentures to State of Franklin  Statutory
Trust I (Trust),  a business trust  subsidiary of ours. The Trust  purchased the
debentures with the proceeds from the sale of trust preferred  securities issued
by the Trust in a private placement. We guaranteed the preferred securities. For
more  information,  see  notes  1,  4,  and  13 to  the  Consolidated  Financial
Statements  included  elsewhere in this report.  The capital  levels of State of
Franklin  as of  December  31,  2004  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,
2004,  the total amount of  $8,000,000  in  debentures  were  included as Tier 1
capital of the Company with no portion included as Tier 2 capital,  component of
total risk-based capital.

                                      -22-

<PAGE>

Liquidity

     The purpose of liquidity  management  is to ensure that there is sufficient
cash  flow to  satisfy  demands  for  credit,  deposit  withdrawals,  and  other
corporate needs.  Traditional  sources of liquidity include asset maturities and
growth in core  deposits.  Other sources of funds such as securities  sold under
agreements  to  repurchase,   negotiable   certificates  of  deposit  and  other
liabilities   are  sources  of  liquidity   which  State  of  Franklin  has  not
significantly  used.  State of Franklin  had unused  sources of liquidity in the
form of unused  federal  funds lines of credit and a line of credit for the FHLB
of Cincinnati up to $60,000,000  depending on the amount of loans and securities
available that can be used as collateral.

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.
















                                      -23-
<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, 2004 and 2003

      Audited Consolidated Financial Statements:

      Independent Auditor's Report                                           25

      Consolidated Statements of Financial Condition                         26

      Consolidated Statements of Income                                      27

      Consolidated Statements of Changes in Stockholders' Equity             28

      Consolidated Statements of Cash Flows                               29-30

      Notes to Consolidated Financial Statements                          31-48

      Statement of Management Responsibility                                 49



                                      -24-
<PAGE>

                             BAYLOR AND BACKUS
 R.F. VANHOY, CPA     CERTIFIED PUBLIC ACCOUNTANTS  E.N. BACKUS, CPA (1907-1971)
                                                     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)
                    JOHNSON CITY, TENNESSEE 37605 W.E. MORELOCK, CPA (1927-1985)
J.M. WOODY, CPA              423) 282-9000       H.L. SIENKNECHT, CPA(1917-1990)
J.F. RODGERS, CPA                                  D.G. LEONARD, CPA (1945-2005)



                          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, 2004 and 2003,  and the related  consolidated  statements  of
income,  changes in  stockholders'  equity  and cash  flows for the years  ended
December 31, 2004, 2003 and 2002. 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, 2004 and 2003,  and the
results of their  operations  and their cash flows for the years ended  December
31, 2004,  2003 and 2002 in  conformity  with  accounting  principles  generally
accepted in the United States.



/s/ Baylor and Backus

BAYLOR AND BACKUS
Certified Public Accountants

Johnson City, Tennessee

February 24, 2005





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


                                      -25-
<PAGE>

State of Franklin Bancshares, Inc.
Consolidated Statements of Financial Condition
December 31, 2004 and 2003
<TABLE>
<CAPTION>
                                                                            2004                  2003
                                                                     ----------------      ----------------
<S>                                                                    <C>                    <C>

Assets
-------

Cash and Due from Banks                                                    5,564,907             3,764,363
Federal Funds Sold                                                         7,130,000            25,040,000
Short-Term Interest-Bearing Deposits                                       2,279,711             3,336,670
                                                                       -------------          ------------
   Total Cash and Cash Equivalents                                        14,974,618            32,141,033
                                                                       -------------          ------------
Investments - Held-To-Maturity
  (Estimated Market 2004 - $49,864,335 and 2003 - $34,274,290)            49,702,867            34,031,676
Investments - Available-for-Sale                                          53,650,416            63,375,496
Loans Held for Sale                                                          374,700               413,179
Loans and Leases Receivable                                              164,458,145           150,646,605
  Less: Allowance for Loan and Lease Loss                              (   1,601,332)         (  1,870,279)
                                                                       -------------          ------------
Loans and Leases Receivable, Net                                         162,856,813           148,776,326
                                                                       -------------          ------------
Accrued Interest Receivable, Net                                           1,490,634             1,366,640
Land, Buildings and Equipment at Cost Less
  Accumulated Depreciation of $2,643,828 in 2004
  and $2,091,874 in 2003                                                   7,468,710             6,218,358
Prepaid Expense and Accounts Receivable                                      175,816               108,260
FHLB Stock                                                                 2,453,300             2,354,800
Stock in Service Bureau at Cost                                              815,009               815,009
Other Real Estate Owned and Repossessed Property                             921,654             1,171,919
Trust Preferred Placement Fee, Net                                            92,000               140,000
Deferred Tax Assets, Net                                                   1,727,642             1,141,342
Other Assets                                                                   2,000                    --
                                                                       -------------          ------------
         Total Assets                                                    296,706,179           292,054,038
                                                                       =============          ============

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

Liabilities:

Interest-Free Deposits                                                    15,371,046            12,114,590
Interest-Bearing Deposits                                                198,784,547           209,877,896
Advances by Borrowers for Taxes and Insurance                                110,328               103,632
Accrued Interest on Deposits                                                 136,476               141,757
Accounts Payable and Accrued Expenses                                        635,586               404,720
Repurchase Agreements                                                      1,024,608               536,419
FHLB Long-Term Advances                                                   46,180,671            36,210,071
Deferred Credits on REO                                                      189,384               173,996
                                                                       -------------          ------------
Total Liabilities                                                        262,432,646           259,563,081
                                                                       -------------          ------------
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, 2004 and at December 31, 2003                          1,465,512             1,465,512
Paid-In Capital                                                           14,251,461            14,251,461
Accumulated Other Comprehensive Income                                 (   2,005,925)         (    797,592)
Retained Earnings                                                         13,204,732            10,356,571
Less: Employee Stock Ownership                                         (     642,247)         (    784,995)
                                                                       -------------          ------------
Total Stockholders' Equity                                                26,273,533            24,490,957
                                                                       -------------          ------------
         Total Liabilities and Stockholders' Equity                      296,706,179           292,054,038
                                                                       =============          ============
</TABLE>
The  accompanying  notes  are an  integral  part of the  consolidated  financial
statements.

                                      -26-
<PAGE>


State of Franklin Bancshares, Inc.
Consolidated Statements of Income
For the Years Ended December 31, 2004, 2003, and 2002

<TABLE>
<CAPTION>
                                                                     2004             2003              2002
                                                           --------------   --------------     -------------
<S>                                                           <C>              <C>               <C>
Interest Income
Interest on Loans                                               9,797,116       10,431,443        11,240,780
Other Interest Income                                           4,818,929        3,787,596         4,973,991
                                                              -----------      -----------       -----------
         Total Interest Income                                 14,616,045       14,219,039        16,214,771
                                                              -----------       ----------       -----------
Interest Expense
Interest on Deposits                                            3,867,267        4,437,705         5,380,118
Other Interest Expense                                          2,514,266        2,199,250         2,177,742
                                                              -----------      -----------       -----------
         Total Interest Expense                                 6,381,533        6,636,955         7,557,860
                                                              -----------      -----------       -----------
Net Interest Income before Provision for Loan Losses            8,234,512        7,582,084         8,656,911
Provision for Loan Losses                                          62,000      (   444,548)      (   578,979)
                                                              -----------      -----------       -----------
         Net Interest Income after Provision for Loan Losses    8,296,512        7,137,536         8,077,932
                                                              -----------      -----------       -----------
Other Income
Other Fees and Service Charges                                    559,804          540,166           461,736
Net Gain on Loans Sold                                            347,017          820,419           368,418
Realized Gain on Securities                                           --               460           259,772
Real Estate Sales Commission Income                               416,077          290,014           175,704
Insurance Commission Income                                        55,916           80,139            71,921
Rental Income, Net                                                 80,101           85,070            91,429
                                                              -----------      -----------       -----------
         Total Other Income                                     1,458,915        1,816,268         1,428,980
                                                              -----------      -----------       -----------
Other Expenses
Compensation and Related Benefits                               2,978,393        2,729,560         2,479,700
Occupancy Expenses                                                502,572          462,727           401,406
Furniture and Equipment Expenses                                  452,015          383,880           445,524
Advertising                                                       330,698          194,490           191,739
Data Processing Expense                                           605,693          529,743           520,068
Other                                                           1,381,576        1,249,529         1,523,904
                                                              -----------      -----------       -----------

         Total Other Expenses                                   6,250,947        5,549,929         5,562,341
                                                              -----------      -----------       -----------
Income before Income Taxes                                      3,504,480        3,403,875         3,944,571
Provision for Income Taxes                                    (   656,321)     (   758,430)      (   760,430)
                                                              -----------      -----------       -----------
Net Income                                                      2,848,159        2,645,445         3,184,141
                                                              ===========      ===========       ===========
Basic Earnings per Share                                            2.04             1.90              2.31
                                                                    ====             ====              ====
Diluted Earnings per Share                                          1.86             1.77              2.16
                                                                    ====             ====              ====
</TABLE>
The  accompanying  notes  are an  integral  part of the  consolidated  financial
statements.

                                      -27-
<PAGE>

State of Franklin Bancshares, Inc.
Consolidated Statements of Changes in Stockholders' Equity
For the Years Ended December 31, 2004, 2003, and 2002
<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, 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
                                                                                                       ----------
ESOP Shares Allocated                             --           --         --           --     273,455     273,455
                                                                                                       ----------
Comprehensive Income
   Other Comprehensive Income,
     Net of Tax:
     Unrealized Gains on Securities
       Available-For-Sale:
       Unrealized Holding Gains
         Arising During the Period
           (Net of $656,269 Income Tax Benefit)   --           -- (1,057,399)          --          --  (1,057,399)
       Less: Reclassification Adjustment
           (Net of $4,780 Income Tax)             --           --      7,701           --          --       7,701
                                                                                                       ----------
                                                                                                       (1,049,698)
Net Income                                        --           --         --    2,645,445          --   2,645,445
                                                                                                       ----------
         Total Comprehensive Income               --           --         --           --          --   1,595,747
                                           ---------   ---------- ----------   ----------  ----------  ----------
Balance at December 31, 2003               1,465,512   14,251,461 (  797,592)  10,356,573   ( 784,995) 24,490,959
                                                                                                       ----------
ESOP Shares Allocated                             --           --         --           --     142,748     142,748
                                                                                                       ----------
Comprehensive Income
   Other Comprehensive Income,
     Net of Tax:
     Unrealized Gains on Securities
       Available-For-Sale:
       Unrealized Holding Losses
         Arising During the Period
           (Net of $764,826 Income Tax Benefit)   --           -- (1,232,308)          --          --  (1,232,308)
       Less: Reclassification Adjustment
           (Net of $14,880 Income Tax)            --           --     23,975           --          --      23,975
                                                                                                       ----------
                                                                                                       (1,208,333)
Net Income                                        --           --         --    2,848,159          --   2,848,159
                                                                                                       ----------
         Total Comprehensive Income               --           --         --           --          --   1,639,826
                                           ---------   ---------- ----------  -----------  ----------  ----------
Balance at December 31, 2004               1,465,512   14,251,461 (2,005,925)  13,204,732  (  642,247) 26,273,533
                                           =========   ========== ==========   ==========  ==========  ==========
</TABLE>
The  accompanying  notes  are an  integral  part of the  consolidated  financial
statements.

                                      -28-
<PAGE>
State of Franklin Bancshares, Inc.
Consolidated Statements of Cash Flows
For the Years Ended December 31, 2004, 2003, and 2002

<TABLE>
<CAPTION>
                                                                            2004              2003               2002
                                                                    --------------        -----------       -----------
<S>                                                                    <C>                <C>               <C>

Cash Flows from Operating Activities
Net Income                                                               2,848,159          2,645,445         3,184,141
Items Not Affecting Cash and Cash Equivalents:
 Depreciation                                                              551,954            421,502           520,473
 (Increase) Decrease in Accrued Interest                               (   123,994)           135,808       (   138,168)
 Deferred Tax Assets                                                       147,553        (    91,645)      (   104,430)
 Provisions for Loan Losses                                            (    62,000)           444,548           578,979
 (Increase) Decrease in Prepaid Expenses
   and Accounts Receivable                                             (    67,556)            92,338       (    80,951)
 Increase (Decrease) in Interest Payable                               (     5,281)       (    42,608)            4,468
 Increase (Decrease) in Accounts Payable
   and Accrued Expenses                                                    230,866        (   433,443)          417,379
 Increase (Decrease) in Deferred Loan Fees, Net                             10,660        (     2,635)          105,497
 Realized (Gain) on Securities                                                  --        (       460)      (   259,772)
 Discount Accretion                                                    (   239,678)       (   165,632)      (   534,407)
 Amortization Expense                                                      623,195            649,620           113,753
 Increase in Deferred Gain on Sale of REO                                   15,388             37,936                --
 Earned ESOP Shares                                                        142,748            273,455            31,644
 FHLB Stock Dividends                                                  (    98,500)       (    91,700)      (   101,400)
 (Increase) Decrease in Loans Available-For-Sale                            38,479          2,034,573           100,618
                                                                    --------------        -----------       -----------
       Net Cash Provided  by Operating Activities                        4,011,993          5,907,102         3,837,824
                                                                    --------------        -----------       -----------
Cash Flows from Investing Activities
Purchase of Held-to-Maturity Investments                               (30,692,594)       (36,457,514)      (21,376,120)
Purchase of Available-for-Sale Investments                                      --        (14,014,267)      (13,475,457)
Proceeds from Maturities of Held-to-Maturity Investments                 8,668,216          8,495,000         8,835,000
Proceeds from Sale of Available-for-Sale Investments                            --                 --           655,517
Proceeds from Maturities of Available-for-Sale Investments               5,781,670          5,932,581        12,484,105
Principal Payments on Mortgage-Backed Securities
  Available-for-Sale                                                     1,972,114          4,017,574        10,244,598
      Held-to-Maturity                                                   6,033,541          9,434,389                --
Proceeds from Sale of Other Real Estate Owned                              232,000            505,000           436,000
(Increase) Decrease in Loans Receivable, Net                           (13,999,641)         6,778,952       (20,543,511)
Purchases of Premises and Equipment                                    ( 1,802,306)       (   879,093)      (   942,110)
                                                                       -----------        -----------      ------------
       Net Cash Used by Investing Activities                           (23,807,000)       (16,187,378)      (23,681,978)
                                                                       -----------        -----------        ----------
</TABLE>

                                 (continued...)


                                      -29-

<PAGE>
State of Franklin Bancshares, Inc.
Consolidated Statements of Cash Flows
For the Years Ended December 31, 2004, 2003, and 2002
<TABLE>
<CAPTION>

                                                                            2004                2003               2002
                                                                     -----------      --------------     --------------
<S>                                                                  <C>                 <C>                <C>
Cash Flows from Financing Activities
Net Increase (Decrease) in Deposits                                  ( 7,836,893)         23,152,599        ( 1,297,187)
Net Increase (Decrease) in Advances by Borrowers
  for Taxes and Insurance                                                  6,696         (    11,559)            15,777
Net Increase (Decrease) in Repurchase Agreements                         488,189         (   513,362)         1,049,781
    Proceeds from FHLB Advances                                       10,000,000                  --          6,013,060
    Repayment of FHLB Advances                                       (    29,400)        (    28,638)       (    15,346)
                                                                     -----------          ----------         ----------
       Net Cash Provided by Financing Activities                       2,628,592          22,599,040          5,766,085
                                                                     -----------          ----------         ----------
       Net Increase (Decrease) in Cash and Cash Equivalents          (17,166,415)         12,318,764        (14,078,069)
Cash and Cash Equivalents at Beginning of Period                      32,141,033          19,822,269         33,900,338
                                                                     -----------          ----------         ----------
       Cash and Cash Equivalents at End of Period                     14,974,618          32,141,033         19,822,269
                                                                     ===========          ==========         ==========

Supplemental Schedule of Noncash Investing and Financing Activities:
Increase (Decrease) in Unrealized Gain on Securities
   Available-For-Sale, Net of Deferred Tax Liability                 ( 1,208,333)        ( 1,049,699)           620,136
                                                                     ===========         ===========         ==========
   Acquisition of Real Estate Property through
   Foreclosure of Related Loans                                          891,413           1,152,919          1,321,575
                                                                     ===========         ===========         ==========
Origination of Mortgage Loans to Finance
   the Sale of Foreclosed Real Estate                                  1,083,010             452,800          1,191,348
                                                                     ===========         ===========         ==========
Supplemental Disclosures of Cash Flow Information:

Cash Paid During the Period for:

     Taxes                                                               597,061           1,381,742          1,369,167
                                                                    ============         ===========        ===========

     Interest                                                          6,386,814           6,679,563          7,553,392
                                                                     ===========         ===========        ===========

</TABLE>

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

                                      -30-
<PAGE>

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

          State of  Franklin  Savings  Bank  (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).  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.  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.  (Title
          Company)  are wholly  owned  subsidiaries  of the  Savings  Bank.  The
          leasing Corp is a wholly owned subsidiary of the Company.

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

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

          A summary of significant accounting policies of the Company follows:

          Basis of Financial Statement Presentation

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

                                      -31-
<PAGE>
          In preparing  the  consolidated  financial  statements,  management is
          required to make  estimates and  assumptions  that affect the reported
          amounts of assets and  liabilities as of the date of the  consolidated
          financial statements and the reported amounts of revenues and expenses
          during the reporting period. Actual results could differ significantly
          from those estimates.

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

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

          Cash and Cash Equivalents

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

          Land, Buildings and Equipment

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

          Loans Receivable

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

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

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

          The  allowance  for loan  losses is  maintained  at a level,  which in
          management's judgment, is adequate to absorb credit losses inherent in
          the loan portfolio.  Management's  periodic evaluation of the adequacy
          of the  allowance  is based  on the  Savings  Bank's  past  loan  loss
          experience,  known  and  inherent  risks  in  the  portfolio,  adverse
          situations that may affect the borrower's ability to repay,  estimated
          value of any underlying  collateral,  and current economic conditions.
          The  allowance  for loan losses is increased  by a provision  for loan
          losses, which is charged to expense, and decreased by charge-offs (net
          of recoveries).
                                      -32-
<PAGE>

Note 1    Continued
------
          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. Premiums paid on
          securities  with call  features  are  amortized to the call date while
          securities  purchased at a discount are accreted to the maturity date.
          Securities with no call features are amortized, or accreted,  straight
          line  to  maturity.  Amortization  expense  and  accretion  income  on
          mortgage-backed  securities are recognized at a level yield to average
          life method with the average  life  determined  based on the  previous
          three-month average CPR speed.

          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,
          2004, the bank owned $2,453,300 in FHLB stock and the minimum required
          investment was $1,812,000.

          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.

                                      -33-
<PAGE>

Note 1    Continued
------
          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.

          Stock Options

          Stock  options are valued by the intrinsic  value method.  All options
          are granted with the exercise  price equal to the fair market value of
          the stock at the time the options are granted.

          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,
          2004 consolidated financial statements.

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

          The cost of fixed  assets  at  December  31,  2004,  2003 and 2002 are
          summarized as follows:

<TABLE>
<CAPTION>
                                                               2004                  2003                   2002
                                                          --------------        -------------          ------------
         <S>                                                 <C>                   <C>                   <C>
         Land                                                 1,580,000            1,580,000             1,580,000
         Buildings and Leasehold Improvements                 5,082,535            4,030,608             3,457,883
         Furniture, Fixtures and Equipment                    3,450,003            2,699,624             2,395,911
                                                            -----------            ---------             ---------
                                                             10,112,538            8,310,232             7,433,794
         Less: Accumulated Depreciation                       2,643,828            2,091,874             1,673,027
                                                            -----------            ---------             ---------
                                                              7,468,710            6,218,358             5,760,767
                                                            ===========            =========             =========
</TABLE>
                                      -34-
<PAGE>
Note 3   Loans and Leases Receivable
------

Loans and leases  receivable at December 31, 2004,  2003 and 2002 consist of the
following:
<TABLE>
<CAPTION>

                                                                           2004             2003              2002
                                                                     -------------     ------------      ------------
              <S>                                                    <C>               <C>               <C>
              First Mortgage Loans                                      51,965,318       49,702,608        57,183,220
              Construction Loans                                        27,146,299       21,817,058        18,579,725
              Consumer Loans                                            14,407,548       13,070,617        13,679,529
              Participation Loans, Net                                         --           458,452           481,399
              Commercial Loans                                          69,267,247       63,208,012        66,392,958
              Credit Line Advances                                         870,529        1,185,167           519,020
              Direct Finance Leases                                      1,381,883        1,550,376         1,459,185
                                                                     -------------     ------------      ------------
                Gross Loans and Leases Receivable                      165,038,824      150,992,290       158,295,036
                                                                     -------------     ------------      ------------
              Less:
                Undisbursed Portion of Loans in Process              (     326,209)    (    101,875)     (    143,455)
                Net Deferred Loan Origination Fees                   (     254,470)    (    243,810)     (    246,447)
                Accumulated General Loan and Lease Loss Allowance    (   1,601,332)    (  1,870,279)     (  1,563,320)
                                                                     -------------     ------------      ------------
                                                                     (   2,182,011)    (  2,215,964)     (  1,953,222)
                                                                     --------------    ------------      ------------
              Loans and Leases Receivable - Net                        162,856,813      148,776,326       156,341,814
                                                                     =============     ============      ============
         An analysis of the allowance for loan and lease losses is as follows:
                                                                           2004            2003              2002
                                                                     -------------      ------------      -------------
                Balance - Beginning of Period                            1,870,279        1,563,320         1,473,855
                Provision for Losses                                 (      62,000)         444,548           578,979
                Actual Loan and Lease Losses                         (     206,947)    (    137,589)     (    489,514)
                                                                     -------------      ------------      ------------
                Balance - End of Period                                  1,601,332        1,870,279         1,563,320
                                                                     =============      ============      ============
</TABLE>
          The gross amount of participation  loans serviced by State of Franklin
          Savings  Bank was $0 at December  31,  2004,  $916,883 at December 31,
          2003, and $962,371 at year ended December 31, 2002.

          The Company had overdraft  demand deposit balances  totaling  $44,425,
          $40,539,  and  $95,676  that were  reclassified  to loan  balances  at
          December 31, 2004, 2003, and 2002, respectively.

          At  December  31,  2004 the Company  had  non-accrual  loans  totaling
          $1,260,563  which  included  $18,000 in impaired  loans  compared with
          $2,765,465 and $121,000, respectively, at December 31, 2003. A loan is
          impaired when, based on current information and events, it is probable
          that the Company  will be unable to collect all amounts due  according
          to the  contractual  agreement.  The total  allowance  for loan losses
          allocated  to  impaired  loans was  $14,000 at  December  31, 2004 and
          $66,000 at December 31, 2003. No interest income on impaired loans was
          recognized  for the periods  ending  December 31, 2004,  and 2003. The
          Company  had no loans or  leases  90 days or more  past due and  still
          accruing and no restructured loans at December 31, 2004.

Note 4   Supervision and Regulation
------
         General

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

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

                                      -35

<PAGE>
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.
                                      -36-
<PAGE>

          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,  2004,  that the
          Savings Bank meets all capital  adequacy  requirements  to which it is
          subject.

          As of December 31, 2004,  the most recent  notification  from the FDIC
          categorized the 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, 2004  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,
          2004,  the total amount of $8,000,000  in debentures  were included as
          Tier 1 capital  of the  Company  with no  portion  included  as Tier 2
          capital, component of total risk-based capital.

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, 2004:
                Total Risk-Based Capital (to Risk-Weighted Assets) 25,178       12.08%      >20,850       10.0%
                                                                                            -
                Tier 1 Capital (to Risk-Weighted Assets)           23,772       11.40%      >12,510        6.0%
                                                                                            -
                Tier 1 Capital (to Adjusted Total Assets)          23,772        7.98%      >14,891        5.0%
                                                                                            -
         As of December 31, 2003:
                Total Risk-Based Capital (to Risk-Weighted Assets) 23,498       12.35%      >19,021       10.0%
                                                                                            -
                Tier 1 Capital (to Risk-Weighted Assets)           21,923       11.53%      >11,413        6.0%
                                                                                            -
                Tier 1 Capital (to Adjusted Total Assets)          21,923        7.48%      >14,649        5.0%
                                                                                            -
</TABLE>
                                      -37-
<PAGE>

The capital ratios for State of Franklin Bancshares, Inc. 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
         -----------------------------                            ---------     ------      -------      -------
         As of December 31, 2004:
                <S>                                                <C>          <C>         <C>           <C>

                Total Risk-Based Capital (to Risk-Weighted Assets) 34,938       16.71%      >20,908       10.0%
                                                                                            -
                Tier 1 Capital (to Risk-Weighted Assets)           33,337       15.94%      >12,545        6.0%
                                                                                            -
                Tier 1 Capital (to Adjusted Total Assets)          33,337       11.16%      >14,935        5.0%
                                                                                            -

         As of December 31, 2003:

                Total Risk-Based Capital (to Risk-Weighted Assets) 33,361       17.52%      >19,066       10.0%
                                                                                            -
                Tier 1 Capital (to Risk-Weighted Assets)           31,351       16.46%      >11,440        6.0%
                                                                                            -
                Tier 1 Capital (to Adjusted Total Assets)          31,351       10.63%      >14,744        5.0%
</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 in 1997. The ESOP currently has two loans  established
          for the purpose of purchasing shares in the Company for the plan.

          In November 2001, the ESOP loans were  consolidated  into a seven year
          term loan from the  Company in the amount of  $1,071,093  with a fixed
          interest  rate of 6.00%.  Note  payments  are $15,218 per month for 83
          months plus a final  principal  payment of $24,092.  The note  balance
          outstanding  at December 31, 2004 was $642,247.  In November 2001, the
          Company  also  granted a  $300,000  line of credit to the ESOP for the
          purchase  of  additional  shares of stock in the Company as it becomes
          available.  The interest rate for balances  outstanding on the line of
          credit is 6% with a five year  term.  Interest  is paid  monthly  with
          principal payments made as funds are available.  At December 31, 2004,
          no balances were outstanding for advances on the line of credit.

          Shares owned by the ESOP at December 31, 2004  totaled  170,779.  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:

                                      -38-

<PAGE>

Note 5   Continued
------
<TABLE>
<CAPTION>
         December 31,
                                                                                           2004                2003
                                                                                   ------------         -----------
         <S>                                                                          <C>                 <C>
         Number of Shares
              Released and Allocated                                                     46,073              34,566
              Suspense                                                                   44,641              56,147

         Fair Value
              Released and Allocated                                                  1,013,606             691,320
              Suspense                                                                  982,102           1,122,940
</TABLE>
          The expense  recorded by the Company is based on cash  contributed  to
          the  ESOP  during  the  year in  amounts  determined  by the  Board of
          Directors,  plus the  excess  of fair  value of  shares  released  and
          allocated  over  the  ESOP's  cost  of  those  shares.  The  Company's
          contributions to the ESOP are as follows:

                                                             December 31,
                                                      2004                2003
                                                   ---------           ---------

         Compensation Expense                        444,000             408,370
         Contributions                               444,000             408,370

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

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

          Stock Option Plans

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

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

          Additional  stock options were granted to directors and  management at
          fair market value during the years 2000,  and 2001 with terms the same
          as the original options.  During 2002, 3003, and 2004, options granted
          were 42,219,  27,826,  and 15,212  shares,  respectively.  All options
          granted in 2002, 2003, and 2004 expire at the end of ten years.  7,000
          shares  granted in 2002,  7,000 in 2003,  and 4,000 in 2004 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.

          At December 31, 2004,  there were 224,180  options with no termination
          date and a weighted  average  exercise  price of $11.35 with  exercise
          prices ranging from $10.00 to $16.20.  The remaining  119,257  options
          were issued with a 10-year  termination date and have a weight average
          remaining life of 7 years and 2 months and a weighted average exercise
          price of $16.73 with exercise prices ranging from $13.50 to $22.00.

                                      -39-

<PAGE>

          Options granted during 2003 and 2004 are summarized as follows:

<TABLE>
<CAPTION>
                                                                    Awarded And                 Weighted Average
                                                                     Unexercised    Vested       Exercise Price
                                                                       Options      Options         Per Share
<S>                                     <C>                            <C>         <C>           <C>
December 31, 2003
Options Granted - Outside Directors     January 1, 2003                83,014       75,833           $12.00
                                        During 2003                     7,000        7,000           $18.00
Options Granted - Management/Employees  January 1, 2003               217,385      167,594           $12.50
                                        During 2003                    20,826           --           $18.88
                                                                     --------      -------
Total Options Outstanding               December 31, 2003             328,225      250,427           $12.89
                                                                     ========      =======
</TABLE>

<TABLE>
<CAPTION>

         Options granted during 2004 are summarized as follows:
                                                                                Awarded And               Weighted Average
                                                                                 Unexercised    Vested    Exercise Price
                                                                                  Options       Options     Per Share
                                                                                ------------    -------   ---------------
         <S>                                     <C>                              <C>           <C>            <C>
         December 31, 2004
         Options Granted - Outside Directors     January 1, 2004                   90,014        84,323        $12.47
                                                 During 2004                        4,000         4,000        $20.00
         Options Granted - Management/Employees  January 1, 2004                  238,211       193,011        $13.05
                                                 During 2004                       11,212            --        $21.37
                                                                                 --------       -------
         Total Options Outstanding December 31, 2004                              343,437       281,334        $13.25
                                                                                 ========       =======
</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, 2004                 December 31, 2003
                                               ---------------------------------   ---------------------------------
                                              Average                             Average
                                               Rate     Amount        Percent        Rate       Amount       Percent
                                              ------  ----------     --------     -------     ----------     -------
              <S>                              <C>   <C>              <C>           <C>      <C>             <C>
              Passbook                         1.13   72,157,046       33.69        1.75      84,622,380      38.12
              Interest-Free Checking             --   15,371,046        7.18          --      12,114,590       5.46
              NOW                              0.25   20,439,053        9.54        1.17      18,753,775       8.45
              Money Market Deposit             1.07   22,156,509       10.35        1.47      26,308,635      11.85
                                                     -----------     -------                ------------    -------
                                                     130,123,654       60.76                 141,799,380      63.88
                                                     -----------     -------                 -----------    -------
              Fixed Term Certificate Accounts
                Balances $100,000 or Greater   2.84   22,745,289       10.62        2.84      20,284,510       9.14
                Balances Less than $100,000    2.66   61,286,650       28.62        2.66      59,908,596      26.98
                                                     -----------     -------                ------------      -----
                                                      84,031,939       39.24                  80,193,106      36.12
                                                     -----------     -------                ------------    -------
                                                     214,155,593      100.00                 221,992,486     100.00
                                                     ===========      ======                 ===========     ======
</TABLE>


                                      -40-
<PAGE>
The contractual  maturity of certificate accounts at December 31, 2004 and 2003,
is as follows:

           Year Ending December 31, 2004           Year Ending December 31, 2003
           -----------------------------           -----------------------------
              2005            52,996,714             2004             45,642,644
              2006            20,586,376             2005             21,464,822
              2007             4,800,025             2006              6,379,826
              2008             4,138,797             2007              2,937,998
              2009 and After   1,510,027             2008 and After    3,767,816
                             -----------                             -----------
                              84,031,939                              80,193,106
                             ===========                             ===========

Note 7  Accrued Interest Receivable, Net
------
                                                       2004               2003
                                                   ---------          ---------

Loans (net of allowance for uncollected interest)    611,339            590,148
         Investment Securities                       796,095            768,113
         Cash and Due from Banks                       7,040              8,379
                                                   ---------          ---------
                                                   1,414,474          1,366,640
                                                   =========          =========

Note 8   Federal Home Loan Bank Advances
------   -------------------------------
     The  contractual  maturity  of FHLB  advances  at  December  31, 2004 is as
     follows:

              2005            30,475                    2010           8,034,766
              2006            31,279                    2011          19,035,696
              2007            32,116                    2012           5,036,652
              2008         3,032,976                    2013          10,037,634
              2009            33,859                    2014 and after   875,217

     Convertible  fixed rate  advances  were  $45,000,000  for the period ending
     December 31, 2004 and  $35,000,000  at December 31, 2003.  The  convertible
     fixed rate  advances  have an original  maturity of 10 years with an option
     held by FHLB to convert to a variable rate tied to 3-month LIBOR  beginning
     1 to 3 years from the original  issue date. If converted to a variable rate
     the bank  maintains  the option to pay off the  advance or  continue at the
     variable rate over the original  contractual  maturity of the advance.  CRA
     mortgage  match  advances are amortized  over a 30-year  period and totaled
     $1,210,071 at December 31, 2004 and  $1,180,671  at December 31, 2003.  The
     average rate on FHLB advances was 4.56% at both December 31, 2004 and 4.85%
     at December 31, 2003.

     The  Savings  Bank  pledges as  collateral  for these  borrowings  selected
     qualifying  mortgage  loans and  securities (as defined) under an agreement
     with the FHLB.  Loans and  securities  pledged at December 31, 2004 totaled
     $66.9 million in residential mortgage loans and $9.4 million in securities.
     At December  31, 2003 there were  approximately  $54.3  million in mortgage
     loans and no securities pledged for FHLB borrowings.

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

     For periods  ended  December 31, 2004,  2003,  and 2002,  occupancy  rental
     expense  was  $107,607,  $85,142,  and  $75,498;  auto  rental  expense was
     $11,375,  $16,724,  and $19,909;  and  furniture,  fixtures,  and equipment
     rental expense was $16,286, $3,755, and $1,678, respectively.

     No advertising was capitalized for the periods end December 31, 2004, 2003,
     or 2002. All  advertising was expensed as services were performed and costs
     were incurred.

     Other noninterest expense amounts are summarized as follows for the periods
     ended December 31, 2004, 2003 and 2002:
<TABLE>
<CAPTION>
                                                                              2004           2003            2002
                                                                        ----------     ----------       ---------
<S>                                                                      <C>            <C>             <C>
Other Noninterest Expense:
           Insurance Expense                                                92,589         49,614         104,086
           Professional Expenses and Supervisory Examinations              270,634        299,077         311,660
           Office Supplies and Postage                                     224,611        156,128         139,011
           Telephone                                                       148,167        130,814         157,747
           Director Fees                                                   161,314        159,252         126,686
           Other Operating Expenses                                        484,261        454,644         684,714
                                                                        ----------     ----------      ----------
                                                                         1,381,576      1,249,529       1,523,904
                                                                        ==========     ==========      ==========
</TABLE>

                                      -41-

<PAGE>

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, 2004,  2003 and 2002
     were as follows:

<TABLE>
<CAPTION>
                                                                                 2004         2003              2002
                                                                            ----------     ----------     -----------
<S>                                                                          <C>           <C>            <C>
Loan Balances at the Beginning of the Period                                 3,835,244      2,381,392       1,743,756
    New Loans                                                                1,087,831      2,610,748         901,497
             Repayments                                                     (1,927,832)    (1,156,896)    (   263,861)
                                                                             ---------      ---------      ----------
             Loan Balances at the End of the Period                          2,995,243      3,835,244       2,381,392
                                                                             =========      =========       =========
</TABLE>

     Executive  officers and  directors  have lines of credit that have not been
     used in the amount of  $893,159,  $858,923,  and  $498,636 at December  31,
     2004, 2003, and 2002, respectively.

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

          The Savings  Bank and the Real Estate  Company  lease  office space at
          Browns  Mill Road in Johnson  City from the  partnership.  The monthly
          lease  payments for the Savings Bank branch  location were $3,372 from
          March 1, 2003 through February 28, 2006 with an option to renew for an
          additional  three years at $3,878 per month.  Effective April 1, 2004,
          the Real  Estate  Company  entered  into a  three-year  lease with the
          partnership.  The monthly lease  payments are $4,497 through March 31,
          2007 with an option to renew for an  additional  three years at $5,170
          per month.  In addition,  the Savings Bank and the Real Estate Company
          lease   storage   and  office   space  from  the   partnership   on  a
          month-to-month  basis. The monthly payments for the additional storage
          and office space total $1,742 per month.

                                       -42-
<PAGE>

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

          The   amortized   cost  and  fair  value  of   investment   securities
          held-to-maturity and available-for-sale at December 31, 2004 and 2003,
          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. Maturities
          for mortgage backed securities with scheduled contractual payments are
          based on the weighted average life of the remaining payments.

         December 31, 2004:
<TABLE>
<CAPTION>
                                                                               Gross           Gross       Estimated
                                                                Amortized     Unrealized     Unrealized      Market
                                                                 Cost          Gains           Losses         Value
                                                             -----------    ---------       ----------     -----------
         <S>                                                  <C>           <C>              <C>            <C>
         Available-for-Sale:

           United States Government Agency Securities Maturing:
              Within one year                                  1,003,030           --              327       1,002,703

           Mortgage Backed Securities Maturing:
              After one year but within five years               392,232        7,091               --         399,323
              After five years but within ten years            1,585,630       11,487               --       1,597,117

            Municipal Securities Maturing:
              Within one year                                    135,000          707               --         135,707
              After one year but within five years             1,424,064       58,996               --       1,483,060
              After five years but within ten years            8,515,314      451,476               --       8,966,790
              After ten years but within fifteen years         6,661,515      463,180               --       7,124,695
              After fifteen years but within twenty years      3,088,701      186,367               --       3,275,068
              After twenty years                               1,237,890       33,545           28,590       1,242,845

           Corporate Securities Maturing:
              Within one year                                  1,328,412        8,496               --       1,336,908
              After five years but within ten years            3,000,000       59,181               --       3,059,181
              After twenty years                               1,730,269      116,614               --       1,846,883

           Equity Securities (Preferred Stock in
              U S Government Agencies):
              Callable within one year                        21,066,634           --        4,730,734      16,335,900
              Callable after one year but within five years    4,414,150      140,000           98,688       4,455,462
              Callable after five years but within ten years   1,000,000       18,000               --       1,018,000
                Other Equity Stock:
                   After twenty years                            318,155       52,619               --         370,774
                                                             -----------    ---------        ---------      ----------
                          Total Available-for-Sale            56,900,996    1,607,759        4,858,339      53,650,416
                                                             ===========    =========        =========      ==========
         Held-to-Maturity:
           United States Government Agency Securities Maturing:
              After one year but within five years             7,029,168        1,765          143,803       6,887,130

           Mortgage Backed Securities Maturing:
              After one year but within five years             5,816,479        2,598           26,622       5,792,455
              After five years but within ten years           11,811,351        8,788            6,992      11,813,147
              After fifteen years but within twenty years        534,369        5,460               --         539,829
              After twenty years                               4,125,044       11,848           33,091       4,103,801

           Municipal Securities Maturing:
              After one year but within five years             1,245,566       10,202              448       1,255,320
              After five years but within ten years              429,981        9,217               --         439,198
              After ten years but within fifteen years           331,707           --              607         331,100
              After twenty years                               2,563,560       30,321            7,622       2,586,259

           Corporate Securities Maturing:
              Within one year                                  2,258,638       18,250            2,624       2,274,264
              After one year but within five years             7,309,755       40,421            6,479       7,343,697
              After five years but within ten years            1,006,087       34,988            6,798       1,034,277
              After twenty years                               5,241,162      275,390           52,694       5,463,858
                                                             -----------    ---------        ---------      ----------

                     Total Held-to-Maturity                   49,702,867      449,248          287,780      49,864,335
                                                             ===========    ==========       =========      ==========
</TABLE>

                                       -43-
<PAGE>

Note 11  Continued
-------

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

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

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


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

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

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

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

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

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

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

                Corporate Securities Maturing:
                   After one year but within five years        2,323,341        45,505             --       2,368,846
                   After five years but within ten years       1,086,789        41,987          5,363       1,123,413
                   After twenty years                          3,704,657       281,562         15,822       3,970,397
                                                             -----------    ----------     ----------     -----------

                          Total Held-to-Maturity              34,031,676       434,872        192,258      34,274,290
                                                              ==========    ==========      =========      ==========
</TABLE>
          Securities called from investment  securities  available-for-sale  for
          the periods ended December 31, 2004,  2003, and 2002 were  $5,781,670,
          $5,932,581, and $8,923,573,  respectively, resulting in gross gains of
          $0,  $274,  and  $259,772,  respectively.  Calls  on  held-to-maturity
          securities  for the periods ended  December 31, 2004,  2003,  and 2002
          were $8,668,216, $8,495,000, and $2,041,000,  respectively,  resulting
          in gross gains of $0, $186, and $3,465, respectively.

                                      -44-
<PAGE>
Note 11  Continued
-------  ---------

          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,  2004  and  2003  totaled   $2,005,365  and  $2,030,774,
          respectively.

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,   2004                      December 31, 2003
                                      ----------------------------------       --------------------------------------
                                       Fixed       Variable                        Fixed        Variable
                                        Rate         Rate           Total           Rate         Rate         Total
                                    ---------     ----------    ----------    ----------     ----------    ----------
       <S>                          <C>           <C>           <C>            <C>           <C>           <C>
       Mortgage Loans to Originate         --        715,250       715,250            --      1,700,520     1,700,520
       Construction Loans                  --     16,440,968    16,440,968            --     11,466,084    11,466,084
       Unsecured Lines of Credit           --        443,370       443,370            --        599,809       599,809
       Overdraft Protection Accounts  436,337             --       436,337       418,710             --       418,710
       Home Equity Lines of Credit         --      6,787,668     6,787,668            --      5,341,397     5,341,397
       Commercial Loans             1,832,529      8,231,280    10,063,809     1,663,219      9,133,999    10,797,218
                                   ----------     ----------    ----------    ----------     ----------    ----------
                                    2,268,866     32,618,536    34,887,402     2,081,929     28,241,809    30,323,738
                                    =========     ==========    ==========    ==========     ==========    ==========
</TABLE>

          Commitments  under  standby  letters of credit  totaled  approximately
          $88,000 and $212,000 at December 31, 2004 and 2003, 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,  2004,  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 up to
          $60,000,000  depending on the amount of loans and securities available
          that can be used as collateral.

         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:

                                    2004              2003             2002
                               -------------      ------------     ------------

Selling Price                     21,612,537        51,490,655       27,651,336
Less: Carrying Value              21,164,716        50,493,861       27,141,803
      Loan Cost                      100,804           176,375          141,115
                               -------------      ------------     ------------
      Net Gain on Loans Sold         347,017           820,419          368,418
                               =============      ============     ============



                                      -45-

<PAGE>

          At December 31, 2004,  2003,  and 2002,  the Savings Bank had mortgage
          loans  committed  to  be  sold  totaling   $374,700,   $413,179,   and
          $2,447,752, respectively. Commitments to originate loans to be sold on
          the secondary  market were $1,211,860,  $5,116,152,  and $8,397,051 at
          December 31, 2004, 2003, and 2002, 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 also leases office
          space near the Browns Mill Road,  Johnson City,  branch location which
          extends  through  March  31,  2007  with an  option  to  renew  for an
          additional  3 years.  The Savings Bank has one  automobile  lease that
          expires in April 2006.  In  addition,  the  Savings  Bank and the Real
          Estate  Company lease  storage space at the Browns Mill Road,  Johnson
          City,  location under a  month-to-month  operating  lease.  Management
          expects as operating  leases  expire in the normal course of business,
          they will be  renewed or  replaced  by leases on other  properties  at
          current  market  rental  rates  at the  time of  renewal.  Approximate
          minimum   future   rentals  to  be  paid  under  the   cancelable  and
          noncancelable  leases for five years  subsequent  to December 31, 2004
          are as follows:

                                                Noncancelable        Cancelable
         Years Ended                              Leases-              Leases-
         December 31,                          Building & Auto       Building
         -------------                         ---------------      ------------
            2005                                  105,803             20,184
            2006                                   64,500             20,184
            2007                                   13,491             20,184
            2008                                       --             20,184
            2009                                       --             20,184
                                               --------------       ------------
          Total Minimum Future Rentals            183,794             100,920
                                               ==============       ============

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.

                                      -46-
<PAGE>

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, 2004 and 2003:
<TABLE>
<CAPTION>
                                                                                      Carrying              Fair
                                                                                       Amount               Value
                                                                                    -----------         ------------
         <S>                                                                        <C>                 <C>
         December 31, 2004:

         Financial Assets:
              Cash and Cash Equivalents                                              14,974,618          14,974,618
              Investment Securities                                                 103,353,283         103,514,751
              Loans                                                                 164,832,845         164,291,633
              Accrued Interest Receivable                                             1,490,634           1,490,634

         Financial Liabilities:
              Deposits                                                              214,155,593         214,190,536
              Advance Payments by Borrowers for Taxes and Insurance (Escrows)           110,328             110,328
              Accrued Interest on Deposits                                              136,476             136,476
              FHLB Advances                                                          46,180,671          45,564,629
              Preferred Beneficial Interest in Subordinated Debentures                8,000,000           8,000,000

         December 31, 2003:

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

         Financial Liabilities:
              Deposits                                                              221,992,486         222,615,134
              Advance Payments by Borrowers for Taxes and Insurance (Escrows)           103,632             103,632
              Accrued Interest on Deposits                                              141,757             141,757
              FHLB Advances                                                          36,210,071          37,843,293
              Preferred Beneficial Interest in Subordinated Debentures                8,000,000           8,000,000
</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  12.  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.

     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

                                       -47-
<PAGE>

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

     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.

                                      -48-
<PAGE>

Note 15  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 result 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.   Currently,
     components  of  other  comprehensive  income  displayed  in  the  financial
     statements    relate   solely   to   unrealized   gains   and   losses   on
     available-for-sale securities.

                                       -49-
<PAGE>
Note 16  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 periods ended December 31, 2004, 2003 and 2002
         is as follows:

<TABLE>
<CAPTION>
                                                                          2004             2003             2002
                                                                       ---------        ---------         ---------
         <S>                                                          <C>              <C>               <C>
         Computed "Expected" Federal Tax                               1,191,523        1,157,318         1,287,474
         Effect of State Taxes                                           150,342          146,026           104,203
         Tax Exempt Interest                                          (  340,901)      (  305,978)       (  290,720)
         FHLMC  Dividends                                             (  178,672)      (  176,389)       (  283,036)
         Miscellaneous Other                                          (  165,971)      (   62,547)       (   57,491)
                                                                       ---------       ----------        ----------
         Provision for Income Taxes                                      656,321          758,430           760,430
                                                                       =========       ==========        ==========
         Current Income Tax Expense                                      819,770          832,041           850,535
         Deferred Income Tax (Benefit)                                (  163,449)      (   73,611)       (   90,105)
                                                                       ---------       ----------        ----------
         Provision for Income Taxes                                      656,321          758,430           760,430
                                                                       =========       ==========        ==========
         Deferred Tax Assets and Liabilities:
         Due to Reserve for Loan and Lease Losses                        725,232          850,903           742,108
         Due to Unrealized Losses on Investments                       1,244,647          494,897                 -
                                                                       ---------       ----------        ----------
              Deferred Tax Assets                                      1,969,879        1,345,800           742,108
                                                                       ---------       ----------        ----------
         Due to FHLB Dividends                                        (  242,236)      (  204,458)       (  169,274)
         Due to Unrealized Gains on Investments                                -                -        (  155,931)
                                                                       ---------       ----------        ----------
              Deferred Tax Liabilities                                (  242.236)      (  204,458)       (  325,205)
                                                                       ---------       ----------        ----------
         Deferred Tax Assets and Liabilities                           1,727,643        1,141,342           416,903
                                                                       =========       ==========        ==========
</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, 2004, management believes
     it is more likely than not that the Savings  Bank will realize the benefits
     of these deductible differences.

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,  2004,  there were no legal  proceedings  that were  expected to have a
     material impact on the Company's financial statements.

                                      -50-
<PAGE>

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>
                                                                     2004                2003                 2002
                                                                  ----------           ---------          ---------
         <S>                                                       <C>                 <C>                <C>
         Net Income                                                2,848,159           2,645,445          3,184,141

         Average Basic Shares Outstanding                          1,398,138           1,388,782          1,379,713
         Basic Earnings Per Share                                       2.04                1.90               2.31
                                                                        ====                ====               ====

         Net Income                                                2,848,159           2,645,445          3,184,141
         Average Basic Shares Outstanding                          1,398,191           1,388,782          1,379,713
         Dilutive Effect Due to Stock Options                        131,590             105,526             93,444
                                                                  ----------           ---------          ---------

         Average Shares Outstanding, as Adjusted                   1,529,781           1,494,308          1,473,157
         Diluted Earnings Per Share                                     1.86                1.77               2.16
                                                                        ====                ====               ====

                                      -51-
<PAGE>

</TABLE>

Note 19  Condensed Parent Company Only Financial Statements
-------  --------------------------------------------------
         Statement of Financial Position
<TABLE>
<CAPTION>
                                                                                     December 31,       December 31,
                                                                                        2004                 2003
                                                                                     -----------        -----------
         <S>                                                                        <C>                 <C>
                  Assets:
         Cash and Cash Equivalents                                                    8,510,947           8,522,421
         Investments - Available-for-Sale                                               370,775             343,200
         Investment in State of Franklin Leasing                                        653,255             585,204
         Investment in State of Franklin Savings Bank                                24,617,417          22,782,742
         Investment in State of Franklin Statutory Trust I                              248,000             248,000
         Interest Receivable                                                              7,267               9,818
         Trust Preferred Placement Cost, net of amortization                             92,000             140,000
         Accrued Tax Benefit                                                             57,672             130,943
         Other Assets                                                                     2,000                  --
                                                                                    -----------        ------------
                Total Assets                                                         34,559,333          32,762,328
                                                                                    ===========        ============
         Liabilities:

         Accounts Payable and Accrued Expenses                                           17,650              13,780
         Deferred Tax Liability                                                          20,149               9,590
                                                                                    -----------        ------------
                Total Liabilities                                                        37,799              23,370
                                                                                    -----------        ------------
         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                                     ( 2,005,925)       (    797,592)
         Retained Earnings                                                           13,204,733          10,356,572
         Less: Employee Stock Ownership                                             (   642,247)       (    784,995)
                                                                                    -----------        ------------
                Total Stockholders' Equity                                           26,273,534          24,490,958
                                                                                     ----------        ------------
                    Total Liabilities and Stockholders' Equity                       34,559,333          32,762,328
                                                                                     ==========        ============
         Statement of Income
                                                                                    Period Ended       Period Ended
                                                                                    December 31,        December 31,
                                                                                        2004                2003
                                                                                    ------------       -------------
         Interest Income                                                                148,619             190,063

         Interest Expense                                                           (   461,005)        (   433,863)
         Other Operating Expenses                                                   (   137,970)        (   142,881)
                                                                                     ----------          ----------
         Income (Loss) before Income Taxes and Equity
           in Undistributed Earnings of Subsidiaries                                (   450,356)        (   386,681)
         Provision for Income Taxes (Benefit)                                       (   170,440)        (   149,179)
                                                                                     ----------          ----------
                  Income (Loss) before Equity in Undistributed Earnings
                    of Subsidiaries                                                 (   279,916)        (  237,502)

         Equity in undistributed Earnings of Subsidiaries                             3,128,075           2,882,947
                                                                                      ---------           ---------
         Net Income                                                                   2,848,159           2,645,445
                                                                                      =========           =========
</TABLE>

                                       -52-

<PAGE>

Note 19  Continued
-------  ---------
<TABLE>
<CAPTION>
         Statement of Cash Flows
                                                                                 Period Ended         Period Ended
                                                                                  December 31,         December 31,
                                                                                      2004                2003
                                                                                 -------------        ------------
         <S>                                                                       <C>                <C>
         Cash Flows from Operating Activities
                Net Income                                                          2,848,159           2,645,445
                Items Not Affecting Cash and Cash Equivalents:
                Equity in Undistributed Earnings of Subsidiaries                   (3,128,075)        ( 2,882,947)
                (Increase) Decrease in Accrued Tax Benefit                             73,271         (   112,778)
                (Increase) (Decrease) in Accounts Payable                               3,872         (     1,807)
                Amortization Expense                                                   48,000              48,000
                Earned ESOP Shares                                                    142,748             273,455
                (Increase) Decrease in Accounts Receivable                              2,551               3,005
                (Increase) in Other Assets                                         (    2,000)                 --
                                                                                   -----------        ------------
                    Net Cash (Used) by Operating Activities                        (   11,474)        (    27,627)
                                                                                   -----------        ------------
         Cash Flows from Investing Activities
                Purchase of Available-for-Sale Investments                                 --         (   303,080)
                                                                                   -----------        -----------

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

                    Net (Decrease) in Cash and Cash Equivalents                    (   11,474)        (   330,707)

         Cash and Cash Equivalents at Beginning of Period                           8,522,421           8,853,128
                                                                                   -----------        ------------

                    Cash and Cash Equivalents at End of Period                      8,510,947           8,522,421
                                                                                   ===========        ============
</TABLE>
Note 20  Temporary Impairment of Investments
-------  -----------------------------------

     Information  pertaining  to  securities  with  gross  unrealized  losses at
     December 31, 2004 and 2003, aggregated by investment category and length of
     time that  individual  securities  have been in a continuous loss position,
     follows:

         December 31, 2004
<TABLE>
<CAPTION>
                                                     Less than Twelve Months        Twelve Months & Over
                                                         Gross                         Gross
                                                       Unrealized     Fair           Unrealized        Fair
                                                         Losses      Value             Losses         Value
                                                       --------     ---------        ----------     ----------
                  <S>                                  <C>         <C>                <C>           <C>
                  Available-for-Sale
                  U.S. Government Agencies                  327     1,003,030                --             --
                  Municipal Securities                       --            --            28,590        820,478
                           Marketable Equity Securities  98,688     2,414,150         4,730,734     21,066,634
                                                       --------     ---------         ---------     ----------
                           Total Available-for-Sale      99,015     3,417,180         4,759,324     21,887,112
                                                       ========     =========         =========     ==========
                   Held-to-Maturity
                   US Government Agencies               124,624     4,980,275            19,179      1,002,335
                   Mortgage Backed Securities            14,457     7,083,026            52,248      4,878,529
                   Municipal Securities                   8,677       961,646                --             --
                   Corporate Securities                  48,085     5,512,355            20,510        540,563
                                                       --------    -----------        ---------     ----------
                   Total Held-to-Maturity               195,843    18,537,302            91,937      6,421,427
                                                       ========    ===========        =========     ==========
</TABLE>

                                       -53-

<PAGE>


State of Franklin Bancshares, Inc.
Notes to Consolidated Financial Statements
For the Years Ended December 31, 2004, 2003, and 2002


Note 20  Continued
-------  ----------

         December 31, 2003
         -----------------
<TABLE>
<CAPTION>
                                                      Less than Twelve Months          Twelve Months & Over
                                                         Gross                          Gross
                                                      Unrealized     Fair             Unrealized        Fair
                                                        Losses       Value              Losses          Value
                                                       --------    ----------         ---------      ---------
                  <S>                                <C>           <C>                <C>            <C>

                  Available-for-Sale
                    Municipal Securities                    --             --            42,314        882,980

                    Corporate Securities                    16        101,893                --             --
                    Marketable Equity Securities     1,744,811     12,311,000         1,155,000      5,845,000
                                                     ---------     ----------         ---------      ---------

                           Total Available-for-Sale  1,744,827     12,412,893         1,197,314      6,727,980
                                                     =========     ==========         =========      =========

                   Held-to-Maturity
                   US Government Agencies               96,095      2,139,182                --             --
                   Mortgage Backed Securities           69,863      9,382,936                --             --
                   Municipal Securities                  5,115      1,137,970                --             --
                   Corporate Securities                 21,185      1,107,002                --             --
                                                      --------    -----------        ----------     ----------

                   Total Held-to-Maturity              192,258     13,767,090                --             --
                                                       =======     ==========        ==========     ==========
</TABLE>

     Management believes all unrealized losses as of December 31, 2004 represent
     temporary  impairment.  The unrealized  losses have resulted from temporary
     changes  in the  interest  rate  market  and  not  as a  result  of  credit
     deterioration.  Management  does not anticipate  selling the securities for
     losses,  and  State of  Franklin  has  sufficient  cash,  investments  with
     unrealized  gains and unused  lines of credit to provide  resources to meet
     liquidity needs.

                                      -54-
<PAGE>

STATE OF
FRANKLIN
BANCSHARES, INC.

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

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

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

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

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

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

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


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

Chairman of the Board of Directors            President
  and Chief Executive Officer


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

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

                                       -55-
<PAGE>
Item 8.  Changes  In  and  Disagreements  with  Accountants  on  Accounting  and
         Financial Disclosure

         None

Item 8A. Controls and Procedures

     (a) Evaluation of Disclosure  Controls and Procedures.  State of Franklin's
Chief Executive  Officer and its President  (principal  accounting and financial
officer) have evaluated the  effectiveness  of the design and operation of State
of Franklin's  disclosure  controls and  procedures  (as defined in Exchange Act
Rule  13a-14(c)) as of the last day of the period covered by this report.  Based
on that evaluation, the Chief Executive Officer and the President have concluded
that State of Franklin's  disclosure  controls and  procedures  are effective.

     (b)  Changes in  Internal  Controls.  There  have not been any  significant
changes in State of Franklin's  internal controls or in other factors that could
significantly affect these controls subsequent to the date of their evaluation.

                                    PART III

Item 9. Directors and Executive Officers of the Registrant.

                    Information about the Board of Directors

Role of the Board

     Pursuant to Tennessee  law, our business,  property and affairs are managed
under the direction of our Board. The Board has  responsibility for establishing
broad corporate policies and for our overall  performance and direction,  but is
not involved in day-to-day operations. Members of the Board keep informed of our
business by participating in Board and committee meetings, by reviewing analyses
and reports sent to them regularly,  and through  discussions with our executive
officers.

Board Structure

     Our bylaws  provide that the Board shall  consist of no fewer than five nor
more than 25  members.  The Board is  currently  limited  to 12 members by Board
resolution. The directors are divided into three classes, each of which is equal
in number.  The directors in each class hold office for staggered terms of three
years each.  Staggered terms make it more difficult for shareholders,  including
those  holding a majority of our common stock,  to force an immediate  change in
the composition of a majority of the board of directors. Since the terms of only
one-third of the incumbent  directors  expire each year, two annual  meetings of
shareholders  would be required to change a majority of the directors,  provided
that no directors  resigned,  were removed, or died during their terms of office
and the  vacancies  created  thereby were not filled by an  affirmative  vote of
majority of the board of directors.

2004 Board Meetings

     During  2004,  the Board  held 7  meetings.  Our  directors  also  serve as
directors of State of Franklin  Savings Bank. The board of directors of State of
Franklin  Savings  Bank held 12  meetings  in 2004.  During  2004,  no  director
attended  less than 75% of the meetings held by the Board or by any committee on
which he served.

Board Committees

     The  Board  has two  committees:  the Audit  Committee  and the  Nominating
Committee.

     The Audit Committee,  consisting of directors Perry,  Cheek,  Gross, Jeanes
and Allen,  Sr., is  responsible  for the review and  evaluation of our internal
controls and accounting  procedures.  It also periodically reviews audit reports
with our independent auditors and recommends the annual appointment of auditors.
The Audit  Committee  met 6 times


                                      -56-
<PAGE>

during 2004.  The Board has adopted a written  charter for the Audit  Committee.
For more information  about the Audit  Committee,  please see the section called
"Report of the Audit Committee of the Board of Directors."

     The entire Board acts as Nominating Committee for the nomination of members
of the Board.  The Board has not adopted a  Nominating  Committee  Charter.  The
Board met one time in its capacity as the Nominating  Committee during 2004. The
Board does not believe a separate  nominating  committee is necessary because of
our size and  because a majority of the Board is  independent.  The Board has no
set  procedures  or  policy  on the  selection  of  nominees  or  evaluation  of
shareholder  recommendations as it has historically considered these issues on a
case-by-case  basis.  The Board will consider  shareholder  recommendations  for
director  nominees that are properly  received in accordance with our bylaws and
the applicable rules and regulations of the Securities and Exchange  Commission.

Director Compensation

     Each director receives a quarterly  retainer of $1,615, as well as a $1,350
quarterly  retainer  from the  Savings  Bank and $300 for each Board  meeting he
attends.  Each director also receives a $150 fee for each  Committee  meeting he
attends.

Shareholder Communications with the Board

     Shareholders  desiring to  communicate  with the Board should  e-mail their
communications  to  board@sofb.com.  The  communications  will be reviewed by an
independent  member  of the Board  who will  make a  determination  as to how to
proceed.

                                      -57-
<PAGE>

Item 10.  Executive Compensation

                             Executive Compensation

     The following  table sets forth the aggregate cash  compensation we paid to
our Chairman and Chief Executive  Officer and our President.  We did not pay any
other  executive  officer cash  compensation in excess of $100,000 for the years
ended December 31, 2004, 2003 and 2002.

                           Summary Compensation Table
<TABLE>
<CAPTION>
                                                                                               Long Term
                                                              Annual Compensation             Compensation
                                                              -------------------             ------------
                                                                                          Securities Underlying
               Name and Position                  Year     Salary ($)       Bonus($)(1)      Options/SARs(#)
               -----------------                  ----     ----------       -----------     ----------------
<S>                                               <C>      <C>             <C>                 <C>
Charles E. Allen, Jr............................  2004     227,853 (2)                         18,779 (2)
Chairman and Chief Executive Officer              2003     211,636 (3)                         18,896 (3)
                                                  2002     253,177 (4)            (5)          25,117 (4)

Randal R. Greene................................  2004     174,600         31,666 (6)           1,712 (6)
President                                         2003     168,000         35,280                  --
                                                  2002     160,000         40,000                  --
</TABLE>
-----------------------

     (1)  Salary and bonus  amounts  reflect  amounts  earned  during the stated
          fiscal year,  even if paid in the subsequent  fiscal year. All amounts
          have been restated to reflect this position.

     (2)  Does not  include  $56,963 in cash  compensation  in lieu of which Mr.
          Allen elected to receive stock options to purchase 18,779 shares.  The
          options were granted for 2004.

     (3)  Does not  include  $52,909 in cash  compensation  in lieu of which Mr.
          Allen elected to receive stock options to purchase 18,896 shares.  The
          options were granted for 2003.

     (4)  Does not  include  $63,294 in cash  compensation  in lieu of which Mr.
          Allen elected to receive stock options to purchase 25,117 shares.  The
          options were granted for 2002.

     (5)  Mr. Allen elected to receive  stock options to purchase  15,823 shares
          of common stock in lieu of his 2001 bonus of $39,875. The options were
          granted on March 15, 2002.

     (6)  Does not  include  $4,999  in cash  compensation  in lieu of which Mr.
          Greene elected to receive stock options to purchase 1,712 shares.  The
          options were granted for 2004.

                                      -58-
<PAGE>
                        Option Grants in Last Fiscal Year
<TABLE>
<CAPTION>

                                                          % of total options
                                     Number of shares    granted to employees      Exercise      Expiration
               Name                 underlying options      in fiscal year       price ($/sh)       Date
               ----                 ------------------      --------------       -----------        ----
         <S>                               <C>                   <C>                <C>             <C>
         Charles E. Allen, Jr.(1).......   3,553                 91.6%              20.00           2014
                                           7,659                 91.6%              22.00           2014
                                           7,567                 91.6%              25.25           2015

         Randal R. Greene (2)...........   1,712                  8.4%              25.25           2015
</TABLE>

(1) Mr. Allen  elected to receive stock options in lieu of a portion of his cash
compensation in 2004.

(2) Mr. Greene elected to receive stock options in lieu of a portion of his cash
compensation in 2004.


Aggregated  Option/SAR  Exercises  in  Last  Fiscal  Year  And  Fiscal  Year-End
Option/SAR Values

     The following table discloses  information  regarding stock options held at
the end of or exercised in the year 2004 for each of the executive officers.

<TABLE>
<CAPTION>
                             Shares                       Securities underlying           Value of unexercised
                          acquired on       Value          unexercised options            in-the-money options
         Name             exercise(1)    realized (1)      at December 31, 2004         at December 31, 2004 (2)
         ----             -----------    ------------      --------------------         ------------------------
                                                       Exercisable   Unexercisable    Exercisable    Unexercisable
                                                       -----------   -------------    -----------    -------------
<S>                           <C>            <C>          <C>            <C>           <C>             <C>
Charles E. Allen, Jr.         ---            ---          88,632         56,498        $ 918,558       $247,702
Randal R. Greene ....         ---            ---          70,379          3,704         $820,417       $ 34,260
</TABLE>
-----------------

(1)  As of December 31, 2004,  no options have been  exercised by the  executive
     officers under the Stock Incentive Plan.

(2)  Based on the appraised  value of $22.75 per share of our common stock as of
     December 31, 2004.

                                       -59-
<PAGE>
                      Equity Compensation Plan Information

     The table below  includes  information  with  respect to shares  subject to
outstanding options granted under our equity compensation plans.
<TABLE>
<CAPTION>
                                                          (A)                 (B)                 (C)
                                                       Number of                              Number of securities
                                                    securities to be       Weighted        remaining available for
                                                      issued upon          average          future issuance under
                                                      exercise of       exercise price    equity compensation plans
                                                      outstanding       of outstanding      (excluding securities
                      Plan Category                     options            options         reflected in Column A)
                      -------------                     -------            -------         ----------------------
        <S>                                          <C>                    <C>                 <C>
        Equity compensation plans approved by
        shareholders..............................   349,234                $13.38              150,766

        Equity compensation plans not approved
        by shareholders...........................       -0-                                        -0-
</TABLE>

Item 11.  Security  Ownership of Certain  Beneficial  Owners and  Management and
Related Stockholder Matters

                        State of Franklin Stock Ownership

     The following table sets forth certain information  regarding the ownership
of the common stock as of March 29, 2005, for (i) each person who owns more than
5% of the common stock,  (ii) each  director and the executive  officers who are
listed in the executive  compensation  tables,  and (iii) all executive officers
and directors as a group.

<TABLE>
<CAPTION>
                                                          Amount and Nature
                                                            of Beneficial        Percent
           Name of Beneficial                              Ownership        of Class(1)
Owner                                                     (Number of Shares)
<S>                                                         <C>                   <C>
Charles E. Allen, Jr.(2)(3).............................    224,823               14.25
Charles E. Allen, Sr., M.D.(4)..........................     39,169                2.62
Vance W. Cheek(5).......................................     15,669                1.05
Kenneth E. Cutshall, M.D.(4)............................     56,810                3.80
Randal R. Greene(3)(10).................................    154,225                9.94
Stephen K. Gross(6).....................................     33,488                2.25
Alan R. Hubbard(7)......................................     10,200                   *
Donald R. Jeanes(4).....................................     17,069                1.14
Verrill M. Norwood, Jr.(8)..............................     46,169                3.09
Cameron E. Perry(5).....................................     18,169                1.22
Richard S. Venable(4)...................................     22,569                1.51
Henry J. Williams, Jr., M.D.(4).........................     67,939                4.55

Directors and executive officers as a group (12
persons)(9).............................................    661,658               37.78

State of Franklin Savings Bank Employee Stock Ownership
Plan....................................................    186,829               12.61
</TABLE>

---------------------
*        Less than 1%

(1)  Unless otherwise  indicated,  beneficial  ownership consists of sole voting
     and investing  power based on 1,481,462  shares issued and  outstanding  on
     March 31,  2005.  Options to purchase  270,029  shares are  exercisable  or
     become  exercisable within 60 days of March 31, 2005. These shares issuable
     under options are deemed to be outstanding for the purpose of computing the
     percentage of outstanding  shares owned by each person to whom a portion of
     these options relate but are not deemed to be  outstanding  for the purpose
     of computing the percentage owned by any other person.

(2)  Includes  73,719 shares  issuable within 60 days of March 31, 2004 upon the
     exercise of options.

(3)  Includes 44,641 shares held by the State of Franklin  Savings Bank Employee
     Stock  Ownership  Plan  for  which  Mr.  Allen  and  Mr.  Greene  serve  as
     co-trustees.

(4)  Includes  12,169 shares  issuable within 60 days of March 31, 2005 upon the
     exercise of options.

(5)  Includes  8,169 shares  issuable  within 60 days of March 31, 2005 upon the
     exercise of options.

(6)  Includes  9,169 shares  issuable  within 60 days of March 31, 2005 upon the
     exercise of options.

(7)  Includes  5,500 shares  issuable  within 60 days of March 31, 2005 upon the
     exercise of options.

(8)  Includes  11,169 shares  issuable within 60 days of March 31, 2005 upon the
     exercise of options.

(9)  Includes 270,029 shares issuable upon the exercise of options granted under
     the Stock  Incentive  Plan and 44,641  shares held by the State of Franklin
     Savings Bank Employee Stock Ownership Plan.

(10) Includes  70,379 shares  issuable within 60 days of March 31, 2005 upon the
     exercise of options.

     Messrs.  Charles E.  Allen,  Jr. and Randal R.  Greene  serve as  executive
     officers and directors.

                                       -60-

<PAGE>

Item 12. Certain Relationships and Related Transactions

           Transactions with Executive Officers, Directors and Others

     We have had and expect to have in the  future  banking  and other  business
transactions  in the ordinary  course of our banking  business  with  directors,
officers,  and 10% beneficial  owners of our common stock and their  affiliates,
including  members of their families,  or corporations,  partnerships,  or other
organizations in which the officers or directors have a controlling interest, on
substantially the same terms (including price, or interest rates and collateral)
as those  prevailing  at the time for  comparable  transactions  with  unrelated
parties. Any of these banking transactions will not involve more than the normal
risk of collectability nor present other unfavorable  features to us or State of
Franklin Savings Bank.

     State of Franklin  Savings  Bank leases  office  space from a  partnership,
Allen and Allen. Charles E. Allen, Jr., the Chairman of our Board and Charles E.
Allen,  Sr.,  M.D., a director,  are  principals  in Allen and Allen.  The 3,000
square foot building houses the Browns Mill Road branch. The annual rent is $13.
49 per square  foot or  $40,470.  This  amount  includes  taxes,  insurance  and
maintenance.  Also,  State of Franklin Real Estate,  Inc.  leases a 4,000 square
foot suite with road frontage from Allen and Allen at $13.49 per square foot and
an additional  2,500 square foot suite for $6.00 per square foot.  These amounts
include taxes, insurance and maintenance.

Item 13.  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.

          23               Consent of Baylor and Backus

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

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

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

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

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

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

                                      -61-
<PAGE>

Item 14.  Principal Accountant Fees and Services

                                 Audit Committee

The Audit Committee is composed of five directors:  Perry,  Cheek, Gross, Jeanes
and Allen,  Sr.  Although  our common  stock is not listed on the New York Stock
Exchange,  we have adopted the definition of an "independent  director" provided
in the NYSE  rules.  Under  this  definition,  all of the  members  of the Audit
Committee are independent  directors except for Charles E. Allen, Sr., M.D., who
is the father of Charles E. Allen, Jr., our Chairman of the Board.

     The functions of the Audit Committee include:

o    recommending to the Board the appointment of independent auditors;

o    approving  the scope of audits and other  services to be  performed  by the
     independent and internal auditors; and

o    reviewing  the results of internal  and  external  audits,  the  accounting
     principles applied in financial reporting and the adequacy of financial and
     operational controls.

                                   Audit Fees

     The  table  below  sets  out the fees we paid to  Baylor  and  Backus,  our
principal independent auditors, for 2003 and 2004.

                                             2003          2004
                                             ----          ----
 Audit fees..............................  $38,000       40,000
 Audit-related fees......................        0            0
 Tax fees................................    4,000        4,000
 All other fees..........................        0            0
                                          --------     --------
 Total ..................................  $42.000      $44,000





                                       -62-
<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
                                              ----------------------------------
                                              Chairman of the Board

                                          Date: March 25, 2005

     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/Chares E. Allen, Jr.       Chairman of the Board, Director                              March 25, 2005
----------------------------  (principal executive, financial, and accounting officer)

/s/Randal R. Greene           President, Director                                          March 25, 2005
----------------------------

/s/Stephen Gross              Director                                                     March 25, 2005
----------------------------

/s/Donald R. Jeanes           Director                                                     March 25, 2005
----------------------------

/s/Henry J. Williams, M.D.    Director                                                     March 25, 2005
----------------------------

/s/Kenneth E. Cutshall, M.D.  Director                                                     March 25, 2005
----------------------------

/s/Charles E. Allen, Sr.      Director                                                     March 25, 2005
----------------------------

/s/Richard S. Venable         Director                                                     March 25, 2005
----------------------------

/s/Verrill M. Norwood, Jr.    Director                                                     March 25, 2005
----------------------------

/s/Cameron E. Perry           Director                                                     March 25, 2005
----------------------------

/s/Vance W. Cheek             Director                                                     March 25, 2005
----------------------------

/s/Alan R. Hubbard            Director                                                     March 25, 2005
----------------------------
</TABLE>







                                       -63-