##### Table of Contents









UNITED STATES SECURITIES AND EXCHANGE
COMMISSION

Washington, D.C. 20549


|
|
|

Form 10-K


|   |   |  |                                                                                            
|-- | - |  | -------------------------------------------------------------------------------------------
|   | þ |  | ANNUAL REPORT PURSUANT TO SECTION 13 or
    15(d)OF THE SECURITIES EXCHANGE ACT OF 1934    
|   |   |  | For the fiscal year ended December 31,
    2003                                            
|  
|or
|  
|   | o |  | TRANSITION REPORT PURSUANT TO SECTION 13
    or 15(d)OF THE SECURITIES EXCHANGE ACT OF 1934

Commission file number: 0-25141


|
|
|

MetroCorp Bancshares, Inc.


(Exact name of registrant as specified in its
charter)


|                                                                   |  |                                     
|------------------------------------------------------------------ |  | ------------------------------------
|Texas                                                              |  | 76-0579161                          
|(State or other jurisdiction of incorporation
    or organization) |  | (I.R.S. Employer Identification No.)

9600 Bellaire Boulevard,
Suite 252

Houston, Texas 77036


(Address of principal executive offices
including zip code)


(713) 776-3876

(Registrants telephone number, including
area code)


|
|
|

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

None


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

Common Stock, par value $1.00 per
share


(Title of class)


|
|
|

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

Indicate by check mark whether the registrant is
an accelerated filer (as defined in Rule 12b-2 of the Act).
Yes o     No þ

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

As of March 5, 2004, the number of
outstanding shares of Common Stock was 7,162,990.

The aggregate market value of the shares of
Common Stock held by non-affiliates, based on the closing price
of the Common Stock on the Nasdaq National Market System on
June 30, 2003, the last business day of the
registrants most recently completed second quarter, of
$12.15 per share, was approximately $60.0 million.

DOCUMENTS INCORPORATED BY REFERENCE:

Portions of the Companys Proxy Statement
for the 2004 Annual Meeting of Shareholders, which will be filed
within 120 days after December 31, 2003, are
incorporated by reference into Part III, Items 10-14
of this Form 10-K.



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TABLE OF CONTENTS

|                                                 |  |                                                                                                        |    |      |    | 
|------------------------------------------------ |  | ------------------------------------------------------------------------------------------------------ | -- | ---- | -- | 
|                                                 |  |                                                                                                        |    | Page
|                                                 |  |                                                                                                        |    |     
|PART I                                          
|Item 1.                                          |  | Business                                                                                               |    |      | 2  | 
|Item 2.                                          |  | Properties                                                                                             |    |      | 14 | 
|Item 3.                                          |  | Legal Proceedings                                                                                      |    |      | 14 | 
|Item 4.                                          |  | Submission of Matters to a
    Vote of Security Holders                                                |    |      | 15 | 
|PART II                                         
|Item 5.                                          |  | Market for Registrants
    Common Equity and Related Shareholder Matters                              |    |      | 15 | 
|Item 6.                                          |  | Selected Consolidated
    Financial Data                                                               |    |      | 17 | 
|Item 7.                                          |  | Managements Discussion
    and Analysis of Financial Condition and Results of Operations              |    |      | 18 | 
|Item 7A.                                         |  | Quantitative and Qualitative
    Disclosure About Market Risk                                          |    |      | 47 | 
|Item 8.                                          |  | Financial Statements and
    Supplementary Data                                                        |    |      | 48 | 
|Item 9.                                          |  | Changes in and Disagreements
    With Accountants on Accounting and Financial Disclosure               |    |      | 48 | 
|Item 9A.                                         |  | Controls and Procedures                                                                                |    |      | 48 | 
|PART III                                        
|Item 10.                                         |  | Directors and Executive
    Officers of the Company                                                    |    |      | 49 | 
|Item 11.                                         |  | Executive Compensation                                                                                 |    |      | 49 | 
|Item 12.                                         |  | Security Ownership of
    Certain Beneficial Owners and Management and Related Stockholder
    Matters |    |      | 49 | 
|Item 13.                                         |  | Certain Relationships and
    Related Transactions                                                     |    |      | 49 | 
|Item 14.                                         |  | Controls and Procedures                                                                                |    |      | 49 | 
|PART IV                                         
|Item 15.                                         |  | Exhibits, Financial
    Statement Schedules, and Reports on Form 10-K                                  |    |      | 50 | 
|Signatures                                       |  |                                                                                                        | 52 |     
|Consent of PricewaterhouseCoopers LLP           
|Consent of Deloitte & Touche LLP                
|Certification of President pursuant to 13a-14(a)
|Certification CFO pursuant to 13a-14(a)         
|Certification of President pursuant to 18 U.S.C.
|Certification CFO pursuant to 18 U.S.C.         



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##### Table of Contents






PART I

Special Cautionary Notice Regarding
Forward-Looking Statements

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



| |   |                                                                                                                                                                                                                                                                                                                            | 
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | 
| |  | changes in interest rates and market prices,
    which could reduce the Companys net interest margins,
    asset valuations and expense expectations;                                                                                                                                                                     | 
|
| |  | changes in the levels of loan prepayments and the
    resulting effects on the value of the Companys loan
    portfolio;                                                                                                                                                                                                  | 
|
| |  | changes in local economic and business conditions
    which adversely affect the ability of the Companys
    customers to transact profitable business with the Company,
    including the ability of borrowers to repay their loans
    according to their terms or a change in the value of the related
    collateral; | 
|
| |  | increased competition for deposits and loans
    adversely affecting rates and terms;                                                                                                                                                                                                                                      | 
|
| |  | the Companys ability to identify suitable
    acquisition candidates;                                                                                                                                                                                                                                                     | 
|
| |  | the timing, impact and other uncertainties of the
    Companys ability to enter new markets successfully and
    capitalize on growth opportunities;                                                                                                                                                                      | 
|
| |  | increased credit risk in the Companys
    assets and increased operating risk caused by a material change
    in commercial, consumer and/or real estate loans as a percentage
    of the total loan portfolio;                                                                                                           | 
|
| |  | the failure of assumptions underlying the
    establishment of and provisions made to the allowance for loan
    losses;                                                                                                                                                                                                   | 
|
| |  | changes in the availability of funds resulting in
    increased costs or reduced liquidity;                                                                                                                                                                                                                                | 
|
| |  | increased asset levels and changes in the
    composition of assets and the resulting impact on capital levels
    and regulatory capital ratios;                                                                                                                                                                          | 
|
| |  | the Companys ability to acquire, operate
    and maintain cost effective and efficient systems without
    incurring unexpectedly difficult or expensive but necessary
    technological changes;                                                                                                                         | 
|
| |  | the loss of senior management or operating
    personnel and the potential inability to hire qualified
    personnel at reasonable compensation levels; and                                                                                                                                                                | 
|
| |  | changes in statutes and government regulations or
    their interpretations applicable to bank holding companies and
    present and future banking and other subsidiaries, including
    changes in tax requirements and tax rates.                                                                                       | 

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






|        |         
|------- | --------
|Item 1. | Business

General

MetroCorp Bancshares, Inc. (the
Company) was incorporated as a business corporation
under the laws of the State of Texas in 1998 to serve as a
holding company for MetroBank, National Association (the

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Bank). The Companys
headquarters are located at 9600 Bellaire Boulevard,
Suite 252, Houston, Texas 77036, and its telephone number
is (713) 776-3876. The Companys internet website
address is www.metrobank-na.com. The Company makes available,
free of charge, on or through its website its annual report on
Form 10-K, quarterly reports on Form 10-Q, current
reports on Form 8-K and all amendments to those reports as
soon as reasonably practicable after such material is filed with
or furnished to the Securities and Exchange Commission. The
information found on the Companys website is not a part of
this or any other report.


The Companys mission is to enhance
shareholder value by maximizing profitability and operating as
the premier commercial bank in each community that it serves.
The Company operates branches in niche markets by providing
personalize service to the communities in Houston and Dallas. In
the past, the Company has strategically opened each of its 14
banking offices in an area with large multicultural
concentrations and intends to pursue branch opportunities in
multicultural markets with significant small and medium-sized
business activity.

The Bank was organized in 1987 by Don J. Wang,
the Companys current Chairman of the Board, and five other
Asian-American small business owners, four of whom currently
serve as directors of the Company and the Bank. The organizers
perceived that the financial needs of various ethnic groups in
Houston were not being adequately served and sought to provide
modern banking products and services that accommodated the
cultures of the businesses operating in these communities. In
1989, the Company expanded its service philosophy to
Houstons Hispanic community by acquiring from the Federal
Deposit Insurance Corporation (the FDIC) the assets
and liabilities of a community bank located in a primarily
Hispanic section of Houston. This acquisition broadened the
Companys market and increased its assets from
approximately $30.0 million to approximately
$100.0 million. Other than this acquisition, the Company
has accomplished its growth internally through the establishment
of de novo branches in various market areas. Since the
Banks formation in 1987, it has established 11 branches in
the greater Houston metropolitan area. In 1996, the Bank
expanded into the Dallas metropolitan area, and with the success
of the first Dallas area branch, opened two additional branch
offices in 1998 and 1999, respectively.

Business

Management believes that quality products and
services, cross-selling initiatives, relationship building, and
outstanding customer service are all key elements to a
successful retail banking endeavor. The Company intends to focus
more attention on its retail banking initiatives in 2004. To
achieve its goals, the Company has recently added an experienced
senior officer to its management team to implement strategies
throughout the 14-branch network. Specific goals include but are
not limited to: (1) building solid customer relationships
through cross-selling products and services, (2) targeting
new mainstream markets to diversify the customer base,
(3) ensuring that delivery systems for the Banks
products and services are effective and will produce the desired
results, (4) reviewing the Banks product mix to
ensure that customer needs and demands are being met with
existing products, and (5) studying the effectiveness of
the Banks customer service activities and implement
enhancements, where applicable, to make certain that customer
inquiries are being addressed timely and effectively.

In connection with the Companys approach to
community banking, the Company offers products designed to
appeal to its customers and further enhance profitability. The
Company believes that it has developed a reputation as the
premier provider of financial products and services to small and
medium-sized businesses and consumers located in the communities
that it serves. Each of its product lines is an outgrowth of the
Companys expertise in meeting the particular needs of its
customers. The Companys principal lines of business are
the following:



| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Commercial and Industrial
    Loans.The primary lending focus of
    the Company is to small and medium-sized businesses in a variety
    of industries. Its commercial lending emphasis includes loans to
    wholesalers, manufacturers and business service companies. The
    Company makes available to businesses a broad range of short and
    medium-term commercial lending products for working capital
    (including inventory and accounts receivable), purchases of
    equipment and machinery, and business expansion

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| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | (including acquisitions of real estate and
    improvements). As of December 31, 2003, the Companys
    commercial and industrial loan portfolio totaled
    $332.5 million or 59.4% of the gross loan portfolio. At
    that date, the Company had a concentration of loans in the hotel
    and motel industry of $66.1 million. Hotel and motel
    lending was originally targeted by the Company because of
    managements particular expertise in this industry and a
    perception that it was an under-served market. More recently,
    the Company has broadened its lending strategy in efforts to
    further diversify its portfolio to other industries.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|
| | Commercial Mortgage
    Loans.The Company originates
    commercial mortgage loans to finance the purchase of real
    property, which generally consists of developed real estate. The
    Companys commercial mortgage loans are collateralized by
    first liens on real estate, typically have variable rates and
    amortize over a 15 to 20 year period, with balloon payments
    due at the end of five to seven years. As of December 31,
    2003, the Company had a commercial mortgage portfolio of
    $178.3 million or 31.8% of the gross loan portfolio.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|
| | Construction Loans.The Company originates loans to finance the construction of
    residential and non-residential properties. The majority of the
    Companys residential construction loans are for
    single-family dwellings, which are under earnest money
    contracts. The Company also originates loans to finance the
    construction of commercial properties such as multi-family,
    office, industrial, warehouse and retail centers. As of
    December 31, 2003, the Company had a real estate
    construction portfolio of $24.6 million or 4.4% of the
    gross loan portfolio, of which, $12.7 million was
    residential and $11.9 million was commercial.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|
| | Residential Mortgage Brokerage and
    Lending.The Company uses its existing
    branch network to offer a complete line of single-family
    residential mortgage products. The Company solicits and receives
    a fee to process residential mortgage loans, which are
    underwritten and pre-sold to third party mortgage companies. The
    Company does not fund or service the loans underwritten by third
    party mortgage companies. The Company also originates five to
    seven year balloon residential mortgage loans with a 15-year
    amortization to its existing customers on a select basis, which
    loans are retained in the Companys portfolio. As of
    December 31, 2003, the residential mortgage portfolio
    totaled $14.3 million or 2.6% of the gross loan portfolio.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|
| | Government Guaranteed Small Business
    Lending.The Company has developed an
    expertise in several government guaranteed lending programs in
    order to provide credit enhancement to its commercial and
    industrial and mortgage portfolios. As a Preferred Lender under
    the United States Small Business Administration (the
    SBA) federally guaranteed lending program, the
    Companys pre-approved status allows it to quickly respond
    to customers needs. Depending upon prevailing market
    conditions, the Company may sell the guaranteed portion of these
    loans into the secondary market, yet retain servicing of these
    loans. The Company specializes in SBA loans to minority-owned
    businesses. As of December 31, 2003, the Company had
    $92.0 million in the retained portion of its SBA loans,
    approximately $59.4 million of which was guaranteed by the
    SBA. For the SBAs fiscal year ended September 30,
    2003, the Company was ranked as the third largest SBA loan
    originator in the 32-county Houston SBA District in terms of
    dollar volume produced. Another source of government guaranteed
    lending provided by the Company is Business and Industrial loans
    (B&I Loans) which are collateralized by the
    U.S. Department of Agriculture (the USDA) and
    are available to borrowers in areas with a population of less
    than 50,000. As of December 31, 2003, the Companys
    USDA portfolio totaled $2.9 million. The Company also
    offers guaranteed loans through the Overseas Chinese Credit
    Guaranty Fund (OCCGF), which is sponsored by the
    government of Taiwan. These loans are for people of Chinese
    descent or origin, who are not mainland Chinese by birth and who
    reside overseas. As of December 31, 2003, the
    Companys OCCGF portfolio totaled $4.1 million.
|
| | Trade Finance.Since
    its inception in 1987, the Company has originated trade finance
    loans and letters of credit to facilitate export and import
    transactions for small and medium-sized businesses. In this
    capacity, the Company has worked with the Export Import Bank of
    the United States (the Ex-Im Bank), an agency of the
    U.S. Government which provides guarantees for trade finance
    loans. At                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 

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| |                                                                                                                           
| | --------------------------------------------------------------------------------------------------------------------------
| | December 31, 2003, the Companys
    aggregate trade finance portfolio commitments totaled
    approximately $7.3 million.

The Company offers a variety of loan and deposit
products and services to retail customers through its branch
network in Houston and Dallas. Loans to retail customers include
residential mortgage loans, residential construction loans,
automobile loans, lines of credit and other personal loans.
Retail deposit products and services include checking and
savings accounts, money market accounts, time deposits, ATM
cards, debit cards and online banking.

On December 20, 2001, in collaboration with
the Mexican Consulate of Houston, the Company introduced the
Matricula Checking account as a service to the Hispanic
community in the greater Houston metropolitan area. Using an
official Matricula card issued by the consulate as
identification, a Mexican national can open this account.
Matricula Checking was the first account of this type in the
Houston area. It addresses a significant social issue:
Immigrants are typically unable to obtain acceptable
identification and lack basic banking services. With this
account, customers have a safe and secure place to keep their
money, eliminating the need to carry or hide large sums of cash.
The account allows the holder to write checks, execute
transactions and make affordable wire transfers. Account holders
can also designate individuals in Mexico to have limited ATM
access to their account. As of December 31, 2003, the
Companys aggregate Matricula Checking portfolio totaled
approximately $1.8 million.

Competition

The banking business is highly competitive, and
the profitability of the Company depends principally on the
Companys ability to compete in the market areas in which
its banking operations are located. The Company competes with
other commercial banks, savings banks, savings and loan
associations, credit unions, finance companies, mutual funds,
insurance companies, brokerage and investment banking firms,
asset-based non-bank lenders and certain other non-financial
entities, including retail stores which may maintain their own
credit programs and certain governmental organizations which may
offer more favorable financing. The Company has been able to
compete effectively with other financial institutions by
emphasizing customer service, technology and responsive
decision-making. Additionally, management believes the Company
remains competitive by establishing long-term customer
relationships, building customer loyalty and providing a broad
line of products and services designed to address the specific
needs of its customers.

In addition, the enactment of the
Gramm-Leach-Bliley Act, which breaks down the barriers between
financial institutions, securities firms and insurance
companies, may significantly change the competitive environment
in which the Company and the Bank conduct business. See
 Supervision and Regulation  The
Company  Financial Modernization.

Employees

As of December 31, 2003, the Company had
299 full-time equivalent employees, 45 of whom were
officers of the Bank classified as Vice President or above. The
Company considers its relations with employees to be
satisfactory.

Supervision and Regulation

The supervision and regulation of bank holding
companies and their subsidiaries is intended primarily for the
protection of depositors, the deposit insurance funds of the
FDIC and the banking system as a whole, and not for the
protection of the bank holding company shareholders or
creditors. The banking agencies have broad enforcement power
over bank holding companies and banks including the power to
impose substantial fines and other penalties for violations of
laws and regulations.

The following description summarizes some of the
laws to which the Company and the Bank are subject. References
herein to applicable statutes and regulations are brief
summaries thereof, do not purport to be complete, and are
qualified in their entirety by reference to such statutes and
regulations.

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| |            
| | -----------
| | The Company

The Company is a bank holding company registered
under the Bank Holding Company Act, as amended, (the
BHCA), and it is subject to supervision, regulation
and examination by the Board of Governors of the Federal Reserve
System (Federal Reserve Board). The BHCA and other
federal laws subject bank holding companies to particular
restrictions on the types of activities in which they may
engage, and to a range of supervisory requirements and
activities, including regulatory enforcement actions for
violations of laws and regulations.

Regulatory Restrictions on Dividends; Source
of Strength.It is the policy of the
Federal Reserve Board that bank holding companies should pay
cash dividends on common stock only out of income available over
the past year and only if prospective earnings retention is
consistent with the organizations expected future needs
and financial condition. The policy provides that bank holding
companies should not maintain a level of cash dividends that
undermines the bank holding companys ability to serve as a
source of strength to its banking subsidiaries.

Under Federal Reserve Board policy, a bank
holding company is expected to act as a source of financial
strength to each of its banking subsidiaries and commit
resources to their support. Such support may be required at
times when, absent this Federal Reserve Board policy, a holding
company may not be inclined to provide it. As discussed below, a
bank holding company in certain circumstances could be required
to guarantee the capital plan of an undercapitalized banking
subsidiary.

In the event of a bank holding companys
bankruptcy under Chapter 11 of the U.S. Bankruptcy
Code, the trustee will be deemed to have assumed and is required
to cure immediately any deficit under any commitment by the
debtor holding company to any of the federal banking agencies to
maintain the capital of an insured depository institution, and
any claim for breach of such obligation will generally have
priority over most other uncollateralized claims.

Scope of Permissible
Activities.Except as provided below,
the Company is prohibited from acquiring a direct or indirect
interest in or control of more than 5% of the voting shares of
any company which is not a bank or bank holding company and from
engaging directly or indirectly in activities other than those
of banking, managing or controlling banks or furnishing services
to its subsidiary banks, except the Company may engage in and
may own shares of companies engaged in certain activities found
by the Federal Reserve to be so closely related to banking or
managing and controlling banks as to be a proper incident
thereto. These activities include, among others, operating a
mortgage, finance, credit card or factoring company; performing
certain data processing operations; providing investment and
financial advice; acting as an insurance agent for certain types
of credit-related insurance; leasing personal property on a
full-payout, non-operating basis; and providing certain stock
brokerage and investment advisory services. In approving
acquisitions or the addition of activities, the Federal Reserve
considers whether the acquisition or the additional activities
can reasonably be expected to produce benefits to the public,
such as greater convenience, increased competition, or gains in
efficiency, that outweigh such possible adverse effects as undue
concentration of resources, decreased or unfair competition,
conflicts of interest or unsound banking practices.

However, the Gramm-Leach-Bliley Act, effective in
2001, amended the BHC Act and granted certain expanded powers to
bank holding companies. The Gramm-Leach-Bliley Act permits bank
holding companies to become financial holding companies and
thereby affiliate with securities firms and insurance companies
and engage in other activities that are financial in nature. The
Gramm-Leach-Bliley Act defines financial in nature
to include securities underwriting, dealing and market making;
sponsoring mutual funds and investment companies; insurance
underwriting and agency; merchant banking activities; and
activities that the Federal Reserve has determined to be closely
related to banking. No regulatory approval will be required for
a financial holding company to acquire a company, other than a
bank or savings association, engaged in activities that are
financial in nature or incidental to activities that are
financial in nature, as determined by the Federal Reserve

Under the Gramm-Leach-Bliley Act, a bank holding
company may become a financial holding company if each of its
subsidiary banks is well capitalized under the Federal Deposit
Insurance Corporation

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Improvement Act (FDICIA) prompt
corrective action provisions, is well managed, and has at least
a satisfactory rating under the Community Reinvestment Act of
1977 (CRA) by filing a declaration that the bank
holding company wishes to become a financial holding company.
The Gramm-Leach-Bliley Act defines financial in
nature to include securities underwriting, dealing and
market making; sponsoring mutual funds and investment companies;
insurance underwriting and agency; merchant banking activities;
and activities that the Federal Reserve Board has determined to
be closely related to banking. Subsidiary banks of a financial
holding company must remain well capitalized and well managed in
order to continue to engage in activities that are financial in
nature without regulatory actions or restrictions, which could
include divestiture of the financial in nature subsidiary or
subsidiaries. In addition, a financial holding company may not
acquire a company that is engaged in activities that are
financial in nature unless each of its subsidiary banks has a
CRA rating of satisfactory or better. Presently, the Company has
no plans to become a financial holding company.


While the Federal Reserve Board will serve as the
umbrella regulator for financial holding companies
and has the power to examine banking organizations engaged in
new activities, regulation and supervision of activities which
are financial in nature or determined to be incidental to such
financial activities will be handled along functional lines.
Accordingly, activities of subsidiaries of a financial holding
company will be regulated by the agency or authorities with the
most experience regulating that activity as it is conducted in a
financial holding company.

Safe and Sound Banking
Practices.Bank holding companies are
not permitted to engage in unsafe and unsound banking practices.
The Federal Reserve Boards Regulation Y, for example,
generally requires a holding company to give the Federal Reserve
Board prior notice of any redemption or repurchase of its own
equity securities, if the consideration to be paid, together
with the consideration paid for any repurchases or redemptions
in the preceding year, is equal to 10% or more of the
companys consolidated net worth. The Federal Reserve Board
may oppose the transaction if it believes that the transaction
would constitute an unsafe or unsound practice or would violate
any law or regulation. Prior approval of the Federal Reserve
Board would not be required for the redemption or purchase of
equity securities for a bank holding company that would be well
capitalized both before and after such transaction, well-managed
and not subject to unresolved supervisory issues.

The Federal Reserve Board has broad authority to
prohibit activities of bank holding companies and their
non-banking subsidiaries which represent unsafe and unsound
banking practices or which constitute violations of laws or
regulations, and can assess civil money penalties for certain
activities conducted on a knowing and reckless basis, if those
activities caused a substantial loss to a depository
institution. The penalties can be as high as $1.0 million
for each day the activity continues.

Anti-Tying
Restrictions.Bank holding companies
and their affiliates are prohibited from tying the provision of
certain services, such as extensions of credit, to other
services offered by a holding company or its affiliates.

Capital Adequacy
Requirements.The Federal Reserve
Board has adopted a system using risk-based capital guidelines
to evaluate the capital adequacy of bank holding companies.
Under the guidelines, specific categories of assets are assigned
different risk weights, based generally on the perceived credit
risk of the asset. These risk weights are multiplied by
corresponding asset balances to determine a
risk-weighted asset base. The guidelines require a
minimum total risk-based capital ratio of 8.0% (of which at
least 4.0% is required to consist of Tier 1 capital
elements). Total capital is the sum of Tier 1 and
Tier 2 capital. As of December 31, 2003, the
Companys ratio of Tier 1 capital to total
risk-weighted assets was 12.42% and its ratio of total capital
to total risk-weighted assets was 13.67%.

In addition to the risk-based capital guidelines,
the Federal Reserve Board uses a leverage ratio as an additional
tool to evaluate the capital adequacy of bank holding companies.
The leverage ratio is a companys Tier 1 capital
divided by its average total consolidated assets. Certain highly
rated bank holding companies may maintain a minimum leverage
ratio of 3.0%, but other bank holding companies may be required
to maintain a leverage ratio of at least 4.0%. As of
December 31, 2003, the Companys leverage ratio was
8.84%.

7



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The federal banking agencies risk-based and
leverage ratios are minimum supervisory ratios generally
applicable to banking organizations that meet certain specified
criteria. The federal bank regulatory agencies may set capital
requirements for a particular banking organization that are
higher than the minimum ratios when circumstances warrant.
Federal Reserve Board guidelines also provide that banking
organizations experiencing internal growth or making
acquisitions will be expected to maintain strong capital
positions substantially above the minimum supervisory levels,
without significant reliance on intangible assets.

Imposition of Liability for Undercapitalized
Subsidiaries.Bank regulators are
required to take prompt corrective action to resolve
problems associated with insured depository institutions whose
capital declines below certain levels. In the event an
institution becomes undercapitalized, it must submit
a capital restoration plan. The capital restoration plan will
not be accepted by the regulators unless each company having
control of the undercapitalized institution guarantees the
subsidiarys compliance with the capital restoration plan
up to a certain specified amount. Any such guarantee from a
depository institutions holding company is entitled to a
priority of payment in bankruptcy.

The aggregate liability of the holding company of
an undercapitalized bank is limited to the lesser of 5% of the
institutions assets at the time it became undercapitalized
or the amount necessary to cause the institution to be
adequately capitalized. The bank regulators have
greater power in situations where an institution becomes
significantly or critically
undercapitalized or fails to submit a capital restoration plan.
For example, a bank holding company controlling such an
institution can be required to obtain prior Federal Reserve
Board approval of proposed dividends, or might be required to
consent to a consolidation or to divest the troubled institution
or other affiliates.

Acquisitions by Bank Holding
Companies.The BHCA requires every
bank holding company to obtain the prior approval of the Federal
Reserve Board before it may acquire all or substantially all of
the assets of any bank, or ownership or control of any voting
shares of any bank, if after such acquisition it would own or
control, directly or indirectly, more than 5% of the voting
shares of such bank. In approving bank acquisitions by bank
holding companies, the Federal Reserve Board is required to
consider the financial and managerial resources and future
prospects of the bank holding company and the banks concerned,
the convenience and needs of the communities to be served, and
various competitive factors.

Control
Acquisitions.The Change in Bank
Control Act prohibits a person or group of persons from
acquiring control of a bank holding company unless
the Federal Reserve Board has been notified and has not objected
to the transaction. Under a rebuttable presumption established
by the Federal Reserve Board, the acquisition of 10% of more of
a class of voting stock of a bank holding company with a class
of securities registered under Section 12 of the Exchange
Act, such as the Company, would, under the circumstances set
forth in the presumption, constitute acquisition of control of
the Company.

In addition, any entity is required to obtain the
approval of the Federal Reserve Board under the BHCA before
acquiring 25% (5% in the case of an acquirer that is a bank
holding company) or more of the outstanding Common Stock of the
Company, or otherwise obtaining control or a controlling
influence over the Company.



| |         
| | --------
| | The Bank

The Bank is a nationally chartered banking
association, the deposits of which are insured by the Bank
Insurance Fund (BIF) of the FDIC. The Banks
primary regulator is the Office of the Comptroller of the
Currency (the OCC). By virtue of the insurance of
its deposits, however, the Bank is also subject to supervision
and regulation by the FDIC. Such supervision and regulation
subjects the Bank to special restrictions, requirements,
potential enforcement actions, and periodic examination by the
OCC. Because the Federal Reserve Board regulates the bank
holding company parent of the Bank, the Federal Reserve Board
also has supervisory authority, which directly affects the Bank.

Financial
Modernization.Under the
Gramm-Leach-Bliley Act, a national bank may establish a
financial subsidiary and engage, subject to limitations on
investment, in activities that are financial in nature, other
than insurance underwriting, insurance company portfolio
investment, real estate development, real

8



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##### Table of Contents



estate investment, annuity issuance and merchant
banking activities. To do so, a bank must be well capitalized,
well managed and have a CRA rating of satisfactory or better.
National banks with financial subsidiaries must remain well
capitalized and well managed in order to continue to engage in
activities that are financial in nature without regulatory
actions or restrictions, which could include divestiture of the
financial in nature subsidiary or subsidiaries. In addition, a
bank may not acquire a company that is engaged in activities
that are financial in nature unless the bank has a CRA rating of
satisfactory or better.


Branching.The
establishment of a branch must be approved by the OCC, which
considers a number of factors, including financial history,
capital adequacy, earnings prospects, character of management,
needs of the community and consistency with corporate powers.

Restrictions on Transactions with Affiliates
and Insiders.Transactions between the
Bank and its non-banking affiliates, including the Company, are
subject to Section 23A of the Federal Reserve Act. An
affiliate of a bank is any company or entity that controls, is
controlled by, or is under common control with the bank. In
general, Section 23A imposes limits on the amount of such
transactions, and also requires certain levels of collateral for
loans to affiliated parties. It also limits the amount of
advances to third parties which are collateralized by the
securities or obligations of the Company or its non-banking
subsidiaries.

Affiliate transactions are also subject to
Section 23B of the Federal Reserve Act which generally
requires that certain transactions between the Bank and its
affiliates be on terms substantially the same, or at least as
favorable to the Bank, as those prevailing at the time for
comparable transactions with or involving other nonaffiliated
persons. The Federal Reserve has also issued Regulation W
which codifies prior regulations under Sections 23A and 23B
of the Federal Reserve Act and interpretive guidance with
respect to affiliate transactions.

The restrictions on loans to directors, executive
officers, principal shareholders and their related interests
(collectively referred to herein as insiders)
contained in the Federal Reserve Act and Regulation O apply
to all insured depository institutions and their subsidiaries.
These restrictions include limits on loans to one borrower and
conditions that must be met before such a loan can be made.
There is also an aggregate limitation on all loans to insiders
and their related interests. These loans cannot exceed the
institutions total unimpaired capital and surplus, and the
OCC may determine that a lesser amount is appropriate. Insiders
are subject to enforcement actions for knowingly accepting loans
in violation of applicable restrictions.

Restrictions on Distribution of Subsidiary
Bank Dividends and Assets.Dividends
paid by the Bank have provided a substantial part of the
Companys operating funds and for the foreseeable future it
is anticipated that dividends paid by the Bank to the Company
will continue to be the Companys principal source of
operating funds. Capital adequacy requirements serve to limit
the amount of dividends that may be paid by the Bank. Until
capital surplus equals or exceeds capital stock, a national bank
must transfer to surplus 10% of its net income for the preceding
four quarters in the case of an annual dividend or 10% of its
net income for the preceding two quarters in the case of a
quarterly or semiannual dividend. At December 31, 2003, the
Banks capital surplus exceeded its capital stock. Without
prior approval, a national bank may not declare a dividend if
the total amount of all dividends, declared by the bank in any
calendar year exceeds the total of the banks retained net
income for the current year and retained net income for the
preceding two years. Under federal law, the Bank cannot pay a
dividend if, after paying the dividend, the Bank will be
undercapitalized. The OCC may declare a dividend
payment to be unsafe and unsound even though the Bank would
continue to meet its capital requirements after the dividend.

Because the Company is a legal entity separate
and distinct from its subsidiaries, its right to participate in
the distribution of assets of any subsidiary upon the
subsidiarys liquidation or reorganization will be subject
to the prior claims of the subsidiarys creditors. In the
event of a liquidation or other resolution of an insured
depository institution, the claims of depositors and other
general or subordinated creditors are entitled to a priority of
payment over the claims of holders of any obligation of the
institution to its shareholders, arising as a result of their
status as shareholders, including any depository institution
holding company (such as the Company) or any shareholder or
creditor thereof.

9



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Examinations.The
OCC periodically examines and evaluates insured banks. Based
upon such an evaluation, the OCC may revalue the assets of the
institution and require that it establish specific reserves to
compensate for the difference between the OCC-determined value
and the book value of such assets.

Audit Reports.Insured institutions with total assets of $500 million or
more must submit annual audit reports prepared by independent
auditors to federal regulators. In some instances, the audit
report of the institutions holding company can be used to
satisfy this requirement. Auditors must receive examination
reports, supervisory agreements, and reports of enforcement
actions. In addition, financial statements prepared in
accordance with accounting principles generally accepted in the
U.S., managements certifications concerning responsibility
for the financial statements, internal controls and compliance
with legal requirements designated by the OCC, and an
attestation by the auditor regarding the statements of
management relating to the internal controls must be submitted.
For institutions with total assets of more than $3 billion,
independent auditors may be required to review quarterly
financial statements. The Federal Deposit Insurance Corporation
Improvement Act of 1991 (FDICIA) requires that
independent audit committees be formed, consisting of outside
directors only. The committees of such institutions must include
members with experience in banking or financial management, must
have access to outside counsel, and must not include
representatives of large customers.

Capital Adequacy
Requirements.Similar to the Federal
Reserve Boards requirements for bank holding companies,
the OCC has adopted regulations establishing minimum
requirements for the capital adequacy of national banks. The OCC
may establish higher minimum requirements if, for example, a
bank has previously received special attention or has a high
susceptibility to interest rate risk.

The OCCs risk-based capital guidelines
generally require national banks to have a minimum ratio of
Tier 1 capital to total risk-weighted assets of 4.0% and a
ratio of total capital to total risk-weighted assets of 8.0%. As
of December 31, 2003, the Banks ratio of Tier 1
capital to total risk-weighted assets was 11.66% and its ratio
of total capital to total risk-weighted assets was 12.92%.

The OCCs leverage guidelines require
national banks to maintain Tier 1 capital of no less than
4.0% of average total assets, except in the case of certain
highly rated banks for which the requirement is 3.0% of average
total assets unless a higher leverage capital ratio is warranted
by the particular circumstances or risk profile of the
depository institution. As of December 31, 2003, the
Banks ratio of Tier 1 capital to average total assets
(leverage ratio) was 8.30%.

Corrective Measures for Capital
Deficiencies.The federal banking
regulators are required to take prompt corrective
action with respect to capital-deficient institutions.
Agency regulations define, for each capital category, the levels
at which institutions are well capitalized,
adequately capitalized, under
capitalized, significantly under capitalized
and critically under capitalized. A well
capitalized bank has a total risk-based capital ratio of
10.0% or higher; a Tier 1 risk-based capital ratio of 6.0%
or higher; a leverage ratio of 5.0% or higher; and is not
subject to any written agreement, order or directive requiring
it to maintain a specific capital level for any capital measure.
An adequately capitalized bank has a total
risk-based capital ratio of 8.0% or higher; a Tier 1
risk-based capital ratio of 4.0% or higher; a leverage ratio of
4.0% or higher (3.0% or higher if the bank was rated a composite
1 in its most recent examination report and is not experiencing
significant growth); and does not meet the criteria for a well
capitalized bank. A bank is under capitalized if it
fails to meet any one of the ratios required to be adequately
capitalized.

In addition to requiring undercapitalized
institutions to submit a capital restoration plan, agency
regulations authorize broad restrictions on certain activities
of undercapitalized institutions including asset growth,
acquisitions, branch establishment, and expansion into new lines
of business. With certain exceptions, an insured depository
institution is prohibited from making capital distributions,
including dividends, and is prohibited from paying management
fees to control persons if the institution would be
undercapitalized after any such distribution or payment.

As an institutions capital decreases, the
OCCs enforcement powers become more severe. A
significantly undercapitalized institution is subject to
mandated capital raising activities, restrictions on interest
rates paid and transactions with affiliates, removal of
management, and other restrictions. The OCC has only very

10



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##### Table of Contents



limited discretion in dealing with a critically
undercapitalized institution and is virtually required to
appoint a receiver or conservator.


Banks with risk-based capital and leverage ratios
below the required minimums may also be subject to certain
administrative actions, including the termination of deposit
insurance upon notice and hearing, or a temporary suspension of
insurance without a hearing in the event the institution has no
tangible capital.

Deposit Insurance
Assessments.The Bank must pay
assessments to the FDIC for federal deposit insurance
protection. The FDIC has adopted a risk-based assessment system
as required by FDICIA. Under this system, FDIC-insured
depository institutions pay insurance premiums at rates based on
their risk classification. Institutions assigned to higher-risk
classifications (that is, institutions that pose a greater risk
of loss to their respective deposit insurance funds) pay
assessments at higher rates than institutions that pose a lower
risk. An institutions risk classification is assigned
based on its capital levels and the level of supervisory concern
the institution poses to the regulators. In addition, the FDIC
can impose special assessments in certain instances.

The FDIC established a process for raising or
lowering all rates for insured institutions semi-annually if
conditions warrant a change. Under this new system, the FDIC has
the flexibility to adjust the assessment rate schedule twice a
year without seeking prior public comment, but only within a
range of five cents per $100 above or below the assessment
schedule adopted. Changes in the rate schedule outside the
five-cent range above or below the current schedule can be made
by the FDIC only after a full rulemaking with opportunity for
public comment.

On September 30, 1996, President Clinton
signed into law an act that contained a comprehensive approach
to recapitalizing the Savings Association Insurance Fund
(SAIF) and to assure the payment of the Financing
Corporations (FICO) bond obligations. Under
this act, banks insured under the BIF are required to pay a
portion of the interest due on bonds that were issued by FICO to
help shore up the ailing Federal Savings and Loan Insurance
Corporation in 1987. The BIF rate was required to equal
one-fifth of the SAIF rate through year-end 1999, or until the
insurance funds were merged, whichever occurred first.
Thereafter, BIF and SAIF payers will be assessed pro rata for
the FICO bond obligations. With regard to the assessment for the
FICO obligation, for the first quarter of 2004, the BIF and SAIF
rates were .00154% of deposits.

Enforcement Powers.The FDIC and the other federal banking agencies have broad
enforcement powers, including the power to terminate deposit
insurance, impose substantial fines and other civil and criminal
penalties, and appoint a conservator or receiver. Failure to
comply with applicable laws, regulations and supervisory
agreements could subject the Company or its banking
subsidiaries, as well as officers, directors and other
institution-affiliated parties of these organizations, to
administrative sanctions and potentially substantial civil money
penalties. The appropriate federal banking agency may appoint
the FDIC as conservator or receiver for a banking institution
(or the FDIC may appoint itself, under certain circumstances) if
any one or more of a number of circumstances exist, including,
without limitation, the fact that the banking institution is
undercapitalized and has no reasonable prospect of becoming
adequately capitalized; fails to become adequately capitalized
when required to do so; fails to submit a timely and acceptable
capital restoration plan; or materially fails to implement an
accepted capital restoration plan.

Brokered Deposit
Restrictions.Adequately capitalized
institutions (as defined for purposes of the prompt corrective
action rules described above) cannot accept, renew or roll over
brokered deposits except with a waiver from the FDIC, and are
subject to restrictions on the interest rates that can be paid
on such deposits. Undercapitalized institutions may not accept,
renew, or roll over brokered deposits.

Cross-Guarantee
Provisions.The Financial Institutions
Reform, Recovery and Enforcement Act of 1989
(FIRREA) contains a cross-guarantee
provision which generally makes commonly controlled insured
depository institutions liable to the FDIC for any losses
incurred in connection with the failure of a commonly controlled
depository institution.

Community Reinvestment
Act.The CRA and the regulations
issued thereunder are intended to encourage banks to help meet
the credit needs of their service area, including low and
moderate-income

11



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neighborhoods, consistent with the safe and sound
operations of the banks. These regulations also provide for
regulatory assessment of a banks record in meeting the
needs of its service area when considering applications to
establish branches, merger applications and applications to
acquire the assets and assume the liabilities of another bank.
FIRREA requires federal banking agencies to make public a rating
of a banks performance under the CRA. In the case of a
bank holding company, the CRA performance record of the banks
involved in the transaction are reviewed in connection with the
filing of an application to acquire ownership or control of
shares or assets of a bank or to merge with any other bank
holding company. An unsatisfactory record can substantially
delay or block the transaction.


Consumer Laws and
Regulations.In addition to the laws
and regulations discussed herein, the Bank is also subject to
certain consumer laws and regulations that are designed to
protect consumers in transactions with banks. While the list set
forth herein is not exhaustive, these laws and regulations
include the Truth in Lending Act, the Truth in Savings Act, the
Electronic Funds Transfer Act, the Expedited Funds Availability
Act, the Equal Credit Opportunity Act, and the Fair Housing Act,
among others. These laws and regulations mandate certain
disclosure requirements and regulate the manner in which
financial institutions must deal with customers when taking
deposits or making loans to such customers. The Bank must comply
with the applicable provisions of these consumer protection laws
and regulations as part of their ongoing customer relations.

Privacy.In addition
to expanding the activities in which banks and bank holding
companies may engage, the Gramm-Leach-Bliley Act imposes new
requirements on financial institutions with respect to customer
privacy. The Gramm-Leach-Bliley Act generally prohibits
disclosure of customer information to non-affiliated third
parties unless the customer has been given the opportunity to
object and has not objected to such disclosure. Financial
institutions are further required to disclose their privacy
policies to customers annually. Financial institutions, however,
will be required to comply with state law if it is more
protective of customer privacy than the Gramm-Leach-Bliley Act.
The privacy provisions became effective on July 1, 2002.
The Gramm-Leach-Bliley Act contains a variety of other
provisions including a prohibition against ATM surcharges unless
the customer has first been provided notice of the imposition
and amount of the fee.

USA Patriot Act of
2002.The Uniting and Strengthening
America by Providing Appropriate Tools Required to Intercept and
Obstruct Terrorism (USA Patriot) Act of 2002 was enacted in
October 2002. The USA Patriot Act is intended to strengthen the
ability of U.S. law enforcement and the intelligence
communities to work cohesively to combat terrorism on a variety
of fronts. The potential impact of the USA Patriot Act on
financial institutions of all kinds is significant and wide
ranging. The USA Patriot Act contains a broad range of
anti-money laundering and financial transparency laws and
requires various regulations, including: (i) due diligence
requirements for financial institutions that administer,
maintain, or manage private bank accounts or correspondent
accounts for non-U.S. persons; (ii) standards for
verifying customer identification at account opening;
(iii) rules to promote cooperation among financial
institutions, regulators and law enforcement entities in
identifying parties that may be involved in terrorism or money
laundering; (iv) reports by nonfinancial trades and
business filed with the Treasury Departments Financial
Crimes Enforcement Network for transactions exceeding $10,000;
and (v) filing of suspicious activities reports involving
securities by brokers and dealers if they believe a customer may
be violating U.S. laws and regulations.



| |                                        
| | ---------------------------------------
| | Instability of Regulatory
    Structure

Various legislation and proposals to overhaul the
bank regulatory system and limit the investments that a
depository institution may make with insured funds, is from time
to time introduced in Congress. Such legislation may change
banking statutes and the operating environment of the Company
and its banking subsidiaries in substantial and unpredictable
ways. The Company cannot determine the ultimate effect that
potential legislation, if enacted, or implementing regulations
with respect thereto, would have upon the financial condition or
results of operations of the Company or its subsidiaries.

12



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##### Table of Contents





| |                                    
| | -----------------------------------
| | Expanding Enforcement
    Authority

One of the major additional burdens imposed on
the banking industry by FDICIA is the increased ability of
banking regulators to monitor the activities of banks and their
holding companies. In addition, the Federal Reserve Board and
OCC possess extensive authority to police unsafe or unsound
practices and violations of applicable laws and regulations by
depository institutions and their holding companies. For
example, the FDIC may terminate the deposit insurance of any
institution which it determines has engaged in an unsafe or
unsound practice. The agencies can also assess civil money
penalties, issue cease and desist or removal orders, seek
injunctions, and publicly disclose such actions. FDICIA, FIRREA
and other laws have expanded the agencies authority in
recent years, and the agencies have not yet fully tested the
limits of their powers.



| |                          
| | -------------------------
| | Effect of Monetary Policy

The policies of regulatory authorities, including
the monetary policy of the Federal Reserve Board, have a
significant effect on the operating results of bank holding
companies and their subsidiaries. Among the means available to
the Federal Reserve Board to affect the money supply are open
market operations in U.S. Government securities, changes in
the discount rate or federal funds rate on member bank
borrowings, and changes in reserve requirements against member
bank deposits. These means are used in varying combinations to
influence overall growth and distribution of bank loans,
investments and deposits, and their use may affect interest
rates charged on loans or paid for deposits.

Federal Reserve Board monetary policies have
materially affected the operating results of commercial banks in
the past and are expected to continue to do so in the future.
The nature of future monetary policies and the effect of such
policies on the business and earnings of the Company and its
subsidiaries cannot be predicted.

13



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##### Table of Contents








|        |           
|------- | ----------
|Item 2. | Properties

Facilities

The Company conducts business at 15 locations, 10
of which are leased. Included are 14 full-service banking
locations and the Companys corporate offices. The
following table sets forth specific information on each
location. The Companys headquarters are located at 9600
Bellaire Boulevard, Suite 252, Houston, Texas. The lease
for the Companys corporate headquarters will expire in
December 2008.

|                                    |  |        |        |         |  |                   |        |  |  |   |         | 
|----------------------------------- |  | ------ | ------ | ------- |  | ----------------- | ------ |  |  | - | ------- | 
|                                    |  | Owned/ |        |         |  | Deposits at      
|Location                            |  | Leased |        | Sq. Ft. |  | December 31, 2003
|                                    |  |        |        |         |  |                  
|                                    |  |        |        |         |  | (In thousands)   
|Houston Area:                       |  |        |        |         |  |                   |        |  |  |   |         | 
|Corporate Offices                   |  |        | Leased |         |  |                   | 36,298 |  |  | $ | N/A     | 
|9600 Bellaire Boulevard, Suite 252  |  |        |        |         |  |                   |        |  |  |   |         | 
|Bellaire Boulevard                  |  |        | Leased |         |  |                   | 7,002  |  |  |   | 320,210 | 
|9600 Bellaire Boulevard, Suite 100  |  |        |        |         |  |                   |        |  |  |   |         | 
|East                                |  |        | Owned  |         |  |                   | 16,400 |  |  |   | 81,598  | 
|6730 Capitol at Wayside             |  |        |        |         |  |                   |        |  |  |   |         | 
|Chinatown                           |  |        | Leased |         |  |                   | 2,500  |  |  |   | 30,790  | 
|1005 Saint Emanuel                  |  |        |        |         |  |                   |        |  |  |   |         | 
|Sugar Land                          |  |        | Owned  |         |  |                   | 5,665  |  |  |   | 38,459  | 
|15144 Southwest Freeway             |  |        |        |         |  |                   |        |  |  |   |         | 
|Harwin                              |  |        | Leased |         |  |                   | 2,463  |  |  |   | 31,086  | 
|10000 Harwin Drive                  |  |        |        |         |  |                   |        |  |  |   |         | 
|Clear Lake                          |  |        | Owned  |         |  |                   | 1,986  |  |  |   | 29,985  | 
|2424 Bay Area Boulevard             |  |        |        |         |  |                   |        |  |  |   |         | 
|Veterans Memorial                   |  |        | Owned  |         |  |                   | 5,571  |  |  |   | 30,540  | 
|13480 Veterans Memorial Boulevard   |  |        |        |         |  |                   |        |  |  |   |         | 
|Milam                               |  |        | Leased |         |  |                   | 2,546  |  |  |   | 14,474  | 
|2808 Milam Street                   |  |        |        |         |  |                   |        |  |  |   |         | 
|Boone Road                          |  |        | Leased |         |  |                   | 905    |  |  |   | 9,972   | 
|11205 Bellaire Boulevard, Suite B-9 |  |        |        |         |  |                   |        |  |  |   |         | 
|Dulles                              |  |        | Owned  |         |  |                   | 479    |  |  |   | 18,906  | 
|4635 Highway 6                      |  |        |        |         |  |                   |        |  |  |   |         | 
|Long Point                          |  |        | Leased |         |  |                   | 3,000  |  |  |   | 23,257  | 
|1426 Blalock                        |  |        |        |         |  |                   |        |  |  |   |         | 
|Dallas Area:                        |  |        |        |         |  |                   |        |  |  |   |         | 
|Richardson                          |  |        | Leased |         |  |                   | 4,948  |  |  |   | 62,065  | 
|275 West Campbell Road              |  |        |        |         |  |                   |        |  |  |   |         | 
|Dallas (Harry Hines)                |  |        | Leased |         |  |                   | 6,000  |  |  |   | 24,498  | 
|2527 Royal Lane                     |  |        |        |         |  |                   |        |  |  |   |         | 
|Garland                             |  |        | Leased |         |  |                   | 2,400  |  |  |   | 9,101   | 
|3500 West Walnut Street             |  |        |        |         |  |                   |        |  |  |   |         | 






|        |                  
|------- | -----------------
|Item 3. | Legal Proceedings

Legal Proceedings

In September 2003, Advantage Finance Corporation
(AFC), a subsidiary of the Company that is no longer
active, was served in connection with a lawsuit based on alleged
malicious prosecution and conspiracy.
Also included in the lawsuit are BDO Seidman LLP and the CIT
Group/ Commercial Services, Inc. The plaintiff has filed
his case in both Federal and State courts. In December 2003, the
case was

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##### Table of Contents



dismissed from Federal court and a request for
dismissal from State court is anticipated. An appeal is
expected, however none has been filed to date. Management is
unable to determine whether the outcome will have a material
impact on the Companys financial statements. The lawsuit
does not seek a specified amount.







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

No matters were submitted to a vote of security
holders during the fourth quarter of 2003.




PART II






|        |                                                                          
|------- | -------------------------------------------------------------------------
|Item 5. | Market for Registrants Common Equity
    and Related Shareholder Matters

The Companys Common Stock is listed on the
Nasdaq National Market System (Nasdaq NMS) under the
symbol MCBI. As of March 5, 2004, there were
7,162,990 shares outstanding and approximately
175 shareholders of record. The number of beneficial owners
is unknown to the Company at this time.

The following table presents the high and low
sales prices for the Common Stock reported on the Nasdaq NMS
during the two years ended December 31, 2003:

|               |  |      |       |     |  |   |       | 
|-------------- |  | ---- | ----- | --- |  | - | ----- | 
|               |  | High |       | Low
|               |  |      |       |    
|2003           |  |      |       |     |  |   |       | 
|               |  |      |       |     |  |   |       | 
|Fourth quarter |  | $    | 15.15 |     |  | $ | 12.50 | 
|Third quarter  |  |      | 13.08 |     |  |   | 12.10 | 
|Second quarter |  |      | 14.30 |     |  |   | 11.94 | 
|First quarter  |  |      | 13.00 |     |  |   | 11.60 | 
|              
|2002           |  |      |       |     |  |   |       | 
|               |  |      |       |     |  |   |       | 
|Fourth quarter |  | $    | 12.13 |     |  | $ | 11.40 | 
|Third quarter  |  |      | 12.40 |     |  |   | 11.00 | 
|Second quarter |  |      | 13.50 |     |  |   | 11.65 | 
|First quarter  |  |      | 11.81 |     |  |   | 10.50 | 

Dividends

Holders of Common Stock are entitled to receive
dividends when, and if, declared by the Companys Board of
Directors, out of funds legally available. While the Company has
declared and paid quarterly dividends since the fourth quarter
1998, there is no assurance that the Company will pay dividends
in the future.

The cash dividends paid per share by quarter for
the Companys last two fiscal years were as follows:

|               |  |      |      |      |  |   |      | 
|-------------- |  | ---- | ---- | ---- |  | - | ---- | 
|               |  | 2003 |      | 2002
|               |  |      |      |     
|Fourth quarter |  | $    | 0.06 |      |  | $ | 0.06 | 
|Third quarter  |  |      | 0.06 |      |  |   | 0.06 | 
|Second quarter |  |      | 0.06 |      |  |   | 0.06 | 
|First quarter  |  |      | 0.06 |      |  |   | 0.06 | 

The principal source of cash revenues to the
Company is dividends paid by the Bank with respect to the
Banks capital stock. There are certain restrictions on the
payment of such dividends imposed by federal banking laws,
regulations and authorities. Until capital surplus equals or
exceeds capital, a national bank must transfer to surplus 10% of
its net income for the preceding four quarters in the case of an
annual dividend or 10% of its net income for the preceding two
quarters in the case of a quarterly or semiannual dividend. As
of December 31, 2003, the Banks capital surplus
exceeded its capital stock. Without prior approval, a national

15



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##### Table of Contents



bank may not declare a dividend if the total
amount of all dividends, declared by the bank in any calendar
year exceeds the total of the banks retained net income
for the current year and retained net income for the preceding
two years. As of December 31, 2003, an aggregate of
approximately $15.0 million was available for payment of
dividends by the Bank to the Company under applicable
restrictions, without regulatory approval. Regulatory
authorities could impose administratively stricter limitations
on the ability of the Bank to pay dividends to the Company if
such limits were deemed appropriate to preserve certain capital
adequacy requirements.


In the future, the declaration and payment of
dividends on the Common Stock will depend upon the earnings and
financial condition of the Company, liquidity and capital
requirements, the general economic and regulatory climate, the
Companys ability to service any equity or debt obligations
senior to the Common Stock and other factors deemed relevant by
the Companys Board of Directors.

Securities Authorized for Issuance Under
Equity Compensation Plans

The Company currently has stock options
outstanding. The following table provides information as of
December 31, 2003 regarding the Companys equity
compensation plans under which the Companys equity
securities are authorized for issuance:

EQUITY COMPENSATION PLAN INFORMATION

|                                                               |  |                   |         |                     |  |                         |       |  |  |  |         | 
|-------------------------------------------------------------- |  | ----------------- | ------- | ------------------- |  | ----------------------- | ----- |  |  |  | ------- | 
|                                                               |  | (a)               |         | (b)                 |  | (c)                    
|                                                               |  |                   |         |                     |  |                        
|                                                               |  | Number of         |         |                     |  | Number of Securities   
|                                                               |  | Securities to be  |         |                     |  | Remaining Available for
|                                                               |  | Issued Upon       |         |                     |  | Future Issuance Under  
|                                                               |  | Exercise of       |         |                     |  | Equity Compensation    
|                                                               |  | Outstanding       |         | Weighted Average    |  | Plans (excluding       
|                                                               |  | Options, Warrants |         | Exercise Price of   |  | securities reflected in
|Plan Category                                                  |  | and Rights        |         | Outstanding Options |  | column (a))            
|                                                               |  |                   |         |                     |  |                        
|Equity compensation plans approved by security
    holders     |  |                   | 212,000 |                     |  | $                       | 11.10 |  |  |  | 477,500 | 
|Equity compensation plans not approved by
    security holders |  |                   |        |                     |  |                         |      |  |  |  |        | 
|                                                               |  |                   |         |                     |  |                         |       |  |  |  |         | 
|Total                                                          |  |                   | 212,000 |                     |  | $                       | 11.10 |  |  |  | 477,500 | 
|                                                               |  |                   |         |                     |  |                         |       |  |  |  |         | 

16



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|        |                                         
|------- | ----------------------------------------
|Item 6. | Selected Consolidated Financial
    Data

The following Selected Consolidated Financial
Data of the Company should be read in conjunction with the
consolidated financial statements of the Company, and the
accompanying notes, appearing elsewhere in this Annual Report on
Form 10-K, and the information contained in
Item 7, Managements Discussion and Analysis of
Financial Condition and Results of Operations. The
selected historical consolidated financial data as of and for
each of the five years ended December 31, 2003 is derived
from the Companys Consolidated Financial Statements which
have been audited by independent accountants. Certain prior year
amounts have been reclassified to conform with the 2003
presentation.

|                                                        |                                                         |                                               |         |        |  |      |         |        |  |      |         |        |  |   |         |        |  |   |         |        | 
|------------------------------------------------------- | ------------------------------------------------------- | --------------------------------------------- | ------- | ------ |  | ---- | ------- | ------ |  | ---- | ------- | ------ |  | - | ------- | ------ |  | - | ------- | ------ | 
|                                                        |                                                         |                                              
|                                                        |                                                         | Years Ended December 31,                     
|                                                        |                                                         |                                              
|                                                        |                                                         | 2003                                          |         | 2002   |  | 2001 |         | 2000   |  | 1999
|                                                        |                                                         |                                               |         |        |  |      |         |        |  |     
|                                                        |                                                         |                                              
|                                                        |                                                         | (Dollars in thousands, except per share data)
|Income Statement Data:                                  |                                                         |                                               |         |        |  |      |         |        |  |      |         |        |  |   |         |        |  |   |         |       
|                                                        |                                                         |                                               |         |        |  |      |         |        |  |      |         |        |  |   |         |        |  |   |         |       
|Interest income                                         |                                                         | $                                             | 43,838  |        |  | $    | 48,711  |        |  | $    | 55,451  |        |  | $ | 63,466  |        |  | $ | 53,668  |       
|Interest expense                                        |                                                         |                                               | 12,134  |        |  |      | 14,628  |        |  |      | 23,799  |        |  |   | 27,276  |        |  |   | 21,026  |       
|                                                        |                                                         |                                               |         |        |  |      |         |        |  |      |         |        |  |   |         |        |  |   |         |       
|                                                        | Net interest income                                     |                                               |         | 31,704 |  |      |         | 34,083 |  |      |         | 31,652 |  |   |         | 36,190 |  |   |         | 32,642 | 
|Provision for loan losses                               |                                                         |                                               | 5,690   |        |  |      | 3,853   |        |  |      | 3,799   |        |  |   | 7,508   |        |  |   | 5,550   |       
|                                                        |                                                         |                                               |         |        |  |      |         |        |  |      |         |        |  |   |         |        |  |   |         |       
|                                                        | Net interest income after provision for loan
    losses |                                               |         | 26,014 |  |      |         | 30,230 |  |      |         | 27,853 |  |   |         | 28,682 |  |   |         | 27,092 | 
|Noninterest income                                      |                                                         |                                               | 8,927   |        |  |      | 8,967   |        |  |      | 8,660   |        |  |   | 7,032   |        |  |   | 6,088   |       
|Noninterest expense                                     |                                                         |                                               | 29,704  |        |  |      | 26,058  |        |  |      | 25,383  |        |  |   | 27,230  |        |  |   | 22,412  |       
|                                                        |                                                         |                                               |         |        |  |      |         |        |  |      |         |        |  |   |         |        |  |   |         |       
|                                                        | Income before provision for income taxes                |                                               |         | 5,237  |  |      |         | 13,139 |  |      |         | 11,130 |  |   |         | 8,484  |  |   |         | 10,768 | 
|Provision for income taxes                              |                                                         |                                               | 1,529   |        |  |      | 4,350   |        |  |      | 3,553   |        |  |   | 3,001   |        |  |   | 3,638   |       
|                                                        |                                                         |                                               |         |        |  |      |         |        |  |      |         |        |  |   |         |        |  |   |         |       
|Net income                                              |                                                         | $                                             | 3,708   |        |  | $    | 8,789   |        |  | $    | 7,577   |        |  | $ | 5,483   |        |  | $ | 7,130   |       
|                                                        |                                                         |                                               |         |        |  |      |         |        |  |      |         |        |  |   |         |        |  |   |         |       
|                                                       
|Per Share Data:                                         |                                                         |                                               |         |        |  |      |         |        |  |      |         |        |  |   |         |        |  |   |         |       
|                                                        |                                                         |                                               |         |        |  |      |         |        |  |      |         |        |  |   |         |        |  |   |         |       
|Net income:                                             |                                                         |                                               |         |        |  |      |         |        |  |      |         |        |  |   |         |        |  |   |         |       
|                                                        | Basic                                                   |                                               | $       | 0.52   |  |      | $       | 1.25   |  |      | $       | 1.08   |  |   | $       | 0.79   |  |   | $       | 1.00   | 
|                                                        | Diluted                                                 |                                               |         | 0.51   |  |      |         | 1.23   |  |      |         | 1.07   |  |   |         | 0.79   |  |   |         | 1.00   | 
|Book value                                              |                                                         |                                               | 10.65   |        |  |      | 10.59   |        |  |      | 9.32    |        |  |   | 8.42    |        |  |   | 7.38    |       
|Tangible book value                                     |                                                         |                                               | 10.65   |        |  |      | 10.59   |        |  |      | 9.32    |        |  |   | 8.42    |        |  |   | 7.38    |       
|Cash dividends                                          |                                                         |                                               | 0.24    |        |  |      | 0.24    |        |  |      | 0.24    |        |  |   | 0.24    |        |  |   | 0.24    |       
|Weighted average shares outstanding (in
    thousands): |                                                         |                                               |         |        |  |      |         |        |  |      |         |        |  |   |         |        |  |   |         |       
|                                                        | Basic                                                   |                                               |         | 7,089  |  |      |         | 7,024  |  |      |         | 6,998  |  |   |         | 6,972  |  |   |         | 7,114  | 
|                                                        | Diluted                                                 |                                               |         | 7,213  |  |      |         | 7,154  |  |      |         | 7,059  |  |   |         | 6,973  |  |   |         | 7,114  | 
|                                                       
|Balance Sheet Data (Period End):                        |                                                         |                                               |         |        |  |      |         |        |  |      |         |        |  |   |         |        |  |   |         |       
|                                                        |                                                         |                                               |         |        |  |      |         |        |  |      |         |        |  |   |         |        |  |   |         |       
|Total assets                                            |                                                         | $                                             | 864,773 |        |  | $    | 840,065 |        |  | $    | 742,174 |        |  | $ | 736,757 |        |  | $ | 660,589 |       
|Securities                                              |                                                         |                                               | 262,264 |        |  |      | 264,418 |        |  |      | 176,230 |        |  |   | 143,759 |        |  |   | 110,065 |       
|Total loans                                             |                                                         |                                               | 553,783 |        |  |      | 527,759 |        |  |      | 493,145 |        |  |   | 483,738 |        |  |   | 495,669 |       
|Allowance for loan losses                               |                                                         |                                               | 10,448  |        |  |      | 10,150  |        |  |      | 8,903   |        |  |   | 9,271   |        |  |   | 7,537   |       
|Total deposits                                          |                                                         |                                               | 724,941 |        |  |      | 691,361 |        |  |      | 642,751 |        |  |   | 625,906 |        |  |   | 544,436 |       
|Other borrowings                                        |                                                         |                                               | 54,173  |        |  |      | 65,774  |        |  |      | 25,195  |        |  |   | 25,573  |        |  |   | 55,636  |       
|Total shareholders equity                              |                                                         |                                               | 76,210  |        |  |      | 74,463  |        |  |      | 65,229  |        |  |   | 58,701  |        |  |   | 52,580  |       

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|                                                              |  |                                               |         |      |  |      |         |      |  |      |         |   |  |   |         |   |  |   |         |  
|------------------------------------------------------------- |  | --------------------------------------------- | ------- | ---- |  | ---- | ------- | ---- |  | ---- | ------- | - |  | - | ------- | - |  | - | ------- | -
|                                                              |  |                                              
|                                                              |  | Years Ended December 31,                     
|                                                              |  |                                              
|                                                              |  | 2003                                          |         | 2002 |  | 2001 |         | 2000 |  | 1999
|                                                              |  |                                               |         |      |  |      |         |      |  |     
|                                                              |  |                                              
|                                                              |  | (Dollars in thousands, except per share data)
|Balance Sheet Data (Average):                                 |  |                                               |         |      |  |      |         |      |  |      |         |   |  |   |         |   |  |   |         |  
|                                                              |  |                                               |         |      |  |      |         |      |  |      |         |   |  |   |         |   |  |   |         |  
|Total assets                                                  |  | $                                             | 851,960 |      |  | $    | 790,752 |      |  | $    | 727,841 |   |  | $ | 698,209 |   |  | $ | 620,646 |  
|Securities                                                    |  |                                               | 251,828 |      |  |      | 222,752 |      |  |      | 159,416 |   |  |   | 127,865 |   |  |   | 119,952 |  
|Total loans                                                   |  |                                               | 549,610 |      |  |      | 505,495 |      |  |      | 474,986 |   |  |   | 486,549 |   |  |   | 456,653 |  
|Allowance for loan losses                                     |  |                                               | 10,595  |      |  |      | 9,238   |      |  |      | 9,315   |   |  |   | 8,589   |   |  |   | 6,720   |  
|Total deposits                                                |  |                                               | 708,575 |      |  |      | 656,824 |      |  |      | 626,970 |   |  |   | 590,217 |   |  |   | 501,808 |  
|Other borrowings                                              |  |                                               | 60,309  |      |  |      | 53,056  |      |  |      | 25,570  |   |  |   | 42,757  |   |  |   | 58,037  |  
|Total shareholders equity                                    |  |                                               | 75,306  |      |  |      | 70,607  |      |  |      | 63,539  |   |  |   | 53,462  |   |  |   | 53,010  |  
|                                                             
|Performance Ratios:                                           |  |                                               |         |      |  |      |         |      |  |      |         |   |  |   |         |   |  |   |         |  
|                                                              |  |                                               |         |      |  |      |         |      |  |      |         |   |  |   |         |   |  |   |         |  
|Return on average assets                                      |  |                                               | 0.44    | %    |  |      | 1.11    | %    |  |      | 1.04    | % |  |   | 0.79    | % |  |   | 1.15    | %
|Return on average equity                                      |  |                                               | 4.92    |      |  |      | 12.45   |      |  |      | 11.92   |   |  |   | 10.26   |   |  |   | 13.52   |  
|Net interest margin                                           |  |                                               | 3.89    |      |  |      | 4.54    |      |  |      | 4.64    |   |  |   | 5.57    |   |  |   | 5.55    |  
|Efficiency ratio(1)                                           |  |                                               | 73.11   |      |  |      | 60.53   |      |  |      | 62.97   |   |  |   | 62.98   |   |  |   | 57.92   |  
|                                                             
|Asset Quality Ratios:                                         |  |                                               |         |      |  |      |         |      |  |      |         |   |  |   |         |   |  |   |         |  
|                                                              |  |                                               |         |      |  |      |         |      |  |      |         |   |  |   |         |   |  |   |         |  
|Nonperforming assets to total loans and other
    real estate |  |                                               | 5.08    | %    |  |      | 3.55    | %    |  |      | 1.13    | % |  |   | 0.62    | % |  |   | 1.42    | %
|Nonperforming assets to total assets                          |  |                                               | 3.27    |      |  |      | 2.24    |      |  |      | 0.75    |   |  |   | 0.40    |   |  |   | 1.07    |  
|Net loan charge-offs to total loans                           |  |                                               | 0.97    |      |  |      | 0.49    |      |  |      | 0.84    |   |  |   | 1.19    |   |  |   | 0.90    |  
|Allowance for loan losses to total loans                      |  |                                               | 1.89    |      |  |      | 1.92    |      |  |      | 1.81    |   |  |   | 1.92    |   |  |   | 1.52    |  
|Allowance for loan losses to nonperforming
    loans(2)       |  |                                               | 40.64   |      |  |      | 57.71   |      |  |      | 250.86  |   |  |   | 416.67  |   |  |   | 115.03  |  
|                                                             
|Capital Ratios:                                               |  |                                               |         |      |  |      |         |      |  |      |         |   |  |   |         |   |  |   |         |  
|                                                              |  |                                               |         |      |  |      |         |      |  |      |         |   |  |   |         |   |  |   |         |  
|Leverage ratio(3)                                             |  |                                               | 8.84    | %    |  |      | 8.58    | %    |  |      | 8.91    | % |  |   | 8.39    | % |  |   | 8.80    | %
|Average shareholders equity to average
    total assets      |  |                                               | 8.84    |      |  |      | 8.93    |      |  |      | 8.73    |   |  |   | 7.66    |   |  |   | 8.54    |  
|Tier-1 risk-based capital ratio 
    period end              |  |                                               | 12.42   |      |  |      | 12.71   |      |  |      | 12.50   |   |  |   | 11.74   |   |  |   | 11.41   |  
|Total risk-based capital ratio  period
    end               |  |                                               | 13.67   |      |  |      | 13.97   |      |  |      | 13.76   |   |  |   | 13.00   |   |  |   | 12.66   |  

---

|    |                                                                                                                              
|--- | -----------------------------------------------------------------------------------------------------------------------------
|(1) | Calculated by dividing total noninterest expense
    by net interest income plus noninterest income.                         
|(2) | Nonperforming loans consist of nonaccrual loans,
    loans contractually past due 90 days or more and
    restructured loans.
|(3) | The leverage ratio is calculated by dividing
    Tier 1 capital by average assets at period end.                             





|        |                                                                                          
|------- | -----------------------------------------------------------------------------------------
|Item 7. | Managements Discussion and Analysis
    of Financial Condition and Results of Operations

Managements Discussion and Analysis of
Financial Condition and Results of Operations of the Company
analyzes the major elements of the Companys balance sheets
and statements of operations. This section should be read in
conjunction with the Companys Consolidated Financial
Statements and accompanying notes and other detailed information
appearing elsewhere in this document.

18



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##### Table of Contents



For the Years Ended December 31, 2003,
2002 and 2001

Overview

The Company, primarily through the Bank,
generates earnings from several sources. First, the Bank
attracts customer deposits through its fourteen branches located
in Houston and Dallas. The types of deposits vary from
noninterest-bearing demand deposit transaction accounts to
interest-bearing NOW and money market transaction accounts,
savings accounts, and various termed time deposits such as
certificates of deposit (CDs) and individual
retirement accounts (IRAs). With the funds
attracted from the communities surrounding the branches, the
Bank originates loans to individuals and small businesses to
finance business operations, purchases of real estate, or other
business opportunities. The Banks net interest income
represents the difference between the interest income earned on
loans and securities and the interest expense paid on customer
deposits and other borrowed funds. Interest rate fluctuations,
as well as changes in the amount and type of earning assets and
liabilities, combine to affect net interest income. This
represents the primary source of income generated by the Bank
during each fiscal year and can be found on the Statement of
Income under net interest income.

To compliment the foregoing earnings, the Bank
also earns fee income from both deposits and loans through
service fees and charges collected from customers. Generally,
the Bank receives the greater portion of its fees from its
deposit customers in the form of service fees, nonsufficient
funds (NSF) fees, and other fees for services
provided to the customer. Loan fees are generally earned from
late charges, administrative document and processing fees, and
other loan-related type fees. The fees collected by the Bank may
be found on the Statement of Income under noninterest
income.

The Bank may also generate earnings through the
sale of loans and securities which are categorized on the
Balance Sheet as held-for-sale or
available-for-sale. While it is not uncommon to see
such gains, they are generally not consistent throughout the
year. This inconsistency is directly related to the availability
and/or the market for these types of assets that the bank might
want to sell.

Offsetting these earnings are operating expenses
referred to as noninterest expense. Because banking
is a very people intensive industry, the largest of the
Banks operating expenses is salaries and benefits.

Total assets at December 31, 2003 were
$864.8 million, an increase of $24.7 million or 2.9%
compared to $840.1 million at December 31, 2002. Total
loans at December 31, 2003 were $553.8 million, an
increase of $26.0 million or 4.9% compared to
$527.8 million at December 31, 2002. Investment
securities at December 31, 2003 were $262.3 million,
down $2.1 million or 0.8% from $264.4 million at
December 31, 2002. Total deposits at December 31, 2003
were $724.9 million, an increase of $33.5 million or
4.9% compared to $691.4 million at December 31, 2002.
Other borrowings at December 31, 2003 were
$54.2 million, down $11.6 million or 17.6% compared to
$65.8 million at December 31, 2002.

Total assets at December 31, 2002 were
$840.1 million, an increase of $97.9 million or 13.2%
compared to $742.2 million at December 31, 2001.
Growth in loans and investment securities accounted for the
majority of the Companys asset growth during this period,
increasing to $527.8 million and $264.4 million,
respectively, at December 31, 2002 from $493.1 million
and $176.2 million, respectively, at December 31,
2001. Supporting this growth was an increase in deposits and
other borrowings to $691.4 million and $65.8 million,
respectively, at December 31, 2002 from $642.8 million
and $25.2 million, respectively, at December 31, 2001,
an increase of $48.6 million and $40.6 million,
respectively. Shareholders equity at December 31,
2002 was $74.5 million, an increase of $9.3 million or
14.2% compared with $65.2 million at December 31, 2001.

Net income for the years ended December 31,
2003, 2002, and 2001 was $3.7 million, $8.8 million,
and $7.6 million, respectively. Diluted earnings per common
share for the years ended December 31, 2003, 2002, and 2001
were $0.51, $1.23, and $1.07, respectively. The Companys
returns on average assets for the years ended December 31,
2003, 2002, and 2001 were 0.44%, 1.11%, and 1.04, respectively.
The Companys returns on average equity for the same
periods were 4.92%, 12.45%, and 11.92%, respectively. The 2003
decreases in net income, diluted earnings per share, return on
average assets, and return on average equity was primarily

19



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##### Table of Contents



the result of lower net interest income, a higher
provision for loan losses, and lower of cost or market
adjustments on loans held-for-sale.


The 2003 provision for loan losses was
$5.7 million, up $1.8 million or 46.2% compared to
$3.9 million in 2002. In 2003, management determined an
additional provision was needed primarily due to the results of
continued asset quality risk assessment procedures and a 4.9%
increase in the loan portfolio. The loan review process involves
the grading of each loan by its respective loan officer.
Depending on the grade, a loan will be aggregated with other
loans of similar grade and a loss factor is applied to the total
loans in each group to establish the required level of allowance
for loan losses.

In June 2003 the Company transferred the status
of approximately $13.1 million in hospitality-related loans
to held-for-sale. While the Company has not historically made
such transfers, the high concentration of these loans was deemed
necessary to reduce the Companys exposure to credit risk.
In August 2003, an additional $3.9 million in
hospitality-related loans was transferred to held-for-sale.

Results of Operations



| |                    
| | -------------------
| | Net Interest Income

Net interest income represents the amount by
which interest income on interest-earning assets, including
securities and loans, exceeds interest expense incurred on
interest-bearing liabilities, including deposits and other
borrowed funds.

Interest income in 2003, was 10.0% lower than
interest income in 2002, and interest expense in 2003 was 17.0%
lower than interest expense in 2002. Net interest income for
2003 was 7.0% lower than net interest income in 2002 primarily
due to a decrease in the yield on earning assets of
112 basis points that was partially offset by a decrease in
the cost of interest-bearing liabilities of 57 basis
points. The lower net interest income in 2003, compared to 2002,
primarily reflects the current low interest rate environment,
refinancing activity on existing loans, and lower yields on new
earning assets (both loans and investments). The Federal
Reserves interest rate reductions in November 2002 and
June 2003 contributed to the lower yields. However, the effect
of interest rate floors on approximately 64.7% of the loan
portfolio helped to soften the decline in yield on earning
assets. The loans with interest rate floors had a weighted
average yield of approximately 5.88% at December 31, 2003
compared to approximately 61.3% of the loan portfolio with
interest rate floors that had a weighted average yield of
approximately 6.58% at December 31, 2002.

2003 versus 2002.Net interest income in 2003 was $31.7 million compared with
$34.1 million in 2002, a decrease of $2.4 million or
7.0%. The decrease in net interest income for 2003 was primarily
due to a decrease of $4.9 million in interest income that
was partially offset by a decrease of $2.5 million in
interest expense. The net interest spread is the difference
between the yield on earning assets and the cost of
interest-bearing liabilities. The net interest spread in 2003
decreased 55 basis points to 3.41% compared to 3.96% in
2002. The decrease in the net interest spread reflects a
decrease of 112 basis points in the average yield on
earning assets that was partially offset by a decrease of
57 basis points in the average rate paid for
interest-bearing liabilities. The net interest margin is the
difference between the yield on earning assets and the cost of
earning assets. The cost of earning assets is annualized
interest expense divided by average earning assets. The net
interest margin in 2003 decreased 65 basis points to 3.89%
compared to 4.54% in 2002 and primarily reflects the
112 basis point decline in earning asset yield that was
partially offset by a decline in the cost of earning assets of
47 basis points.

Interest income in 2003 was $43.8 million
compared with $48.7 million in 2002, a decrease of
$4.9 million or 10.0%. The decrease in interest income for
2003 was primarily due to the lower interest rate economy, a
lower yield on loans as a result of refinancing, increased
nonaccrual loan balances, and lower yields on the investment
portfolio. Approximately 85.1% of the loans in the loan
portfolio have variable interest rates tied to the prime rate
and are, therefore, sensitive to interest rate movement.
However, at December 31, 2003 approximately 64.7% of the
loans in the loan portfolio had interest rate floors with a
weighted average yield of 5.88%. This was down 70 basis
points from 6.58% at December 31, 2002, primarily as a
result of new loans with floors at lower interest rates in
addition to refinanced floor rates on pre-existing loans. These
floor rates

20



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helped to partially offset the decline in loan
interest rate yield. The average yield on the total loan
portfolio for 2003 was 6.41%, down 110 basis points
compared to 7.51% in 2002. The average yield on the investment
portfolio for 2003 was 3.23%, down 115 basis points
compared to 4.38% in 2002. The yield on average earning assets
for 2003 was 5.37%, down 112 basis points compared to 6.49%
in 2002.


Interest expense in 2003 was $12.1 million
compared to $14.6 million in 2002, a decrease of
$2.5 million or 17.0%. The decrease in interest expense for
2003 was also primarily the result of lower interest rates paid
for interest-bearing liabilities in 2003. The average cost of
interest-bearing liabilities for 2003 was 1.96%, down
57 basis points compared to 2.53% in 2002.

2002 versus 2001.Net interest income in 2002 was $34.1 million compared with
$31.7 million in 2001, an increase of $2.4 million or
7.7%. The increase in net interest income for 2002 was primarily
due to a decrease of $9.1 million in interest expense
partially offset by a decrease of $6.7 million in interest
income. The net interest spread in 2002 improved 20 basis
points to 3.96% compared to 3.76% in 2001. The increase in the
net interest spread reflects a decrease of 185 basis points
in the average rate paid on interest-bearing liabilities that
was partially offset by a decrease of 165 basis points in
the average yield on interest-earning assets. Interest rate
floors on approximately 61.3% of the loan portfolio helped
curtail the decrease in the average yield on total loans. The
net interest margin in 2002 decreased 10 basis points to
4.54% compared to 4.64% in 2001 and was primarily due to the
refinancing of existing loans and the origination of new loans
both at lower interest rates. The Federal Reserves
50 basis point interest rate reduction in November 2002
partially contributed to this decrease.

Interest income in 2002 was $48.7 million
compared with $55.5 million in 2001, a decrease of
$6.7 million or 12.2%. The decrease in interest income in
2002 was primarily due to the lower interest rate economy, a
lower yield on loans as a result of refinancing, increased
nonaccrual loan balances, and lower yields on the investment
portfolio. Approximately 84.0% of the loans in the loan
portfolio had variable interest rates tied to the prime rate and
were, therefore, sensitive to interest rate movement. However,
at December 31, 2002 approximately 61.3% of the loans in
the loan portfolio had interest rate floors with a weighted
average yield of 6.58%. This was down 117 basis points from
7.75% at December 31, 2001, primarily as a result of new
loans with floors at lower interest rates in addition to
refinanced floor rates on pre-existing loans. These floor rates
helped to partially offset the decline in interest rate yield
and therefore, curtail the decline in interest income. The
average yield on the total loan portfolio for 2002 was 7.51%,
down 174 basis points compared to 9.25% in 2001. The
average yield on the investment portfolio for 2002 was 4.38%,
down 120 basis points compared to 5.58% in 2001. The yield
on average earning assets for 2002 was 6.49%, down
165 basis points compared to 8.14% in 2001.

Interest expense in 2002 was $14.6 million
compared to $23.8 million in 2001, a decrease of
$9.2 million or 38.5%. The decrease in interest expense for
2002 was also primarily the result of lower interest rates paid
for deposits in 2002. The average cost of interest-bearing
liabilities for 2002 was 2.53%, down 185 basis points
compared to 4.38% in 2001.

21



---



##### Table of Contents



The following table presents for the periods
indicated the total dollar amount of interest income from
average interest-earning assets and the resulting yields, as
well as the interest expense on average interest-bearing
liabilities, expressed both in dollars and rates. No
tax-equivalent adjustments were made and all average balances
are average daily balances. Nonaccrual loans have been included
in the tables as loans carrying a zero yield with income, if
any, recognized at the end of the loan term.

|                                         |                                                                     |                                            |        |          |         |         |        |             |        |          |      |         |      |             |        |          |         |         |        |        |        |  |      |      |      |   |        |         |         |   |        |        |        |  |      |      |      |  
|---------------------------------------- | ------------------------------------------------------------------- | ------------------------------------------ | ------ | -------- | ------- | ------- | ------ | ----------- | ------ | -------- | ---- | ------- | ---- | ----------- | ------ | -------- | ------- | ------- | ------ | ------ | ------ |  | ---- | ---- | ---- | - | ------ | ------- | ------- | - | ------ | ------ | ------ |  | ---- | ---- | ---- | -
|                                         |                                                                     |                                           
|                                         |                                                                     | Years Ended December 31,                  
|                                         |                                                                     |                                           
|                                         |                                                                     |                                            |        |          |         |        
|                                         |                                                                     | 2003                                       |        | 2002     |         | 2001   
|                                         |                                                                     |                                            |        |          |         |        
|                                         |                                                                     | Average                                    |        | Interest |         | Average |        | Average     |        | Interest |      | Average |      | Average     |        | Interest |         | Average
|                                         |                                                                     | Outstanding                                |        | Earned/  |         | Yield/  |        | Outstanding |        | Earned/  |      | Yield/  |      | Outstanding |        | Earned/  |         | Yield/ 
|                                         |                                                                     | Balance                                    |        | Paid     |         | Rate    |        | Balance     |        | Paid     |      | Rate    |      | Balance     |        | Paid     |         | Rate   
|                                         |                                                                     |                                            |        |          |         |         |        |             |        |          |      |         |      |             |        |          |         |        
|                                         |                                                                     |                                           
|                                         |                                                                     | (Dollars in thousands)                    
|Assets                                   |                                                                     |                                            |        |          |         |         |        |             |        |          |      |         |      |             |        |          |         |         |        |        |        |  |      |      |      |   |        |         |         |   |        |        |        |  |      |     
|Interest-earning assets:                 |                                                                     |                                            |        |          |         |         |        |             |        |          |      |         |      |             |        |          |         |         |        |        |        |  |      |      |      |   |        |         |         |   |        |        |        |  |      |     
|                                         | Total loans                                                         |                                            | $      | 549,610  |         |         | $      | 35,242      |        |          |      | 6.41    | %    |             | $      | 505,495  |         |         | $      | 37,987 |        |  |      | 7.51 | %    |   | $      | 474,986 |         |   | $      | 43,926 |        |  |      | 9.25 | %   
|                                         | Taxable securities                                                  |                                            |        | 227,054  |         |         |        | 7,321       |        |          |      | 3.22    |      |             |        | 195,649  |         |         |        | 9,080  |        |  |      | 4.64 |      |   |        | 132,366 |         |   |        | 8,356  |        |  |      | 6.31 |     
|                                         | Tax-exempt securities                                               |                                            |        | 20,095   |         |         |        | 997         |        |          |      | 4.96    |      |             |        | 23,362   |         |         |        | 1,160  |        |  |      | 4.97 |      |   |        | 23,491  |         |   |        | 1,177  |        |  |      | 5.01 |     
|                                         | Federal funds sold and other temporary investments                  |                                            |        | 18,854   |         |         |        | 278         |        |          |      | 1.47    |      |             |        | 25,843   |         |         |        | 484    |        |  |      | 1.87 |      |   |        | 50,715  |         |   |        | 1,992  |        |  |      | 3.93 |     
|                                         |                                                                     |                                            |        |          |         |         |        |             |        |          |      |         |      |             |        |          |         |         |        |        |        |  |      |      |      |   |        |         |         |   |        |        |        |  |      |     
|                                         |                                                                     | Total interest-earning assets              |        |          | 815,613 |         |        |             | 43,838 |          |      |         | 5.37 | %           |        |          | 750,349 |         |        |        | 48,711 |  |      |      | 6.49 | % |        |         | 681,558 |   |        |        | 55,451 |  |      |      | 8.14 | %
|                                         |                                                                     |                                            |        |          |         |         |        |             |        |          |      |         |      |             |        |          |         |         |        |        |        |  |      |      |      |   |        |         |         |   |        |        |        |  |      |     
|                                         | Less allowance for loan losses                                      |                                            |        | (10,595  | )       |         |        |             |        |          |      |         |      |             |        | (9,238   | )       |         |        |        |        |  |      |      |      |   |        | (9,315  | )       |   |        |        |        |  |      |      |     
|                                         |                                                                     |                                            |        |          |         |         |        |             |        |          |      |         |      |             |        |          |         |         |        |        |        |  |      |      |      |   |        |         |         |   |        |        |        |  |      |     
|                                         | Total interest-earning assets, net of allowance
    for loan losses |                                            |        | 805,018  |         |         |        |             |        |          |      |         |      |             |        | 741,111  |         |         |        |        |        |  |      |      |      |   |        | 672,243 |         |   |        |        |        |  |      |      |     
|Noninterest-earning assets               |                                                                     |                                            | 46,942 |          |         |         |        |             |        |          |      |         |      |             | 49,641 |          |         |         |        |        |        |  |      |      |      |   | 55,598 |         |         |   |        |        |        |  |      |     
|                                         |                                                                     |                                            |        |          |         |         |        |             |        |          |      |         |      |             |        |          |         |         |        |        |        |  |      |      |      |   |        |         |         |   |        |        |        |  |      |     
|                                         |                                                                     | Total assets                               |        | $        | 851,960 |         |        |             |        |          |      |         |      |             |        | $        | 790,752 |         |        |        |        |  |      |      |      |   |        | $       | 727,841 |   |        |        |        |  |      |      |      |  
|                                         |                                                                     |                                            |        |          |         |         |        |             |        |          |      |         |      |             |        |          |         |         |        |        |        |  |      |      |      |   |        |         |         |   |        |        |        |  |      |     
|Liabilities and shareholders
    equity |                                                                     |                                            |        |          |         |         |        |             |        |          |      |         |      |             |        |          |         |         |        |        |        |  |      |      |      |   |        |         |         |   |        |        |        |  |      |     
|Interest-bearing liabilities:            |                                                                     |                                            |        |          |         |         |        |             |        |          |      |         |      |             |        |          |         |         |        |        |        |  |      |      |      |   |        |         |         |   |        |        |        |  |      |     
|                                         | Interest-bearing demand deposits                                    |                                            | $      | 73,987   |         |         | $      | 460         |        |          |      | 0.62    | %    |             | $      | 71,059   |         |         | $      | 837    |        |  |      | 1.18 | %    |   | $      | 54,694  |         |   | $      | 1,209  |        |  |      | 2.21 | %   
|                                         | Saving and money market accounts                                    |                                            |        | 111,867  |         |         |        | 885         |        |          |      | 0.79    |      |             |        | 110,372  |         |         |        | 1,378  |        |  |      | 1.25 |      |   |        | 102,268 |         |   |        | 2,322  |        |  |      | 2.27 |     
|                                         | Time deposits                                                       |                                            |        | 371,500  |         |         |        | 8,942       |        |          |      | 2.41    |      |             |        | 342,707  |         |         |        | 10,595 |        |  |      | 3.09 |      |   |        | 360,370 |         |   |        | 19,003 |        |  |      | 5.27 |     
|                                         | Federal funds purchased                                             |                                            |        | 55       |         |         |        | 1           |        |          |      | 1.82    |      |             |        | 162      |         |         |        | 4      |        |  |      | 2.47 |      |   |        | 1       |         |   |        |       |        |  |      |     |     
|                                         | Other borrowings                                                    |                                            |        | 60,255   |         |         |        | 1,846       |        |          |      | 3.06    |      |             |        | 52,894   |         |         |        | 1,814  |        |  |      | 3.43 |      |   |        | 25,570  |         |   |        | 1,265  |        |  |      | 4.95 |     
|                                         |                                                                     |                                            |        |          |         |         |        |             |        |          |      |         |      |             |        |          |         |         |        |        |        |  |      |      |      |   |        |         |         |   |        |        |        |  |      |     
|                                         |                                                                     | Total interest-bearing liabilities         |        |          | 617,664 |         |        |             | 12,134 |          |      |         | 1.96 | %           |        |          | 577,194 |         |        |        | 14,628 |  |      |      | 2.53 | % |        |         | 542,903 |   |        |        | 23,799 |  |      |      | 4.38 | %
|                                         |                                                                     |                                            |        |          |         |         |        |             |        |          |      |         |      |             |        |          |         |         |        |        |        |  |      |      |      |   |        |         |         |   |        |        |        |  |      |     
|Noninterest-bearing liabilities:         |                                                                     |                                            |        |          |         |         |        |             |        |          |      |         |      |             |        |          |         |         |        |        |        |  |      |      |      |   |        |         |         |   |        |        |        |  |      |     
|                                         | Noninterest-bearing demand deposits                                 |                                            |        | 151,221  |         |         |        |             |        |          |      |         |      |             |        | 132,686  |         |         |        |        |        |  |      |      |      |   |        | 109,638 |         |   |        |        |        |  |      |      |     
|                                         | Other liabilities                                                   |                                            |        | 7,769    |         |         |        |             |        |          |      |         |      |             |        | 10,265   |         |         |        |        |        |  |      |      |      |   |        | 11,761  |         |   |        |        |        |  |      |      |     
|                                         |                                                                     |                                            |        |          |         |         |        |             |        |          |      |         |      |             |        |          |         |         |        |        |        |  |      |      |      |   |        |         |         |   |        |        |        |  |      |     
|                                         |                                                                     | Total liabilities                          |        |          | 776,654 |         |        |             |        |          |      |         |      |             |        |          | 720,145 |         |        |        |        |  |      |      |      |   |        |         | 664,302 |   |        |        |        |  |      |      |      |  
|Shareholders equity                     |                                                                     |                                            | 75,306 |          |         |         |        |             |        |          |      |         |      |             | 70,607 |          |         |         |        |        |        |  |      |      |      |   | 63,539 |         |         |   |        |        |        |  |      |     
|                                         |                                                                     |                                            |        |          |         |         |        |             |        |          |      |         |      |             |        |          |         |         |        |        |        |  |      |      |      |   |        |         |         |   |        |        |        |  |      |     
|                                         |                                                                     | Total liabilities and shareholders equity |        | $        | 851,960 |         |        |             |        |          |      |         |      |             |        | $        | 790,752 |         |        |        |        |  |      |      |      |   |        | $       | 727,841 |   |        |        |        |  |      |      |      |  
|                                         |                                                                     |                                            |        |          |         |         |        |             |        |          |      |         |      |             |        |          |         |         |        |        |        |  |      |      |      |   |        |         |         |   |        |        |        |  |      |     
|Net interest income                      |                                                                     |                                            |        |          |         | $       | 31,704 |             |        |          |      |         |      |             |        |          |         | $       | 34,083 |        |        |  |      |      |      |   |        |         |         | $ | 31,652 |        |        |  |      |     
|                                         |                                                                     |                                            |        |          |         |         |        |             |        |          |      |         |      |             |        |          |         |         |        |        |        |  |      |      |      |   |        |         |         |   |        |        |        |  |      |     
|Net interest spread                      |                                                                     |                                            |        |          |         |         |        |             |        |          | 3.41 | %       |      |             |        |          |         |         |        |        |        |  | 3.96 | %    |      |   |        |         |         |   |        |        |        |  | 3.76 | %   
|Net interest margin                      |                                                                     |                                            |        |          |         |         |        |             |        |          | 3.89 | %       |      |             |        |          |         |         |        |        |        |  | 4.54 | %    |      |   |        |         |         |   |        |        |        |  | 4.64 | %   

22



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##### Table of Contents



The following table presents the dollar amount of
changes in interest income and interest expense for the major
components of interest-earning assets and interest-bearing
liabilities and distinguishes between changes in outstanding
balances and changes in interest rates. For purposes of this
table, changes attributable to both rate and volume have been
allocated to each accordingly.

|                                           |                                                    |                                               |       |               |       |            |        |        |        |      |        |        |        |   |       |       |       |   |        |        |         |   |       |        |        |  
|------------------------------------------ | -------------------------------------------------- | --------------------------------------------- | ----- | ------------- | ----- | ---------- | ------ | ------ | ------ | ---- | ------ | ------ | ------ | - | ----- | ----- | ----- | - | ------ | ------ | ------- | - | ----- | ------ | ------ | -
|                                           |                                                    |                                              
|                                           |                                                    | Years Ended December 31,                     
|                                           |                                                    |                                              
|                                           |                                                    |                                               |       |              
|                                           |                                                    | 2003 vs. 2002                                 |       | 2002 vs. 2001
|                                           |                                                    |                                               |       |              
|                                           |                                                    |                                               |       |               |       |            |        |       
|                                           |                                                    | Increase                                      |       |               |       | Increase   |        |       
|                                           |                                                    | (Decrease)                                    |       |               |       | (Decrease) |        |       
|                                           |                                                    | Due to                                        |       |               |       | Due to     |        |       
|                                           |                                                    |                                               |       |               |       |            |        |       
|                                           |                                                    | Volume                                        |       | Rate          |       | Total      |        | Volume |        | Rate |        | Total 
|                                           |                                                    |                                               |       |               |       |            |        |        |        |      |        |       
|                                           |                                                    |                                              
|                                           |                                                    | (Dollars in thousands)                       
|Interest-earning assets:                   |                                                    |                                               |       |               |       |            |        |        |        |      |        |        |        |   |       |       |       |   |        |        |         |   |       |       
|                                           | Loans                                              |                                               | $     | 3,315         |       |            | $      | (6,060 | )      |      | $      | (2,745 | )      |   | $     | 2,821 |       |   | $      | (8,760 | )       |   | $     | (5,939 | )     
|                                           | Securities                                         |                                               |       | 1,295         |       |            |        | (3,217 | )      |      |        | (1,922 | )      |   |       | 3,989 |       |   |        | (3,282 | )       |   |       | 707    |       
|                                           | Federal funds sold and other temporary investments |                                               |       | (131          | )     |            |        | (75    | )      |      |        | (206   | )      |   |       | (977  | )     |   |        | (531   | )       |   |       | (1,508 | )     
|                                           |                                                    |                                               |       |               |       |            |        |        |        |      |        |        |        |   |       |       |       |   |        |        |         |   |       |       
|                                           |                                                    | Total increase (decrease) in interest income  |       |               | 4,479 |            |        |        | (9,352 | )    |        |        | (4,873 | ) |       |       | 5,833 |   |        |        | (12,573 | ) |       |        | (6,740 | )
|                                           |                                                    |                                               |       |               |       |            |        |        |        |      |        |        |        |   |       |       |       |   |        |        |         |   |       |       
|Interest-bearing liabilities:              |                                                    |                                               |       |               |       |            |        |        |        |      |        |        |        |   |       |       |       |   |        |        |         |   |       |       
|                                           | Interest-bearing demand deposits                   |                                               |       | 34            |       |            |        | (411   | )      |      |        | (377   | )      |   |       | 362   |       |   |        | (734   | )       |   |       | (372   | )     
|                                           | Saving and money market accounts                   |                                               |       | 19            |       |            |        | (512   | )      |      |        | (493   | )      |   |       | 184   |       |   |        | (1,128 | )       |   |       | (944   | )     
|                                           | Time deposits                                      |                                               |       | 890           |       |            |        | (2,543 | )      |      |        | (1,653 | )      |   |       | (931  | )     |   |        | (7,477 | )       |   |       | (8,408 | )     
|                                           | Federal funds purchased                            |                                               |       | (3            | )     |            |        |       |        |      |        | (3     | )      |   |       |      |       |   |        | 4      |         |   |       | 4      |       
|                                           | Other borrowings                                   |                                               |       | 252           |       |            |        | (220   | )      |      |        | 32     |        |   |       | 1,352 |       |   |        | (803   | )       |   |       | 549    |       
|                                           |                                                    |                                               |       |               |       |            |        |        |        |      |        |        |        |   |       |       |       |   |        |        |         |   |       |       
|                                           |                                                    | Total increase (decrease) in interest expense |       |               | 1,192 |            |        |        | (3,686 | )    |        |        | (2,494 | ) |       |       | 967   |   |        |        | (10,138 | ) |       |        | (9,171 | )
|                                           |                                                    |                                               |       |               |       |            |        |        |        |      |        |        |        |   |       |       |       |   |        |        |         |   |       |       
|Increase (decrease) in net interest income |                                                    | $                                             | 3,287 |               |       | $          | (5,666 | )      |        | $    | (2,379 | )      |        | $ | 4,866 |       |       | $ | (2,435 | )      |         | $ | 2,431 |       
|                                           |                                                    |                                               |       |               |       |            |        |        |        |      |        |        |        |   |       |       |       |   |        |        |         |   |       |       



| |                          
| | -------------------------
| | Provision for Loan Losses

Provisions for loan losses are charged to income
to bring the Companys allowance for loan losses to a
target level based on the factors discussed under
 Financial Condition  Allowance for
Loan Losses.

The 2003 provision for loan losses was
$5.7 million, up by $1.8 million or 46.2% compared to
$3.9 million in 2002. In 2003, management determined an
additional provision was needed primarily due to the results of
continued asset quality risk assessment procedures and a 4.9%
increase in the loan portfolio. The loan review process involves
the grading of each loan by its respective loan officer.
Depending on the grade, a loan will be aggregated with other
loans of similar grade and a loss factor is applied to the total
loans in each group to establish the required level of allowance
for loan losses. Grades of 1-10 are applied to each loan where
grades of 7-10 require the most allowance for loan losses.
Factors utilized in the grading process include but are not
limited to historical performance, current status, collateral
value, and financial strength of the borrower. Oversight of the
loan grades is vested with the Loan Review/ Compliance Officer.
Differences of opinion are resolved among the loan officer, loan
review officer, and the chief credit officer.

The ratio of the allowance for loan losses to
total loans at December 31, 2003 was 1.89% compared with
1.92% and 1.81% at December 31, 2002 and 2001,
respectively. The Company strives to maintain its allowance for
loan losses at target levels commensurate with probable losses
inherent in the loan portfolio. Management conducts ongoing risk
assessments that may, from time to time, necessitate varying
levels of allowance for loan losses based on these risk
assessments.

23



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| |                   
| | ------------------
| | Noninterest Income

For the years ended December 31, 2003, 2002
and 2001, noninterest income was $8.9 million,
$9.0 million, and $8.7 million, respectively,
reflecting a decrease of approximately $40,000 in 2003 compared
to 2002, and an increase of $307,000 or 3.5% in 2002 compared to
2001. The service fees category of noninterest income includes
monthly account service charge assessments, non-sufficient funds
charges, and all other traditional non-lending bank service
fees. Service fees for 2003 were $6.5 million, down
$126,000 primarily due to less NSF related activity. Other
loan-related fees for 2003 were $1.0 million, down $74,000
compared to $1.1 million in 2002 primarily due to a
decrease in mortgage brokerage fees of $187,000 that was
partially offset by increases in late charges and SBA servicing
fees of $48,000 and $36,000, respectively. The gain on sale of
SBA loans in 2003 was approximately $460,000, and increase of
$139,000 over 2002.

The following table presents the major categories
of noninterest income:

|                                           |                          |                          |       |       |  |      |       |       |  |   |       |       | 
|------------------------------------------ | ------------------------ | ------------------------ | ----- | ----- |  | ---- | ----- | ----- |  | - | ----- | ----- | 
|                                           |                          |                         
|                                           |                          | Years Ended December 31,
|                                           |                          |                         
|                                           |                          | 2003                     |       | 2002  |  | 2001
|                                           |                          |                          |       |       |  |     
|                                           |                          |                         
|                                           |                          | (Dollars in thousands)  
|Service fees                               |                          | $                        | 6,544 |       |  | $    | 6,670 |       |  | $ | 6,360 |      
|Other loan-related fees                    |                          |                          | 1,009 |       |  |      | 1,083 |       |  |   | 936   |      
|Letters of credit commissions and fees     |                          |                          | 516   |       |  |      | 610   |       |  |   | 655   |      
|Gain on sale of investment securities, net |                          |                          | 165   |       |  |      | 34    |       |  |   | 189   |      
|Gain on sale of loans                      |                          |                          | 600   |       |  |      | 322   |       |  |   | 127   |      
|Other noninterest income                   |                          |                          | 93    |       |  |      | 248   |       |  |   | 393   |      
|                                           |                          |                          |       |       |  |      |       |       |  |   |       |      
|                                           | Total noninterest income |                          | $     | 8,927 |  |      | $     | 8,967 |  |   | $     | 8,660 | 
|                                           |                          |                          |       |       |  |      |       |       |  |   |       |      



| |                    
| | -------------------
| | Noninterest Expense

For the years ended December 31, 2003, 2002
and 2001, noninterest expense was $29.7 million,
$26.1 million, and $25.4 million, respectively,
reflecting an increase of approximately $3.6 million or
14.0% in 2003 compared to 2002, and an increase of $675,000 or
2.7% in 2002 compared to 2001.

The increase in total noninterest expense in 2003
compared to 2002 was primarily due to $437,000 in higher
employee salaries and benefits expense as a result of annual
salary adjustments and $2.1 million in lower of cost or
market adjustments on loans held-for-sale. Legal and
professional fees in 2003, compared to 2002, increased
approximately $987,000 as a result of increased costs related to
matters concerning problem assets. Occupancy and equipment
expense in 2003, compared to 2002, increased approximately
$272,000 and was primarily the result of additional leased space
in the corporate offices. All other categories of noninterest
expense in 2003, compared to 2002, decreased approximately
$199,000.

The increase in total noninterest expense in 2002
compared to 2001 was primarily due to higher employee salaries
and benefits expense as a result of increased staffing levels in
lending operations and compliance functions in addition to the
full-year effect of executive level additions made during the
third and fourth quarters of 2001. With the exception of losses
incurred on net foreclosed assets, generally, all other
categories of noninterest expense decreased in 2002 compared to
2001.

In June 2003, the Company transferred the status
of approximately $13.1 million in hospitality-related loans
to held-for-sale. While the Company has not historically made
such transfers, the high concentration of these loans was deemed
necessary to reduce the Companys exposure to credit risk.
In August 2003, an additional $3.9 million composed of two
restaurant loans totaling $2.6 million and an office
building loan of $1.3 million, was transferred to
held-for-sale. Approximately $11.0 million of the
loans-held-for-sale were sold during 2003 and a gain of
approximately $139,000 was recognized. The remaining
$6.0 million were held-for-sale at December 31, 2003
and are carried at the lower of cost or market. During 2003, the
Company recorded lower of cost or market adjustments of
$2.1 million on the loans held-for-sale. The Company may
consider

24



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##### Table of Contents



future transfers with concentrations in
hospitality and other related loans that may expose the Company
to potential losses.


The efficiency ratio is a measure designed to
show how well a company utilizes its resources and manages its
expenses. The efficiency ratio is calculated by dividing
noninterest expense by net interest income plus noninterest
income. The Companys efficiency ratio for 2003 was 73.11%
and reflects the impact of the lower of cost or market
adjustments on loans held-for-sale and the decline in the net
interest margin. The Companys efficiency ratio for 2002
was 60.53%, an improvement compared to 62.97% for 2001,
primarily as a result of higher net interest income and higher
noninterest income.

Salaries and employee benefits for the years
ended December 31, 2003, 2002 and 2001 was
$15.2 million, $14.7 million, and $13.2 million,
respectively, reflecting an increase of $437,000 or 3.0% in 2003
compared to 2002 and a $1.6 million or 11.9% increase in
2002 compared to 2001. The increase in 2003 versus 2002
primarily reflected the result of annual salary adjustments. The
increase in 2002 versus 2001 primarily reflected the full-year
effect of increased staffing levels in lending operations and
compliance functions in addition to the full-year effect of
executive level additions made during the third and fourth
quarters of 2002. Total full-time equivalent employees
(FTE) at December 31, 2003, 2002 and 2001 were
299, 309, and 298, respectively.

Non-staff expenses for 2003, 2002 and 2001 were
$14.5 million, $11.3 million, and $12.2 million,
respectively, reflecting an increase of $3.2 million in
2003 compared to 2002 and a decrease of $891,000 in 2002
compared to 2001.

The $3.2 million increase in non-staff
expense during 2003 compared to 2002 was primarily due to the
$2.1 million in lower of cost or market adjustments on
loans held-for-sale. Legal and professional fees increased
approximately $987,000 as a result of increased costs related to
matters concerning problem assets. Occupancy and equipment
expense increased approximately $272,000 and was primarily the
result of additional lease space in the corporate offices. All
other categories of noninterest expense in 2003, compared to
2002, decreased approximately $199,000.

The $891,000 decrease in non-staff expense during
2002 compared to 2001 was primarily due to lower legal and
professional fees of $395,000, lower occupancy expense of
$100,000, and lower other noninterest expense of $820,000, that
was partially offset by higher net real estate expense of
$527,000.

The following table presents the major categories
of noninterest expense:

|                               |                                                               |                            |        |       |        |      |        |       |        |   |        |       |        | 
|------------------------------ | ------------------------------------------------------------- | -------------------------- | ------ | ----- | ------ | ---- | ------ | ----- | ------ | - | ------ | ----- | ------ | 
|                               |                                                               |                           
|                               |                                                               | Years Ended December 31,  
|                               |                                                               |                           
|                               |                                                               | 2003                       |        | 2002  |        | 2001
|                               |                                                               |                            |        |       |        |     
|                               |                                                               |                           
|                               |                                                               | (Dollars in thousands)    
|Salaries and employee benefits |                                                               | $                          | 15,183 |       |        | $    | 14,746 |       |        | $ | 13,180 |      
|Non-staff expenses:            |                                                               |                            |        |       |        |      |        |       |        |   |        |      
|                               | Lower of cost or market adjustment on loans
    held-for-sale |                            |        | 2,149 |        |      |        |      |        |   |        |      |       
|                               | Occupancy and equipment                                       |                            |        | 5,361 |        |      |        | 5,089 |        |   |        | 5,189 |       
|                               | Foreclosed assets, net                                        |                            |        | 248   |        |      |        | 680   |        |   |        | 153   |       
|                               | Data processing                                               |                            |        | 99    |        |      |        | 94    |        |   |        | 86    |       
|                               | Legal and professional fees                                   |                            |        | 1,555 |        |      |        | 568   |        |   |        | 963   |       
|                               | Advertising                                                   |                            |        | 244   |        |      |        | 314   |        |   |        | 426   |       
|                               | Printing and supplies                                         |                            |        | 597   |        |      |        | 572   |        |   |        | 526   |       
|                               | Telecommunications                                            |                            |        | 500   |        |      |        | 578   |        |   |        | 623   |       
|                               | Other noninterest expense                                     |                            |        | 3,768 |        |      |        | 3,417 |        |   |        | 4,237 |       
|                               |                                                               |                            |        |       |        |      |        |       |        |   |        |      
|                               |                                                               | Total non-staff expenses   |        |       | 14,521 |      |        |       | 11,312 |   |        |       | 12,203 | 
|                               |                                                               |                            |        |       |        |      |        |       |        |   |        |      
|                               |                                                               | Total noninterest expenses |        | $     | 29,704 |      |        | $     | 26,058 |   |        | $     | 25,383 | 
|                               |                                                               |                            |        |       |        |      |        |       |        |   |        |      

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| |             
| | ------------
| | Income Taxes

Income tax expense includes the regular federal
income tax at the statutory rate plus the income tax component
of the Texas franchise tax. The amount of federal income tax
expense is influenced by the amount of taxable income, the
amount of tax-exempt income, the amount of non-deductible
interest expense and the amount of other non-deductible
expenses. Taxable income for the income tax component of the
Texas franchise tax is the federal pre-tax income, plus certain
officers salaries, less interest income on federal
securities.

Income tax expense is influenced by the level and
mix of taxable and tax-exempt income and the amount of
non-deductible interest and other expenses. Income tax expense
for 2003 was $1.5 million, down approximately
$2.8 million or 64.9% from income tax of $4.4 million
in 2002. Income tax expense for 2002 was up approximately
$797,000 or 22.4% from income tax expense of $3.6 million
in 2001. The effective income tax rates in 2003, 2002 and 2001
were 29.2%, 33.1%, and 31.9%, respectively. The effective income
tax rate in 2003 was lower due to a higher percentage of
non-taxable income, primarily from tax-exempt securities, to
pre-tax income.

The Texas franchise tax was $185,000, $57,000,
and $345,800, in 2003, 2002, and 2001, respectively. In 2002,
the Company received a franchise tax refund as a result of a
franchise tax audit conducted on tax years 1999, 2001, and 2002.



| |                    
| | -------------------
| | Impact of Inflation

The effects of inflation on the local economy and
on the Companys operating results have been relatively
modest for the past several years. Since substantially all of
the Companys assets and liabilities are monetary in
nature, such as cash, securities, loans and deposits, their
values are less sensitive to the effects of inflation than to
changing interest rates, which do not necessarily change in
accordance with inflation rates. The Company tries to control
the impact of interest rate fluctuations by managing the
relationship between its interest rate sensitive assets and
liabilities. See  Financial
Condition  Interest Rate Sensitivity and
Liquidity.

Financial Condition



| |               
| | --------------
| | Loan Portfolio

Total loans, which include approximately
$6.0 million in loans held-for-sale, were
$553.8 million at December 31, 2003, up
$26.0 million or 4.9% from $527.8 million at
December 31, 2002. The increase in 2003 represented growth
of $7.1 million in commercial and industrial loans,
$18.8 million in real estate loans, and $161,000 in
consumer and other loans. Total loans were $527.8 million
at December 31, 2002, an increase of $34.7 million or
7.0% from $493.1 million at December 31, 2001. The
$34.7 million increase in 2002 compared to 2001 reflected
increases of $12.5 million in commercial and industrial
loans, $23.3 million in real estate loans, that was
partially offset by a decrease of $1.1 million in consumer
and other loans.

For the years ended December 31, 2003, 2002,
and 2001, the ratios of total loans to total deposits were
76.4%, 76.3%, and 76.7%, respectively. For the same periods,
total loans represented 64.0%, 62.8%, and 66.4%, of total
assets, respectively.

26



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##### Table of Contents



The following table summarizes the loan portfolio
of the Company by type of loan:

|                                                         |             |                        |         |         |  |        |        |         |  |        |         |         |  |        |        |         |  |        |         |         |  |  |        |       |  |   |         |         |  |  |        |       |  |   |         |         |  |  |        |       | 
|-------------------------------------------------------- | ----------- | ---------------------- | ------- | ------- |  | ------ | ------ | ------- |  | ------ | ------- | ------- |  | ------ | ------ | ------- |  | ------ | ------- | ------- |  |  | ------ | ----- |  | - | ------- | ------- |  |  | ------ | ----- |  | - | ------- | ------- |  |  | ------ | ----- | 
|                                                         |             |                       
|                                                         |             | As of December 31,    
|                                                         |             |                       
|                                                         |             |                        |         |         |  |        |        |         |  |       
|                                                         |             | 2003                   |         | 2002    |  | 2001   |        | 2000    |  | 1999  
|                                                         |             |                        |         |         |  |        |        |         |  |       
|                                                         |             | Amount                 |         | Percent |  | Amount |        | Percent |  | Amount |         | Percent |  | Amount |        | Percent |  | Amount |         | Percent
|                                                         |             |                        |         |         |  |        |        |         |  |        |         |         |  |        |        |         |  |        |         |        
|                                                         |             |                       
|                                                         |             | (Dollars in thousands)
|Commercial and industrial                                |             | $                      | 332,480 |         |  |        | 59.36  | %       |  | $      | 325,424 |         |  |        | 60.94  | %       |  | $      | 312,899 |         |  |  | 62.67  | %     |  | $ | 298,134 |         |  |  | 60.92  | %     |  | $ | 298,150 |         |  |  | 59.55  | %    
|Real estate mortgage:                                    |             |                        |         |         |  |        |        |         |  |        |         |         |  |        |        |         |  |        |         |         |  |  |        |       |  |   |         |         |  |  |        |       |  |   |         |         |  |  |        |      
|                                                         | Residential |                        |         | 14,315  |  |        |        | 2.56    |  |        |         | 7,326   |  |        |        | 1.37    |  |        |         | 7,833   |  |  |        | 1.57  |  |   |         | 10,141  |  |  |        | 2.07  |  |   |         | 10,934  |  |  |        | 2.18  | 
|                                                         | Commercial  |                        |         | 178,290 |  |        |        | 31.83   |  |        |         | 165,608 |  |        |        | 31.01   |  |        |         | 131,022 |  |  |        | 26.24 |  |   |         | 128,242 |  |  |        | 26.20 |  |   |         | 126,363 |  |  |        | 25.24 | 
|                                                         |             |                        |         |         |  |        |        |         |  |        |         |         |  |        |        |         |  |        |         |         |  |  |        |       |  |   |         |         |  |  |        |       |  |   |         |         |  |  |        |      
|                                                         |             |                        | 192,605 |         |  |        | 34.39  |         |  |        | 172,934 |         |  |        | 32.38  |         |  |        | 138,855 |         |  |  | 27.81  |       |  |   | 138,383 |         |  |  | 28.27  |       |  |   | 137,297 |         |  |  | 27.42  |      
|                                                         |             |                        |         |         |  |        |        |         |  |        |         |         |  |        |        |         |  |        |         |         |  |  |        |       |  |   |         |         |  |  |        |       |  |   |         |         |  |  |        |      
|Real estate construction:                                |             |                        |         |         |  |        |        |         |  |        |         |         |  |        |        |         |  |        |         |         |  |  |        |       |  |   |         |         |  |  |        |       |  |   |         |         |  |  |        |      
|                                                         | Residential |                        |         | 12,652  |  |        |        | 2.26    |  |        |         | 10,589  |  |        |        | 1.99    |  |        |         | 5,962   |  |  |        | 1.19  |  |   |         | 7,542   |  |  |        | 1.54  |  |   |         | 11,348  |  |  |        | 2.27  | 
|                                                         | Commercial  |                        |         | 11,906  |  |        |        | 2.12    |  |        |         | 14,805  |  |        |        | 2.76    |  |        |         | 30,215  |  |  |        | 6.05  |  |   |         | 32,059  |  |  |        | 6.55  |  |   |         | 28,661  |  |  |        | 5.72  | 
|                                                         |             |                        |         |         |  |        |        |         |  |        |         |         |  |        |        |         |  |        |         |         |  |  |        |       |  |   |         |         |  |  |        |       |  |   |         |         |  |  |        |      
|                                                         |             |                        | 24,558  |         |  |        | 4.38   |         |  |        | 25,394  |         |  |        | 4.75   |         |  |        | 36,177  |         |  |  | 7.24   |       |  |   | 39,601  |         |  |  | 8.09   |       |  |   | 40,009  |         |  |  | 7.99   |      
|                                                         |             |                        |         |         |  |        |        |         |  |        |         |         |  |        |        |         |  |        |         |         |  |  |        |       |  |   |         |         |  |  |        |       |  |   |         |         |  |  |        |      
|Consumer and other                                       |             |                        | 10,447  |         |  |        | 1.87   |         |  |        | 10,286  |         |  |        | 1.93   |         |  |        | 11,364  |         |  |  | 2.28   |       |  |   | 11,986  |         |  |  | 2.45   |       |  |   | 11,550  |         |  |  | 2.31   |      
|Factored receivables                                     |             |                        |        |         |  |        |       |         |  |        |        |         |  |        |       |         |  |        |        |         |  |  |       |       |  |   | 1,297   |         |  |  | 0.27   |       |  |   | 13,700  |         |  |  | 2.73   |      
|                                                         |             |                        |         |         |  |        |        |         |  |        |         |         |  |        |        |         |  |        |         |         |  |  |        |       |  |   |         |         |  |  |        |       |  |   |         |         |  |  |        |      
|Gross loans                                              |             |                        | 560,090 |         |  |        | 100.00 | %       |  |        | 534,038 |         |  |        | 100.00 | %       |  |        | 499,295 |         |  |  | 100.00 | %     |  |   | 489,401 |         |  |  | 100.00 | %     |  |   | 500,706 |         |  |  | 100.00 | %    
|                                                         |             |                        |         |         |  |        |        |         |  |        |         |         |  |        |        |         |  |        |         |         |  |  |        |       |  |   |         |         |  |  |        |       |  |   |         |         |  |  |        |      
|Less: unearned discounts, interest and deferred
    fees |             |                        | (6,306  | )       |  |        |        |         |  |        | (6,279  | )       |  |        |        |         |  |        | (6,150  | )       |  |  |        |       |  |   | (5,663  | )       |  |  |        |       |  |   | (5,037  | )       |  |  |        |      
|                                                         |             |                        |         |         |  |        |        |         |  |        |         |         |  |        |        |         |  |        |         |         |  |  |        |       |  |   |         |         |  |  |        |       |  |   |         |         |  |  |        |      
|Total loans                                              |             | $                      | 553,784 |         |  |        |        |         |  | $      | 527,759 |         |  |        |        |         |  | $      | 493,145 |         |  |  |        |       |  | $ | 483,738 |         |  |  |        |       |  | $ | 495,669 |         |  |  |        |      
|                                                         |             |                        |         |         |  |        |        |         |  |        |         |         |  |        |        |         |  |        |         |         |  |  |        |       |  |   |         |         |  |  |        |       |  |   |         |         |  |  |        |      

Each of the following principal product lines is
an outgrowth of the Companys expertise in meeting the
particular needs of the small and medium-sized businesses and
consumers in the multicultural communities it serves:

Commercial and Industrial
Loans.The primary lending focus of
the Company is on loans to small and medium-sized businesses in
a wide variety of industries. The Companys commercial
lending emphasis includes loans to wholesalers, manufacturers
and business service companies. A broad range of short and
medium-term commercial lending products are made available to
businesses for working capital (including inventory and accounts
receivable), purchases of equipment and machinery and business
expansion (including acquisitions of real estate and
improvements). Generally, the Companys commercial loans
are underwritten on the basis of the borrowers ability to
service such debt as reflected by cash flow projections.
Commercial loans are generally collateralized by business
assets, which may include accounts receivable and inventory,
certificates of deposit, securities, real estate, guarantees or
other collateral. The Company also generally obtains personal
guarantees from the principals of the business. Working capital
loans are primarily collateralized by short-term assets, whereas
term loans are primarily collateralized by long-term assets. As
a result, commercial loans involve additional complexities,
variables and risks and require more thorough underwriting and
servicing than other types of loans. Indigenous to individuals
in the Asian business community is the desire to own the
building and land which houses their businesses. Accordingly,
while a loan may be principally driven and classified by the
type of business operated, real estate is frequently the primary
source of collateral. As of December 31, 2003,
approximately $229.4 million or 68.9% of the commercial and
industrial loan portfolio was collateralized by real estate. The
Company continually monitors real estate value trends and takes
into consideration changes in market trends in its underwriting
standards. As of December 31, 2003, the Companys
commercial and industrial loan portfolio totaled
$332.5 million or 59.4% of the gross loan portfolio.

Commercial Mortgage
Loans.In addition to commercial
loans, the Company makes commercial mortgage loans to finance
the purchase of real property, which generally consists of
developed real estate. The Companys commercial mortgage
loans are collateralized by first liens on real estate,
typically have variable rates and amortize over a 15 to
20 year period with balloon payments due at the end of five
to seven years. Payments on loans collateralized by such
properties are dependent on the successful operation or
management

27



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##### Table of Contents



of the properties. Accordingly, repayment of
these loans may be subject to adverse conditions in the real
estate market or the economy to a greater extent than other
types of loans. In underwriting commercial mortgage loans,
consideration is given to the propertys historical cash
flow, current and projected occupancy, location and physical
condition. The underwriting analysis also includes credit
checks, appraisals, environmental impact reports and a review of
the financial condition of the borrower. As of December 31,
2003, the Company had a commercial mortgage portfolio of
$178.3 million or 31.8% of the gross loan portfolio.


Construction Loans.The Company makes loans to finance the construction of
residential and non-residential properties. The substantial
majority of the Companys residential construction loans
are for single-family dwellings that are pre-sold or are under
earnest money contracts. The Company also originates loans to
finance the construction of commercial properties such as
multi-family, office, industrial, warehouse and retail centers.
Construction loans involve additional risks attributable to the
fact that loan funds are advanced upon the security of a project
under construction, and the project is of uncertain value prior
to its completion. Because of uncertainties inherent in
estimating construction costs, the market value of the completed
project and the effects of governmental regulation on real
property, it can be difficult to accurately evaluate the total
funds required to complete a project and the related loan to
value ratio. As a result of these uncertainties, construction
lending often involves the disbursement of substantial funds
with repayment dependent, in part, on the success of the
ultimate project rather than the ability of a borrower or
guarantor to repay the loan. If the Company is forced to
foreclose on a project prior to completion, there is no
assurance that the Company will be able to recover all of the
unpaid portion of the loan. In addition, the Company may be
required to fund additional amounts to complete a project and
may have to hold the property for an indeterminable period of
time. While the Company has underwriting procedures designed to
identify what it believes to be acceptable levels of risks in
construction lending, no assurance can be given that these
procedures will prevent losses from the risks described above.
As of December 31, 2003, the Company had a real estate
construction portfolio of $24.6 million or 4.4% of the
gross loan portfolio, of which $12.7 million was
residential and $11.9 million was commercial.

Residential Mortgage Brokerage and
Lending.The Company uses its existing
branch network to offer a complete line of single-family
residential mortgage products through third party mortgage
companies. The Company specializes in mortgages that conform
with government sponsored programs, such as those offered by
Fannie Mae. The Company solicits and receives a fee to process
these residential mortgage loans, which are then underwritten
and pre-sold to third party mortgage companies. The Company does
not fund or service these loans. The volume of residential
mortgage loans processed by the Company and pre-sold to third
party mortgage companies in 2003 was $20.0 million. Since
the Company does not fund these loans, there is no interest rate
or credit risk to the Company. The Company also makes five to
seven year balloon residential mortgage loans primarily
collateralized by non-owner occupied residential properties,
which are retained in the Companys residential mortgage
portfolio. At December 31, 2003, the Companys
residential mortgage portfolio totaled $14.3 million.

Government Guaranteed Small Business
Lending.The Company has developed an
expertise in several government guaranteed lending programs in
order to provide credit enhancement to its commercial and
industrial and mortgage portfolio. As a Preferred Lender under
the federally guaranteed SBA lending program, the Companys
pre-approved status allows it to quickly respond to
customers needs. Under this program, the Company
originates and funds SBA 7-A and 504 chapter loans qualifying
for federal guarantees of 75% to 90% of principal and accrued
interest. Depending upon prevailing market conditions, the
Company may sell the guaranteed portion of these loans into the
secondary market with servicing retained. The Company
specializes in SBA loans to minority-owned businesses. As of
December 31, 2003, the Company had $94.2 million in
the retained portion of SBA loans, approximately
$60.9 million of which was guaranteed by the SBA. These
loans are included in most all types of loans such as commercial
and industrial, real estate mortgage, and real estate
construction.

For the SBAs fiscal year ended
September 30, 2003, the Company was the third largest SBA
loan originator in the 32-county Houston SBA District in terms
of dollar volume. SBA loan originations were $25.7 million
and $19.1 million for the years ended December 31,
2003 and 2002, respectively. Another source of government
guaranteed lending is B&I loans which are collateralized by
the U.S. Department of

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Agriculture and are available to borrowers in
areas with a population of less than 50,000. The Company also
offers guaranteed loans through the OCCGF, which is sponsored by
the government of Taiwan. These loans are for people of Chinese
descent or origin, who are not mainland Chinese by birth and
reside overseas. As of December 31, 2003, the
Companys OCCGF portfolio totaled $4.1 million.


Trade Finance.Since
its inception in 1987, the Company has originated trade finance
loans and letters of credit to facilitate export and import
transactions for small and medium-sized businesses. In this
capacity, the Company has worked with the Ex-Im Bank, an agency
of the U.S. Government which provides guarantees for trade
finance loans. Trade finance credit facilities rely heavily on
the quality of the business customers accounts receivable
and the ability to perform the underlying transaction which, if
monitored and controlled properly, limits the financial risks to
the Company associated with this short-term financing. To
mitigate the risk of nonpayment, the Company generally obtains a
governmental guaranty or credit insurance from a governmental
agency such as the Ex-Im Bank. As of December 31, 2003, the
Companys aggregate trade finance portfolio commitments
totaled approximately $7.3 million.

Consumer Loans.The
Company offers a wide variety of loan products to retail
customers through its branch network in Houston and Dallas.
Loans to retail customers include residential mortgage loans,
residential construction loans, automobile loans, lines of
credit and other personal loans. The terms of these loans
typically range from 12 to 60 months depending on the
nature of the collateral and the size of the loan.

The Company selectively extends credit for the
purpose of establishing long-term relationships with its
customers. The Company mitigates the risks inherent in lending
by focusing on businesses and individuals with demonstrated
payment history, historically favorable profitability trends and
stable cash flows. In addition to these primary sources of
repayment, the Company looks to tangible collateral and personal
guarantees as secondary sources of repayment. Lending officers
are provided with detailed underwriting policies covering all
lending activities in which the Company is engaged and that
require all lenders to obtain appropriate approvals for the
extension of credit. The Company also maintains documentation
requirements and extensive credit quality assurance practices in
order to identify credit portfolio weaknesses as early as
possible so any exposures that are discovered may be reduced.

Inherent in all lending is the risk of
nonpayment. The types of collateral required, the terms of the
loans and the underwriting practices discussed under each
category above are all designed to minimize the risk of
nonpayment. In addition, as further risk protection, the Company
rarely makes loans at its legal lending limit. Although the
Companys legal loan limit is $11.8 million to one
borrower, the Company generally does not make loans larger than
$6.0 million to one borrower. Loans are approved by lending
officers pursuant to a lending authorization schedule which is
based on each loan officers credit experience and
portfolio. The Banks Loan Committee approves loans
between $1.5 million and $2.0 million. The
Directors Credit Committee approves loans over
$2.0 million. Control systems and procedures are in place
to ensure all loans are approved in accordance with credit
policies. The Companys policies and procedures, discussed
under Nonperforming Assets, are designed to minimize
the risk of nonpayment with respect to outstanding loans.

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The following table summarizes the industry
concentrations (greater than 25% of capital) of the
Companys loan portfolio, which includes gross loans of
$6.0 million held-for-sale at December 31, 2003, 2002,
and 2001:

|                                     |             |                        |         |         |  |      |         |         |  |   |         |         | 
|------------------------------------ | ----------- | ---------------------- | ------- | ------- |  | ---- | ------- | ------- |  | - | ------- | ------- | 
|                                     |             |                       
|                                     |             | As of December 31,    
|                                     |             |                       
|                                     |             | 2003                   |         | 2002    |  | 2001
|                                     |             |                        |         |         |  |     
|                                     |             |                       
|                                     |             | (Dollars in thousands)
|Hotels/motels                        |             | $                      | 66,062  |         |  | $    | 82,015  |         |  | $ | 87,991  |        
|Retail centers                       |             |                        | 112,380 |         |  |      | 103,623 |         |  |   | 100,649 |        
|Restaurants                          |             |                        | 31,524  |         |  |      | 33,094  |         |  |   | 36,160  |        
|Apartment buildings                  |             |                        | 14,868  |         |  |      | 14,941  |         |  |   | 13,362  |        
|Convenience stores/gasoline stations |             |                        | 26,983  |         |  |      | 27,383  |         |  |   | 31,556  |        
|All other                            |             |                        | 308,273 |         |  |      | 272,982 |         |  |   | 229,577 |        
|                                     |             |                        |         |         |  |      |         |         |  |   |         |        
|                                     | Gross loans |                        | $       | 560,090 |  |      | $       | 534,038 |  |   | $       | 499,295 | 
|                                     |             |                        |         |         |  |      |         |         |  |   |         |        

The contractual maturity ranges of the commercial
and industrial, real estate, and consumer loan portfolios and
the amount of such loans with predetermined interest rates and
floating rates in each maturity range as of December 31,
2003 are summarized in the following table:

|                                         |             |                         |         |            |  |            |         |         |  |   |         |        |  |   |         |         | 
|---------------------------------------- | ----------- | ----------------------- | ------- | ---------- |  | ---------- | ------- | ------- |  | - | ------- | ------ |  | - | ------- | ------- | 
|                                         |             |                        
|                                         |             | As of December 31, 2003
|                                         |             |                        
|                                         |             |                         |         | After One  |  |           
|                                         |             | One Year                |         | Through    |  | After Five |         |        
|                                         |             | or Less                 |         | Five Years |  | Years      |         | Total  
|                                         |             |                         |         |            |  |            |         |        
|                                         |             |                        
|                                         |             | (Dollars in thousands) 
|Commercial and industrial                |             | $                       | 74,573  |            |  | $          | 162,614 |         |  | $ | 95,293  |        |  | $ | 332,480 |        
|Real estate mortgage:                    |             |                         |         |            |  |            |         |         |  |   |         |        |  |   |         |        
|                                         | Residential |                         |         | 5,263      |  |            |         | 6,472   |  |   |         | 2,580  |  |   |         | 14,315  | 
|                                         | Commercial  |                         |         | 25,556     |  |            |         | 137,248 |  |   |         | 15,486 |  |   |         | 178,290 | 
|Real estate construction:                |             |                         |         |            |  |            |         |         |  |   |         |        |  |   |         |        
|                                         | Residential |                         |         | 8,909      |  |            |         | 3,743   |  |   |         |       |  |   |         | 12,652  | 
|                                         | Commercial  |                         |         |           |  |            |         | 9,528   |  |   |         | 2,378  |  |   |         | 11,906  | 
|Consumer                                 |             |                         | 1,592   |            |  |            | 8,319   |         |  |   | 536     |        |  |   | 10,447  |        
|                                         |             |                         |         |            |  |            |         |         |  |   |         |        |  |   |         |        
|Total                                    |             | $                       | 115,893 |            |  | $          | 327,924 |         |  | $ | 116,273 |        |  | $ | 560,090 |        
|                                         |             |                         |         |            |  |            |         |         |  |   |         |        |  |   |         |        
|Loans with a predetermined interest rate |             | $                       | 27,384  |            |  | $          | 42,172  |         |  | $ | 13,880  |        |  | $ | 83,436  |        
|Loans with a floating interest rate      |             |                         | 88,509  |            |  |            | 285,752 |         |  |   | 102,393 |        |  |   | 476,654 |        
|                                         |             |                         |         |            |  |            |         |         |  |   |         |        |  |   |         |        
|Total                                    |             | $                       | 115,893 |            |  | $          | 327,924 |         |  | $ | 116,273 |        |  | $ | 560,090 |        
|                                         |             |                         |         |            |  |            |         |         |  |   |         |        |  |   |         |        



| |                     
| | --------------------
| | Nonperforming Assets

The Company believes that it has adequate loan
procedures in place. These procedures include the approval of
lending policies and underwriting guidelines by the Board of
Directors, review of the loan portfolio by the Companys
internal loan review department (formally approved by the Board
of Directors in the fourth quarter of 2002 and established in
January 2003), review of the loan portfolio by an independent
external loan review company as necessary, approval from the
Directors Credit Committee for large credit relationships, and
policy/administrative oversight by the Directors
Loan Committee. The loan review department reports credit
risk grade changes on a monthly basis to management and the
Board of Directors. Facilitating the loan review process, loan
review and problem resolution personnel were added during the
first and second quarters of 2002. The Company performs monthly
and quarterly concentration analyses based on industries,
collateral types, business lines, large credit sizes and officer
portfolio loads. There can be no assurance, however, that the
Companys loan portfolio will not become subject to
increasing pressures from deteriorating borrowers

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financial condition due to general economic and
other factors. While future deterioration in the loan portfolio
is possible, management is continuing its risk assessment and
resolution program. In addition, management is focusing its
attention on minimizing the Banks credit risk through more
diversified business development avenues.


The Company generally places a loan on nonaccrual
status and ceases accruing interest when, in the opinion of
management, full payment of loan principal or interest is in
doubt. All loans past due 90 days are placed on nonaccrual
status unless the loan is both well collateralized and in the
process of collection. Cash payments received while a loan is
classified as nonaccrual are recorded as a reduction of
principal as long as significant doubt exists as to collection
of the principal. In addition to nonaccrual loans, the Company
evaluates on an ongoing basis additional loans which are
potential problem loans as to risk exposure in determining the
adequacy of the allowance for loan losses.

The Company reviews the real estate values, and
when necessary, orders new appraisals on loans collateralized by
real estate when loans are renewed, prior to foreclosure and at
other times as necessary, particularly in problem loan
situations. In instances where updated appraisals reflect
reduced collateral values, an evaluation of the borrowers
overall financial condition is made to determine the need, if
any, for possible write-downs or appropriate additions to the
allowance for loan losses. The Company records other real estate
at fair value at the time of acquisition less estimated costs to
sell.

A loan is considered impaired based on current
information and events, if it is probable that the Company will
be unable to collect the scheduled payments of principal or
interest when due according to the contractual terms of the loan
agreement. The measurement of impaired loans is based on the
present value of expected future cash flows discounted at the
loans effective interest rate or the loans
observable market price or based on the fair value of the
collateral if the loan is collateral-dependent.

In addition to the Companys loan review
process described in the preceding paragraphs, the OCC
periodically examines and evaluates national banks. Based upon
such an examination, the OCC may revalue the assets of the
institution and require that it charge-off certain assets,
establish specific reserves to compensate for the difference
between the OCC-determined value and the book value of such
assets or take other regulatory action designed to lessen the
risk in the asset portfolio. The OCC is currently conducting its
annual examination of the Bank and while no such actions have
been taken by the OCC, no assurance can be provided that such
actions will not occur in the future.

2003 versus 2002.Total nonperforming assets at December 31, 2003 and 2002
were $28.3 million and $18.8 million, respectively, an
increase of $9.5 million. Nonaccrual loans at
December 31, 2003 and 2002 were $25.4 million and
$17.2 million, respectively, an increase of
$8.2 million. The increase in nonperforming assets in 2003
compared to 2002 was primarily related to an $8.2 million
increase in nonaccrual loans. The largest loan included in
nonaccrual loans at December 31, 2003 was a
$5.3 million hotel loan which was placed on nonaccrual
status in the fourth quarter of 2003. The second largest is a
$3.7 million commercial loan to a wholesale food
distributor that was added to nonaccrual status in the third
quarter of 2002. While each of these loans are continuing to
make payments, they have been placed on nonaccrual status due to
uncertainty of future cash flows and the ability of the borrower
to service the debt. A restaurant loan in the amount of
$3.6 million was added to nonaccrual status in 2003 and is
not current due to lack of payments. Had the total of nonaccrual
loans remained on an accrual basis, interest in the amount of
approximately $1.0 million and $657,000 would have been
recorded on these loans during the years ended December 31,
2003 and 2002, respectively.

2002 versus 2001.Total nonperforming assets at December 31, 2002 and 2001
were $18.8 million and $5.6 million, respectively, an
increase of $13.2 million. Nonaccrual loans at
December 31, 2002 and 2001 were $17.2 million and
$3.8 million, respectively, an increase of
$13.4 million. The increase in nonperforming assets and
nonaccrual loans primarily occurred during the first quarter of
2002 with approximately $9.0 million added to nonaccrual
loans as part of an identification process that represents an
integral part of an overall effort to improve credit quality.
The largest of these loans were a $3.2 million hotel loan,
a $1.2 million entertainment facility, and two restaurant
loans of $1.4 million and $1.3 million. The
$1.3 million restaurant loan paid off in July 2002 and the
$1.4 million loan was paid off in January 2003. During the
third quarter of 2002, a

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$5.1 million commercial loan to a wholesale
food distributor was added to nonaccrual status. During the
fourth quarter of 2002, a $1.1 million hotel loan and a
$1.0 million convenience store loan were added to
nonaccrual status. Had these nonaccrual loans remained on an
accrual basis, interest in the amount of approximately $657,000
and $202,000 would have been recorded on these loans during the
years ended December 31, 2002 and 2001, respectively.


Included in total nonperforming assets are the
portions guaranteed by the SBA, OCCGF and Ex-Im Bank, which
totaled $3.3 million at December 31, 2003 and 2002.
Nonperforming assets, net of their guaranteed portions, were
$25.0 million and $15.5 million, for the same periods,
respectively. The ratios for net nonperforming assets to total
loans and other real estate were 4.49% and 2.92% at
December 31, 2003 and 2002, respectively. The ratios for
net nonperforming assets to total assets were 2.89% and 1.84%,
for the same periods, respectively.

The following table presents information
regarding nonperforming assets at the periods indicated:

|                                                                              |                            |                        |        |        |  |      |        |        |  |      |        |       |  |   |        |       |  |   |        |       | 
|----------------------------------------------------------------------------- | -------------------------- | ---------------------- | ------ | ------ |  | ---- | ------ | ------ |  | ---- | ------ | ----- |  | - | ------ | ----- |  | - | ------ | ----- | 
|                                                                              |                            |                       
|                                                                              |                            | As of December 31,    
|                                                                              |                            |                       
|                                                                              |                            | 2003                   |        | 2002   |  | 2001 |        | 2000   |  | 1999
|                                                                              |                            |                        |        |        |  |      |        |        |  |     
|                                                                              |                            |                       
|                                                                              |                            | (Dollars in thousands)
|Nonaccrual loans                                                              |                            | $                      | 25,442 |        |  | $    | 17,209 |        |  | $    | 3,758  |       |  | $ | 2,225  |       |  | $ | 6,552  |      
|Accruing loans 90 days or more past due                                       |                            |                        | 264    |        |  |      | 380    |        |  |      | 783    |       |  |   |       |       |  |   |       |      
|Other real estate (ORE) and other
    assets repossessed (OAR)            |                            |                        | 2,585  |        |  |      | 1,190  |        |  |      | 1,025  |       |  |   | 757    |       |  |   | 490    |      
|                                                                              |                            |                        |        |        |  |      |        |        |  |      |        |       |  |   |        |       |  |   |        |      
|                                                                              | Total nonperforming assets |                        |        | 28,291 |  |      |        | 18,779 |  |      |        | 5,566 |  |   |        | 2,982 |  |   |        | 7,042 | 
|Less: nonperforming loans guaranteed by the SBA,
    Ex-Im Bank, or the OCCGF |                            |                        | (3,323 | )      |  |      | (3,310 | )      |  |      | (1,833 | )     |  |   | (1,049 | )     |  |   | (1,821 | )    
|                                                                              |                            |                        |        |        |  |      |        |        |  |      |        |       |  |   |        |       |  |   |        |      
|                                                                              | Net nonperforming assets   |                        | $      | 24,968 |  |      | $      | 15,469 |  |      | $      | 3,733 |  |   | $      | 1,933 |  |   | $      | 5,221 | 
|                                                                              |                            |                        |        |        |  |      |        |        |  |      |        |       |  |   |        |       |  |   |        |      
|Total nonperforming assets to total loans and
    ORE/ OAR                    |                            |                        | 5.08   | %      |  |      | 3.55   | %      |  |      | 1.13   | %     |  |   | 0.62   | %     |  |   | 1.42   | %    
|Total nonperforming assets to total assets                                    |                            |                        | 3.27   | %      |  |      | 2.24   | %      |  |      | 0.75   | %     |  |   | 0.40   | %     |  |   | 1.07   | %    
|Net nonperforming assets to total loans and ORE/
    OAR                      |                            |                        | 4.49   | %      |  |      | 2.92   | %      |  |      | 0.76   | %     |  |   | 0.40   | %     |  |   | 1.05   | %    
|Net nonperforming assets to total assets                                      |                            |                        | 2.89   | %      |  |      | 1.84   | %      |  |      | 0.50   | %     |  |   | 0.26   | %     |  |   | 0.79   | %    



| |                          
| | -------------------------
| | Allowance for Loan Losses

The allowance for loan losses is a reserve
established through charges to earnings in the form of a
provision for loan losses. Management has established an
allowance for loan losses which it believes is adequate to
absorb estimated losses inherent in the Companys loan
portfolio. Based on an evaluation of the loan portfolio,
management presents a quarterly review of the allowance for loan
losses to the Companys Board of Directors, indicating any
change in the allowance since the last review and any
recommendations as to adjustments in the allowance. In making
its evaluation, management considers the diversification by
industry of the Companys commercial loan portfolio, the
effect of changes in the local real estate market on collateral
values, the results of recent regulatory examinations, the
effects on the loan portfolio of current economic indicators and
their probable impact on borrowers, the amount of charge-offs
for the period, the amount of nonperforming loans and related
collateral security and the evaluation of its loan portfolio by
the independent loan review function. Charge-offs occur when
loans are deemed to be uncollectible in whole or in part.

The Company follows a loan review program to
evaluate the credit risk in the loan portfolio as discussed
under Nonperforming Assets. Through the loan review
process, the Company maintains an internally classified loan
list which, along with the delinquency list of loans, helps
management assess the overall quality of the loan portfolio and
the adequacy of the allowance for loan losses. Loans classified
as substandard are those loans with clear and
defined weaknesses such as a highly-leveraged position,
unfavorable financial ratios,

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uncertain repayment sources or poor financial
condition, which may jeopardize recoverability of the debt.
Loans classified as doubtful are those loans which
have characteristics similar to substandard loans but with an
increased risk that a loss may occur, or at least a portion of
the loan may require a charge-off if liquidated at present.
Although loans classified as substandard do not duplicate loans
classified as doubtful, both substandard and doubtful loans
include some loans that are delinquent at least 30 days or
on nonaccrual status. Loans classified as loss are
those loans which are in the process of being charged off.


In addition to the internally classified loan
list and delinquency list of loans, the Company maintains a
separate watch list which further aids the Company
in monitoring loan portfolios. Watch list loans show warning
elements where the present status portrays one or more
deficiencies that require attention in the short-term or where
pertinent ratios of the loan account have weakened to a point
where more frequent monitoring is warranted. These loans do not
have all of the characteristics of a classified loan
(substandard or doubtful) but do show weakened elements compared
with those of a satisfactory credit. The Company reviews these
loans to assist in assessing the adequacy of the allowance for
loan losses.

In order to determine the adequacy of the
allowance for loan losses, management establishes specific
allowances for loans which management believes require reserves
greater than those allocated according to their classification
or the delinquent status of specific loans. Management then
considers the risk classification or delinquency status of the
remaining portfolio and other factors, such as collateral value,
portfolio composition, trends in economic conditions and the
financial strength of borrowers. The Company then charges to
operations a provision for loan losses to maintain the allowance
for loan losses at a level determined by the foregoing
methodology.

The Company allocates the allowance for loan
losses according to managements assessments of risk
inherent in the portfolio. In addition, on July 6, 2002,
the Securities and Exchange Commission released Staff Accounting
Bulletin (SAB) No. 102, Selected Loan Loss
Allowance Methodology and Documentation Issues, which
requires companies to have adequate documentation on the
development and application of a systematic methodology in
determining allowance for loan losses. The Company believes that
it is generally in compliance with the requirements, however, it
is developing revisions to the process to utilize historical
loan loss experience.

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The following table presents an analysis of the
allowance for loan losses and other related data:

|                                                               |                            |                                            |         |        |        |      |         |        |        |      |         |        |        |   |         |        |        |   |         |        |        |  
|-------------------------------------------------------------- | -------------------------- | ------------------------------------------ | ------- | ------ | ------ | ---- | ------- | ------ | ------ | ---- | ------- | ------ | ------ | - | ------- | ------ | ------ | - | ------- | ------ | ------ | -
|                                                               |                            |                                           
|                                                               |                            | As of and for the Years Ended December 31,
|                                                               |                            |                                           
|                                                               |                            | 2003                                       |         | 2002   |        | 2001 |         | 2000   |        | 1999
|                                                               |                            |                                            |         |        |        |      |         |        |        |     
|                                                               |                            |                                           
|                                                               |                            | (Dollars in thousands)                    
|Average total loans outstanding                                |                            | $                                          | 549,610 |        |        | $    | 505,495 |        |        | $    | 474,986 |        |        | $ | 486,549 |        |        | $ | 456,653 |       
|                                                               |                            |                                            |         |        |        |      |         |        |        |      |         |        |        |   |         |        |        |   |         |       
|Total loans outstanding at end of period                       |                            | $                                          | 553,784 |        |        | $    | 527,759 |        |        | $    | 493,145 |        |        | $ | 483,738 |        |        | $ | 495,669 |       
|                                                               |                            |                                            |         |        |        |      |         |        |        |      |         |        |        |   |         |        |        |   |         |       
|Allowance for loan losses at beginning of period               |                            | $                                          | 10,150  |        |        | $    | 8,903   |        |        | $    | 9,271   |        |        | $ | 7,537   |        |        | $ | 6,119   |       
|Provision for loan losses                                      |                            |                                            | 5,690   |        |        |      | 3,853   |        |        |      | 3,799   |        |        |   | 7,508   |        |        |   | 5,550   |       
|Charge-offs:                                                   |                            |                                            |         |        |        |      |         |        |        |      |         |        |        |   |         |        |        |   |         |       
|                                                               | Commercial and industrial  |                                            |         | (5,173 | )      |      |         | (2,721 | )      |      |         | (4,075 | )      |   |         | (1,479 | )      |   |         | (3,563 | )     
|                                                               | Real estate  mortgage     |                                            |         | (755   | )      |      |         | (271   | )      |      |         |       |        |   |         | (23    | )      |   |         | (32    | )     
|                                                               | Real estate  construction |                                            |         |       |        |      |         |       |        |      |         |       |        |   |         |       |        |   |         |       |       
|                                                               | Consumer and other         |                                            |         | (193   | )      |      |         | (132   | )      |      |         | (201   | )      |   |         | (5,524 | )      |   |         | (807   | )     
|                                                               |                            |                                            |         |        |        |      |         |        |        |      |         |        |        |   |         |        |        |   |         |       
|                                                               |                            | Total charge-offs                          |         |        | (6,121 | )    |         |        | (3,124 | )    |         |        | (4,276 | ) |         |        | (7,026 | ) |         |        | (4,402 | )
|                                                               |                            |                                            |         |        |        |      |         |        |        |      |         |        |        |   |         |        |        |   |         |       
|Recoveries:                                                    |                            |                                            |         |        |        |      |         |        |        |      |         |        |        |   |         |        |        |   |         |       
|                                                               | Commercial and industrial  |                                            |         | 593    |        |      |         | 450    |        |      |         | 54     |        |   |         | 901    |        |   |         | 94     |       
|                                                               | Real estate  mortgage     |                                            |         | 100    |        |      |         | 20     |        |      |         | 11     |        |   |         | 8      |        |   |         |       |       
|                                                               | Real estate  construction |                                            |         |       |        |      |         |       |        |      |         |       |        |   |         |       |        |   |         |       |       
|                                                               | Consumer and other         |                                            |         | 36     |        |      |         | 48     |        |      |         | 44     |        |   |         | 343    |        |   |         | 176    |       
|                                                               |                            |                                            |         |        |        |      |         |        |        |      |         |        |        |   |         |        |        |   |         |       
|                                                               |                            | Total recoveries                           |         |        | 729    |      |         |        | 518    |      |         |        | 109    |   |         |        | 1,252  |   |         |        | 270    |  
|                                                               |                            |                                            |         |        |        |      |         |        |        |      |         |        |        |   |         |        |        |   |         |       
|Net loan charge-offs                                           |                            |                                            | (5,392  | )      |        |      | (2,606  | )      |        |      | (4,167  | )      |        |   | (5,774  | )      |        |   | (4,132  | )     
|                                                               |                            |                                            |         |        |        |      |         |        |        |      |         |        |        |   |         |        |        |   |         |       
|Allowance for loan losses at end of period                     |                            | $                                          | 10,448  |        |        | $    | 10,150  |        |        | $    | 8,903   |        |        | $ | 9,271   |        |        | $ | 7,537   |       
|                                                               |                            |                                            |         |        |        |      |         |        |        |      |         |        |        |   |         |        |        |   |         |       
|Ratio of allowance to end of period total loans                |                            |                                            | 1.89    | %      |        |      | 1.92    | %      |        |      | 1.81    | %      |        |   | 1.92    | %      |        |   | 1.52    | %     
|Ratio of net loan charge-offs to end of period
    total loans |                            |                                            | 0.97    | %      |        |      | 0.49    | %      |        |      | 0.84    | %      |        |   | 1.19    | %      |        |   | 0.83    | %     
|Ratio of allowance to end of period nonperforming
    loans    |                            |                                            | 40.64   | %      |        |      | 57.71   | %      |        |      | 196.06  | %      |        |   | 416.67  | %      |        |   | 115.03  | %     



For the years ended December 31, 2003, 2002,
and 2001, net loan charge-offs were $5.4 million,
$2.6 million, and $4.2 million, respectively. The
significant charge-offs for the year 2003 were primarily related
to the hospitality industry where approximately
$3.0 million was charged off. The largest charge-off in
this category was $1.9 million on a hospitality loan that
was subsequently foreclosed and as of March 2, 2004 has a
sale pending. The second largest charge-off in this category was
approximately $659,000 on a hospitality loan that was
subsequently transferred to loans held-for-sale. Approximately
$612,000 in charge-offs was related to the wholesale trade
business, where the largest charge-off was $404,000. Charge-offs
related to the restaurant business were approximately $448,000,
with the largest charge-off being $220,000.

The significant charge-offs for the year 2002
were related to the restaurant and grocery categories.
Approximately $1.0 million in charge-offs was related to
full-service restaurants and approximately $572,000 was related
to the grocery category. The largest individual charge-off for
2002 totaled approximately $250,000. Of the $4.2 million in
charge-offs in 2001, $3.0 million was charged-off in the
fourth quarter following a

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significant review of the loan portfolio. The
significant charge-offs included in the $3.0 million were
related to twelve credits, with the two largest being commercial
operating lines of credit of $1.0 million and $900,000.


The ratios of net loan charge-offs to total loans
outstanding for the years ended December 31, 2003, 2002,
and 2001, were 0.97%, 0.49%, and 0.84%, respectively. The
Company seeks recovery on its charge-offs through all available
channels. At December 31, 2003, 2002, and 2001, the
allowance for loan losses aggregated $10.4 million,
$10.2 million, and $8.9 million, respectively, or
1.89%, 1.92%, and 1.81% of total loans, respectively.

The following table describes the allocation of
the allowance for loan losses among various categories of loans
and certain other information. The allocation is made for
analytical purposes and is not necessarily indicative of the
categories in which future losses may occur. The total allowance
is available to absorb losses from any segment of the credit
portfolio.

|                                                        |                            |                        |        |          |  |        |        |          |   |        |        |          |  |        |        |          |   |        |       |          |  |  |        |       |   |   |       |       |  |  |        |       |   |   |       |       |  |  |        |       |  
|------------------------------------------------------- | -------------------------- | ---------------------- | ------ | -------- |  | ------ | ------ | -------- | - | ------ | ------ | -------- |  | ------ | ------ | -------- | - | ------ | ----- | -------- |  |  | ------ | ----- | - | - | ----- | ----- |  |  | ------ | ----- | - | - | ----- | ----- |  |  | ------ | ----- | -
|                                                        |                            |                       
|                                                        |                            | As of December 31,    
|                                                        |                            |                       
|                                                        |                            |                        |        |          |  |        |        |          |   |       
|                                                        |                            | 2003                   |        | 2002     |  | 2001   |        | 2000     |   | 1999  
|                                                        |                            |                        |        |          |  |        |        |          |   |       
|                                                        |                            |                        |        | Percent  |  |        |        | Percent  |   |        |        | Percent  |  |        |        | Percent  |   |        |       | Percent 
|                                                        |                            |                        |        | of Loans |  |        |        | of Loans |   |        |        | of Loans |  |        |        | of Loans |   |        |       | of Loans
|                                                        |                            |                        |        | to Gross |  |        |        | to Gross |   |        |        | to Gross |  |        |        | to Gross |   |        |       | to Gross
|                                                        |                            | Amount                 |        | Loans    |  | Amount |        | Loans    |   | Amount |        | Loans    |  | Amount |        | Loans    |   | Amount |       | Loans   
|                                                        |                            |                        |        |          |  |        |        |          |   |        |        |          |  |        |        |          |   |        |       |         
|                                                        |                            |                       
|                                                        |                            | (Dollars in thousands)
|Balance of allowance for loan losses applicable
    to: |                            |                        |        |          |  |        |        |          |   |        |        |          |  |        |        |          |   |        |       |          |  |  |        |       |   |   |       |       |  |  |        |       |   |   |       |       |  |  |        |      
|                                                        | Commercial and industrial  |                        | $      | 6,281    |  |        |        | 59.36    | % |        | $      | 6,383    |  |        |        | 60.94    | % |        | $     | 5,054    |  |  |        | 62.67 | % |   | $     | 4,814 |  |  |        | 60.92 | % |   | $     | 3,783 |  |  |        | 59.55 | %
|                                                        | Real estate  mortgage     |                        |        | 2,460    |  |        |        | 34.39    |   |        |        | 2,285    |  |        |        | 32.38    |   |        |       | 1,947    |  |  |        | 27.81 |   |   |       | 758   |  |  |        | 28.27 |   |   |       | 823   |  |  |        | 27.42 |  
|                                                        | Real estate  construction |                        |        | 267      |  |        |        | 4.38     |   |        |        | 355      |  |        |        | 4.75     |   |        |       | 274      |  |  |        | 7.24  |   |   |       | 230   |  |  |        | 8.09  |   |   |       | 204   |  |  |        | 7.99  |  
|                                                        | Consumer and other         |                        |        | 101      |  |        |        | 1.87     |   |        |        | 136      |  |        |        | 1.93     |   |        |       | 686      |  |  |        | 2.28  |   |   |       | 444   |  |  |        | 2.45  |   |   |       | 357   |  |  |        | 2.31  |  
|                                                        | Factored receivables       |                        |        |         |  |        |        |         |   |        |        |         |  |        |        |         |   |        |       |         |  |  |        |      |   |   |       | 20    |  |  |        | 0.27  |   |   |       | 243   |  |  |        | 2.73  |  
|                                                        | Unallocated                |                        |        | 1,339    |  |        |        |         |   |        |        | 991      |  |        |        |         |   |        |       | 942      |  |  |        |      |   |   |       | 3,005 |  |  |        |      |   |   |       | 2,127 |  |  |        |      |  
|                                                        |                            |                        |        |          |  |        |        |          |   |        |        |          |  |        |        |          |   |        |       |          |  |  |        |       |   |   |       |       |  |  |        |       |   |   |       |       |  |  |        |      
|Total allowance for loan losses                         |                            | $                      | 10,448 |          |  |        | 100.00 | %        |   | $      | 10,150 |          |  |        | 100.00 | %        |   | $      | 8,903 |          |  |  | 100.00 | %     |   | $ | 9,271 |       |  |  | 100.00 | %     |   | $ | 7,537 |       |  |  | 100.00 | %    
|                                                        |                            |                        |        |          |  |        |        |          |   |        |        |          |  |        |        |          |   |        |       |          |  |  |        |       |   |   |       |       |  |  |        |       |   |   |       |       |  |  |        |      

The level of allowance for loan losses has
remained relatively constant in 2003 and 2002 even though net
charge-offs have increased. This is primarily due to loans being
charged down to their collateral value where there has been no
further deterioration. In addition, the Company has observed a
slowing in the migration of loans requiring charge-off, however,
there is no assurance this trend will continue. While nonaccrual
loans increased in 2003, no corresponding increase in the
allowance for loan losses was required since collateral values
were able to support the loan balances. Also, many of the loans
on nonaccrual are paying as agreed but were placed on nonaccrual
due to the uncertainty that the borrowers will continue making
loan payments.



| |           
| | ----------
| | Securities

The Company uses its securities portfolio
primarily as a source of income and secondarily as a source of
liquidity. At December 31, 2003, the fair value of
securities net of the Federal Home Loan Bank
(FHLB) and Federal Reserve Bank stock was
$257.1 million, a decrease of $3.0 million or 1.1%
from the fair value of net securities at December 31, 2002.
The decrease in 2003 was primarily the result of excess
liquidity created from increased deposits that was reinvested
into loans rather than securities. At December 31, 2002,
the fair value of securities net of FHLB and Federal Reserve
Bank stock totaled $260.0 million, an increase of
$86.9 million or 50.2% from $173.1 million at
December 31, 2001. The increase in 2002 was primarily due
to liquidity created from increased deposits and loan
prepayments in excess of loan funding requirements.

At the date of purchase, the Company is required
to classify debt and equity securities into one of three
categories: held-to-maturity, trading or available-for-sale. At
each reporting date, the appropriateness of the classification
is reassessed. Investments in debt securities are classified as
held-to-maturity and measured at

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amortized cost in the financial statements only
if management has the positive intent and ability to hold those
securities to maturity. The Company does not have a trading
account. Investments not classified as either held-to-maturity
or trading are classified as available-for-sale and measured at
fair value in the financial statements with unrealized gains and
losses reported, net of tax, as a component of accumulated other
comprehensive income in shareholders equity until
realized. On January 1, 2001, the Company reclassified its
held-to-maturity investment securities to the available-for-sale
category as allowed under SFAS 133. The adoption of
SFAS 133 allowed this one-time reclassification of
securities between held-to-maturity and available-for-sale.


The following table presents the amortized cost
of securities classified as available-for-sale and their
approximate fair values as of the date shown:

|                                                                         |                  |                         |         |                         |  |            |       |            |  |           |        |            |   |            |         |            |  |   |         |         |  |   |       |       |  |   |      |      |   |   |         |         | 
|------------------------------------------------------------------------ | ---------------- | ----------------------- | ------- | ----------------------- |  | ---------- | ----- | ---------- |  | --------- | ------ | ---------- | - | ---------- | ------- | ---------- |  | - | ------- | ------- |  | - | ----- | ----- |  | - | ---- | ---- | - | - | ------- | ------- | 
|                                                                         |                  |                         |         |                        
|                                                                         |                  | As of December 31, 2003 |         | As of December 31, 2002
|                                                                         |                  |                         |         |                        
|                                                                         |                  |                         |         | Gross                   |  | Gross      |       |            |  |           |        | Gross      |   | Gross      |         |           
|                                                                         |                  | Amortized               |         | Unrealized              |  | Unrealized |       |            |  | Amortized |        | Unrealized |   | Unrealized |         |           
|                                                                         |                  | Cost                    |         | Gain                    |  | Loss       |       | Fair Value |  | Cost      |        | Gain       |   | Loss       |         | Fair Value
|                                                                         |                  |                         |         |                         |  |            |       |            |  |           |        |            |   |            |         |           
|                                                                         |                  |                        
|                                                                         |                  | (Dollars in thousands) 
|U.S. Treasury securities and obligations of
    U.S. government agencies |                  | $                       | 4,965   |                         |  | $          |      |            |  | $         | (12    | )          |   | $          | 4,953   |            |  | $ | 2,488   |         |  | $ | 50    |       |  | $ |     |      |   | $ | 2,538   |        
|Obligations of state and political subdivisions                          |                  |                         | 18,925  |                         |  |            | 1,249 |            |  |           |       |            |   |            | 20,174  |            |  |   | 22,059  |         |  |   | 591   |       |  |   | (2   | )    |   |   | 22,648  |        
|Mortgage-backed securities and collateralized
    mortgage obligations   |                  |                         | 209,323 |                         |  |            | 1,170 |            |  |           | (1,254 | )          |   |            | 209,239 |            |  |   | 180,599 |         |  |   | 2,862 |       |  |   | (151 | )    |   |   | 183,310 |        
|Other debt securities                                                    |                  |                         | 1,096   |                         |  |            | 3     |            |  |           | (10    | )          |   |            | 1,089   |            |  |   | 2,378   |         |  |   | 33    |       |  |   | (20  | )    |   |   | 2,391   |        
|Investment in an ARM and CRA funds                                       |                  |                         | 21,739  |                         |  |            | 73    |            |  |           | (203   | )          |   |            | 21,609  |            |  |   | 48,982  |         |  |   | 169   |       |  |   |     |      |   |   | 49,151  |        
|FHLB/ Federal Reserve Bank Stock                                         |                  |                         | 5,200   |                         |  |            |      |            |  |           |       |            |   |            | 5,200   |            |  |   | 4,380   |         |  |   |      |       |  |   |     |      |   |   | 4,380   |        
|                                                                         |                  |                         |         |                         |  |            |       |            |  |           |        |            |   |            |         |            |  |   |         |         |  |   |       |       |  |   |      |      |   |   |         |        
|                                                                         | Total securities |                         | $       | 261,248                 |  |            | $     | 2,495      |  |           | $      | (1,479     | ) |            | $       | 262,264    |  |   | $       | 260,886 |  |   | $     | 3,705 |  |   | $    | (173 | ) |   | $       | 264,418 | 
|                                                                         |                  |                         |         |                         |  |            |       |            |  |           |        |            |   |            |         |            |  |   |         |         |  |   |       |       |  |   |      |      |   |   |         |        

|                                                                         |                  |                         |         |            |  |            |       |            |  |   |      |        |   |   |         |         | 
|------------------------------------------------------------------------ | ---------------- | ----------------------- | ------- | ---------- |  | ---------- | ----- | ---------- |  | - | ---- | ------ | - | - | ------- | ------- | 
|                                                                         |                  |                        
|                                                                         |                  | As of December 31, 2001
|                                                                         |                  |                        
|                                                                         |                  |                         |         | Gross      |  | Gross      |       |           
|                                                                         |                  | Amortized               |         | Unrealized |  | Unrealized |       |           
|                                                                         |                  | Cost                    |         | Gain       |  | Loss       |       | Fair Value
|                                                                         |                  |                         |         |            |  |            |       |           
|                                                                         |                  |                        
|                                                                         |                  | (Dollars in thousands) 
|U.S. Treasury securities and obligations of
    U.S. government agencies |                  | $                       | 2,453   |            |  | $          | 122   |            |  | $ |     |        |   | $ | 2,575   |        
|Obligations of state and political subdivisions                          |                  |                         | 25,045  |            |  |            | 183   |            |  |   | (589 | )      |   |   | 24,639  |        
|Mortgage-backed securities and collateralized
    mortgage obligations   |                  |                         | 138,696 |            |  |            | 1,561 |            |  |   | (671 | )      |   |   | 139,586 |        
|Other debt securities                                                    |                  |                         | 3,229   |            |  |            | 20    |            |  |   | (57  | )      |   |   | 3,192   |        
|Investment in an ARM and CRA funds                                       |                  |                         | 3,094   |            |  |            | 1     |            |  |   |     |        |   |   | 3,095   |        
|FHLB/ Federal Reserve Bank Stock                                         |                  |                         | 3,143   |            |  |            |      |            |  |   |     |        |   |   | 3,143   |        
|                                                                         |                  |                         |         |            |  |            |       |            |  |   |      |        |   |   |         |        
|                                                                         | Total securities |                         | $       | 175,660    |  |            | $     | 1,887      |  |   | $    | (1,317 | ) |   | $       | 176,230 | 
|                                                                         |                  |                         |         |            |  |            |       |            |  |   |      |        |   |   |         |        

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The following table summarizes the contractual
maturity of investment securities at amortized cost and their
weighted average yields. No tax-equivalent adjustments were made.

|                                                                         |                  |                         |        |                |  |                  |      |                 |   |        |       |        |  |        |      |       |   |        |        |        |  |  |      |      |   |   |         |         |  |  |      |      |   |   |         |         |  |  |      |      |  
|------------------------------------------------------------------------ | ---------------- | ----------------------- | ------ | -------------- |  | ---------------- | ---- | --------------- | - | ------ | ----- | ------ |  | ------ | ---- | ----- | - | ------ | ------ | ------ |  |  | ---- | ---- | - | - | ------- | ------- |  |  | ---- | ---- | - | - | ------- | ------- |  |  | ---- | ---- | -
|                                                                         |                  |                        
|                                                                         |                  | As of December 31, 2003
|                                                                         |                  |                        
|                                                                         |                  |                         |        |                |  |                  |      |                
|                                                                         |                  |                         |        | After One Year |  | After Five Years |      |                
|                                                                         |                  | Within One              |        | But Within     |  | But Within       |      |                 |   |       
|                                                                         |                  | Year                    |        | Five Years     |  | Ten Years        |      | After Ten Years |   | Total 
|                                                                         |                  |                         |        |                |  |                  |      |                 |   |       
|                                                                         |                  | Amount                  |        | Yield          |  | Amount           |      | Yield           |   | Amount |       | Yield  |  | Amount |      | Yield |   | Amount |        | Yield 
|                                                                         |                  |                         |        |                |  |                  |      |                 |   |        |       |        |  |        |      |       |   |        |        |       
|                                                                         |                  |                        
|                                                                         |                  | (Dollars in thousands) 
|U.S. Treasury securities and obligations of
    U.S. government agencies |                  | $                       |       |                |  |                  |     | %               |   | $      | 4,965 |        |  |        | 4.37 | %     |   | $      |       |        |  |  |     | %    |   | $ |        |         |  |  |     | %    |   | $ | 4,965   |         |  |  | 4.37 | %   
|Obligations of state and political subdivisions                          |                  |                         | 185    |                |  |                  | 4.86 |                 |   |        | 3,321 |        |  |        | 5.14 |       |   |        | 2,140  |        |  |  | 4.74 |      |   |   | 13,279  |         |  |  | 5.13 |      |   |   | 18,925  |         |  |  | 5.09 |     
|Mortgage-backed securities and collateralized
    mortgage obligations   |                  |                         |       |                |  |                  |     |                 |   |        | 2,650 |        |  |        | 4.93 |       |   |        | 52,413 |        |  |  | 4.16 |      |   |   | 154,260 |         |  |  | 3.81 |      |   |   | 209,324 |         |  |  | 3.91 |     
|Other debt securities                                                    |                  |                         |       |                |  |                  |     |                 |   |        |      |        |  |        |     |       |   |        | 53     |        |  |  | 4.97 |      |   |   | 1,043   |         |  |  | 4.60 |      |   |   | 1,096   |         |  |  | 4.62 |     
|Investment in ARM and CRA funds                                          |                  |                         | 18,430 |                |  |                  | 3.60 |                 |   |        |      |        |  |        |     |       |   |        |       |        |  |  |     |      |   |   | 3,309   |         |  |  | 4.55 |      |   |   | 21,739  |         |  |  | 3.75 |     
|FHLB and Federal Reserve Bank stock(1)                                   |                  |                         |       |                |  |                  |     |                 |   |        |      |        |  |        |     |       |   |        |       |        |  |  |     |      |   |   | 5,200   |         |  |  | 3.00 |      |   |   | 5,200   |         |  |  | 3.00 |     
|                                                                         |                  |                         |        |                |  |                  |      |                 |   |        |       |        |  |        |      |       |   |        |        |        |  |  |      |      |   |   |         |         |  |  |      |      |   |   |         |         |  |  |      |     
|                                                                         | Total securities |                         | $      | 18,615         |  |                  |      | 3.61            | % |        | $     | 10,936 |  |        |      | 4.74  | % |        | $      | 54,606 |  |  |      | 4.18 | % |   | $       | 177,091 |  |  |      | 3.90 | % |   | $       | 261,248 |  |  |      | 3.98 | %
|                                                                         |                  |                         |        |                |  |                  |      |                 |   |        |       |        |  |        |      |       |   |        |        |        |  |  |      |      |   |   |         |         |  |  |      |      |   |   |         |         |  |  |      |     

---

|    |                                                                
|--- | ---------------------------------------------------------------
|(1) | FHLB and Federal Reserve Bank stock do not have
    maturities.

The following table summarizes the fair value and
classification of securities:

|                   |                  |                        |         |         |  |      |         |         |  |   |         |         | 
|------------------ | ---------------- | ---------------------- | ------- | ------- |  | ---- | ------- | ------- |  | - | ------- | ------- | 
|                   |                  |                       
|                   |                  | As of December 31,    
|                   |                  |                       
|                   |                  | 2003                   |         | 2002    |  | 2001
|                   |                  |                        |         |         |  |     
|                   |                  |                       
|                   |                  | (Dollars in thousands)
|Available-for-sale |                  | $                      | 262,264 |         |  | $    | 264,418 |         |  | $ | 176,230 |        
|Held-to maturity   |                  |                        |        |         |  |      |        |         |  |   |        |        
|                   |                  |                        |         |         |  |      |         |         |  |   |         |        
|                   | Total securities |                        | $       | 262,264 |  |      | $       | 264,418 |  |   | $       | 176,230 | 
|                   |                  |                        |         |         |  |      |         |         |  |   |         |        

The securities portfolio includes mortgage-backed
securities which have been developed by pooling a number of real
estate mortgages and are principally issued by federal agencies
such as Fannie Mae, Freddie Mac and Ginnie Mae. These securities
are deemed to have high credit ratings, and certain minimum
levels of regular monthly cash flows of principal and interest
are insured or guaranteed by the issuing agencies. Included in
the Companys mortgage-backed securities at
December 31, 2003, 2002 and 2001, were $77.7 million,
$100.2 million, and $89.2 million, respectively, in
agency-issued collateral mortgage obligations (CMOs).

As of December 31, 2003, 2002 and 2001,
73.7%, 80.2%, and 81.1%, respectively, of the mortgage-backed
securities held by the Company had final maturities of more than
ten years. However, unlike U.S. Treasury and
U.S. Government agency securities, which have a lump sum
payment at maturity, mortgage-backed securities provide cash
flows from regular principal and interest payments and principal
prepayments throughout the lives of the securities.
Mortgage-backed securities which are purchased at a premium will
generally suffer decreasing net yields as interest rates drop
because homeowners tend to refinance their mortgages. Thus, the
premium paid must be amortized over a shorter period. Therefore,
securities purchased at a discount will obtain higher net yields
in a decreasing interest rate environment. As interest rates
rise, the opposite will generally be true. During a period of
increasing interest rates, fixed rate mortgage-backed securities
do not tend to experience heavy prepayments of principal and
consequently, the average life of this security will not be
unduly shortened. Additionally, the value of mortgage-backed
securities generally

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##### Table of Contents



decreases as interest rates increase. At
December 31, 2003, approximately $9.0 million or 4.3%
of the Companys mortgage-backed securities earn interest
at floating rates and reprice within one year, and accordingly
are less susceptible to declines in value should interest rates
increase.


CMOs are bonds that are backed by pools of
mortgages. The pools can be Ginnie Mae, Fannie Mae, or Freddie
Mac pools or they can be private-label pools. The CMOs are
designed so that the mortgage collateral will generate a cash
flow sufficient to provide for the timely repayment of the
bonds. The mortgage collateral pool can be structured to
accommodate various desired bond repayment schedules, provided
that the collateral cash flow is adequate to meet scheduled bond
payments. This is accomplished by dividing the bonds into
classes to which payments on the underlying mortgage pools are
allocated in different order. The bonds cash flow, for
example can be dedicated to one class of bondholders at a time,
thereby increasing call protection to bondholders. In
private-label CMOs, losses on underlying mortgages are directed
to the most junior of all classes and then to the classes above
in order of increasing seniority, which means that the senior
classes have enough credit protection to be given the highest
credit rating by the rating agencies.



| |         
| | --------
| | Deposits

The Companys lending and investing
activities are funded principally by deposits. At
December 31, 2003, 49.9% of the Companys total
deposits were interest-bearing certificates of deposit (CDs),
26.8% were interest-bearing savings, NOW, and money market
accounts and 23.3% were noninterest-bearing demand deposit
accounts. Total deposits at December 31, 2003 were
$724.9 million compared with $691.4 million at
December 31, 2002 and $642.8 million at
December 31, 2001. This represents annual increases over
the two-year period of $33.5 million or 4.9% and
$48.6 million or 7.6%, respectively.

Average noninterest-bearing demand deposits for
the year ended December 31, 2003 were $151.2 million,
an increase of $18.5 million or 13.9%, compared with
$132.7 million for the same period in 2002. Average
noninterest-bearing demand deposits for the year ended
December 31, 2002 compared with the same period in 2001
increased $23.1 million or 21.1% from $109.6 million.

Average interest-bearing deposits for the year
ended December 31, 2003 were $557.4 million, an
increase of $33.3 million or 6.4%, compared with
$524.1 million for the same period in 2002. Average
interest-bearing deposits for the year ended December 31,
2002 compared with the same period in 2001 increased
$6.8 million or 1.3% from $517.3 million.

Average total deposits for the year ended
December 31, 2003 were $708.6 million, an increase of
$51.8 million or 7.9%, compared with $656.8 million
for the same period in 2002. Average total deposits for the year
ended December 31, 2002 compared with the same period in
2001 increased $29.9 million or 4.8%.

The increases in deposits during 2003 and 2002
were primarily the result of continued relationship
banking initiatives. The Companys ratio of average
noninterest-bearing demand deposits to average total deposits
for the years ended December 31, 2003, 2002 and 2001 was
21.3%, 20.2%, and 17.5%, respectively.

As part of its effort to cross-sell its products
and services, the Company actively solicits time deposits from
existing customers. In addition, the Company receives time
deposits from government municipalities and utility districts as
well as from corporations seeking to place deposits in
minority-owned businesses, such as the Company. These time
deposits typically renew at maturity and have provided a stable
source of funds. The Company believes that based on its
historical experience its large time deposits have core-type
characteristics. In pricing its time deposits, the Company seeks
to be competitive but typically prices near the middle of a
given market.

38



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The average daily balances and weighted average
rates paid on deposits for each of the years ended
December 31, 2003, 2002 and 2001 are presented below:

|                              |                                   |                                 |         |         |         |        |   |      |      |        |         |         |         |  |   |      |      |   |         |         |         |  |   |      |      |  
|----------------------------- | --------------------------------- | ------------------------------- | ------- | ------- | ------- | ------ | - | ---- | ---- | ------ | ------- | ------- | ------- |  | - | ---- | ---- | - | ------- | ------- | ------- |  | - | ---- | ---- | -
|                              |                                   |                                
|                              |                                   | Years Ended December 31,       
|                              |                                   |                                
|                              |                                   |                                 |         |         |         |       
|                              |                                   | 2003                            |         | 2002    |         | 2001  
|                              |                                   |                                 |         |         |         |       
|                              |                                   | Amount                          |         | Rate    |         | Amount |   | Rate |      | Amount |         | Rate   
|                              |                                   |                                 |         |         |         |        |   |      |      |        |         |        
|                              |                                   |                                
|                              |                                   | (Dollars in thousands)         
|Interest-bearing deposits:    |                                   |                                 |         |         |         |        |   |      |      |        |         |         |         |  |   |      |      |   |         |         |         |  |   |     
|                              | Money market checking             |                                 | $       | 73,987  |         |        |   | 0.62 | %    |        | $       | 71,059  |         |  |   | 1.18 | %    |   | $       | 54,694  |         |  |   | 2.21 | %   
|                              | Savings and money market deposits |                                 |         | 111,867 |         |        |   | 0.79 |      |        |         | 110,372 |         |  |   | 1.25 |      |   |         | 102,268 |         |  |   | 2.27 |     
|                              | Time deposits less than $100,000  |                                 |         | 169,314 |         |        |   | 2.19 |      |        |         | 176,941 |         |  |   | 2.69 |      |   |         | 182,588 |         |  |   | 5.13 |     
|                              | Time deposits $100,000 and over   |                                 |         | 202,186 |         |        |   | 2.59 |      |        |         | 165,766 |         |  |   | 3.52 |      |   |         | 177,782 |         |  |   | 5.42 |     
|                              |                                   |                                 |         |         |         |        |   |      |      |        |         |         |         |  |   |      |      |   |         |         |         |  |   |     
|                              |                                   | Total interest-bearing deposits |         |         | 557,354 |        |   |      | 1.85 |        |         |         | 524,138 |  |   |      | 2.44 |   |         |         | 517,332 |  |   |      | 4.36 |  
|Non interest-bearing deposits |                                   |                                 | 151,221 |         |         |        |  |      |      |        | 132,686 |         |         |  |  |      |      |   | 109,638 |         |         |  |  |     
|                              |                                   |                                 |         |         |         |        |   |      |      |        |         |         |         |  |   |      |      |   |         |         |         |  |   |     
|                              |                                   | Total deposits                  |         | $       | 708,575 |        |   |      | 1.45 | %      |         | $       | 656,824 |  |   |      | 1.95 | % |         |         | 626,970 |  |   |      | 3.59 | %
|                              |                                   |                                 |         |         |         |        |   |      |      |        |         |         |         |  |   |      |      |   |         |         |         |  |   |     

The following table sets forth the amount of the
Companys time deposits that are $100,000 or greater by
time remaining until maturity:

|                              |  |                        |         | 
|----------------------------- |  | ---------------------- | ------- | 
|                              |  | As of                 
|                              |  | December 31, 2003     
|                              |  |                       
|                              |  | (Dollars in thousands)
|Three months or less          |  | $                      | 44,829  | 
|Over three through six months |  |                        | 37,295  | 
|Over six through 12 months    |  |                        | 65,241  | 
|Over 12 months                |  |                        | 46,582  | 
|                              |  |                        |         | 
|Total                         |  | $                      | 193,947 | 
|                              |  |                        |         | 



| |                 
| | ----------------
| | Other Borrowings

Other borrowings include $25.0 million of
loans from the FHLB of Dallas, maturing in September 2008. The
loans bear interest at an average rate of 4.99% per annum
until the fifth anniversary at which time they may be repaid or
the interest rate may be renegotiated.

Other borrowings also include several FHLB
advances obtained in 2002 and 2003 to acquire mortgage-related
securities in order to increase earning assets. These borrowings
were $28.3 million at December 31, 2003 with
maturities ranging from one month to five years and carried a
weighted average interest rate of 1.52%.

Additionally, the Company had several unused,
uncollateralized lines of credit with correspondent banks
totaling $15.0 million at December 31, 2003, 2002, and
2001, respectively.

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The following table presents the categories of
other borrowings by the Company:

|                             |                                           |                        |   |        |  |      |   |        |  |  |   |        | 
|---------------------------- | ----------------------------------------- | ---------------------- | - | ------ |  | ---- | - | ------ |  |  | - | ------ | 
|                             |                                           |                       
|                             |                                           | As of December 31,    
|                             |                                           |                       
|                             |                                           | 2003                   |   | 2002   |  | 2001
|                             |                                           |                        |   |        |  |     
|                             |                                           |                       
|                             |                                           | (Dollars in thousands)
|Federal funds purchased:     |                                           |                        |   |        |  |      |   |        |  |  |   |       
|                             | on December 31,                           |                        | $ |       |  |      | $ |       |  |  | $ |       | 
|                             | average during the year                   |                        |   | 55     |  |      |   | 162    |  |  |   | 1      | 
|                             | maximum month end balance during the year |                        |   |       |  |      |   |       |  |  |   |       | 
|FHLB notes:                  |                                           |                        |   |        |  |      |   |        |  |  |   |       
|                             | on December 31,                           |                        | $ | 53,300 |  |      | $ | 65,200 |  |  | $ | 25,000 | 
|                             | average during the year                   |                        |   | 59,667 |  |      |   | 52,343 |  |  |   | 25,000 | 
|                             | maximum month end balance during the year |                        |   | 69,300 |  |      |   | 69,700 |  |  |   | 25,000 | 
|Other short-term borrowings: |                                           |                        |   |        |  |      |   |        |  |  |   |       
|                             | on December 31,                           |                        | $ | 873    |  |      | $ | 574    |  |  | $ | 195    | 
|                             | average during the year                   |                        |   | 587    |  |      |   | 551    |  |  |   | 570    | 
|                             | maximum month end balance during the year |                        |   | 873    |  |      |   | 713    |  |  |   | 555    | 

At December 31, 2003, the following table
presents the payments due by period for the Companys
contractual borrowing obligations (other than deposit
obligations with no stated maturities):

|                            |                               |                        |         |             |  |             |        |            |  |       |       |       |  |   |        |        |  |   |         |         | 
|--------------------------- | ----------------------------- | ---------------------- | ------- | ----------- |  | ----------- | ------ | ---------- |  | ----- | ----- | ----- |  | - | ------ | ------ |  | - | ------- | ------- | 
|                            |                               |                        |         | After One   |  | After Three |        |            |  |      
|                            |                               | Within One             |         | But Within  |  | But Within  |        | After Five |  |      
|                            |                               | Year                   |         | Three Years |  | Five Years  |        | Years      |  | Total
|                            |                               |                        |         |             |  |             |        |            |  |      
|                            |                               |                       
|                            |                               | (Dollars in thousands)
|Certificates of deposit     |                               | $                      | 292,978 |             |  | $           | 61,177 |            |  | $     | 7,359 |       |  | $ | 67     |        |  | $ | 361,581 |        
|Federal Reserve TT&L        |                               |                        | 873     |             |  |             |       |            |  |       |      |       |  |   |       |        |  |   | 873     |        
|Short-term borrowings       |                               |                        | 28,300  |             |  |             |       |            |  |       |      |       |  |   |       |        |  |   | 28,300  |        
|Long-term borrowings        |                               |                        |        |             |  |             |       |            |  |       |      |       |  |   | 25,000 |        |  |   | 25,000  |        
|                            |                               |                        |         |             |  |             |        |            |  |       |       |       |  |   |        |        |  |   |         |        
|                            | Total borrowing obligations   |                        |         | 322,151     |  |             |        | 61,177     |  |       |       | 7,359 |  |   |        | 25,067 |  |   |         | 415,754 | 
|Operating lease obligations |                               |                        | 944     |             |  |             | 1,290  |            |  |       | 655   |       |  |   | 1,082  |        |  |   | 3,971   |        
|                            |                               |                        |         |             |  |             |        |            |  |       |       |       |  |   |        |        |  |   |         |        
|                            | Total contractual obligations |                        | $       | 323,095     |  |             | $      | 62,467     |  |       | $     | 8,014 |  |   | $      | 26,149 |  |   | $       | 419,725 | 
|                            |                               |                        |         |             |  |             |        |            |  |       |       |       |  |   |        |        |  |   |         |        



| |                                              
| | ---------------------------------------------
| | Interest Rate Sensitivity and Market
    Risk

As a financial institution, the Companys
primary component of market risk is interest rate volatility,
primarily in the prime lending rate. Fluctuations in interest
rates will ultimately impact both the level of income and
expense recorded on most of the Companys assets and
liabilities, and the market value of all interest-earning assets
and interest-bearing liabilities, other than those which have a
short term to maturity. Based upon the nature of the
Companys operations, the Company is not subject to foreign
exchange or commodity price risk. The Company does not own any
trading assets.

The Companys Funds Management Policy
provides management with the necessary guidelines for effective
funds management, and the Company has established a measurement
system for monitoring its net interest rate sensitivity
position. The Company manages its sensitivity position within
established guidelines.

Interest rate risk is managed by the Asset and
Liability Committee (ALCO) which is composed of
senior officers of the Company, in accordance with policies
approved by the Companys Board of Directors. Interest rate
risk is the potential of economic losses due to future interest
rate changes. These economic losses can be reflected as a loss
of future net interest income and/or a loss of current fair
market values. The objective is to measure the effect on net
interest income and to adjust the balance sheet to minimize the

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inherent risk while at the same time maximizing
income. Management realizes certain risks are inherent, and that
the goal is to identify, monitor, manage or exploit the risks.


The ALCO formulates strategies based on
appropriate levels of interest rate risk. In determining the
appropriate level of interest rate risk, the ALCO considers the
impact on earnings and capital of the current outlook on
interest rates, potential changes in interest rates, regional
economies, liquidity, business strategies and other factors. The
ALCO meets regularly to review, among other things, the
sensitivity of assets and liabilities to interest rate changes,
the book and market values of assets and liabilities, unrealized
gains and losses, purchase and sale activities, commitments to
originate loans and the maturities of investments and
borrowings. Additionally, the ALCO reviews liquidity, cash flow
flexibility, maturities of deposits and consumer and commercial
deposit activity. Management uses two methodologies to manage
interest rate risk: (i) an analysis of relationships
between interest-earning assets and interest-bearing liabilities
and (ii) an interest rate shock simulation model. The
Company has traditionally managed its business to reduce its
overall exposure to changes in interest rates, however, under
current policies of the Companys Board of Directors,
management has been given some latitude to increase the
Companys interest rate sensitivity position within certain
limits if, in managements judgment, it will enhance
profitability. As a result, changes in market interest rates may
have a greater impact on the Companys financial
performance in the future than they have had historically.

An interest rate sensitive asset or liability is
one that, within a defined time period, either matures or
experiences an interest rate change in line with general market
interest rates. The management of interest rate risk is
performed by analyzing the maturity and repricing relationships
between interest-earning assets and interest-bearing liabilities
at specific points in time (GAP) and by analyzing
the effects of interest rate changes on net interest income over
specific periods of time by projecting the performance of the
mix of assets and liabilities in varied interest rate
environments. Interest rate sensitivity reflects the potential
effect on net interest income of a movement in interest rates. A
company is considered to be asset sensitive, or having a
positive GAP, when the amount of its interest-earning assets
maturing or repricing within a given period exceeds the amount
of its interest-bearing liabilities also maturing or repricing
within that time period. Conversely, a company is considered to
be liability sensitive, or having a negative GAP, when the
amount of its interest-bearing liabilities maturing or repricing
within a given period exceeds the amount of its interest-earning
assets also maturing or repricing within that time period.
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.

41



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The following table sets forth an interest rate
sensitivity analysis for the Company at December 31, 2003:

|                              |                                                                                   |                              |   |          |   |         |   |          |     |       |   |         |    |         |   |         |     |  |   |         |     |  |   |         |    |  |   |         |   |  |   |         | 
|----------------------------- | --------------------------------------------------------------------------------- | ---------------------------- | - | -------- | - | ------- | - | -------- | --- | ----- | - | ------- | -- | ------- | - | ------- | --- |  | - | ------- | --- |  | - | ------- | -- |  | - | ------- | - |  | - | ------- | 
|                              |                                                                                   |                             
|                              |                                                                                   | Volumes Subject to Repricing
|                              |                                                                                   |                             
|                              |                                                                                   |                              |   | Greater  |   |        
|                              |                                                                                   | 0-30                         |   | 31-180   |   | 181-365 |   | 1-3      |     | 3-5   |   | 5-10    |    | Than 10 |   |        
|                              |                                                                                   | Days                         |   | Days     |   | Days    |   | Years    |     | Years |   | Years   |    | Years   |   | Total  
|                              |                                                                                   |                              |   |          |   |         |   |          |     |       |   |         |    |         |   |        
|                              |                                                                                   |                             
|                              |                                                                                   | (Dollars in thousands)      
|Interest-earning assets:      |                                                                                   |                              |   |          |   |         |   |          |     |       |   |         |    |         |   |         |     |  |   |         |     |  |   |         |    |  |   |         |   |  |   |        
|                              | Securities                                                                        |                              | $ | 34,466   |   |         | $ | 50,491   |     |       | $ | 46,401  |    |         | $ | 50,726  |     |  | $ | 37,490  |     |  | $ | 28,943  |    |  | $ | 8,547   |   |  | $ | 257,064 | 
|                              | Total loans                                                                       |                              |   | 460,904  |   |         |   | 22,342   |     |       |   | 17,327  |    |         |   | 34,243  |     |  |   | 6,684   |     |  |   | 1,798   |    |  |   | 38      |   |  |   | 543,336 | 
|                              | Federal funds sold and other temporary investments                                |                              |   | 36,927   |   |         |   |         |     |       |   |        |    |         |   |        |     |  |   |        |     |  |   |        |    |  |   |        |   |  |   | 36,927  | 
|                              |                                                                                   |                              |   |          |   |         |   |          |     |       |   |         |    |         |   |         |     |  |   |         |     |  |   |         |    |  |   |         |   |  |   |        
|                              | Total interest-bearing assets                                                     |                              |   | 532,297  |   |         |   | 72,833   |     |       |   | 63,728  |    |         |   | 84,969  |     |  |   | 44,174  |     |  |   | 30,741  |    |  |   | 8,585   |   |  |   | 837,327 | 
|                              |                                                                                   |                              |   |          |   |         |   |          |     |       |   |         |    |         |   |         |     |  |   |         |     |  |   |         |    |  |   |         |   |  |   |        
|Interest-bearing liabilities: |                                                                                   |                              |   |          |   |         |   |          |     |       |   |         |    |         |   |         |     |  |   |         |     |  |   |         |    |  |   |         |   |  |   |        
|                              | Demand, money market and savings deposits                                         |                              |   |         |   |         |   | 17,484   |     |       |   | 17,484  |    |         |   | 60,222  |     |  |   | 40,795  |     |  |   | 58,279  |    |  |   |        |   |  |   | 194,264 | 
|                              | Time deposits                                                                     |                              |   | 33,800   |   |         |   | 141,677  |     |       |   | 117,500 |    |         |   | 61,178  |     |  |   | 7,359   |     |  |   | 67      |    |  |   |        |   |  |   | 361,581 | 
|                              | Federal funds purchased                                                           |                              |   |         |   |         |   |         |     |       |   |        |    |         |   |        |     |  |   |        |     |  |   |        |    |  |   |        |   |  |   |        | 
|                              | Other borrowings                                                                  |                              |   | 2,973    |   |         |   | 23,700   |     |       |   | 2,500   |    |         |   |        |     |  |   | 25,000  |     |  |   |        |    |  |   |        |   |  |   | 54,173  | 
|                              |                                                                                   |                              |   |          |   |         |   |          |     |       |   |         |    |         |   |         |     |  |   |         |     |  |   |         |    |  |   |         |   |  |   |        
|                              | Total interest-bearing liabilities                                                |                              |   | 36,773   |   |         |   | 182,861  |     |       |   | 137,484 |    |         |   | 121,400 |     |  |   | 73,154  |     |  |   | 58,346  |    |  |   |        |   |  |   | 610,018 | 
|                              |                                                                                   |                              |   |          |   |         |   |          |     |       |   |         |    |         |   |         |     |  |   |         |     |  |   |         |    |  |   |         |   |  |   |        
|                              | Period GAP                                                                        |                              | $ | 495,524  |   |         | $ | (110,028 | )   |       | $ | (73,756 | )  |         | $ | (36,431 | )   |  | $ | (28,980 | )   |  | $ | (27,605 | )  |  | $ | 8,585   |   |  | $ | 227,309 | 
|                              |                                                                                   |                              |   |          |   |         |   |          |     |       |   |         |    |         |   |         |     |  |   |         |     |  |   |         |    |  |   |         |   |  |   |        
|                              | Cumulative GAP                                                                    |                              | $ | 495,524  |   |         | $ | 385,496  |     |       | $ | 311,740 |    |         | $ | 275,309 |     |  | $ | 246,329 |     |  | $ | 218,724 |    |  | $ | 227,309 |   |  |   |         | 
|                              |                                                                                   |                              |   |          |   |         |   |          |     |       |   |         |    |         |   |         |     |  |   |         |     |  |   |         |    |  |   |         |   |  |   |        
|                              | Period GAP to total assets                                                        |                              |   | 58.99    | % |         |   | (13.10   | ) % |       |   | (8.78   | )% |         |   | (4.34   | ) % |  |   | (3.45   | ) % |  |   | (3.29   | )% |  |   | 1.02    | % |  |   |         | 
|                              | Cumulative GAP to total assets                                                    |                              |   | 58.99    | % |         |   | 45.89    | %   |       |   | 37.11   | %  |         |   | 32.77   | %   |  |   | 29.32   | %   |  |   | 26.04   | %  |  |   | 27.06   | % |  |   |         | 
|                              | Cumulative interest-earning assets to cumulative
    interest-bearing liabilities |                              |   | 1,447.52 | % |         |   | 275.52   | %   |       |   | 187.29  | %  |         |   | 157.53  | %   |  |   | 144.65  | %   |  |   | 135.86  | %  |  |   | 137.26  | % |  |   |         | 

The preceding table provides Company management
with repricing data within given time frames. The purpose of
this information is to assist management in the elements of
pricing and of matching interest sensitive assets with interest
sensitive liabilities within time frames. The table indicates a
positive GAP on a cumulative basis for the three time periods
covering the next 365 days of $495.5 million
(1-30 days), $385.5 million (31-180 days) and
$311.7 million (181-365 days), respectively. With this
condition, the Company is susceptible to a decrease in net
interest income should market interest rates decrease. GAP
reflects a one-day position that is continually changing and is
not indicative of the Companys position at any other time.
While the GAP position is a useful tool in measuring interest
rate risk and contributes toward effective asset and liability
management, it is difficult to predict the effect of changing
interest rates solely on that measure, without accounting for
alterations in the maturity or repricing characteristics of the
balance sheet that occur during changes in market interest
rates. For example, the GAP position reflects only the
prepayment assumptions pertaining to the current rate
environment. Assets tend to prepay more rapidly during periods
of declining interest rates than during periods of rising
interest rates. Because of this and other risk factors not
contemplated by the GAP position, an institution could have a
matched GAP position in the current rate environment and still
have its net interest income exposed to increased rate risk. The
Companys Rate Committee and the ALCO review the
Companys interest rate risk position on a weekly and
monthly basis, respectively.

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The Company applies an economic value of equity
(EVE) methodology to gauge its interest rate risk
exposure as derived from its simulation model. Generally, EVE is
the discounted present value of the difference between incoming
cash flows on interest-earning assets and other investments and
outgoing cash flows on interest-bearing liabilities. The
application of the methodology attempts to quantify interest
rate risk by measuring the change in the EVE that would result
from a theoretical instantaneous and sustained 100 or 200 basis
point shifts in market interest rates.

Presented below, as of December 31, 2003, is
an analysis of the Companys interest rate risk as measured
by changes in EVE for a 200 basis point increase and a
100 basis point decrease in market interest rates:

|                |  |                        |        |                 |  |                  |       |        |  |  |        |  |  |  |       |   
|--------------- |  | ---------------------- | ------ | --------------- |  | ---------------- | ----- | ------ |  |  | ------ |  |  |  | ----- | --
|                |  |                        |        |                 |  |                 
|                |  |                        |        |                 |  | EVE as a % of   
|                |  |                        |        |                 |  | Present Value of
|                |  |                        |        |                 |  | Assets          
|                |  |                        |        |                 |  |                 
|Change in Rates |  | $ Change in EVE        |        | % Change in EVE |  | EVE Ratio        |       | Change
|                |  |                        |        |                 |  |                  |       |       
|                |  | (Dollars in thousands) |        |                 |  |                  |       |       
|-100 bp         |  | $                      | (9,073 | )               |  |                  | (8.98 | )%     |  |  | 10.60% |  |  |  | (105) | bp
|0 bp            |  |                        |       |                 |  |                  |      |        |  |  | 11.65% |  |  |  |      |   
|+200 bp         |  | $                      | 8,537  |                 |  |                  | 8.45  | %      |  |  | 12.63% |  |  |  | 98    | bp

The percentage change in EVE as a result of a
100 basis point decrease in interest rates at
December 31, 2003 was (8.98)% compared with (10.24)% as of
December 31, 2002. The percentage change in EVE as a result
of a 200 basis point increase in interest rates on
December 31, 2003 of 8.45% compared with 7.53% as of
December 31, 2002.

In 2003, the investment portfolio experienced a
significant amount of mortgage-backed security prepayments and
agency security calls as a result of interest rate declines. The
proceeds from these cash flows were generally invested in
shorter-term securities resulting in a shortening in the
weighted-average life of the portfolio. The shorter duration
should mitigate future portfolio price depreciation as interest
rates increase.

Management believes that the EVE methodology
overcomes three shortcomings of the typical maturity GAP
methodology. First, it does not use arbitrary repricing
intervals and accounts for all expected future cash flows.
Second, because the EVE method projects cash flows of each
financial instrument under different interest rate environments,
it can incorporate the effect of embedded options on an
institutions interest rate risk exposure. Third, it allows
interest rates on different instruments to change by varying
amounts in response to a change in market interest rates,
resulting in more accurate estimates of cash flows.

As with any method of gauging interest rate risk,
however, there are certain shortcomings inherent to the EVE
methodology. The model assumes interest rate changes are
instantaneous parallel shifts in the yield curve. In reality,
rate changes are rarely instantaneous. The use of the
simplifying assumption that short-term and long-term rates
change by the same degree may also misstate historical rate
patterns which rarely show parallel yield curve shifts. Further,
the model assumes that certain assets and liabilities of similar
maturity or repricing will react identically to changes in
rates. In reality, the market value of certain types of
financial instruments may adjust in anticipation of changes in
market rates, while any adjustment in the valuation of other
types of financial instruments may lag behind the change in
general market rates. Additionally, the EVE methodology does not
reflect the full impact of contractual restrictions on changes
in rates for certain assets, such as adjustable rate loans. When
interest rates change, actual loan prepayments and actual early
withdrawals from time deposits may deviate significantly from
the assumptions used in the model. Finally, this methodology
does not measure or reflect the impact that higher rates may
have on the ability of adjustable rate loan clients to service
their debt. All of these factors are considered in monitoring
the Companys exposure to interest rate risk.

The prime rate in effect for December 31,
2003 and December 31, 2002 was 4.00% and 4.25%
respectively. In November 2002, the Federal Reserve lowered
interest rates 50 basis points, and another 25 basis
points in June 2003.

43



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##### Table of Contents





| |          
| | ---------
| | Liquidity

Liquidity involves the Companys ability to
raise funds to support asset growth or reduce assets to meet
deposit withdrawals and other payment obligations, to maintain
reserve requirements and otherwise to operate the Company on an
ongoing basis. The Companys liquidity needs are met
primarily by financing activities, which consist mainly of
growth in deposits, supplemented by available-for-sale
investment securities, other borrowings and earnings through
operating activities. Although access to purchased funds from
correspondent banks is available and has been utilized on
occasion to take advantage of investment opportunities, the
Company does not generally rely on these external funding
sources. The cash and federal funds sold position, supplemented
by amortizing investments along with payments and maturities
within the loan portfolio, have historically created an adequate
liquidity position.

The Company uses federal funds purchased and
other borrowings as funding sources and in its management of
interest rate risk. Federal funds purchased generally represent
overnight borrowings. Other borrowings principally consist of
U.S. Treasury tax note option accounts that have maturities
of 14 days or less and borrowings from the FHLB.

FHLB advances may be utilized from time to time
as either a short-term funding source or a longer-term funding
source. FHLB advances can be particularly attractive as a
longer-term funding source to balance interest rate sensitivity
and reduce interest rate risk. The Company is eligible for
several borrowing programs through the FHLB. The first, a
short-term borrowing program, requires delivery of eligible
securities for collateral. Maturities under this program range
from one to 365 days. The Company currently maintains most
of its investment securities in safekeeping at the FHLB of
Dallas.

Under another borrowing program, long-term
borrowings are available to the Company from the FHLB. These
borrowings have maturities greater than one year and are
collateralized first by FHLB stock, second by the Companys
one to four family mortgage loans and third by the
Companys investment securities in safekeeping at the FHLB.
Borrowings collateralized by the Companys one to four
family mortgage loans are limited to 75% of the loan value. At
December 31, 2003, the Company had $53.3 million in
borrowings under this program.



| |                                   
| | ----------------------------------
| | Off-Balance Sheet
    Arrangements

The Bank is party to financial instruments with
off-balance sheet risk in the normal course of business to meet
the financing needs of its customers. These financial
instruments include various guarantees, commitments to extend
credit and standby letters of credit. Additionally, these
instruments may involve, to varying degrees, credit risk in
excess of the amount recognized in the statement of financial
condition. The Banks maximum exposure to credit loss under
such arrangements is represented by the contractual amount of
those instruments. The Bank applies the same credit policies and
collateralization guidelines in making commitments and
conditional obligations as it does for on-balance sheet
instruments. Unfunded loan commitments including unfunded lines
of credit at December 31, 2003 and 2002 aggregated
approximately $87.7 million and $74.9 million,
respectively. Commitments under standby and commercial letters
of credit at December 31, 2003 and 2002 totaled
$14.9 million and $10.4 million, respectively.
Operating leases at December 31, 2003 and 2002 totaled
$4.0 million and $3.3 million, respectively.

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The contractual amount of the Companys
financial instruments with off-balance sheet risk expiring by
period at December 31, 2003 is presented below:

|                                                                 |  |                        |         |             |  |             |       |            |  |       |     |  |  |   |       |  |  |   |         | 
|---------------------------------------------------------------- |  | ---------------------- | ------- | ----------- |  | ----------- | ----- | ---------- |  | ----- | --- |  |  | - | ----- |  |  | - | ------- | 
|                                                                 |  |                        |         | After One   |  | After Three |       |            |  |      
|                                                                 |  | Within One             |         | but Within  |  | but Within  |       | After Five |  |      
|                                                                 |  | Year                   |         | Three Years |  | Five Years  |       | Years      |  | Total
|                                                                 |  |                        |         |             |  |             |       |            |  |      
|                                                                 |  |                       
|                                                                 |  | (Dollars in thousands)
|Unfunded loan commitments including unfunded
    lines of credit |  | $                      | 87,706  |             |  | $           |      |            |  | $     |    |  |  | $ |      |  |  | $ | 87,706  | 
|Standby letters of credit                                        |  |                        | 7,215   |             |  |             | 115   |            |  |       |    |  |  |   |      |  |  |   | 7,330   | 
|Commercial letters of credit                                     |  |                        | 7,527   |             |  |             |      |            |  |       |    |  |  |   |      |  |  |   | 7,527   | 
|Operating leases                                                 |  |                        | 944     |             |  |             | 1,290 |            |  |       | 656 |  |  |   | 1,082 |  |  |   | 3,972   | 
|                                                                 |  |                        |         |             |  |             |       |            |  |       |     |  |  |   |       |  |  |   |         | 
|Total financial instruments with off-balance
    sheet risk      |  | $                      | 103,392 |             |  | $           | 1,405 |            |  | $     | 656 |  |  | $ | 1,082 |  |  | $ | 106,535 | 
|                                                                 |  |                        |         |             |  |             |       |            |  |       |     |  |  |   |       |  |  |   |         | 



| |                  
| | -----------------
| | Capital Resources

Capital management consists of providing equity
to support both current and future operations. The Company is
subject to capital adequacy requirements imposed by the Federal
Reserve Board and the Bank is subject to capital adequacy
requirements imposed by the OCC. Both the Federal Reserve Board
and the OCC have adopted risk-based capital requirements for
assessing bank holding company and bank capital adequacy. These
standards define capital and establish minimum capital
requirements in relation to assets and off-balance sheet
exposure, adjusted for credit risk. The risk-based capital
standards currently in effect are designed to make regulatory
capital requirements more sensitive to differences in risk
profiles among bank holding companies and banks, to account for
off-balance sheet exposure and to minimize disincentives for
holding liquid assets. Assets and off-balance sheet items are
assigned to broad risk categories, each with appropriate
relative risk weights. The resulting capital ratios represent
capital as a percentage of total risk-weighted assets and
off-balance sheet items.

The risk-based capital standards of the Federal
Reserve Board require all bank holding companies to have
Tier 1 capital of at least 4.0% and total
risk-based capital (Tier 1 and Tier 2) of
at least 8.0% of total risk-adjusted assets. Tier 1
capital generally includes common shareholders
equity and qualifying perpetual preferred stock together with
related surpluses and retained earnings, less deductions for
goodwill and various other intangibles. Tier 2
capital may consist of a limited amount of
intermediate-term preferred stock, a limited amount of term
subordinated debt, certain hybrid capital instruments and other
debt securities, perpetual preferred stock not qualifying as
Tier 1 capital, and a limited amount of the general
valuation allowance for loan losses. The sum of Tier 1
capital and Tier 2 capital is total risk-based
capital.

The Federal Reserve Board has also adopted
guidelines which supplement the risk-based capital guidelines
with a minimum ratio of Tier 1 capital to average total
consolidated assets (leverage ratio) of 3.0% for
institutions with well diversified risk, including no undue
interest rate exposure; excellent asset quality; high liquidity;
good earnings; and that are generally considered to be strong
banking organizations, rated composite 1 under applicable
federal guidelines, and that are not experiencing or
anticipating significant growth. Other banking organizations are
required to maintain a leverage ratio of at least 4.0%. These
rules further provide that banking organizations experiencing
internal growth or making acquisitions will be expected to
maintain capital positions substantially above the minimum
supervisory levels and comparable to peer group averages,
without significant reliance on intangible assets.

Pursuant to FDICIA, each federal banking agency
revised its risk-based capital standards to ensure that those
standards take adequate account of interest rate risk,
concentration of credit risk and the risks of nontraditional
activities, as well as reflect the actual performance and
expected risk of loss on multifamily mortgages. The Bank is
subject to capital adequacy guidelines of the OCC that are
substantially similar to the Federal Reserve Boards
guidelines. Also pursuant to FDICIA, the OCC has promulgated
regulations setting the levels at which an insured institution
such as the Bank would be considered well
capitalized,

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adequately capitalized as,
undercapitalized, significantly
undercapitalized and critically
undercapitalized. The Bank is classified well
capitalized for purposes of the OCCs prompt
corrective action regulations. See Business 
Supervision and Regulation  The Company and
 The Bank.


Shareholders equity at December 31,
2003 was $76.2 million, an increase of $1.7 million or
2.3% compared to shareholders equity of $74.5 million
at December 31, 2002. This increase was primarily the
result of net income of $3.7 million, common and treasury
stock issuances of $150,000, and an increase in paid-in capital
of $1.3 million that was partially offset by a reduction in
the net unrealized gain on securities of approximately
$1.7 million and dividend payments of $1.7 million.

The following table provides a comparison of the
Companys and the Banks leverage and risk-weighted
capital ratios as of December 31, 2003 to the minimum and
well-capitalized regulatory standards:

|            |                                 |                  |  |                   |      |                   |  |       |   |  |  |       |  
|----------- | ------------------------------- | ---------------- |  | ----------------- | ---- | ----------------- |  | ----- | - |  |  | ----- | -
|            |                                 | Minimum          |  | To Be Well        |      |                  
|            |                                 | Required For     |  | Capitalized Under |      |                  
|            |                                 | Capital Adequacy |  | Prompt Corrective |      | Actual Ratio At  
|            |                                 | Purposes         |  | Action Provisions |      | December 31, 2003
|            |                                 |                  |  |                   |      |                  
|The Company |                                 |                  |  |                   |      |                   |  |       |   |  |  |      
|            | Leverage ratio                  |                  |  | 4.00              | %(1) |                   |  | N/A   | % |  |  | 8.84  | %
|            | Tier 1 risk-based capital ratio |                  |  | 4.00              |      |                   |  | N/A   |   |  |  | 12.42 |  
|            | Risk-based capital ratio        |                  |  | 8.00              |      |                   |  | N/A   |   |  |  | 13.67 |  
|The Bank    |                                 |                  |  |                   |      |                   |  |       |   |  |  |      
|            | Leverage ratio                  |                  |  | 4.00              | %(2) |                   |  | 5.00  | % |  |  | 8.30  | %
|            | Tier 1 risk-based capital ratio |                  |  | 4.00              |      |                   |  | 6.00  |   |  |  | 11.66 |  
|            | Risk-based capital ratio        |                  |  | 8.00              |      |                   |  | 10.00 |   |  |  | 12.92 |  




|    |                                                                                                               
|--- | --------------------------------------------------------------------------------------------------------------
|(1) | The Federal Reserve Board may require the Company
    to maintain a leverage ratio above the required minimum.
|(2) | The OCC may require the Bank to maintain a
    leverage ratio above the required minimum.                     



| |                             
| | ----------------------------
| | Critical Accounting Policies

The Company has established various accounting
policies which govern the application of accounting principles
generally accepted in the United States in the preparation of
the Companys financial statements. Certain accounting
policies involve significant judgments and assumptions by
management which have a material impact on the carrying value of
certain assets and liabilities; management considers such
accounting policies to be critical accounting policies. The
judgments and assumptions used by management are based on
historical experience and other factors, which are believed to
be reasonable under the circumstances. Because of the nature of
the judgments and assumptions made by management, actual results
could differ from these judgments and estimates which could have
a material impact on the carrying values of assets and
liabilities and the results of operations of the Company. The
Company believes the allowance for loan losses is a critical
accounting policy that requires the most significant judgments
and estimates used in the preparation of its consolidated
financial statements. In estimating the allowance for loan
losses, management reviews effect of changes in the local real
estate market on collateral values, the effect of current
economic indicators on the loan portfolio and their probable
impact on borrowers and increases or decreases in nonperforming
and impaired loans. Changes in these factors may cause
managements estimate of the allowance to increase or
decrease and result in adjustments to the Companys
provision for loan losses. See Financial
Condition  Allowance for Loan Losses.

The Company believes that loans held-for-sale and
the related lower of cost or market adjustment is also a
critical accounting policy that requires significant judgments
and estimates in preparation of its consolidated financial
statements. In estimating the requirement for market
adjustments, management utilizes outside sources to determine
the market value of the loans held-for-sale through solicitation
of market bids or

46



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##### Table of Contents



indications of market value. Decreases in market
value will be reflected in the consolidated statement of income
under noninterest expense as Lower of Cost or Market
Adjustment.


New Accounting Pronouncements

On November 25, 2002, the FASB issued FASB
Interpretation (FIN) No. 45,
Guarantors Accounting and Disclosure Requirements for
Guarantees, Including Indirect Guarantees of Indebtedness
of Others. FIN No. 45 considers standby letters of
credit, excluding commercial letters of credit and other lines
of credit, a guarantee of the Bank. The Bank enters into a
standby letter of credit to guarantee performance of a customer
to a third party. These guarantees are primarily issued to
support public and private borrowing arrangements. The credit
risk involved is represented by the contractual amounts of those
instruments. Under the standby letters of credit, the Bank is
required to make payments to the beneficiary of the letters of
credit upon request by the beneficiary so long as all
performance criteria have been met. Most guarantees extend up to
one year. At December 31, 2003 the maximum potential amount
of future payments is $7.3 million. The Company has
recorded a liability of approximately $2,542 at
December 31, 2003, for the fair value of the Companys
potential obligations, which represents the unamortized portion
of the letter of credit fees. See Note 12 
Off-Balance Sheet Risk for a discussion of significant
guarantees that have been entered into by the Company.

On January 17, 2003, the FASB issued FIN
No. 46, Consolidation of Variable Interest Entities,which addresses consolidation by business enterprises of
variable interest entities. FIN No. 46 clarifies the
application of ARB No. 51, Consolidated Financial
Statements,to certain entities in which equity investors do
not have the characteristics of a controlling financial interest
or do not have sufficient equity at risk for the entity to
finance its activities without additional subordinated financial
support from other parties. The Company has determined the
impact of this interpretation will not have any effect on its
financial condition or results of operations.

On April 30, 2003, the FASB approved
SFAS No. 149, an amendment to SFAS No. 133,
Accounting for Derivative Instruments and Hedging Activities.This statement amends and clarifies financial accounting and
reporting for derivative instruments, including certain
derivative instruments embedded in other contracts (collectively
referred to as derivatives) and for hedging activities under
SFAS No. 133. The provisions of this statement were
effective for contracts entered into or modified after
June 30, 2003 and for hedging relationships designated
after June 30, 2003. The adoption of SFAS No. 149
did not have a material effect on the Companys financial
condition or results of operations.

On May 15, 2003, the FASB approved
SFAS No. 150, Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and
Equity. This statement changes the accounting for certain
financial instruments that, under previous guidance, could be
classified as equity or mezzanine equity, but now is
requiring those instruments to be classified as liabilities (or
assets in some circumstances) in the statement of financial
condition. Further, SFAS No. 150 requires disclosure
regarding the terms of those instruments and settlement
alternatives. This statement is generally effective for all such
financial instruments entered into or modified after
May 31, 2003, and otherwise is effective at the beginning
of the first interim period beginning after June 15, 2003,
except for mandatorily redeemable financial instruments of
non-public entities. It is not expected that this statement will
have a material effect on the Companys financial condition
or results of operations. On October 29, 2003, the FASB
deferred certain provisions of this statement.






|         |                                                              
|-------- | -------------------------------------------------------------
|Item 7A. | Quantitative and Qualitative Disclosure
    About Market Risk

For information regarding the market risk of the
Companys financial instruments, see Item 7.
Managements Discussion and Analysis of Financial Condition
and Results of Operations-Interest Rate Sensitivity and Market
Risk. The Companys principal market risk exposure is
to interest rates.

47



---



##### Table of Contents








|        |                                                
|------- | -----------------------------------------------
|Item 8. | Financial Statements and Supplementary
    Data

Reference is made to the financial statements,
the reports thereon, the notes thereto and supplementary data
commencing at page 53 of this Form 10-K, which
financial statements, reports, notes and data are incorporated
herein by reference.



| |                         
| | ------------------------
| | Quarterly Financial Data

The following table represents summarized data
for each of the quarters in fiscal 2003 and 2002 (in thousands,
except per share data):

|                                     |                                                         |         |        |         |  |         |        |         |  |         |        |         |   |         |        |         |  |   |        |       |  |   |        |       |  |   |        |       |  |   |        |       | 
|------------------------------------ | ------------------------------------------------------- | ------- | ------ | ------- |  | ------- | ------ | ------- |  | ------- | ------ | ------- | - | ------- | ------ | ------- |  | - | ------ | ----- |  | - | ------ | ----- |  | - | ------ | ----- |  | - | ------ | ----- | 
|                                     |                                                         |         |        |        
|                                     |                                                         | 2003    |        | 2002   
|                                     |                                                         |         |        |        
|                                     |                                                         | Fourth  |        | Third   |  | Second  |        | First   |  | Fourth  |        | Third   |   | Second  |        | First  
|                                     |                                                         | Quarter |        | Quarter |  | Quarter |        | Quarter |  | Quarter |        | Quarter |   | Quarter |        | Quarter
|                                     |                                                         |         |        |         |  |         |        |         |  |         |        |         |   |         |        |        
|Interest income                      |                                                         | $       | 11,032 |         |  | $       | 10,749 |         |  | $       | 10,966 |         |   | $       | 11,091 |         |  | $ | 11,865 |       |  | $ | 12,298 |       |  | $ | 12,354 |       |  | $ | 11,687 |      
|Interest expense                     |                                                         |         | 2,740  |         |  |         | 2,956  |         |  |         | 3,189  |         |   |         | 3,249  |         |  |   | 3,532  |       |  |   | 3,610  |       |  |   | 3,596  |       |  |   | 3,891  |      
|                                     |                                                         |         |        |         |  |         |        |         |  |         |        |         |   |         |        |         |  |   |        |       |  |   |        |       |  |   |        |       |  |   |        |      
|                                     | Net interest income                                     |         |        | 8,292   |  |         |        | 7,793   |  |         |        | 7,777   |   |         |        | 7,842   |  |   |        | 8,333 |  |   |        | 8,688 |  |   |        | 8,758 |  |   |        | 7,796 | 
|Provision for loan losses            |                                                         |         | 300    |         |  |         | 575    |         |  |         | 4,015  |         |   |         | 800    |         |  |   | 1,533  |       |  |   | 750    |       |  |   | 970    |       |  |   | 600    |      
|                                     |                                                         |         |        |         |  |         |        |         |  |         |        |         |   |         |        |         |  |   |        |       |  |   |        |       |  |   |        |       |  |   |        |      
|                                     | Net interest income after provision for loan
    losses |         |        | 7,992   |  |         |        | 7,218   |  |         |        | 3,762   |   |         |        | 7,042   |  |   |        | 6,800 |  |   |        | 7,938 |  |   |        | 7,788 |  |   |        | 7,196 | 
|Noninterest income                   |                                                         |         | 2,034  |         |  |         | 2,429  |         |  |         | 2,170  |         |   |         | 2,294  |         |  |   | 2,261  |       |  |   | 2,440  |       |  |   | 2,297  |       |  |   | 2,476  |      
|Noninterest expense                  |                                                         |         | 7,358  |         |  |         | 7,798  |         |  |         | 8,028  |         |   |         | 6,520  |         |  |   | 6,023  |       |  |   | 6,519  |       |  |   | 6,892  |       |  |   | 6,623  |      
|                                     |                                                         |         |        |         |  |         |        |         |  |         |        |         |   |         |        |         |  |   |        |       |  |   |        |       |  |   |        |       |  |   |        |      
|                                     | Income before income taxes                              |         |        | 2,668   |  |         |        | 1,849   |  |         |        | (2,096  | ) |         |        | 2,816   |  |   |        | 3,038 |  |   |        | 3,859 |  |   |        | 3,193 |  |   |        | 3,049 | 
|Provision for income taxes           |                                                         |         | 860    |         |  |         | 504    |         |  |         | (742   | )       |   |         | 907    |         |  |   | 1,060  |       |  |   | 1,329  |       |  |   | 1,003  |       |  |   | 958    |      
|                                     |                                                         |         |        |         |  |         |        |         |  |         |        |         |   |         |        |         |  |   |        |       |  |   |        |       |  |   |        |       |  |   |        |      
|Net income                           |                                                         | $       | 1,808  |         |  | $       | 1,345  |         |  | $       | (1,354 | )       |   | $       | 1,909  |         |  | $ | 1,978  |       |  | $ | 2,530  |       |  | $ | 2,190  |       |  | $ | 2,091  |      
|                                     |                                                         |         |        |         |  |         |        |         |  |         |        |         |   |         |        |         |  |   |        |       |  |   |        |       |  |   |        |       |  |   |        |      
|Earnings per share:                  |                                                         |         |        |         |  |         |        |         |  |         |        |         |   |         |        |         |  |   |        |       |  |   |        |       |  |   |        |       |  |   |        |      
|                                     | Basic                                                   |         | $      | 0.25    |  |         | $      | 0.19    |  |         | $      | (0.19   | ) |         | $      | 0.27    |  |   | $      | 0.28  |  |   | $      | 0.36  |  |   | $      | 0.31  |  |   | $      | 0.30  | 
|                                     | Diluted                                                 |         | $      | 0.24    |  |         | $      | 0.19    |  |         | $      | (0.19   | ) |         | $      | 0.27    |  |   | $      | 0.28  |  |   | $      | 0.35  |  |   | $      | 0.30  |  |   | $      | 0.29  | 
|                                    
|Weighted average shares outstanding: |                                                         |         |        |         |  |         |        |         |  |         |        |         |   |         |        |         |  |   |        |       |  |   |        |       |  |   |        |       |  |   |        |      
|                                     | Basic                                                   |         |        | 7,154   |  |         |        | 7,132   |  |         |        | 7,037   |   |         |        | 7,033   |  |   |        | 7,031 |  |   |        | 7,026 |  |   |        | 7,020 |  |   |        | 7,020 | 
|                                     | Diluted                                                 |         |        | 7,242   |  |         |        | 7,215   |  |         |        | 7,037   |   |         |        | 7,196   |  |   |        | 7,179 |  |   |        | 7,147 |  |   |        | 7,140 |  |   |        | 7,140 | 
|                                    
|Dividends per common share           |                                                         | $       | 0.06   |         |  | $       | 0.06   |         |  | $       | 0.06   |         |   | $       | 0.06   |         |  | $ | 0.06   |       |  | $ | 0.06   |       |  | $ | 0.06   |       |  | $ | 0.06   |      





|        |                                                                                         
|------- | ----------------------------------------------------------------------------------------
|Item 9. | Changes in and Disagreements With
    Accountants on Accounting and Financial Disclosure

There were no changes in and disagreements with
accountants on accounting and financial disclosure.






|         |                        
|-------- | -----------------------
|Item 9A. | Controls and Procedures

Evaluation of disclosure controls and
procedures.As of the end of the
period covered by this report, the Company carried out an
evaluation, under the supervision and with the participation of
our management, including our President and Chief Financial
Officer, of the effectiveness of the design and operation of our
disclosure controls and procedures. Based on this evaluation,
the Companys President and Chief Financial Officer
concluded that the Companys disclosure controls and
procedures (as defined in Rules 13a-15(e) and 15d-15(e)
under the Securities Exchange Act of 1934 (the Exchange
Act)) are effective to ensure that information required to
be disclosed by the Company in reports that it files or submits
under the Exchange Act is recorded, processed, summarized and
reported to the Companys management within the time
periods specified in the Securities and Exchange
Commissions rules and forms.

48



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##### Table of Contents



Changes in internal controls over financial
reporting.There were no changes in
the Companys internal controls over financial reporting
during the last fiscal quarter that materially affected, or is
reasonably likely to materially affect, the Companys
internal control over financial reporting.




PART III






|         |                                                    
|-------- | ---------------------------------------------------
|Item 10. | Directors and Executive Officers of the
    Company

The information under the captions Election
of Directors, Continuing Directors and Executive
Officers, Section 16(a) Beneficial Ownership
Reporting Compliance and Code of Ethics in the
Companys definitive Proxy Statement for its 2004 Annual
Meeting of Shareholders to be filed with the Commission within
120 days after December 31, 2003 pursuant to
Regulation 14A under the Securities Exchange Act of 1934,
as amended (the 2004 Proxy Statement), is
incorporated herein by reference in response to this item.






|         |                       
|-------- | ----------------------
|Item 11. | Executive Compensation

The information under the caption Executive
Compensation and Other Matters in the 2004 Proxy Statement
is incorporated herein by reference in response to this item.






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

The information under the caption
Beneficial Ownership of Common Stock by Management of the
Company and Principal Shareholders in the 2004 Proxy
Statement is incorporated herein by reference in response to
this item.






|         |                                                   
|-------- | --------------------------------------------------
|Item 13. | Certain Relationships and Related
    Transactions

The information under the caption Interests
of Management and Others in Certain Transactions in the
2004 Proxy Statement is incorporated herein by reference in
response to this item.






|         |                                           
|-------- | ------------------------------------------
|Item 14. | Principal Accounting Fees and
    Services

The information under the caption Principal
Accounting Fees and Services in the 2004 Proxy Statement
is incorporated herein by reference in response to this item.

49



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##### Table of Contents






PART IV






|         |                                                                      
|-------- | ---------------------------------------------------------------------
|Item 15. | Exhibits, Financial Statement Schedules,
    and Reports on Form 10-K

Consolidated Financial Statements and
Financial Statement Schedules

Reference is made to the Consolidated Financial
Statements, the reports thereon, the notes thereto and
supplementary data commencing at page 53 of this Annual
Report on Form 10-K. Set forth below is a list of such
Consolidated Financial Statements:

|                                                                                                                         |  |  |  | 
|------------------------------------------------------------------------------------------------------------------------ |  |  |  | 
|Report of Independent Auditors                                                                                           |  |  |  | 
|Independent Auditors Report                                                                                             |  |  |  | 
|Consolidated Balance Sheets as of
    December 31, 2003 and 2002                                                         |  |  |  | 
|Consolidated Statements of Income for the Years
    Ended December 31, 2003, 2002, and 2001                              |  |  |  | 
|Consolidated Statements of Comprehensive Income
    for the Years Ended December 31, 2003, 2002, and 2001                |  |  |  | 
|Consolidated Statements of Changes in
    Shareholders Equity for the Years Ended December 31,
    2003, 2002, and 2001 |  |  |  | 
|Consolidated Statements of Cash Flows for the
    Years Ended December 31, 2003, 2002, and 2001                          |  |  |  | 
|Notes to Consolidated Financial Statements                                                                               |  |  |  | 

Financial Statement Schedules

All supplemental schedules are omitted as
inapplicable or because the required information is included in
the Consolidated Financial Statements or notes thereto.

|        |    |             |  |                                                                                                                                                                                                                                                 
|------- | -- | ----------- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |    |            
|Number  |    | Description
|        |    |            
|        | 3  | .1          |  | Amended and Restated Articles of Incorporation of
    the Company (incorporated herein by reference to
    Exhibit 3.1 to the Companys Registration Statement on
    Form S-1 (Registration No. 333-62667) (the
    Registration Statement)).
|        | 3  | .2          |  | Amended and Restated Bylaws of the Company
    (incorporated herein by reference to Exhibit 3.2 to the
    Registration Statement).                                                                                                             
|        | 4  |             |  | Specimen form of certificate evidencing the
    Common Stock (incorporated herein by reference to Exhibit 4
    to the Registration Statement).                                                                                                 
|        | 10 | .1          |  | Agreement and Plan of Reorganization by and among
    MetroCorp Bancshares, Inc., MC Bancshares of
    Delaware, Inc. and MetroBank, N.A. (incorporated herein by
    reference to Exhibit 10.1 to the Registration Statement).                 
|        | 10 | .2         |  | Form of Director Stock Option Agreement
    (incorporated herein by reference to Exhibit 10.2 to the
    Registration Statement).                                                                                                               
|        | 10 | .3         |  | MetroCorp Bancshares, Inc. Non-Employee
    Director Stock Bonus Plan (incorporated herein by reference to
    Exhibit 10.3 to the Registration Statement).                                                                                     
|        | 10 | .4          |  | MetroCorp Bancshares, Inc. 1998 Employee
    Stock Purchase Plan (incorporated herein by reference to
    Exhibit 10.4 to the Registration Statement).                                                                                          
|        | 10 | .5         |  | MetroCorp Bancshares, Inc. 1998 Stock
    Incentive Plan (incorporated herein by reference to
    Exhibit 10.5 to the Registration Statement).                                                                                                  
|        | 10 | .6         |  | First Amendment to the MetroCorp
    Bancshares, Inc. 1998 Employee Stock Purchase Plan
    (incorporated herein by reference to Exhibit 10.6 to the
    Companys Annual Report on Form 10-K for the year
    ended December 31, 1998).        
|        | 10 | .7         |  | First Amendment to the MetroCorp
    Bancshares, Inc. Non-Employee Director Stock Bonus Plan
    (incorporated herein by reference to Exhibit 4.5 to the
    Companys Registration Statement on Form S-8
    (Registration Number 333-94327)). 

50



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##### Table of Contents



|        |    |             |  |                                                                                                                                                                                                                                                 
|------- | -- | ----------- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |    |            
|Number  |    | Description
|        |    |            
|        | 10 | .8         |  | Second Amendment to the MetroCorp
    Bancshares, Inc. Non-Employee Director Stock Bonus Plan
    (incorporated herein by reference to Exhibit 4.6 to the
    Companys Registration Statement on Form S-8
    (Registration Number 333-94327)).
|        | 10 | .9         |  | Employment Agreement between MetroCorp
    Bancshares, Inc. and Allen D. Brown (incorporated herein by
    reference to Exhibit 10.9 to the Companys Annual
    Report on Form 10-K for the year ended December 31,
    2003).                 
|        | 21 |             |  | Subsidiaries of MetroCorp Bancshares, Inc.
    (incorporated herein by reference to Exhibit 21 to the
    Registration Statement).                                                                                                              
|        | 23 | .1*         |  | Consent of PricewaterhouseCoopers LLP.                                                                                                                                                                                                          
|        | 23 | .2*         |  | Consent of Deloitte & Touche LLP.                                                                                                                                                                                                               
|        | 31 | .1*         |  | Certification of the President pursuant to
    Rule 13a-14(a) of the Securities Exchange Act of 1934, as
    amended.                                                                                                                           
|        | 31 | .2*         |  | Certification of the Chief Financial Officer
    pursuant to Rule 13a-14(a) of the Securities Exchange Act
    of 1934, as amended.                                                                                                             
|        | 32 | .1*         |  | Certification of President pursuant to 18 U.S.C.
    Section 1350, as adopted pursuant to Section 906 of
    the Sarbanes-Oxley Act of 2002.                                                                                                    
|        | 32 | .2*         |  | Certification of Chief Financial Officer pursuant
    to 18 U.S.C. Section 1350, as adopted pursuant to
    Section 906 of the Sarbanes Oxley Act of 2002.                                                                                      



---



|  |                
|- | ---------------
|* | Filed herewith.



|  |                                                             
|- | ------------------------------------------------------------
| | Management contract or compensatory plan or
    arrangement.

Reports on Form 8-K

The following reports on Form 8-K were filed
during the quarter ended December 31, 2003:

Current report on Form 8-K filed
October 29, 2003 announcing the release of the
Companys earnings for the third quarter of 2003.

51



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SIGNATURES

Pursuant to the requirements of Section 13
or 15(d) of the Securities Exchange Act of 1934, the registrant
has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized, in the City of Houston,
on March 17, 2004.

| |                           
| | --------------------------
| | METROCORP BANCSHARES, INC.



| |     |                   
| | --- | ------------------
| | By: | /s/ ALLEN D. BROWN

| |               
| | --------------
| |               
| | Allen D. Brown
| | President     

Pursuant to the requirements of the Securities
Exchange Act of 1934, this report has been signed by the
following persons in the indicated capacities on March 17,
2004.

|                                       |  |                                                                                                                             |  | 
|-------------------------------------- |  | --------------------------------------------------------------------------------------------------------------------------- |  | 
|                                       |  |                                                                                                                            
|Signature                              |  | Title                                                                                                                      
|                                       |  |                                                                                                                            
|                                      
|/s/ DON J. WANGDon J. Wang             |  | Chairman of the Board                                                                                                      
|                                      
|/s/ GEORGE M. LEEGeorge M. Lee         |  | Executive Vice Chairman                                                                                                    
|                                      
|/s/ ALLEN D. BROWNAllen D. Brown       |  | Director and President (principal executive
    officer)                                                                   
|                                      
|/s/ DAVID TAIDavid Tai                 |  | Director                                                                                                                   
|                                      
|/s/ DAVID D. RINEHARTDavid D. Rinehart |  | Chief Financial Officer and Executive
    Vice President (principal financial officer and
    principal accounting officer)
|                                      
|/s/ TIONG L. ANGTiong L. Ang           |  | Director                                                                                                                   
|                                      
|/s/ HELEN F. CHENHelen F. Chen         |  | Director                                                                                                                   
|                                      
|/s/ TOMMY F. CHENTommy F. Chen         |  | Director                                                                                                                   
|                                      
|/s/ MAY P. CHUMay P. Chu               |  | Director                                                                                                                   
|                                      
|/s/ JOHN LEEJohn Lee                   |  | Director                                                                                                                   
|                                      
|/s/ EDWARD A. MONTOEdward A. Monto     |  | Director                                                                                                                   
|                                      
|/s/ CHARLES L. ROFFCharles L. Roff     |  | Director                                                                                                                   
|                                      
|/s/ JOE TINGJoe Ting                   |  | Director                                                                                                                   

52



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INDEX TO CONSOLIDATED FINANCIAL
STATEMENTS

METROCORP BANCSHARES, INC. AND
SUBSIDIARIES

|                                                                                                                         |  |      |    | 
|------------------------------------------------------------------------------------------------------------------------ |  | ---- | -- | 
|                                                                                                                         |  | Page
|                                                                                                                         |  |     
|Report of Independent Auditors                                                                                           |  |      | 54 | 
|Independent Auditors Report                                                                                             |  |      | 55 | 
|Consolidated Balance Sheets as of
    December 31, 2003 and 2002                                                         |  |      | 56 | 
|Consolidated Statements of Income for the Years
    Ended
    December 31, 2003, 2002, and 2001                          |  |      | 57 | 
|Consolidated Statements of Comprehensive Income
    for the Years Ended
    December 31, 2003, 2002, and 2001            |  |      | 58 | 
|Consolidated Statements of Changes in
    Shareholders Equity for the Years Ended
    December 31, 2003, 2002, and 2001 |  |      | 59 | 
|Consolidated Statements of Cash Flows for the
    Years Ended
    December 31, 2003, 2002, and 2001                      |  |      | 60 | 
|Notes to Consolidated Financial Statements                                                                               |  |      | 61 | 

53



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##### Table of Contents



REPORT OF INDEPENDENT AUDITORS

To the Board of Directors and Shareholders of

MetroCorp Bancshares, Inc.


In our opinion, the accompanying consolidated
balance sheets as of December 31, 2003 and 2002 and the
related consolidated statements of income, comprehensive income,
changes in shareholders equity and cash flows present
fairly, in all material respects, the consolidated financial
position of MetroCorp Bancshares, Inc. and subsidiaries
(the Company) at December 31, 2003 and 2002,
and the consolidated results of their operations and their cash
flows for the years then ended in conformity with accounting
principles generally accepted in the United States of America.
These financial statements are the responsibility of the
Companys management; our responsibility is to express an
opinion on these financial statements based on our audits. We
conducted our audits of these statements in accordance with
auditing standards generally accepted in the United States of
America, which require that we plan and perform the audit to
obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the
accounting principles used and significant estimates made by
management, and evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable
basis for our opinion.

/s/ PRICEWATERHOUSECOOPERS LLP

March 12, 2004

Houston, Texas


54



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##### Table of Contents



INDEPENDENT AUDITORS REPORT

To the Board of Directors and Shareholders of

MetroCorp Bancshares, Inc.


Houston, Texas


We have audited the accompanying consolidated
statements of income, shareholders equity and cash flows
of MetroCorp Bancshares, Inc. and subsidiary (the
Company) for the year ended December 31, 2001.
These financial statements are the responsibility of the
Companys management. Our responsibility is to express an
opinion on these financial statements based on our audit.

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

In our opinion, such consolidated financial
statements present fairly, in all material respects, the results
of their operations and their cash flows for the year ended
December 31, 2001 in conformity with accounting principles
generally accepted in the United States of America.

/s/ DELOITTE & TOUCHE LLP

March 20, 2002

Houston, Texas


55



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METROCORP BANCSHARES, INC.

CONDENSED CONSOLIDATED BALANCE
SHEETS

(In thousands, except share amounts)


|                                                                                 |                                                                                                                                                                                                                             |                                            |         |         |         |   |         |         |         | 
|-------------------------------------------------------------------------------- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | ------------------------------------------ | ------- | ------- | ------- | - | ------- | ------- | ------- | 
|                                                                                 |                                                                                                                                                                                                                             |                                           
|                                                                                 |                                                                                                                                                                                                                             | December 31,                              
|                                                                                 |                                                                                                                                                                                                                             |                                           
|                                                                                 |                                                                                                                                                                                                                             | 2003                                       |         | 2002   
|                                                                                 |                                                                                                                                                                                                                             |                                            |         |        
|ASSETS                                                                          
|Cash and due from banks                                                          |                                                                                                                                                                                                                             | $                                          | 26,347  |         |         | $ | 30,195  |        
|Federal funds sold and other temporary investments                               |                                                                                                                                                                                                                             |                                            | 10,580  |         |         |   | 7,991   |        
|                                                                                 |                                                                                                                                                                                                                             |                                            |         |         |         |   |         |        
|                                                                                 | Total cash and cash equivalents                                                                                                                                                                                             |                                            |         | 36,927  |         |   |         | 38,186  |        
|Securities available-for-sale, at fair value                                     |                                                                                                                                                                                                                             |                                            | 257,064 |         |         |   | 260,038 |        
|Other investments                                                                |                                                                                                                                                                                                                             |                                            | 5,200   |         |         |   | 4,380   |        
|Loans, net of allowance for loan losses of
    $10,448 and $10,150, respectively |                                                                                                                                                                                                                             |                                            | 537,305 |         |         |   | 517,609 |        
|Loans, held-for-sale                                                             |                                                                                                                                                                                                                             |                                            | 6,030   |         |         |   |        |        
|Premises and equipment, net                                                      |                                                                                                                                                                                                                             |                                            | 5,674   |         |         |   | 5,841   |        
|Accrued interest receivable                                                      |                                                                                                                                                                                                                             |                                            | 3,452   |         |         |   | 3,391   |        
|Deferred tax asset                                                               |                                                                                                                                                                                                                             |                                            | 5,774   |         |         |   | 4,584   |        
|Customers liability on acceptances                                              |                                                                                                                                                                                                                             |                                            | 3,352   |         |         |   | 4,080   |        
|Foreclosed assets, net                                                           |                                                                                                                                                                                                                             |                                            | 2,585   |         |         |   | 1,190   |        
|Other assets                                                                     |                                                                                                                                                                                                                             |                                            | 1,410   |         |         |   | 766     |        
|                                                                                 |                                                                                                                                                                                                                             |                                            |         |         |         |   |         |        
|                                                                                 |                                                                                                                                                                                                                             | Total assets                               |         | $       | 864,773 |   |         | $       | 840,065 | 
|                                                                                 |                                                                                                                                                                                                                             |                                            |         |         |         |   |         |        
|LIABILITIES AND SHAREHOLDERS
    EQUITY                                        
|Deposits:                                                                        |                                                                                                                                                                                                                             |                                            |         |         |         |   |         |        
|                                                                                 | Noninterest-bearing                                                                                                                                                                                                         |                                            | $       | 169,097 |         |   | $       | 144,544 |        
|                                                                                 | Interest-bearing                                                                                                                                                                                                            |                                            |         | 555,844 |         |   |         | 546,817 |        
|                                                                                 |                                                                                                                                                                                                                             |                                            |         |         |         |   |         |        
|                                                                                 |                                                                                                                                                                                                                             | Total deposits                             |         |         | 724,941 |   |         |         | 691,361 | 
|Other borrowings                                                                 |                                                                                                                                                                                                                             |                                            | 54,173  |         |         |   | 65,774  |        
|Accrued interest payable                                                         |                                                                                                                                                                                                                             |                                            | 567     |         |         |   | 717     |        
|Acceptances outstanding                                                          |                                                                                                                                                                                                                             |                                            | 3,352   |         |         |   | 4,080   |        
|Other liabilities                                                                |                                                                                                                                                                                                                             |                                            | 5,530   |         |         |   | 3,670   |        
|                                                                                 |                                                                                                                                                                                                                             |                                            |         |         |         |   |         |        
|                                                                                 |                                                                                                                                                                                                                             | Total liabilities                          |         |         | 788,563 |   |         |         | 765,602 | 
|Shareholders equity:                                                            |                                                                                                                                                                                                                             |                                            |         |         |         |   |         |        
|                                                                                 | Common stock, $1.00 par value,
    20,000,000 shares authorized; 7,306,627 shares and
    7,195,927 shares issued and 7,156,689 shares and
    7,031,882 shares outstanding at December 31, 2003 and
    2002, respectively |                                            |         | 7,307   |         |   |         | 7,196   |        
|Additional paid-in-capital                                                       |                                                                                                                                                                                                                             |                                            | 27,620  |         |         |   | 26,344  |        
|Retained earnings                                                                |                                                                                                                                                                                                                             |                                            | 41,942  |         |         |   | 39,938  |        
|Accumulated other comprehensive income                                           |                                                                                                                                                                                                                             |                                            | 671     |         |         |   | 2,354   |        
|Treasury stock, at cost                                                          |                                                                                                                                                                                                                             |                                            | (1,330  | )       |         |   | (1,369  | )      
|                                                                                 |                                                                                                                                                                                                                             |                                            |         |         |         |   |         |        
|                                                                                 |                                                                                                                                                                                                                             | Total shareholders equity                 |         |         | 76,210  |   |         |         | 74,463  | 
|                                                                                 |                                                                                                                                                                                                                             |                                            |         |         |         |   |         |        
|                                                                                 |                                                                                                                                                                                                                             | Total liabilities and shareholders equity |         | $       | 864,773 |   |         | $       | 840,065 | 
|                                                                                 |                                                                                                                                                                                                                             |                                            |         |         |         |   |         |        

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

56



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##### Table of Contents



METROCORP BANCSHARES, INC.

CONSOLIDATED STATEMENTS OF INCOME

(In thousands, except per share
amounts)


|                                                        |                                                               |                          |                           |        |       |        |        |        |       |        |        |        |       |        | 
|------------------------------------------------------- | ------------------------------------------------------------- | ------------------------ | ------------------------- | ------ | ----- | ------ | ------ | ------ | ----- | ------ | ------ | ------ | ----- | ------ | 
|                                                        |                                                               |                         
|                                                        |                                                               | Years Ended December 31,
|                                                        |                                                               |                         
|                                                        |                                                               | 2003                     |                           | 2002   |       | 2001  
|                                                        |                                                               |                          |                           |        |       |       
|Interest income:                                        |                                                               |                          |                           |        |       |        |        |        |       |        |        |       
|                                                        | Loans                                                         |                          | $                         | 35,242 |       |        | $      | 37,987 |       |        | $      | 43,926 |      
|                                                        | Securities:                                                   |                          |                           |        |       |        |        |        |       |        |        |        |      
|                                                        |                                                               | Taxable                  |                           |        | 7,321 |        |        |        | 9,080 |        |        |        | 8,356 |       
|                                                        |                                                               | Tax-exempt               |                           |        | 997   |        |        |        | 1,160 |        |        |        | 1,177 |       
|                                                        | Federal funds sold and other investments                      |                          |                           | 278    |       |        |        | 484    |       |        |        | 1,992  |      
|                                                        |                                                               |                          |                           |        |       |        |        |        |       |        |        |       
|                                                        |                                                               |                          | Total interest income     |        |       | 43,838 |        |        |       | 48,711 |        |        |       | 55,451 | 
|                                                        |                                                               |                          |                           |        |       |        |        |        |       |        |        |       
|Interest expense:                                       |                                                               |                          |                           |        |       |        |        |        |       |        |        |       
|                                                        | Time deposits                                                 |                          |                           | 8,942  |       |        |        | 10,595 |       |        |        | 19,003 |      
|                                                        | Demand and savings deposits                                   |                          |                           | 1,345  |       |        |        | 2,215  |       |        |        | 3,531  |      
|                                                        | Other borrowings                                              |                          |                           | 1,847  |       |        |        | 1,818  |       |        |        | 1,265  |      
|                                                        |                                                               |                          |                           |        |       |        |        |        |       |        |        |       
|                                                        |                                                               |                          | Total interest expense    |        |       | 12,134 |        |        |       | 14,628 |        |        |       | 23,799 | 
|                                                        |                                                               |                          |                           |        |       |        |        |        |       |        |        |       
|Net interest income                                     |                                                               |                          | 31,704                    |        |       |        | 34,083 |        |       |        | 31,652 |       
|Provision for loan losses                               |                                                               |                          | 5,690                     |        |       |        | 3,853  |        |       |        | 3,799  |       
|                                                        |                                                               |                          |                           |        |       |        |        |        |       |        |        |       
|Net interest income after provision for loan
    losses |                                                               |                          | 26,014                    |        |       |        | 30,230 |        |       |        | 27,853 |       
|                                                        |                                                               |                          |                           |        |       |        |        |        |       |        |        |       
|Noninterest income:                                     |                                                               |                          |                           |        |       |        |        |        |       |        |        |       
|                                                        | Service fees                                                  |                          |                           | 6,544  |       |        |        | 6,670  |       |        |        | 6,360  |      
|                                                        | Other loan-related fees                                       |                          |                           | 1,009  |       |        |        | 1,083  |       |        |        | 936    |      
|                                                        | Letters of credit commissions and fees                        |                          |                           | 516    |       |        |        | 610    |       |        |        | 655    |      
|                                                        | Gain on sale of securities, net                               |                          |                           | 165    |       |        |        | 34     |       |        |        | 189    |      
|                                                        | Gain on sale of loans                                         |                          |                           | 600    |       |        |        | 322    |       |        |        | 127    |      
|                                                        | Other noninterest income                                      |                          |                           | 93     |       |        |        | 248    |       |        |        | 393    |      
|                                                        |                                                               |                          |                           |        |       |        |        |        |       |        |        |       
|                                                        |                                                               |                          | Total noninterest income  |        |       | 8,927  |        |        |       | 8,967  |        |        |       | 8,660  | 
|                                                        |                                                               |                          |                           |        |       |        |        |        |       |        |        |       
|Noninterest expense:                                    |                                                               |                          |                           |        |       |        |        |        |       |        |        |       
|                                                        | Salaries and employee benefits                                |                          |                           | 15,183 |       |        |        | 14,746 |       |        |        | 13,180 |      
|                                                        | Lower of cost or market adjustment on loans
    held-for-sale |                          |                           | 2,149  |       |        |        |       |       |        |        |       |      
|                                                        | Occupancy and equipment                                       |                          |                           | 5,361  |       |        |        | 5,089  |       |        |        | 5,189  |      
|                                                        | Foreclosed assets, net                                        |                          |                           | 248    |       |        |        | 680    |       |        |        | 153    |      
|                                                        | Other noninterest expense                                     |                          |                           | 6,763  |       |        |        | 5,543  |       |        |        | 6,861  |      
|                                                        |                                                               |                          |                           |        |       |        |        |        |       |        |        |       
|                                                        |                                                               |                          | Total noninterest expense |        |       | 29,704 |        |        |       | 26,058 |        |        |       | 25,383 | 
|                                                        |                                                               |                          |                           |        |       |        |        |        |       |        |        |       
|Income before provision for income taxes                |                                                               |                          | 5,237                     |        |       |        | 13,139 |        |       |        | 11,130 |       
|Provision for income taxes                              |                                                               |                          | 1,529                     |        |       |        | 4,350  |        |       |        | 3,553  |       
|                                                        |                                                               |                          |                           |        |       |        |        |        |       |        |        |       
|Net income                                              |                                                               | $                        | 3,708                     |        |       | $      | 8,789  |        |       | $      | 7,577  |       
|                                                        |                                                               |                          |                           |        |       |        |        |        |       |        |        |       
|Earnings per common share:                              |                                                               |                          |                           |        |       |        |        |        |       |        |        |       
|                                                        | Basic                                                         |                          | $                         | 0.52   |       |        | $      | 1.25   |       |        | $      | 1.08   |      
|                                                        | Diluted                                                       |                          | $                         | 0.51   |       |        | $      | 1.23   |       |        | $      | 1.07   |      
|Weighted average shares outstanding:                    |                                                               |                          |                           |        |       |        |        |        |       |        |        |       
|                                                        | Basic                                                         |                          |                           | 7,089  |       |        |        | 7,024  |       |        |        | 6,998  |      
|                                                        | Diluted                                                       |                          |                           | 7,213  |       |        |        | 7,154  |       |        |        | 7,059  |      
|                                                        |                                                               |                          |                           |        |       |        |        |        |       |        |        |       
|Dividends per common share                              |                                                               | $                        | 0.24                      |        |       | $      | 0.24   |        |       | $      | 0.24   |       

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

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METROCORP BANCSHARES, INC.

CONSOLIDATED STATEMENTS OF COMPREHENSIVE
INCOME

(In thousands)


|                                        |                                                            |                                                                        |       |        |        |      |       |        |       |   |       |       |      |  
|--------------------------------------- | ---------------------------------------------------------- | ---------------------------------------------------------------------- | ----- | ------ | ------ | ---- | ----- | ------ | ----- | - | ----- | ----- | ---- | -
|                                        |                                                            | 2003                                                                   |       | 2002   |        | 2001
|                                        |                                                            |                                                                        |       |        |        |     
|Net income                              |                                                            | $                                                                      | 3,708 |        |        | $    | 8,789 |        |       | $ | 7,577 |      
|Other comprehensive income, net of tax: |                                                            |                                                                        |       |        |        |      |       |        |       |   |       |      
|                                        | Unrealized gains on investment securities, net of
    tax: |                                                                        |       |        |        |      |       |        |       |   |       |       |     
|                                        |                                                            | Unrealized holding (losses) gains arising during
    the period        |       |        | (1,576 | )    |       |        | 2,000 |   |       |       | 380  |  
|                                        |                                                            | Less: reclassification adjustment for gains
    included in net income |       |        | (107   | )    |       |        | (22   | ) |       |       | (125 | )
|                                        |                                                            |                                                                        |       |        |        |      |       |        |       |   |       |      
|                                        | Other comprehensive (loss) income                          |                                                                        |       | (1,683 | )      |      |       | 1,978  |       |   |       | 255   |     
|                                        |                                                            |                                                                        |       |        |        |      |       |        |       |   |       |      
|                                        | Total comprehensive income                                 |                                                                        | $     | 2,025  |        |      | $     | 10,767 |       |   | $     | 7,832 |     
|                                        |                                                            |                                                                        |       |        |        |      |       |        |       |   |       |      

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

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METROCORP BANCSHARES, INC.

CONSOLIDATED STATEMENTS OF CHANGES IN
SHAREHOLDERS EQUITY

Years Ended December 31, 2003, 2000 and
2001


(In thousands)


|                                         |  |              |       |            |  |          |       |               |  |               |        |      |  |       |        |   |  |   |        |   |  |   |        |   |  |   |        |  
|---------------------------------------- |  | ------------ | ----- | ---------- |  | -------- | ----- | ------------- |  | ------------- | ------ | ---- |  | ----- | ------ | - |  | - | ------ | - |  | - | ------ | - |  | - | ------ | -
|                                         |  |              |       |            |  |          |       | Accumulated   |  |               |        |     
|                                         |  | Common Stock |       | Additional |  |          |       | Other         |  | Treasury      |        |     
|                                         |  |              |       | Paid-in    |  | Retained |       | Comprehensive |  | Stock At      |        |     
|                                         |  | Shares       |       | At Par     |  | Capital  |       | Earnings      |  | Income (Loss) |        | Cost |  | Total
|                                         |  |              |       |            |  |          |       |               |  |               |        |      |  |      
|Balance at December 31, 2000             |  |              | 6,979 |            |  | $        | 7,180 |               |  | $             | 26,033 |      |  | $     | 26,936 |   |  | $ | 121    |   |  | $ | (1,569 | ) |  | $ | 58,701 |  
|Issuance of common stock                 |  |              | 7     |            |  |          | 7     |               |  |               | 52     |      |  |       |       |   |  |   |       |   |  |   |       |   |  |   | 59     |  
|Re-issuance of treasury stock            |  |              | 31    |            |  |          |      |               |  |               | 59     |      |  |       |       |   |  |   |       |   |  |   | 257    |   |  |   | 316    |  
|Net income                               |  |              |      |            |  |          |      |               |  |               |       |      |  |       | 7,577  |   |  |   |       |   |  |   |       |   |  |   | 7,577  |  
|Other comprehensive income               |  |              |      |            |  |          |      |               |  |               |       |      |  |       |       |   |  |   | 255    |   |  |   |       |   |  |   | 255    |  
|Dividends ($0.24 per share)              |  |              |      |            |  |          |      |               |  |               |       |      |  |       | (1,679 | ) |  |   |       |   |  |   |       |   |  |   | (1,679 | )
|                                         |  |              |       |            |  |          |       |               |  |               |        |      |  |       |        |   |  |   |        |   |  |   |        |   |  |   |        |  
|Balance at December 31, 2001             |  |              | 7,017 |            |  |          | 7,187 |               |  |               | 26,144 |      |  |       | 32,834 |   |  |   | 376    |   |  |   | (1,312 | ) |  |   | 65,229 |  
|                                         |  |              |       |            |  |          |       |               |  |               |        |      |  |       |        |   |  |   |        |   |  |   |        |   |  |   |        |  
|Issuance of common stock                 |  |              | 9     |            |  |          | 9     |               |  |               | 67     |      |  |       |       |   |  |   |       |   |  |   |       |   |  |   | 76     |  
|Re-issuance of treasury stock            |  |              | 37    |            |  |          |      |               |  |               | 133    |      |  |       |       |   |  |   |       |   |  |   | 292    |   |  |   | 425    |  
|Repurchase of common stock               |  |              | (31   | )          |  |          |      |               |  |               |       |      |  |       |       |   |  |   |       |   |  |   | (349   | ) |  |   | (349   | )
|Net income                               |  |              |      |            |  |          |      |               |  |               |       |      |  |       | 8,789  |   |  |   |       |   |  |   |       |   |  |   | 8,789  |  
|Other comprehensive income               |  |              |      |            |  |          |      |               |  |               |       |      |  |       |       |   |  |   | 1,978  |   |  |   |       |   |  |   | 1,978  |  
|Dividends ($0.24 per share)              |  |              |      |            |  |          |      |               |  |               |       |      |  |       | (1,685 | ) |  |   |       |   |  |   |       |   |  |   | (1,685 | )
|                                         |  |              |       |            |  |          |       |               |  |               |        |      |  |       |        |   |  |   |        |   |  |   |        |   |  |   |        |  
|Balance at December 31, 2002             |  |              | 7,032 |            |  |          | 7,196 |               |  |               | 26,344 |      |  |       | 39,938 |   |  |   | 2,354  |   |  |   | (1,369 | ) |  |   | 74,463 |  
|                                         |  |              |       |            |  |          |       |               |  |               |        |      |  |       |        |   |  |   |        |   |  |   |        |   |  |   |        |  
|Issuance of common stock                 |  |              | 111   |            |  |          | 111   |               |  |               | 1,075  |      |  |       |       |   |  |   |       |   |  |   |       |   |  |   | 1,186  |  
|Re-issuance of treasury stock            |  |              | 32    |            |  |          |      |               |  |               | 146    |      |  |       |       |   |  |   |       |   |  |   | 251    |   |  |   | 397    |  
|Repurchase of common stock               |  |              | (18   | )          |  |          |      |               |  |               |       |      |  |       |       |   |  |   |       |   |  |   | (212   | ) |  |   | (212   | )
|Tax benefit from stock options exercised |  |              |      |            |  |          |      |               |  |               | 55     |      |  |       |       |   |  |   |       |   |  |   |       |   |  |   | 55     |  
|Net income                               |  |              |      |            |  |          |      |               |  |               |       |      |  |       | 3,708  |   |  |   |       |   |  |   |       |   |  |   | 3,708  |  
|Other comprehensive loss                 |  |              |      |            |  |          |      |               |  |               |       |      |  |       |       |   |  |   | (1,683 | ) |  |   |       |   |  |   | (1,683 | )
|Dividends ($0.24 per share)              |  |              |      |            |  |          |      |               |  |               |       |      |  |       | (1,704 | ) |  |   |       |   |  |   |       |   |  |   | (1,704 | )
|                                         |  |              |       |            |  |          |       |               |  |               |        |      |  |       |        |   |  |   |        |   |  |   |        |   |  |   |        |  
|Balance at December 31, 2003             |  |              | 7,157 |            |  | $        | 7,307 |               |  | $             | 27,620 |      |  | $     | 41,942 |   |  | $ | 671    |   |  | $ | (1,330 | ) |  | $ | 76,210 |  
|                                         |  |              |       |            |  |          |       |               |  |               |        |      |  |       |        |   |  |   |        |   |  |   |        |   |  |   |        |  

The accompanying notes are an integral part of
these consolidated financial

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METROCORP BANCSHARES, INC

CONSOLIDATED STATEMENTS OF CASH
FLOWS

(In thousands)


|                                                 |                                                                                                 |                                                               |                             |                                                         |         |        |         |          |        |       |          |          |        |         |         |  
|------------------------------------------------ | ----------------------------------------------------------------------------------------------- | ------------------------------------------------------------- | --------------------------- | ------------------------------------------------------- | ------- | ------ | ------- | -------- | ------ | ----- | -------- | -------- | ------ | ------- | ------- | -
|                                                 |                                                                                                 |                                                              
|                                                 |                                                                                                 | Years Ended December 31,                                     
|                                                 |                                                                                                 |                                                              
|                                                 |                                                                                                 | 2003                                                          |                             | 2002                                                    |         | 2001  
|                                                 |                                                                                                 |                                                               |                             |                                                         |         |       
|Cash flows from operating activities:            |                                                                                                 |                                                               |                             |                                                         |         |        |         |          |        |       |          |         
|                                                 | Net income                                                                                      |                                                               | $                           | 3,708                                                   |         |        | $       | 8,789    |        |       | $        | 7,577    |       
|                                                 | Adjustments to reconcile net income to net cash
    provided by (used in) operating activities: |                                                               |                             |                                                         |         |        |         |          |        |       |          |          |       
|                                                 |                                                                                                 | Depreciation                                                  |                             |                                                         | 1,337   |        |         |          | 1,435  |       |          |          | 1,636  |        
|                                                 |                                                                                                 | Provision for loan losses                                     |                             |                                                         | 5,690   |        |         |          | 3,853  |       |          |          | 3,799  |        
|                                                 |                                                                                                 | Lower of cost or market adjustment on loans
    held-for-sale |                             |                                                         | 2,149   |        |         |          |       |       |          |          |       |        
|                                                 |                                                                                                 | Gain on securities sales, net                                 |                             |                                                         | (165    | )      |         |          | (34    | )     |          |          | (189   | )      
|                                                 |                                                                                                 | Gain on sale of premises and equipment                        |                             |                                                         |        |        |         |          | (5     | )     |          |          |       |        
|                                                 |                                                                                                 | Gain on sale of loans, net                                    |                             |                                                         | (600    | )      |         |          | (322   | )     |          |          | (127   | )      
|                                                 |                                                                                                 | Amortization of premiums and discounts on
    securities      |                             |                                                         | 2,251   |        |         |          | 1,332  |       |          |          | 39     |        
|                                                 |                                                                                                 | Amortization of deferred loan fees and discounts              |                             |                                                         | (32     | )      |         |          | 142    |       |          |          | 507    |        
|                                                 |                                                                                                 | Deferred income taxes                                         |                             |                                                         | (386    | )      |         |          | (121   | )     |          |          | 195    |        
|                                                 |                                                                                                 | Changes in:                                                   |                             |                                                         |         |        |         |          |        |       |          |          |        |        
|                                                 |                                                                                                 |                                                               | Loans held-for-sale         |                                                         |         | (5,891 | )       |          |        |      |          |          |        |        |        
|                                                 |                                                                                                 |                                                               | Accrued interest receivable |                                                         |         | (61    | )       |          |        | 211   |          |          |        | 669     |        
|                                                 |                                                                                                 |                                                               | Accrued interest payable    |                                                         |         | (150   | )       |          |        | (146  | )        |          |        | (953    | )      
|                                                 |                                                                                                 |                                                               | Income taxes payable        |                                                         |         | (299   | )       |          |        | (63   | )        |          |        | (1,279  | )      
|                                                 |                                                                                                 |                                                               | Other liabilities           |                                                         |         | 1,923  |         |          |        | 866   |          |          |        | (16,516 | )      
|                                                 |                                                                                                 |                                                               | Other assets                |                                                         |         | (614   | )       |          |        | 2,506 |          |          |        | 2,312   |        
|                                                 |                                                                                                 |                                                               |                             |                                                         |         |        |         |          |        |       |          |         
|                                                 |                                                                                                 |                                                               |                             | Net cash provided by (used in) operating
    activities |         |        | 8,860   |          |        |       | 18,443   |          |        |         | (2,330  | )
|                                                 |                                                                                                 |                                                               |                             |                                                         |         |        |         |          |        |       |          |         
|Cash flows from investing activities:            |                                                                                                 |                                                               |                             |                                                         |         |        |         |          |        |       |          |         
|                                                 | Purchases of securities available-for-sale                                                      |                                                               |                             | (182,039                                                | )       |        |         | (179,932 | )      |       |          | (111,207 | )     
|                                                 | Proceeds from sales, maturities and principal
    paydowns of securities available-for-sale     |                                                               |                             | 179,591                                                 |         |        |         | 93,406   |        |       |          | 79,273   |       
|                                                 | Net change in loans                                                                             |                                                               |                             | (31,546                                                 | )       |        |         | (38,504  | )      |       |          | (15,415  | )     
|                                                 | Proceeds from sale of foreclosed assets                                                         |                                                               |                             | 3,391                                                   |         |        |         | 659      |        |       |          | 1,078    |       
|                                                 | Proceeds from sale of premises and equipment                                                    |                                                               |                             |                                                        |         |        |         | 5        |        |       |          |         |       
|                                                 | Purchases of premises and equipment                                                             |                                                               |                             | (1,170                                                  | )       |        |         | (1,653   | )      |       |          | (684     | )     
|                                                 |                                                                                                 |                                                               |                             |                                                         |         |        |         |          |        |       |          |         
|                                                 |                                                                                                 |                                                               |                             | Net cash used in investing activities                   |         |        | (31,773 | )        |        |       | (126,019 | )        |        |         | (46,955 | )
|                                                 |                                                                                                 |                                                               |                             |                                                         |         |        |         |          |        |       |          |         
|Cash flows from financing activities:            |                                                                                                 |                                                               |                             |                                                         |         |        |         |          |        |       |          |         
|                                                 | Net change in:                                                                                  |                                                               |                             |                                                         |         |        |         |          |        |       |          |          |       
|                                                 |                                                                                                 | Deposits                                                      |                             |                                                         | 33,580  |        |         |          | 48,610 |       |          |          | 16,845 |        
|                                                 |                                                                                                 | Other borrowings                                              |                             |                                                         | (11,601 | )      |         |          | 40,579 |       |          |          | (378   | )      
|                                                 | Proceeds from issuance of common stock                                                          |                                                               |                             | 1,186                                                   |         |        |         | 76       |        |       |          | 59       |       
|                                                 | Treasury stock sold                                                                             |                                                               |                             | 397                                                     |         |        |         | 425      |        |       |          | 316      |       
|                                                 | Treasury stock purchased                                                                        |                                                               |                             | (212                                                    | )       |        |         | (349     | )      |       |          |         |       
|                                                 | Dividends paid                                                                                  |                                                               |                             | (1,696                                                  | )       |        |         | (1,685   | )      |       |          | (1,677   | )     
|                                                 |                                                                                                 |                                                               |                             |                                                         |         |        |         |          |        |       |          |         
|                                                 |                                                                                                 |                                                               |                             | Net cash provided by financing activities               |         |        | 21,654  |          |        |       | 87,656   |          |        |         | 15,165  |  
|                                                 |                                                                                                 |                                                               |                             |                                                         |         |        |         |          |        |       |          |         
|Net decrease in cash and cash equivalents        |                                                                                                 |                                                               | (1,259                      | )                                                       |         |        | (19,920 | )        |        |       | (34,120  | )       
|Cash and cash equivalents at beginning of period |                                                                                                 |                                                               | 38,186                      |                                                         |         |        | 58,106  |          |        |       | 92,226   |         
|                                                 |                                                                                                 |                                                               |                             |                                                         |         |        |         |          |        |       |          |         
|Cash and cash equivalents at end of period       |                                                                                                 | $                                                             | 36,927                      |                                                         |         | $      | 38,186  |          |        | $     | 58,106   |         
|                                                 |                                                                                                 |                                                               |                             |                                                         |         |        |         |          |        |       |          |         

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

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METROCORP BANCSHARES, INC.

NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS



|   |                                               
|-- | ----------------------------------------------
|1. | Summary of Significant Accounting
    Policies

The consolidated financial statements of
MetroCorp Bancshares, Inc. (the Company)
include the accounts of the Company and its wholly-owned
subsidiary, MetroBank, National Association (the
Bank). The Bank was formed in 1987 and is engaged in
commercial banking activities through its fourteen branches in
Houston and Dallas, Texas.

The accounting principles followed by the Company
and the methods of applying these principles conform with
accounting principles generally accepted in the United States
and with general practices within the banking industry. Certain
principles which significantly affect the determination of
financial position, results of operations and cash flows are
summarized below.



| |                 
| | ----------------
| | Use of Estimates

These financial statements are prepared in
conformity with accounting principles generally accepted in the
United States of America, which require management to make
estimates and assumptions. These assumptions affect the reported
amounts of assets and liabilities and the disclosure of
contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses
during the reporting period. Significant estimates include the
allowance for loan losses. Amounts are recognized when it is
probable that an asset has been impaired or a liability has been
incurred and the cost can be reasonable estimated. Actual
results could differ from those estimates.



| |                            
| | ---------------------------
| | Principles of Consolidation

All significant intercompany accounts and
transactions are eliminated in consolidation.



| |                          
| | -------------------------
| | Cash and Cash Equivalents

Cash and cash equivalents include cash on hand,
amounts due from banks, federal funds sold, and other temporary
investments with original maturities of less than three months.



| |           
| | ----------
| | Securities

Investments in securities for which the Company
has both the ability and intent to hold to maturity are
classified as investments held-to-maturity and are stated at
amortized cost. Amortization of premiums and accretion of
discounts are recognized as adjustments to interest income using
the effective-interest method. Investments in securities which
management believes may be sold prior to maturity are classified
as investments available-for-sale and are stated at fair value.
Unrealized net gains and losses, net of the associated deferred
income tax effect, are excluded from income and reported as a
separate component of shareholders equity in
Accumulated other comprehensive income. Realized
gains and losses from sales of investments available-for-sale
are recorded on the trade date and determined using the specific
identification method.



| |                                        
| | ---------------------------------------
| | Loans and Allowance for Loan
    Losses

Loans are reported at the principal amount
outstanding, reduced by unearned discounts, net deferred loan
fees, and an allowance for loan losses. Unearned income on
installment loans is recognized using the effective interest
method over the term of the loan. Interest on other loans is
calculated using the simple interest method on the daily
principal amount outstanding.

Loans are placed on nonaccrual status when
principal or interest is past due more than 90 days or
when, in managements opinion, collection of principal and
interest is not likely to be made in accordance with a
loans contractual terms. Interest accrued but not
collected at the date a loan is placed on nonaccrual status is

61



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METROCORP BANCSHARES, INC.


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)

reversed against interest income. In addition,
the amortization of deferred loan fees is suspended when a loan
is placed on nonaccrual status. Interest income on nonaccrual
loans is recognized only to the extent received in cash;
however, where there is doubt regarding the ultimate
collectibility of the loan principal, cash receipts, whether
designated as principal or interest, are thereafter applied to
reduce the principal balance of the loan. Loans are restored to
accrual status only when interest and principal payments are
brought current and, in managements judgment, future
payments are reasonably assured.

A loan, with the exception of groups of
smaller-balance homogenous loans that are collectively evaluated
for impairment, is considered impaired when, based on current
information, it is probable that the borrower will be unable to
pay contractual interest or principal payments as scheduled in
the loan agreement. A creditor may use existing methods for
recognizing interest income on impaired loans. The Bank
recognizes interest income on impaired loans pursuant to the
discussion above for nonaccrual loans.

The allowance for loan losses related to impaired
loans is determined based on the difference of carrying value of
loans and the present value of expected cash flows discounted at
the loans effective interest rate or, as a practical
expedient, the loans observable market price or the fair
value of the collateral if the loan is collateral dependent.

Estimates of loan losses involve an exercise of
judgment. While it is possible that in the short-term the
Company may sustain losses which are substantial in relation to
the allowance for loan losses, it is the judgment of management
that the allowance for loan losses reflected in the consolidated
balance sheets is adequate to absorb probable losses that exist
in the current loan portfolio.

The allowance for loan losses provides for the
risk of losses inherent in the lending process. The allowance
for loan losses is based on periodic reviews and analyses of the
loan portfolio which include consideration of such factors as
the risk rating of individual credits, the size and diversity of
the portfolio, economic conditions, prior loss experience and
results of periodic credit reviews of the portfolio. The
allowance for loan losses is increased by provisions for loan
losses charged against income and reduced by charge-offs, net of
recoveries. In managements judgment, the allowance for
loan losses is considered adequate to absorb losses inherent in
the loan portfolio.



| |                                                                    
| | -------------------------------------------------------------------
| | Nonrefundable Fees and Costs Associated
    with Lending Activities

Loan origination fees in excess of the associated
costs are recognized over the life of the related loan as an
adjustment to yield using the interest method.

Generally, loan commitment fees are deferred and
recognized as an adjustment of yield by the interest method over
the related loan life or, if the commitment expires unexercised,
recognized in income upon expiration of the commitment.



| |                       
| | ----------------------
| | Premises and Equipment

Premises and equipment are stated at cost, less
accumulated depreciation. For financial accounting purposes,
depreciation is computed using the straight-line method over the
estimated useful lives of the assets. Expenditures for
maintenance and repairs, which do not extend the life of bank
premises and equipment, are charged to operations as incurred.



| |                  
| | -----------------
| | Other Real Estate

Other real estate consists of properties acquired
through a foreclosure proceeding or acceptance of a deed in lieu
of foreclosure. These properties are initially recorded at fair
value less estimated costs to sell. On an ongoing basis they are
carried at the lower of cost or fair value minus estimated costs
to sell based on appraised

62



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##### Table of Contents



METROCORP BANCSHARES, INC.


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)

value. Operating expenses, net of related revenue
and gain and losses on sale of such assets, are reported in
noninterest expense.



| |                 
| | ----------------
| | Other Borrowings

Other borrowings include U.S. Treasury tax
note option accounts with maturities of 14 days or less and
Federal Home Loan Bank (FHLB) borrowings.



| |             
| | ------------
| | Income Taxes

The Company provides for an asset and liability
approach to income taxes that requires the recognition of
deferred tax assets and liabilities for the expected future tax
consequences of events that have been recognized in the
Companys financial statements or tax returns. When
management determines that it is more likely than not that a
deferred tax asset will not be realized, a valuation allowance
is established. In estimating future tax consequences, all
expected future events other than enactments of changes in tax
laws or rates are considered.



| |                   
| | ------------------
| | Earnings Per Share

Basic earnings per common share is calculated by
dividing net earnings available for common shareholders by the
weighted average number of common shares outstanding during the
period. Diluted earnings per share is calculated by dividing net
earnings available for common shareholders by the weighted
average number of common and potentially dilutive common shares.
Stock options can be dilutive common shares and are therefore
considered in the earnings per share calculation, if dilutive.
The number of potentially dilutive common shares is determined
using the treasury stock method.



| |                              
| | -----------------------------
| | Interest Rate Risk Management

The operations of the Bank are subject to the
risk of interest rate fluctuations to the extent that
interest-bearing assets and interest-bearing liabilities mature
or reprice at different times or in differing amounts. Risk
management activities are aimed at optimizing net interest
income, given a level of interest rate risk consistent with the
Banks business strategies.

Asset liability management activities are
conducted in the context of the Banks asset sensitivity to
interest rate changes. This asset sensitivity arises due to
interest-earning assets repricing more frequently than
interest-bearing liabilities. For example, if interest rates are
declining, margins will narrow as assets reprice downward more
quickly than liabilities. The converse applies when interest
rates are on the rise.

As part of the Banks interest rate risk
management, loans of approximately $362.7 million and
$316.7 million, at December 31, 2003 and 2002,
respectively, contain interest rate floors to reduce the
unfavorable impact to the Bank during interest rate declines.
The weighted average interest rate on these loans at
December 31, 2003 and 2002 was 5.88% and 6.58%,
respectively, and the interest rate floors ranged from 4.00% to
10.00% and 4.75% to 11.00%, respectively.



| |                   
| | ------------------
| | Stock Compensation

The Company grants stock options under several
stock-based incentive compensation plans. The Company applies
APB Opinion 25 and related Interpretations in accounting for
such plans. The Company utilizes the intrinsic value method for
its stock compensation plans. No compensation cost is recognized
for fixed stock options in which the exercise price is equal to
or greater than the estimated market price on the date of grant.
In 1995, the Financial Accounting Standards Board
(FASB) issued Statement of Financial Accounting
Standards (SFAS) No. 123 Accounting for
Stock-Based Compensation, as amended by
SFAS No. 198, which, if fully adopted by the Company,
would change the methods the Company applies in recognizing the
cost of the plans. Adoption of the expense recognition
provisions of SFAS No. 123, as

63



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##### Table of Contents



METROCORP BANCSHARES, INC.


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)

amended by SFAS No. 198, is optional
and the Company has decided not to elect these provisions of
SFAS No. 123. However, pro forma disclosures as if the
Company adopted the expense recognition provisions of
SFAS No. 123 are required by SFAS No. 123,
as amended by SFAS No. 198.

If the fair value based method of accounting
under SFAS No. 123 had been applied, the
Companys net income available for common shareholders and
earnings per common share would have been reduced to the pro
forma amounts indicated below (assuming that the fair value of
options granted during the year are amortized over the vesting
period) (in thousands except per share amounts):

|                                                        |             |                          |   |       |  |      |   |       |  |  |   |       | 
|------------------------------------------------------- | ----------- | ------------------------ | - | ----- |  | ---- | - | ----- |  |  | - | ----- | 
|                                                        |             |                         
|                                                        |             | Years Ended December 31,
|                                                        |             |                         
|                                                        |             | 2003                     |   | 2002  |  | 2001
|                                                        |             |                          |   |       |  |     
|Net income:                                             |             |                          |   |       |  |      |   |       |  |  |   |      
|                                                        | As reported |                          | $ | 3,708 |  |      | $ | 8,789 |  |  | $ | 7,577 | 
|                                                        | Pro forma   |                          | $ | 3,598 |  |      | $ | 8,681 |  |  | $ | 7,546 | 
|Stock-based compensation cost, net of income
    taxes: |             |                          |   |       |  |      |   |       |  |  |   |      
|                                                        | As reported |                          | $ |      |  |      | $ |      |  |  | $ |      | 
|                                                        | Pro forma   |                          | $ | 110   |  |      | $ | 108   |  |  | $ | 31    | 
|Basic earnings per common share:                        |             |                          |   |       |  |      |   |       |  |  |   |      
|                                                        | As reported |                          | $ | 0.52  |  |      | $ | 1.25  |  |  | $ | 1.08  | 
|                                                        | Pro forma   |                          | $ | 0.51  |  |      | $ | 1.24  |  |  | $ | 1.07  | 
|Diluted earnings per common share:                      |             |                          |   |       |  |      |   |       |  |  |   |      
|                                                        | As reported |                          | $ | 0.51  |  |      | $ | 1.23  |  |  | $ | 1.08  | 
|                                                        | Pro forma   |                          | $ | 0.50  |  |      | $ | 1.21  |  |  | $ | 1.07  | 



The effects of applying SFAS No. 123 in
this pro forma disclosure are not indicative of future amounts.
SFAS No. 123 does not apply to awards prior to 1995,
and the Company anticipates making awards in the future under
its stock-based compensation plans. The Black-Scholes option
valuation model was developed for use in estimating the fair
value of traded options which have no vesting restrictions and
are fully transferable. In addition, option valuation models
require the input of highly subjective assumptions including the
expected stock price volatility. Because the Companys
employee stock options have characteristics significantly
different from those of traded options, and because changes in
the subjective input assumptions can materially affect the fair
value estimate, the existing models do not necessarily provide a
reliable single measure of the fair value of its employee stock
options.



| |                              
| | -----------------------------
| | Off-Balance Sheet Instruments

The Company has entered into off-balance sheet
financial instruments consisting of commitments to extend
credit. Such financial instruments are recorded in the financial
statements when they are funded.



| |                              
| | -----------------------------
| | New Accounting Pronouncements

On November 25, 2002, the FASB issued FASB
Interpretation (FIN) No. 45,
Guarantors Accounting and Disclosure Requirements for
Guarantees, Including Indirect Guarantees of Indebtedness
of Others. FIN No. 45 considers standby letters of
credit, excluding commercial letters of credit and other lines
of credit, a guarantee of the Bank. The Bank enters into a
standby letter of credit to guarantee performance of a customer
to a third party. These guarantees are primarily issued to
support public and private borrowing arrangements. The credit
risk involved is represented by the contractual amounts of those
instruments. Under the standby letters of credit, the Bank is
required to make payments to the beneficiary of the letters of
credit upon request by the beneficiary so long as all
performance criteria have been met. Most guarantees extend up

64



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##### Table of Contents



METROCORP BANCSHARES, INC.


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)

to one year. At December 31, 2003 the
maximum potential amount of future payments is
$7.3 million. See Note 12 
Off-Balance Sheet Risk for a discussion of significant
guarantees that have been entered into by the Company. The
adoption of FIN No. 45 has not had a material effect
on the Companys financial condition or results of
operations.

On January 17, 2003, the FASB issued FIN
No. 46, Consolidation of Variable Interest Entities,which addresses consolidation by business enterprises of
variable interest entities. FIN No. 46, as amended by
FIN No. 46R, clarifies the application of ARB
No. 51, Consolidated Financial Statements,to
certain entities in which equity investors do not have the
characteristics of a controlling financial interest or do not
have sufficient equity at risk for the entity to finance its
activities without additional subordinated financial support
from other parties. The adoption has not had a material impact
on the Companys financial condition or results of
operations.

On May 15, 2003, the FASB approved
SFAS No. 150, Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and
Equity. This statement changes the accounting for certain
financial instruments that, under previous guidance, could be
classified as equity or mezzanine equity, but now is
requiring those instruments to be classified as liabilities (or
assets in some circumstances) in the statement of financial
condition. Further, SFAS No. 150 requires disclosure
regarding the terms of those instruments and settlement
alternatives. This statement is generally effective for all such
financial instruments entered into or modified after
May 31, 2003, and otherwise is effective at the beginning
of the first interim period beginning after June 15, 2003,
except for mandatorily redeemable financial instruments of
non-public entities. It is not expected that this statement will
have a material effect on the Companys financial condition
or results of operations. On October 29, 2003, the FASB
deferred certain provisions of this statement.



| |                  
| | -----------------
| | Reclassifications

Certain 2002 and 2001 amounts have been
reclassified to conform to the 2003 presentation, and has had no
impact on net income or shareholders equity.



|   |                          
|-- | -------------------------
|2. | Cash and Cash Equivalents

The Bank is required by the Board of Governors of
the Federal Reserve System to maintain average reserve balances.
The balance requirement is more than satisfied by the
Banks vault cash.

65



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##### Table of Contents



METROCORP BANCSHARES, INC.


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)



|   |           
|-- | ----------
|3. | Securities

In the normal course of business, the Bank
invests in Federal government, Federal agency, state and
municipal securities, which inherently carry interest rate risks
based upon overall economic trends and related market yield
fluctuations. Securities within the available-for-sale portfolio
may be used as part of the Companys asset/liability
strategy and may be sold in response to changes in interest rate
risk, prepayment risk or other similar economic factors.
Declines in the fair value of individual available-for-sale
securities below their cost that are other than temporary would
result in write-down of the individual securities to their fair
value. The related write-downs would be included in earnings as
realized losses. At December 31, 2003 and 2002, the
amortized cost and fair value of securities classified as
available-for-sale is as follows:

|                    |                                                                          |                         |   |            |         |            |   |            |       |  |   |        |        |   |   |         |         | 
|------------------- | ------------------------------------------------------------------------ | ----------------------- | - | ---------- | ------- | ---------- | - | ---------- | ----- |  | - | ------ | ------ | - | - | ------- | ------- | 
|                    |                                                                          |                        
|                    |                                                                          | As of December 31, 2003
|                    |                                                                          |                        
|                    |                                                                          |                         |   | Gross      |         | Gross      |   |           
|                    |                                                                          | Amortized               |   | Unrealized |         | Unrealized |   |           
|                    |                                                                          | Cost                    |   | Gains      |         | Losses     |   | Fair Value
|                    |                                                                          |                         |   |            |         |            |   |           
|                    |                                                                          |                        
|                    |                                                                          | (In thousands)         
|Available-for-sale: |                                                                          |                         |   |            |         |            |   |            |       |  |   |        |        |   |   |        
|                    | U.S. Treasury securities and obligations of
    U.S. government agencies |                         | $ | 4,965      |         |            | $ |           |       |  | $ | (12    | )      |   | $ | 4,953   |        
|                    | Obligations of state and political subdivisions                          |                         |   | 18,925     |         |            |   | 1,249      |       |  |   |       |        |   |   | 20,174  |        
|                    | Mortgage-backed securities and collateralized
    mortgage obligations   |                         |   | 209,323    |         |            |   | 1,170      |       |  |   | (1,254 | )      |   |   | 209,239 |        
|                    | Other debt securities                                                    |                         |   | 1,096      |         |            |   | 3          |       |  |   | (10    | )      |   |   | 1,089   |        
|                    | Investment in ARM and CRA funds                                          |                         |   | 21,739     |         |            |   | 73         |       |  |   | (203   | )      |   |   | 21,609  |        
|                    | FHLB and Federal Reserve Bank stock(1)(2)                                |                         |   | 5,200      |         |            |   |           |       |  |   |       |        |   |   | 5,200   |        
|                    |                                                                          |                         |   |            |         |            |   |            |       |  |   |        |        |   |   |        
|                    |                                                                          | Total securities        |   | $          | 261,248 |            |   | $          | 2,495 |  |   | $      | (1,479 | ) |   | $       | 262,264 | 
|                    |                                                                          |                         |   |            |         |            |   |            |       |  |   |        |        |   |   |        

|                    |                                                                          |                         |   |            |         |            |   |            |       |  |   |      |      |   |   |         |         | 
|------------------- | ------------------------------------------------------------------------ | ----------------------- | - | ---------- | ------- | ---------- | - | ---------- | ----- |  | - | ---- | ---- | - | - | ------- | ------- | 
|                    |                                                                          |                        
|                    |                                                                          | As of December 31, 2002
|                    |                                                                          |                        
|                    |                                                                          |                         |   | Gross      |         | Gross      |   |           
|                    |                                                                          | Amortized               |   | Unrealized |         | Unrealized |   |           
|                    |                                                                          | Cost                    |   | Gains      |         | Losses     |   | Fair Value
|                    |                                                                          |                         |   |            |         |            |   |           
|                    |                                                                          |                        
|                    |                                                                          | (In thousands)         
|Available-for-sale: |                                                                          |                         |   |            |         |            |   |            |       |  |   |      |      |   |   |        
|                    | U.S. Treasury securities and obligations of
    U.S. government agencies |                         | $ | 2,488      |         |            | $ | 50         |       |  | $ |     |      |   | $ | 2,538   |        
|                    | Obligations of state and political subdivisions                          |                         |   | 22,059     |         |            |   | 591        |       |  |   | (2   | )    |   |   | 22,648  |        
|                    | Mortgage-backed securities and collateralized
    mortgage obligations   |                         |   | 180,599    |         |            |   | 2,862      |       |  |   | (151 | )    |   |   | 183,310 |        
|                    | Other debt securities                                                    |                         |   | 2,378      |         |            |   | 33         |       |  |   | (20  | )    |   |   | 2,391   |        
|                    | Investment in ARM and CRA funds                                          |                         |   | 48,982     |         |            |   | 169        |       |  |   |     |      |   |   | 49,151  |        
|                    | FHLB and Federal Reserve Bank stock (1)(2)                               |                         |   | 4,380      |         |            |   |           |       |  |   |     |      |   |   | 4,380   |        
|                    |                                                                          |                         |   |            |         |            |   |            |       |  |   |      |      |   |   |        
|                    |                                                                          | Total securities        |   | $          | 260,886 |            |   | $          | 3,705 |  |   | $    | (173 | ) |   | $       | 264,418 | 
|                    |                                                                          |                         |   |            |         |            |   |            |       |  |   |      |      |   |   |        



---

|    |                                                                                                                                                                                                                  
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | FHLB stock held by the Bank is subject to certain
    restrictions under a credit policy of the FHLB dated May 1,
    1997. Redemption of FHLB stock is dependent upon repayment of
    borrowings from the FHLB.
|(2) | Federal Reserve Bank stock held by the Bank is
    subject to certain restrictions under Federal Reserve Bank
    Policy.                                                                                        

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##### Table of Contents



METROCORP BANCSHARES, INC.


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)

The following sets forth information concerning
sales (excluding maturities) of available-for-sale securities
(in thousands):

|                      |  |                          |        |      |  |      |        |  |  |   |        | 
|--------------------- |  | ------------------------ | ------ | ---- |  | ---- | ------ |  |  | - | ------ | 
|                      |  |                         
|                      |  | Years Ended December 31,
|                      |  |                         
|                      |  | 2003                     |        | 2002 |  | 2001
|                      |  |                          |        |      |  |     
|Amortized cost        |  | $                        | 19,818 |      |  | $    | 18,981 |  |  | $ | 37,059 | 
|Proceeds              |  |                          | 19,983 |      |  |      | 19,015 |  |  |   | 37,248 | 
|Gross realized gains  |  |                          | 165    |      |  |      | 98     |  |  |   | 201    | 
|Gross realized losses |  |                          |       |      |  |      | 64     |  |  |   | 12     | 

Investments carried at approximately
$1.6 million and $1.8 million at December 31,
2003 and 2002, respectively, were pledged to collateralize
public deposits and short-term borrowings of approximately
$1.4 million and $1.6 million, respectively.
Additionally, investments in the securities portfolio carried at
approximately $25.7 million and $34.5 million were
pledged as collateral for other borrowings at December 31,
2003 and 2002, respectively.

At December 31, 2003, future contractual
maturities of securities are as follows (in thousands):

|                                                                       |                  |                               |         |            |  |   |         |         | 
|---------------------------------------------------------------------- | ---------------- | ----------------------------- | ------- | ---------- |  | - | ------- | ------- | 
|                                                                       |                  |                              
|                                                                       |                  | Securities Available-for-Sale
|                                                                       |                  |                              
|                                                                       |                  | Amortized Cost                |         | Fair Value
|                                                                       |                  |                               |         |           
|Within one year                                                        |                  | $                             | 185     |            |  | $ | 186     |        
|Within two to five years                                               |                  |                               | 3,321   |            |  |   | 3,367   |        
|Within six to ten years                                                |                  |                               | 7,159   |            |  |   | 7,309   |        
|After ten years                                                        |                  |                               | 14,321  |            |  |   | 15,354  |        
|Mortgage-backed securities and collateralized
    mortgage obligations |                  |                               | 209,323 |            |  |   | 209,239 |        
|                                                                       |                  |                               |         |            |  |   |         |        
|Debt securities                                                        |                  |                               | 234,309 |            |  |   | 235,455 |        
|Investment in ARM and CRA funds                                        |                  |                               | 21,739  |            |  |   | 21,609  |        
|FHLB and Federal Reserve Bank stock                                    |                  |                               | 5,200   |            |  |   | 5,200   |        
|                                                                       |                  |                               |         |            |  |   |         |        
|                                                                       | Total securities |                               | $       | 261,248    |  |   | $       | 262,264 | 
|                                                                       |                  |                               |         |            |  |   |         |        

The Company had one security with a fair value of
$472,000 where the fair value was less than the amortized cost
for twelve consecutive months. The amount of unrealized loss at
December 31, 2003, was $19,000.

The Bank holds mortgage-backed securities which
may mature at an earlier date than the contractual maturity due
to prepayments. The Bank also holds certain securities which may
be called by the issuer at an earlier date than the contractual
maturity date.

The Company does not own any securities of any
one issuer (other than U.S. government and its agencies) of
which aggregate adjusted cost exceeded 10% of consolidated
shareholders equity at December 31, 2003 or 2002.



|   |                                    
|-- | -----------------------------------
|4. | Loans and Allowance for Loan Losses

The Bank originates commercial, real estate and
other loans to commercial and individual customers throughout
the markets it serves in Texas.

In June 2003, the Company transferred the status
of approximately $13.1 million in hospitality-related loans
to held-for-sale. While the Company has not historically made
such transfers, the high concentration of

67



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##### Table of Contents



METROCORP BANCSHARES, INC.


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)

these loans was deemed necessary to reduce the
Companys exposure to credit risk. In August 2003, an
additional $3.9 million composed of two restaurant loans
totaling $2.6 million and an office building loan of
$1.3 million, was transferred to held-for-sale.
Approximately $11.0 million of the loans held-for-sale were
sold during 2003 and a gain of approximately $139,000 was
recognized. The remaining $6.0 million were held-for-sale
at December 31, 2003 and are carried at the lower of cost
or market. During 2003, the Company recorded lower of cost or
market adjustments of $2.1 million on the loans
held-for-sale. The Company may consider future transfers with
concentrations in hospitality and other related loans that may
expose the Company to potential losses.

The loan portfolio is summarized by major
categories as follows (in thousands):

|                                |               |                    |         |         |  |   |         |         | 
|------------------------------- | ------------- | ------------------ | ------- | ------- |  | - | ------- | ------- | 
|                                |               |                   
|                                |               | As of December 31,
|                                |               |                   
|                                |               | 2003               |         | 2002   
|                                |               |                    |         |        
|Commercial and industrial       |               | $                  | 332,480 |         |  | $ | 325,424 |        
|Real estate-mortgage            |               |                    | 192,605 |         |  |   | 172,934 |        
|Real estate-construction        |               |                    | 24,558  |         |  |   | 25,394  |        
|Consumer and other              |               |                    | 10,447  |         |  |   | 10,286  |        
|                                |               |                    |         |         |  |   |         |        
|                                | Gross loans   |                    |         | 560,090 |  |   |         | 534,038 | 
|Unearned discounts and interest |               |                    | (864    | )       |  |   | (805    | )      
|Deferred loan fees              |               |                    | (5,443  | )       |  |   | (5,474  | )      
|                                |               |                    |         |         |  |   |         |        
|                                | Total loans   |                    |         | 553,783 |  |   |         | 527,759 | 
|Allowance for loan losses       |               |                    | (10,448 | )       |  |   | (10,150 | )      
|                                |               |                    |         |         |  |   |         |        
|                                | Loans, net(1) |                    | $       | 543,335 |  |   | $       | 517,609 | 
|                                |               |                    |         |         |  |   |         |        
|Variable rate loans             |               | $                  | 476,654 |         |  | $ | 447,655 |        
|Fixed rate loans                |               |                    | 83,436  |         |  |   | 86,383  |        
|                                |               |                    |         |         |  |   |         |        
|                                | Gross loans   |                    | $       | 560,090 |  |   | $       | 534,038 | 
|                                |               |                    |         |         |  |   |         |        

---

|    |                                                             
|--- | ------------------------------------------------------------
|(1) | Includes $6.0 million in commercial loans
    held-for-sale.

Although the Banks loan portfolio is
diversified, a substantial portion of its customers
ability to service their debts is dependent primarily on the
service sectors of the economy. At December 31, 2003 and
2002, the Banks loan portfolio consisted of concentrations
in the following industries. With the exception of the
concentration in apartment buildings, all such amounts represent
a concentration greater than 25% of capital (in thousands):

|                              |             |                    |         |         |  |   |         |         | 
|----------------------------- | ----------- | ------------------ | ------- | ------- |  | - | ------- | ------- | 
|                              |             |                   
|                              |             | As of December 31,
|                              |             |                   
|                              |             | 2003               |         | 2002   
|                              |             |                    |         |        
|Hotels/motels                 |             | $                  | 66,062  |         |  | $ | 82,015  |        
|Retail centers                |             |                    | 112,380 |         |  |   | 103,623 |        
|Restaurants                   |             |                    | 31,524  |         |  |   | 33,094  |        
|Apartment buildings           |             |                    | 14,868  |         |  |   | 14,941  |        
|Convenience/gasoline stations |             |                    | 26,983  |         |  |   | 27,383  |        
|All other                     |             |                    | 308,273 |         |  |   | 272,982 |        
|                              |             |                    |         |         |  |   |         |        
|                              | Gross loans |                    | $       | 560,090 |  |   | $       | 534,038 | 
|                              |             |                    |         |         |  |   |         |        

68



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##### Table of Contents



METROCORP BANCSHARES, INC.


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)

Changes in the allowance for loan losses are as
follows (in thousands):

|                             |  |                    |        |      |  |   |        |  
|---------------------------- |  | ------------------ | ------ | ---- |  | - | ------ | -
|                             |  |                   
|                             |  | As of December 31,
|                             |  |                   
|                             |  | 2003               |        | 2002
|                             |  |                    |        |     
|Balance at beginning of year |  | $                  | 10,150 |      |  | $ | 8,903  |  
|Provision for loan losses    |  |                    | 5,690  |      |  |   | 3,853  |  
|Charge-offs                  |  |                    | (6,121 | )    |  |   | (3,124 | )
|Recoveries                   |  |                    | 729    |      |  |   | 518    |  
|                             |  |                    |        |      |  |   |        |  
|Balance at end of year       |  | $                  | 10,448 |      |  | $ | 10,150 |  
|                             |  |                    |        |      |  |   |        |  



Loans for which the accrual of interest has been
discontinued totaled approximately $25.4 million and
$17.2 million at December 31, 2003 and 2002,
respectively. Had these loans remained on an accrual basis,
interest in the amount of approximately $1.0 million and
$657,000 would have been accrued on these loans during the years
ended December 31, 2003 and 2002, respectively.

Included in other assets on the balance sheet at
December 31, 2003 and 2002 is $125,000 and $105,000,
respectively, due from the SBA, the Export Import Bank of the
United States (Ex-Im Bank), an independent agency of
the United States Government, and the Overseas Chinese Community
Guaranty Fund (OCCGF), an agency sponsored by the
government of Taiwan. These amounts represent the guaranteed
portions of loans previously charged-off.

The recorded investment in loans for which
impairment has been recognized and the related specific
allowance for loan losses on such loans at December 31,
2003 and 2002, is presented below (in thousands):

|                                                            |                                                          |                                                                     |       |            |       |          |        |        |        |   |     |     |    |   |        |        |        |  | 
|----------------------------------------------------------- | -------------------------------------------------------- | ------------------------------------------------------------------- | ----- | ---------- | ----- | -------- | ------ | ------ | ------ | - | --- | --- | -- | - | ------ | ------ | ------ |  | 
|                                                            |                                                          | Real Estate                                                         |       | Commercial |       | Consumer |        | Total 
|                                                            |                                                          |                                                                     |       |            |       |          |        |       
|December 31, 2003:                                          |                                                          |                                                                     |       |            |       |          |        |        |        |   |     |     |    |   |        |       
|Impaired loans having related allowance for loan
    losses |                                                          | $                                                                   | 6,041 |            |       | $        | 19,341 |        |        | $ | 60  |     |    | $ | 25,442 |       
|                                                            | Less: Allowance for loan losses                          |                                                                     |       | (914       | )     |          |        | (7,956 | )      |   |     | (30 | )  |   |        | (8,900 | )     
|                                                            | Less: Guaranteed portion (SBA, OCCGF and Ex-Im
    Bank) |                                                                     |       |           |       |          |        | (3,323 | )      |   |     |     |    |   |        | (3,323 | )     
|                                                            |                                                          |                                                                     |       |            |       |          |        |        |        |   |     |     |    |   |        |       
|                                                            |                                                          | Impaired loans, net of allowance for loan losses
    and guarantees |       | $          | 5,127 |          |        | $      | 8,062  |   |     | $   | 30 |   |        | $      | 13,219 | 
|                                                            |                                                          |                                                                     |       |            |       |          |        |        |        |   |     |     |    |   |        |       
|December 31, 2002:                                          |                                                          |                                                                     |       |            |       |          |        |        |        |   |     |     |    |   |        |       
|Impaired loans having related allowance for loan
    losses |                                                          | $                                                                   |      |            |       | $        | 17,101 |        |        | $ | 108 |     |    | $ | 17,209 |       
|                                                            | Less: Allowance for loan losses                          |                                                                     |       |           |       |          |        | (3,224 | )      |   |     | (54 | )  |   |        | (3,278 | )     
|                                                            | Less: Guaranteed portion (SBA, OCCGF and Ex-Im
    Bank) |                                                                     |       |           |       |          |        | (3,310 | )      |   |     |    |    |   |        | (3,310 | )     
|                                                            |                                                          |                                                                     |       |            |       |          |        |        |        |   |     |     |    |   |        |       
|                                                            |                                                          | Impaired loans, net of allowance for loan losses
    and guarantees |       | $          |      |          |        | $      | 10,567 |   |     | $   | 54 |   |        | $      | 10,621 | 
|                                                            |                                                          |                                                                     |       |            |       |          |        |        |        |   |     |     |    |   |        |       



As of December 31, 2003 and 2002, the
average recorded investment in impaired loans was approximately
$21.8 million and $13.0 million, respectively. The
related amount of interest income recognized while the loans
were impaired approximated $215,000 for the year ended
December 31, 2002. No interest income was recognized in the
year ended December 31, 2003.

69



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##### Table of Contents



METROCORP BANCSHARES, INC.


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)

Additionally, at December 31, 2003, loans
with a value of approximately $28.0 million were available
as collateral under a blanket loan agreement with the Federal
Home Loan Bank of Dallas. At December 31, 2003, there
were no loans specifically pledged to collateralize borrowed
funds.



|   |                       
|-- | ----------------------
|5. | Premises and Equipment

Premises and equipment are summarized as follows
(in thousands):

|                                  |  |                  |      |                    |  |      |         |   |  |   |         |  
|--------------------------------- |  | ---------------- | ---- | ------------------ |  | ---- | ------- | - |  | - | ------- | -
|                                  |  |                  |      |                   
|                                  |  |                  |      | As of December 31,
|                                  |  | Estimated useful |      |                   
|                                  |  | lives (in years) |      | 2003               |  | 2002
|                                  |  |                  |      |                    |  |     
|Furniture, fixtures and equipment |  |                  | 3-10 |                    |  | $    | 12,382  |   |  | $ | 11,633  |  
|Building and improvements         |  |                  | 3-20 |                    |  |      | 4,379   |   |  |   | 4,018   |  
|Land                              |  |                  |     |                    |  |      | 1,679   |   |  |   | 1,679   |  
|Leasehold improvements            |  |                  | 5    |                    |  |      | 2,715   |   |  |   | 2,655   |  
|                                  |  |                  |      |                    |  |      |         |   |  |   |         |  
|                                  |  |                  |      |                    |  |      | 21,155  |   |  |   | 19,985  |  
|Accumulated depreciation          |  |                  |      |                    |  |      | (15,481 | ) |  |   | (14,144 | )
|                                  |  |                  |      |                    |  |      |         |   |  |   |         |  
|Premises and equipment, net       |  |                  |      |                    |  | $    | 5,674   |   |  | $ | 5,841   |  
|                                  |  |                  |      |                    |  |      |         |   |  |   |         |  



|   |                          
|-- | -------------------------
|6. | Interest-Bearing Deposits

The types of accounts and their respective
balances included in interest-bearing deposits are as follows
(in thousands):

|                                  |  |                    |         |      |  |   |         | 
|--------------------------------- |  | ------------------ | ------- | ---- |  | - | ------- | 
|                                  |  |                   
|                                  |  | As of December 31,
|                                  |  |                   
|                                  |  | 2003               |         | 2002
|                                  |  |                    |         |     
|Interest-bearing demand deposits  |  | $                  | 74,112  |      |  | $ | 78,147  | 
|Savings and money market accounts |  |                    | 120,151 |      |  |   | 107,722 | 
|Time deposits less than $100,000  |  |                    | 167,672 |      |  |   | 166,261 | 
|Time deposits $100,000 and over   |  |                    | 193,909 |      |  |   | 194,687 | 
|                                  |  |                    |         |      |  |   |         | 
|Interest-bearing deposits         |  | $                  | 555,844 |      |  | $ | 546,817 | 
|                                  |  |                    |         |      |  |   |         | 

At December 31, 2003, the scheduled
maturities of time deposits are as follows (in thousands):

|           |  |   |         | 
|---------- |  | - | ------- | 
|2004       |  | $ | 292,978 | 
|2005       |  |   | 33,144  | 
|2006       |  |   | 28,033  | 
|2007       |  |   | 3,141   | 
|2008       |  |   | 4,218   | 
|After 2008 |  |   | 67      | 
|           |  |   |         | 
|           |  | $ | 361,581 | 
|           |  |   |         | 

The Bank had no brokered deposits as of
December 31, 2003 or 2002. There were no major deposit
concentrations as of December 31, 2003 or 2002.

70



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##### Table of Contents



METROCORP BANCSHARES, INC.


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)





|   |                 
|-- | ----------------
|7. | Other Borrowings

Other borrowings include $25.0 million of
loans from the FHLB of Dallas, maturing in September 2008. The
loans bear interest at an average rate of 4.99% per annum
until September 2003 after which time the FHLB may request
repayment or the interest rate may be renegotiated.

Other borrowings also include several FHLB
advances obtained to acquire mortgage-related securities in
order to increase earning assets. These borrowings were
$28.3 million and $65.2 million at December 31,
2003 and 2002, respectively, with maturities ranging from one
month to two years and carried a weighted average interest rate
of 1.52% and 1.85%, respectively.

The following is a schedule by year of payments
required on the Companys FHLB borrowings (in thousands):

|           |  |        |        | 
|---------- |  | ------ | ------ | 
|Year       |  | Amount
|           |  |       
|2004       |  | $      | 28,300 | 
|2005       |  |        |       | 
|2006       |  |        |       | 
|2007       |  |        |       | 
|2008       |  |        | 25,000 | 
|After 2008 |  |        |       | 
|           |  |        |        | 
|           |  | $      | 53,300 | 
|           |  |        |        | 

Other short-term borrowings at December 31,
2003 and 2002 consist of $873,000 and $574,000, respectively, in
Treasury, Tax and Loan (TT&L) payments in
Company accounts for the benefit of the U.S. Treasury.
These funds typically remain in the Company for one day and are
then moved to the U.S. Treasury.

Additionally, the Bank has several unused,
unsecured lines of credit with correspondent banks totaling
$15.0 million at December 31, 2003 and 2002.

71



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##### Table of Contents



METROCORP BANCSHARES, INC.


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)



|   |             
|-- | ------------
|8. | Income Taxes

Deferred income taxes result from differences
between the amounts of assets and liabilities as measured for
income tax return and for financial reporting purposes. The
significant components of the net deferred tax asset are as
follows (in thousands):

|                                                                       |                        |                    |       |       |  |   |       |       | 
|---------------------------------------------------------------------- | ---------------------- | ------------------ | ----- | ----- |  | - | ----- | ----- | 
|                                                                       |                        |                   
|                                                                       |                        | As of December 31,
|                                                                       |                        |                   
|                                                                       |                        | 2003               |       | 2002 
|                                                                       |                        |                    |       |      
|Deferred Tax Assets:                                                   |                        |                    |       |       |  |   |       |      
|Allowance for loan losses                                              |                        | $                  | 3,552 |       |  | $ | 3,451 |      
|Recognition of deferred loan fees                                      |                        |                    | 1,850 |       |  |   | 1,861 |      
|Premises and equipment                                                 |                        |                    | 1,044 |       |  |   | 1,011 |      
|Recognition of interest on nonaccrual loans                            |                        |                    | 435   |       |  |   | 640   |      
|                                                                       |                        |                    |       |       |  |   |       |      
|Gross deferred tax assets                                              |                        |                    | 6,881 |       |  |   | 6,963 |      
|                                                                       |                        |                    |       |       |  |   |       |      
|Deferred Tax Liabilities:                                              |                        |                    |       |       |  |   |       |      
|Unrealized gains on investments securities
    available-for-sale, net |                        |                    | 346   |       |  |   | 1,201 |      
|FHLB stock dividends                                                   |                        |                    | 403   |       |  |   | 374   |      
|Other                                                                  |                        |                    | 358   |       |  |   | 804   |      
|                                                                       |                        |                    |       |       |  |   |       |      
|Gross deferred tax liabilities                                         |                        |                    | 1,107 |       |  |   | 2,379 |      
|                                                                       |                        |                    |       |       |  |   |       |      
|                                                                       | Net deferred tax asset |                    | $     | 5,774 |  |   | $     | 4,584 | 
|                                                                       |                        |                    |       |       |  |   |       |      

The Bank has not provided a valuation allowance
for the net deferred tax asset at December 31, 2003 and
2002 due primarily to its ability to offset reversals of net
deductible temporary differences against income taxes paid in
previous years and expected to be paid in future years.

Components of the provision for income taxes are
as follows (in thousands):

|                                                |                                  |                          |       |       |  |      |       |       |  |   |       |       | 
|----------------------------------------------- | -------------------------------- | ------------------------ | ----- | ----- |  | ---- | ----- | ----- |  | - | ----- | ----- | 
|                                                |                                  |                         
|                                                |                                  | Years Ended December 31,
|                                                |                                  |                         
|                                                |                                  | 2003                     |       | 2002  |  | 2001
|                                                |                                  |                          |       |       |  |     
|Current provision for federal income taxes      |                                  | $                        | 1,915 |       |  | $    | 4,471 |       |  | $ | 3,358 |      
|Deferred federal income tax provision (benefit) |                                  |                          | (386  | )     |  |      | (121  | )     |  |   | 195   |      
|                                                |                                  |                          |       |       |  |      |       |       |  |   |       |      
|                                                | Total provision for income taxes |                          | $     | 1,529 |  |      | $     | 4,350 |  |   | $     | 3,553 | 
|                                                |                                  |                          |       |       |  |      |       |       |  |   |       |      

A reconciliation of the provision for income
taxes computed at statutory rates compared to the actual
provision for income taxes is as follows (in thousands):

|                                             |                            |                          |       |         |  |        |    |         |   |        |       |         |  |  |    |    |   |   |       |       |  |  |    |    |  
|-------------------------------------------- | -------------------------- | ------------------------ | ----- | ------- |  | ------ | -- | ------- | - | ------ | ----- | ------- |  |  | -- | -- | - | - | ----- | ----- |  |  | -- | -- | -
|                                             |                            |                         
|                                             |                            | Years Ended December 31,
|                                             |                            |                         
|                                             |                            |                          |       |         |  |       
|                                             |                            | 2003                     |       | 2002    |  | 2001  
|                                             |                            |                          |       |         |  |       
|                                             |                            | Amount                   |       | Percent |  | Amount |    | Percent |   | Amount |       | Percent
|                                             |                            |                          |       |         |  |        |    |         |   |        |       |        
|Federal income tax expense at statutory rate |                            | $                        | 1,781 |         |  |        | 34 | %       |   | $      | 4,467 |         |  |  | 34 | %  |   | $ | 3,784 |       |  |  | 34 | % 
|Tax-exempt interest income                   |                            |                          | (315  | )       |  |        | (6 | )       |   |        | (361  | )       |  |  | (3 | )  |   |   | (400  | )     |  |  | (3 | ) 
|Other, net                                   |                            |                          | 63    |         |  |        | 1  |         |   |        | 244   |         |  |  | 2  |    |   |   | 169   |       |  |  | 1  |   
|                                             |                            |                          |       |         |  |        |    |         |   |        |       |         |  |  |    |    |   |   |       |       |  |  |    |   
|                                             | Provision for income taxes |                          | $     | 1,529   |  |        |    | 29      | % |        | $     | 4,350   |  |  |    | 33 | % |   | $     | 3,553 |  |  |    | 32 | %
|                                             |                            |                          |       |         |  |        |    |         |   |        |       |         |  |  |    |    |   |   |       |       |  |  |    |   

72



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METROCORP BANCSHARES, INC.


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)

The following sets forth the deferred tax benefit
(expense) related to other comprehensive income (in
thousands):

|                                                                       |                            |                          |      |      |   |      |       |       |  |   |     |     | 
|---------------------------------------------------------------------- | -------------------------- | ------------------------ | ---- | ---- | - | ---- | ----- | ----- |  | - | --- | --- | 
|                                                                       |                            |                         
|                                                                       |                            | Years Ended December 31,
|                                                                       |                            |                         
|                                                                       |                            | 2003                     |      | 2002 |   | 2001
|                                                                       |                            |                          |      |      |   |     
|Unrealized gains (losses) arising during the
    period                |                            | $                        | (775 | )    |   | $    | 1,020 |       |  | $ | 196 |    
|Less: reclassification adjustment for gains
    realized in net income |                            |                          | (58  | )    |   |      | (12   | )     |  |   | (64 | )  
|                                                                       |                            |                          |      |      |   |      |       |       |  |   |     |    
|                                                                       | Other comprehensive income |                          | $    | (833 | ) |      | $     | 1,008 |  |   | $   | 132 | 
|                                                                       |                            |                          |      |      |   |      |       |       |  |   |     |    



|   |                           
|-- | --------------------------
|9. | 401(k) Profit Sharing Plan

The Company has established a defined
contributory profit sharing plan pursuant to Internal Revenue
Code Section 401(k) covering substantially all employees
(the Plan). The Plan provides for pretax employee
contributions of up to 15% of annual compensation. The Company
matches each participants contributions to the Plan up to
4% of such participants salary. The Company made
contributions, before expenses, to the Plan of approximately
$389,000, $354,000, and $308,000 during the years ended
December 31, 2003, 2002, and 2001, respectively.



|    |                     
|--- | --------------------
|10. | Shareholders Equity

The Company declared and paid dividends of
$0.24 per share to the shareholders of record during the
year ended December 31, 2003 which included a dividend
declared of $0.06 per share to shareholders of record as of
December 31, 2003, which was paid on January 15, 2004.
The Company also paid dividends of $0.24 per share in 2002
and 2001.

The declaration and payment of dividends on the
Common Stock by the Company depends upon the earnings and
financial condition of the Company, liquidity and capital
requirements, the general economic and regulatory climate, the
Companys ability to service any equity or debt obligations
senior to the Common Stock and other factors deemed relevant by
the Companys Board of Directors.

The Companys Non-Employee Director Stock
Bonus Plan (Non-Employee Director Plan) authorizes
the issuance of up to 60,000 shares of Common Stock to the
directors of the Company who do not serve as an officer or
employee of the Company. Under the Non-Employee Director Plan,
up to 12,000 shares of Common Stock may be issued each year
for a five-year period beginning in 1998 if the Company achieves
a certain return on equity ratio with no shares to be issued if
the Companys return on equity is below 13.0%. This return
on equity goal was not achieved in 2003, 2002 or 2001. As of
December 31, 2003, 24,000 shares have been issued
under the Non-Employee Director Plan and no additional shares
are available for issuance under this plan.

The Companys 1998 Employee Stock Purchase
Plan (Purchase Plan) authorizes the offer and sale
of up to 200,000 shares of Common Stock to employees of the
Company and its subsidiaries. The Purchase Plan will be
implemented through ten annual offerings. Each year the Board of
Directors determines the number of shares to be offered under
the Purchase Plan; provided that in any one year the offering
may not exceed 20,000 shares plus any unsubscribed shares
from prior years. The offering price per share will be an amount
equal to 90% of the closing trading price of a share of Common
Stock on the business day immediately prior to the commencement
of such offering. In each offering, each employee may purchase a
number of whole shares of Common Stock that are equal to 20% of
the employees base salary divided by the offering price.
Pursuant to the Purchase Plan, the employee pays for the Common
Stock either immediately or through a payroll deduction program
over a period of up to one year, at the employees option.
The first annual offering under the Purchase Plan began in the
second quarter of 1999. As of December 31, 2003 there were
23,743 shares issued under the Purchase Plan.

73



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METROCORP BANCSHARES, INC.


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)



|    |                   
|--- | ------------------
|11. | Regulatory Matters

Regulatory restrictions limit the payment of cash
dividends by the Bank. The approval of the Office of the
Comptroller of the Currency (OCC) is required for any cash
dividend paid by the Bank if the total of all cash dividends
declared in any calendar year exceeds the total of its net
income for that year combined with the net addition to undivided
profits for the preceding two years. As of December 31,
2003, approximately $15.0 million was available for payment
of dividends by the Bank to the Company under applicable
restrictions, without regulatory approval.

The Company and the Bank are subject to various
regulatory capital requirements administered by the federal
banking agencies. Failure to meet minimum capital requirements
can initiate certain mandatory, and possibly additional
discretionary, actions by regulators that, if undertaken, could
have a direct material effect on the Companys financial
statements. The regulations require the Company to meet specific
capital adequacy guidelines that involve quantitative measures
of the Companys assets, liabilities, and certain
off-balance sheet items as calculated under regulatory
accounting practices. The Banks capital classification is
also subject to qualitative judgments by the regulators about
components, risk weightings and other factors.

Quantitative measures established by regulation
to ensure capital adequacy require the Company and the Bank to
maintain minimum amounts and ratios of total and Tier 1
capital to risk-weighted assets, and of Tier 1 capital to
average assets. Management believes, as of December 31,
2003 that the Company and the Bank meet all capital adequacy
requirements to which it is subject.

The most recent notifications from the OCC
categorized the Bank as well capitalized, as
defined, under the regulatory framework for prompt corrective
action. To be categorized as adequately capitalized, the Bank
must maintain minimum total risk-based, Tier 1 risk-based
and Tier leverage ratios as set forth in the table below. There
are no conditions or events since the notifications that
management believes have changed the Banks level of
capital adequacy.

74



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##### Table of Contents



METROCORP BANCSHARES, INC.


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)

The Companys and the Banks actual
capital amounts and ratios are presented in the following table:

|                                |                            |                        |   |                  |  |                   |  |                   |   |        |   |        |  |  |  |      |   |  |   |        |  |  |  |       |  
|------------------------------- | -------------------------- | ---------------------- | - | ---------------- |  | ----------------- |  | ----------------- | - | ------ | - | ------ |  |  |  | ---- | - |  | - | ------ |  |  |  | ----- | -
|                                |                            |                        |   |                  |  |                   |  |                  
|                                |                            |                        |   |                  |  | Minimum           |  | To be Well       
|                                |                            |                        |   |                  |  | Required for      |  | Capitalized Under
|                                |                            |                        |   | Capital Adequacy |  | Prompt Corrective
|                                |                            | Actual                 |   | Purposes         |  | Action Provisions
|                                |                            |                        |   |                  |  |                  
|                                |                            | Amount                 |   | Ratio            |  | Amount            |  | Ratio             |   | Amount |   | Ratio 
|                                |                            |                        |   |                  |  |                   |  |                   |   |        |   |       
|                                |                            |                       
|                                |                            | (Dollars in thousands)
|As of December 31, 2003         |                            |                        |   |                  |  |                   |  |                   |   |        |   |        |  |  |  |      |   |  |   |        |  |  |  |      
|Total risk-based capital ratio  |                            |                        |   |                  |  |                   |  |                   |   |        |   |        |  |  |  |      |   |  |   |        |  |  |  |      
|                                | MetroCorp Bancshares, Inc. |                        | $ | 83,034           |  |                   |  | 13.67             | % |        | $ | 48,577 |  |  |  | 8.00 | % |  | $ | N/A    |  |  |  | N/A   | %
|                                | MetroBank, N.A.            |                        |   | 78,446           |  |                   |  | 12.92             |   |        |   | 48,576 |  |  |  | 8.00 |   |  |   | 60,720 |  |  |  | 10.00 |  
|Tier 1 risk-based capital ratio |                            |                        |   |                  |  |                   |  |                   |   |        |   |        |  |  |  |      |   |  |   |        |  |  |  |      
|                                | MetroCorp Bancshares, Inc. |                        |   | 75,409           |  |                   |  | 12.42             |   |        |   | 24,288 |  |  |  | 4.00 |   |  |   | N/A    |  |  |  | N/A   |  
|                                | MetroBank, N.A.            |                        |   | 70,821           |  |                   |  | 11.66             |   |        |   | 24,288 |  |  |  | 4.00 |   |  |   | 36,432 |  |  |  | 6.00  |  
|Leverage ratio                  |                            |                        |   |                  |  |                   |  |                   |   |        |   |        |  |  |  |      |   |  |   |        |  |  |  |      
|                                | MetroCorp Bancshares, Inc. |                        |   | 75,409           |  |                   |  | 8.84              |   |        |   | 34,141 |  |  |  | 4.00 |   |  |   | N/A    |  |  |  | N/A   |  
|                                | MetroBank, N.A.            |                        |   | 70,821           |  |                   |  | 8.30              |   |        |   | 34,138 |  |  |  | 4.00 |   |  |   | 42,673 |  |  |  | 5.00  |  
|                               
|As of December 31, 2002         |                            |                        |   |                  |  |                   |  |                   |   |        |   |        |  |  |  |      |   |  |   |        |  |  |  |      
|Total risk-based capital ratio  |                            |                        |   |                  |  |                   |  |                   |   |        |   |        |  |  |  |      |   |  |   |        |  |  |  |      
|                                | MetroCorp Bancshares, Inc. |                        | $ | 79,237           |  |                   |  | 13.97             | % |        | $ | 45,375 |  |  |  | 8.00 | % |  | $ | N/A    |  |  |  | N/A   | %
|                                | MetroBank, N.A.            |                        |   | 76,072           |  |                   |  | 13.41             |   |        |   | 45,374 |  |  |  | 8.00 |   |  |   | 56,718 |  |  |  | 10.00 |  
|Tier 1 risk-based capital ratio |                            |                        |   |                  |  |                   |  |                   |   |        |   |        |  |  |  |      |   |  |   |        |  |  |  |      
|                                | MetroCorp Bancshares, Inc. |                        |   | 72,109           |  |                   |  | 12.71             |   |        |   | 22,688 |  |  |  | 4.00 |   |  |   | N/A    |  |  |  | N/A   |  
|                                | MetroBank, N.A.            |                        |   | 68,944           |  |                   |  | 12.16             |   |        |   | 22,687 |  |  |  | 4.00 |   |  |   | 34,031 |  |  |  | 6.00  |  
|Leverage ratio                  |                            |                        |   |                  |  |                   |  |                   |   |        |   |        |  |  |  |      |   |  |   |        |  |  |  |      
|                                | MetroCorp Bancshares, Inc. |                        |   | 72,108           |  |                   |  | 8.58              |   |        |   | 33,627 |  |  |  | 4.00 |   |  |   | N/A    |  |  |  | N/A   |  
|                                | MetroBank, N.A.            |                        |   | 68,944           |  |                   |  | 8.20              |   |        |   | 33,625 |  |  |  | 4.00 |   |  |   | 42,031 |  |  |  | 5.00  |  

The OCC periodically examines and evaluates
national banks. Based upon such an examination, the OCC may
revalue the assets of the institution and require that it
charge-off certain assets, establish specific reserves to
compensate for the difference between the OCC-determined value
and the book value of such assets or take other regulatory
action designed to lessen the risk in the asset portfolio. The
OCC is currently conducting its annual examination of the Bank
and while no such actions have been taken by the OCC, no
assurance can be provided that such actions will not occur in
the future.



|    |                       
|--- | ----------------------
|12. | Off-Balance Sheet Risk

The Bank is party to financial instruments with
off-balance sheet risk in the normal course of business to meet
the financing needs of its customers. These financial
instruments include various guarantees, commitments to extend
credit and standby letters of credit. Additionally, these
instruments may involve, to varying degrees, credit risk in
excess of the amount recognized in the statement of financial
condition. The Banks maximum exposure to credit loss under
such arrangements is represented by the contractual amount of
those instruments. The Bank applies the same credit policies and
collateralization guidelines in making commitments and
conditional obligations as it does for on-balance sheet
instruments. Commitments to extend credit at December 31,
2003 and 2002 aggregated approximately $102.6 million and
$85.4 million,

75



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##### Table of Contents



METROCORP BANCSHARES, INC.


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)

respectively. Commitments under letters of credit
at December 31, 2003 and 2002 totaled $14.9 million
and $10.4 million, respectively.

The contractual amount of the Companys
financial instruments with off-balance sheet risk expiring by
period at December 31, 2003 is presented below:

|                                                                 |  |                        |         |             |  |       |     |  |  |   |         | 
|---------------------------------------------------------------- |  | ---------------------- | ------- | ----------- |  | ----- | --- |  |  | - | ------- | 
|                                                                 |  |                        |         | After One   |  |      
|                                                                 |  | Within One             |         | but Within  |  |      
|                                                                 |  | Year                   |         | Three Years |  | Total
|                                                                 |  |                        |         |             |  |      
|                                                                 |  |                       
|                                                                 |  | (Dollars in thousands)
|Unfunded loan commitments including unfunded
    lines of credit |  | $                      | 87,706  |             |  | $     |    |  |  | $ | 87,706  | 
|Standby letters of credit                                        |  |                        | 7,215   |             |  |       | 115 |  |  |   | 7,330   | 
|Commercial letters of credit                                     |  |                        | 7,527   |             |  |       |    |  |  |   | 7,527   | 
|                                                                 |  |                        |         |             |  |       |     |  |  |   |         | 
|Total financial instruments with off-balance
    sheet risk      |  | $                      | 102,448 |             |  | $     | 115 |  |  | $ | 102,563 | 
|                                                                 |  |                        |         |             |  |       |     |  |  |   |         | 



|    |                                    
|--- | -----------------------------------
|13. | Fair Value of Financial Instruments

SFAS No. 107, Disclosures About Fair
Value of Financial Instruments, requires disclosures of
estimated fair values for all financial instruments and the
methods and assumptions used by management to estimate the fair
value for each type of financial instrument. The fair value of a
financial instrument is the current amount that would be
exchanged between willing parties other than in a forced
liquidation. Fair value is best determined based upon quoted
market prices. However, in many instances, there are no quoted
market prices for the Companys various financial
instruments.

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. Accordingly,
the fair value estimates may not be realized in an immediate
settlement of the instrument. SFAS No. 107 excludes
certain financial instruments and all nonfinancial instruments
from its disclosure requirements. Accordingly, the aggregate
fair value amounts presented may not necessarily represent the
underlying fair value of the Company.

The following summary presents the methodologies
and assumptions used to estimate the fair value of the
Companys financial instruments, required to be valued
pursuant to SFAS No. 107:



| |                                                            
| | -----------------------------------------------------------
| | Assets for Which Fair Value Approximates
    Carrying Value

The fair values of certain financial assets and
liabilities carried at cost, including cash and due from banks,
deposits with banks, federal funds sold, due from customers on
acceptances and accrued interest receivable, are considered to
approximate their respective carrying values due to their
short-term nature and negligible credit losses.



| |                      
| | ---------------------
| | Investment Securities

Fair values are based upon publicly quoted market
prices. See Note 3 in Notes to Consolidated Financial
Statements.



| |      
| | -----
| | Loans

The fair value of loans originated by the Bank is
estimated by discounting the expected future cash flows using a
discount rate commensurate with the risks involved. The loan
portfolio is segregated into groups of loans with homogeneous
characteristics and expected future cash flows and interest
rates reflecting appropriate credit risk are determined for each
group. An estimate of future credit losses based on historical

76



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##### Table of Contents



METROCORP BANCSHARES, INC.


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)

experience is factored into the discounted cash
flow calculation. The estimated fair value of the loan portfolio
at December 31, 2003 and 2002 was $544.4 million and
$519.3 million, respectively.



| |                                                                 
| | ----------------------------------------------------------------
| | Liabilities for Which Fair Value
    Approximates Carrying Value

SFAS No. 107 requires that the fair
value disclosed for deposit liabilities with no stated maturity
(i.e., demand, savings, and certain money market deposits) be
equal to the carrying value. SFAS No. 107 does not
allow for the recognition of the inherent funding value of these
instruments. The fair value of federal funds purchased, borrowed
funds, acceptances outstanding, accounts payable and accrued
liabilities are considered to approximate their respective
carrying values due to their short-term nature.



| |              
| | -------------
| | Time Deposits

The fair values disclosed for demand deposits
(e.g., interest and noninterest checking, passbook savings, and
certain types of money market accounts) are, by definition,
equal to the amount payable on demand at the reporting date
(i.e., their carrying amounts). The carrying amounts of
variable-rate, fixed-term money market accounts and certificates
of deposit (time deposits) approximate their fair values at the
reporting date. Fair values for fixed-rate time deposits are
estimated using a discounted cash flow calculation that applies
interest rates currently being offered on time deposits to a
schedule of aggregated expected monthly maturities on time
deposits. The estimated fair value of time deposits at
December 31, 2003 and 2002 was $364.5 million and
$365.0 million, respectively.



| |                 
| | ----------------
| | Other Borrowings

The carrying amounts of Federal funds purchased,
borrowings under repurchase agreements, and other borrowings
maturing within ninety days approximate their fair values. Fair
values of other borrowings are estimated using discounted cash
flow analyses based on the Companys current incremental
borrowing rates for similar types of borrowing arrangements. The
estimated fair value of other borrowings at December 31,
2003 and 2002 was $55.2 million and $67.3 million,
respectively.



| |                                                               
| | --------------------------------------------------------------
| | Commitments to Extend Credit and Standby
    Letters of Credit

The fair value of the commitments to extend
credit of $102.6 million and $85.4 million is
considered to approximate carrying value at December 31,
2003 and 2002, respectively.



|    |                              
|--- | -----------------------------
|14. | Commitments and Contingencies

The Bank leases certain branch premises and
equipment under operating leases which expire between 2004
through 2008 and thereafter. The Bank incurred rental expense of
approximately $867,000, $859,000, and $825,000, for the years
ended December 31, 2003, 2002 and 2001, respectively, under
these lease

77



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##### Table of Contents



METROCORP BANCSHARES, INC.


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)

agreements. Future minimum lease payments at
December 31, 2003 due under these lease agreements are as
follows (in thousands):

|           |  |        |       | 
|---------- |  | ------ | ----- | 
|Year       |  | Amount
|           |  |       
|2004       |  | $      | 944   | 
|2005       |  |        | 873   | 
|2006       |  |        | 417   | 
|2007       |  |        | 354   | 
|2008       |  |        | 302   | 
|After 2008 |  |        | 1,082 | 
|           |  |        |       | 
|           |  | $      | 3,972 | 
|           |  |        |       | 



In September 2003 a subsidiary of the Company
that is no longer active, Advantage Finance Corporation
(AFC), was served in connection with a lawsuit based
on alleged malicious prosecution and
conspiracy. Also included in the lawsuit are BDO
Seidman LLP and the CIT Group/ Commercial Services, Inc.
The plaintiff has filed his case in both Federal and State
courts. In December 2003 the case was dismissed from Federal
court and a request for dismissal from State court is
anticipated. An appeal is expected, however none has been filed
to date. Management is unable to determine whether the outcome
will have a material impact on the Companys financial
statements. The lawsuit does not seek a specified amount.

78



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##### Table of Contents



METROCORP BANCSHARES, INC.


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)



|    |                                     
|--- | ------------------------------------
|15. | Parent Company Financial Information

The condensed balance sheets, statements of
income and statements of cash flows for MetroCorp
Bancshares, Inc. (parent only) are presented below:

Condensed Balance Sheets

(In thousands, except share amounts)


|                                                               |                                                                                                                                                                                                               |                            |        |       |        |   |        |       |        | 
|-------------------------------------------------------------- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | -------------------------- | ------ | ----- | ------ | - | ------ | ----- | ------ | 
|                                                               |                                                                                                                                                                                                               |                           
|                                                               |                                                                                                                                                                                                               | As of December 31,        
|                                                               |                                                                                                                                                                                                               |                           
|                                                               |                                                                                                                                                                                                               | 2003                       |        | 2002 
|                                                               |                                                                                                                                                                                                               |                            |        |      
|Assets                                                        
|Cash and due from subsidiary bank                              |                                                                                                                                                                                                               | $                          | 4,954  |       |        | $ | 3,587  |      
|Investment in bank subsidiary                                  |                                                                                                                                                                                                               |                            | 71,631 |       |        |   | 71,298 |      
|                                                               |                                                                                                                                                                                                               |                            |        |       |        |   |        |      
|                                                               |                                                                                                                                                                                                               | Total assets               |        | $     | 76,585 |   |        | $     | 74,885 | 
|                                                               |                                                                                                                                                                                                               |                            |        |       |        |   |        |      
|Liabilities and Shareholders
    Equity                      
|Other liabilities                                              |                                                                                                                                                                                                               | $                          | 375    |       |        | $ | 422    |      
|                                                               |                                                                                                                                                                                                               |                            |        |       |        |   |        |      
|                                                               |                                                                                                                                                                                                               | Total liabilities          |        |       | 375    |   |        |       | 422    | 
|                                                               |                                                                                                                                                                                                               |                            |        |       |        |   |        |      
|Shareholders equity:                                          |                                                                                                                                                                                                               |                            |        |       |        |   |        |      
|                                                               | Common stock, $1.00 par value,
    20,000,000 shares authorized; 7,306,627 and
    7,195,927 shares issued and 7,156,689 and
    7,031,882 shares outstanding at December 31, 2003 and
    2002, respectively |                            |        | 7,307 |        |   |        | 7,196 |       
|Additional paid-in-capital                                     |                                                                                                                                                                                                               |                            | 27,620 |       |        |   | 26,344 |      
|Retained earnings                                              |                                                                                                                                                                                                               |                            | 41,942 |       |        |   | 39,938 |      
|Net accumulated other comprehensive income from
    subsidiary |                                                                                                                                                                                                               |                            | 671    |       |        |   | 2,354  |      
|Treasury stock, at cost                                        |                                                                                                                                                                                                               |                            | (1,330 | )     |        |   | (1,369 | )    
|                                                               |                                                                                                                                                                                                               |                            |        |       |        |   |        |      
|                                                               |                                                                                                                                                                                                               | Total shareholders equity |        |       | 76,210 |   |        |       | 74,463 | 
|                                                               |                                                                                                                                                                                                               |                            |        |       |        |   |        |      
|Total liabilities and shareholders equity                     |                                                                                                                                                                                                               | $                          | 76,585 |       |        | $ | 74,885 |      
|                                                               |                                                                                                                                                                                                               |                            |        |       |        |   |        |      

Condensed Statement of Income

(In thousands)


|                                             |  |                          |       |      |  |      |       |  |  |   |       | 
|-------------------------------------------- |  | ------------------------ | ----- | ---- |  | ---- | ----- |  |  | - | ----- | 
|                                             |  |                         
|                                             |  | Years Ended December 31,
|                                             |  |                         
|                                             |  | 2003                     |       | 2002 |  | 2001
|                                             |  |                          |       |      |  |     
|Equity in undistributed income of subsidiary |  | $                        | 3,708 |      |  | $    | 8,789 |  |  | $ | 7,577 | 
|                                             |  |                          |       |      |  |      |       |  |  |   |       | 
|Net income                                   |  | $                        | 3,708 |      |  | $    | 8,789 |  |  | $ | 7,577 | 
|                                             |  |                          |       |      |  |      |       |  |  |   |       | 

79



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##### Table of Contents



METROCORP BANCSHARES, INC.


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)

Condensed Statement of Cash Flows

(In thousands)


|                                               |                                              |                                           |       |        |       |      |       |        |        |   |       |        |        |  
|---------------------------------------------- | -------------------------------------------- | ----------------------------------------- | ----- | ------ | ----- | ---- | ----- | ------ | ------ | - | ----- | ------ | ------ | -
|                                               |                                              |                                          
|                                               |                                              | Years Ended December 31,                 
|                                               |                                              |                                          
|                                               |                                              | 2003                                      |       | 2002   |       | 2001
|                                               |                                              |                                           |       |        |       |     
|Cash flow from operating activities:           |                                              |                                           |       |        |       |      |       |        |        |   |       |       
|                                               | Net income                                   |                                           | $     | 3,708  |       |      | $     | 8,789  |        |   | $     | 7,577  |       
|                                               | Equity in undistributed income of subsidiary |                                           |       | (2,004 | )     |      |       | (7,104 | )      |   |       | (5,898 | )     
|                                               | Decrease in other liabilities                |                                           |       |       |       |      |       | (35    | )      |   |       | (92    | )     
|                                               |                                              |                                           |       |        |       |      |       |        |        |   |       |       
|                                               |                                              | Net cash provided by operating activities |       |        | 1,704 |      |       |        | 1,650  |   |       |        | 1,587  |  
|                                               |                                              |                                           |       |        |       |      |       |        |        |   |       |       
|Cash flow from investment
    activities:      |                                              |                                           |       |        |       |      |       |        |        |   |       |       
|                                               | Investment in subsidiary                     |                                           |       | (12    | )     |      |       |       |        |   |       |       |       
|                                               |                                              |                                           |       |        |       |      |       |        |        |   |       |       
|                                               |                                              | Net cash used in investing activities     |       |        | (12   | )    |       |        |       |   |       |        |       |  
|                                               |                                              |                                           |       |        |       |      |       |        |        |   |       |       
|Cash flow from financing activities:           |                                              |                                           |       |        |       |      |       |        |        |   |       |       
|                                               | Proceeds from issuance of common stock       |                                           |       | 1,186  |       |      |       | 76     |        |   |       | 59     |       
|                                               | Proceeds from re-issuance of treasury stock  |                                           |       | 397    |       |      |       | 425    |        |   |       | 316    |       
|                                               | Payment to repurchase common stock           |                                           |       | (212   | )     |      |       | (349   | )      |   |       |       |       
|                                               | Dividends paid                               |                                           |       | (1,696 | )     |      |       | (1,685 | )      |   |       | (1,679 | )     
|                                               |                                              |                                           |       |        |       |      |       |        |        |   |       |       
|                                               |                                              | Net cash used in financing activities     |       |        | (325  | )    |       |        | (1,533 | ) |       |        | (1,304 | )
|                                               |                                              |                                           |       |        |       |      |       |        |        |   |       |       
|Net increase in cash and cash equivalents      |                                              |                                           | 1,367 |        |       |      | 117   |        |        |   | 283   |       
|Cash and cash equivalents at beginning of year |                                              |                                           | 3,587 |        |       |      | 3,470 |        |        |   | 3,187 |       
|                                               |                                              |                                           |       |        |       |      |       |        |        |   |       |       
|Cash and cash equivalents at end of year       |                                              | $                                         | 4,954 |        |       | $    | 3,587 |        |        | $ | 3,470 |       
|                                               |                                              |                                           |       |        |       |      |       |        |        |   |       |       
|Dividends declared but not paid                |                                              | $                                         | 429   |        |       | $    | 422   |        |        | $ | 421   |       



|    |                           
|--- | --------------------------
|16. | Related Party Transactions

In the ordinary course of business, the Bank
enters into transactions with its and the Companys
officers and directors and their affiliates. It is the
Banks policy that all transactions with these parties are
on the same terms, including interest rates and collateral
requirements on loans, as those prevailing at the same time for
comparable transactions with unrelated parties. At
December 31, 2003 and 2002, certain of these officers and
directors and their affiliated companies were indebted to the
Bank in the aggregate amounts of approximately $2.5 million
and $2.6 million, respectively.

The following is an analysis of activity for the
years ended December 31, 2003 and 2002 for such amounts (in
thousands):

|                        |                        |      |       |        |   |   |       |        |  
|----------------------- | ---------------------- | ---- | ----- | ------ | - | - | ----- | ------ | -
|                        |                        | 2003 |       | 2002  
|                        |                        |      |       |       
|Balance at January 1,   |                        | $    | 2,635 |        |   | $ | 4,846 |       
|                        | New loans and advances |      |       | 1,790  |   |   |       | 1,190  |  
|                        | Repayments             |      |       | (1,893 | ) |   |       | (3,401 | )
|                        |                        |      |       |        |   |   |       |       
|Balance at December 31, |                        | $    | 2,532 |        |   | $ | 2,635 |       
|                        |                        |      |       |        |   |   |       |       

In addition, as of December 31, 2003 and
2002, the Bank held demand and other deposits for related
parties of approximately $4.5 million and
$6.8 million, respectively.

80



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##### Table of Contents



METROCORP BANCSHARES, INC.


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)

New Era Life Insurance Company is the agency used
by the Company for the insurance coverage the Company provides
to employees of the Company and the Bank and their dependents.
The insurance coverage consists of medical, dental, life,
accidental death and dismemberment and long-term disability
insurance. The Companys Chairman is a principal
shareholder in New Era Life Insurance Company. The Company paid
New Era Life Insurance Company $1.4 million and
$1.2 million for such insurance coverage for the years
ended December 31, 2003 and 2002, respectively.

In addition to the insurance transactions, the
Bank has two commercial real estate loan participations with New
Era Life Insurance Company. These loans were originated and are
being serviced by the Bank. Both loans are contractually current
on their payments. The following is an analysis of these loans
as of December 31, 2003 and 2002, respectively (in
thousands):

|                        |                                                                    |      |       |        |   |   |       |        |  
|----------------------- | ------------------------------------------------------------------ | ---- | ----- | ------ | - | - | ----- | ------ | -
|                        |                                                                    | 2003 |       | 2002  
|                        |                                                                    |      |       |       
|Gross balance           |                                                                    | $    | 5,268 |        |   | $ | 7,558 |       
|                        | Less: participation portion sold to New Era Life
    Insurance Co. |      |       | (1,040 | ) |   |       | (2,310 | )
|                        |                                                                    |      |       |        |   |   |       |       
|Net balance outstanding |                                                                    | $    | 4,228 |        |   | $ | 5,248 |       
|                        |                                                                    |      |       |        |   |   |       |       



The loans have interest rates which float with
the prime rate and mature in May 2005 and October 2008. The
percent of the participation portions sold to New Era Life
Insurance Company varies from 8.29% to 50.00%.

Guamnitz, Inc. owns the building in which
the Companys corporate headquarters and the Banks
Bellaire branch are located and has entered into lease
agreements for these locations with the Company. A Company
director is Chairman of the Board and the controlling
shareholder of Gaumnitz, Inc. The lease covering the
Companys headquarters commenced on February 1, 2001
at a net rent of $34,787 per month. The lease covering the
Banks Bellaire branch commenced on January 1, 2003 at
a net rent of $10,853 per month. For these respective lease
agreements, the Company paid Gaumnitz, Inc. $511,000 and
$441,000 during the years ended December 31, 2003 and 2002,
respectively.



|    |                   
|--- | ------------------
|17. | Earnings Per Share

The following data show the amounts used in
computing earnings per share (EPS) and the weighted average
number of shares of dilutive potential common stock (in
thousands):

|                                                                                       |                                         |                          |       |      |  |      |       |      |  |   |       |      | 
|-------------------------------------------------------------------------------------- | --------------------------------------- | ------------------------ | ----- | ---- |  | ---- | ----- | ---- |  | - | ----- | ---- | 
|                                                                                       |                                         |                         
|                                                                                       |                                         | Years Ended December 31,
|                                                                                       |                                         |                         
|                                                                                       |                                         | 2003                     |       | 2002 |  | 2001
|                                                                                       |                                         |                          |       |      |  |     
|Net income                                                                             |                                         | $                        | 3,708 |      |  | $    | 8,789 |      |  | $ | 7,577 |     
|                                                                                       |                                         |                          |       |      |  |      |       |      |  |   |       |     
|Weighted average common shares in basic EPS                                            |                                         |                          | 7,089 |      |  |      | 7,024 |      |  |   | 6,998 |     
|                                                                                       | Effects of dilutive securities: Options |                          |       | 124  |  |      |       | 130  |  |   |       | 61   | 
|                                                                                       |                                         |                          |       |      |  |      |       |      |  |   |       |     
|Weighted average common and potentially dilutive
    common shares used in diluted EPS |                                         |                          | 7,213 |      |  |      | 7,154 |      |  |   | 7,059 |     
|                                                                                       |                                         |                          |       |      |  |      |       |      |  |   |       |     
|Earnings per common share:                                                             |                                         |                          |       |      |  |      |       |      |  |   |       |     
|                                                                                       | Basic                                   |                          | $     | 0.52 |  |      | $     | 1.25 |  |   | $     | 1.08 | 
|                                                                                       | Diluted                                 |                          | $     | 0.51 |  |      | $     | 1.23 |  |   | $     | 1.07 | 

81



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##### Table of Contents



METROCORP BANCSHARES, INC.


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)



|    |                                                     
|--- | ----------------------------------------------------
|18. | Supplemental Statement of Cash Flow
    Information:

|                                            |                                                                   |                          |   |        |  |      |   |        |  |  |   |        | 
|------------------------------------------- | ----------------------------------------------------------------- | ------------------------ | - | ------ |  | ---- | - | ------ |  |  | - | ------ | 
|                                            |                                                                   |                         
|                                            |                                                                   | Years Ended December 31,
|                                            |                                                                   |                         
|                                            |                                                                   | 2003                     |   | 2002   |  | 2001
|                                            |                                                                   |                          |   |        |  |     
|                                            |                                                                   |                         
|                                            |                                                                   | (In thousands)          
|Cash payments during the year for:          |                                                                   |                          |   |        |  |      |   |        |  |  |   |       
|                                            | Interest                                                          |                          | $ | 12,284 |  |      | $ | 14,774 |  |  | $ | 24,752 | 
|                                            | Income taxes                                                      |                          |   | 2,000  |  |      |   | 4,510  |  |  |   | 4,337  | 
|Noncash investing and financing activities: |                                                                   |                          |   |        |  |      |   |        |  |  |   |       
|                                            | Dividends declared not paid                                       |                          |   | 429    |  |      |   | 422    |  |  |   | 421    | 
|                                            | Foreclosed assets acquired                                        |                          |   | 4,583  |  |      |   | 1,464  |  |  |   | 1,461  | 
|                                            | Loans to facilitate the sale of foreclosed assets                 |                          |   | 300    |  |      |   | 325    |  |  |   | 106    | 
|                                            | Transfer of held-to-maturity securities to
    available-for-sale |                          |   |       |  |      |   |       |  |  |   | 31,743 | 



|    |              
|--- | -------------
|19. | Stock Options

The Company has outstanding options issued to
five of the six founding directors of the Bank to purchase an
aggregate of 100,000 shares of Common Stock pursuant to the
1998 Director Stock Option Agreement (Found Director
Plan). Pursuant to the Founding Director Plan, each of the
five participants was granted non-qualified options to purchase
20,000 shares of Common Stock at a price of $11.00 per
share. A total of 20,000 options which were initially granted to
one of the founding directors were cancelled upon his
resignation as a director. Of the six founding directors of the
Bank, the five participants (Tommy F. Chen, May P. Chu, John
Lee, David Tai, and Don J. Wang) currently serve as directors of
the Company and the Bank. The options expired on July 24,
2003 and the participants exercised their options prior to
expiration.

The Companys 1998 Stock Incentive Plan
(Incentive Plan) authorizes the issuance of up to
700,000 shares of Common Stock under both
non-qualified and incentive stock
options and performance shares of Common Stock. Non-qualified
options and incentive stock options will be granted at no less
than the fair market value of the Common Stock and must be
exercised within ten years. Performance shares are certificates
representing the right to acquire shares of Common Stock upon
the satisfaction of performance goals established by the
Company. Holders of performance shares have all of the voting,
dividend and other rights of shareholders of the Company,
subject to the terms of the award agreement relating to such
shares. If the performance goals are achieved, the performance
shares will vest and may be exchanged for shares of Common
Stock. If the performance goals are not achieved, the
performance shares may be forfeited. In 2003, there were options
granted to acquire 22,500 shares of common stock. As of
December 31, 2003, there are options to acquire
212,000 shares of common stock outstanding under the
Incentive Plan. No performance shares have been awarded under
the Incentive Plan.

The options granted during 2001 and 2003 under
the Incentive Plan vest 30% in each of the two years following
the date of the grant and 40% in the third year following the
date of the grant and have contractual terms of seven years. The
options granted in 2002 under the Incentive Plan vest at
20% per year. All options are granted at a fixed exercise
price. The exercise price for the options granted under the
Incentive Plan is the fair market value of the Companys
common stock on the grant date, which was $7.25 for the options
granted in 2001, and a weighted average of $11.30 for the
options granted in 2002 and a weighted average of $13.05 for the
options granted in 2003. Any excess of the fair market value on
the grant date over the exercise price is recognized as
compensation expense in the accompanying financial statements.
There was no compensation expense under any of the plans for the
years ended December 31, 2003, 2002 or 2001.

82



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##### Table of Contents



METROCORP BANCSHARES, INC.


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)

A summary of the status of the Companys
stock options granted to employees as of December 31, 2003,
2002 and 2001 and the changes during the years ended on these
dates is presented below:

|                                                   |  |             |          |          |  |             |       |          |  |             |         |          |  |   |       |  |  |   |         |   |  |   |       | 
|-------------------------------------------------- |  | ----------- | -------- | -------- |  | ----------- | ----- | -------- |  | ----------- | ------- | -------- |  | - | ----- |  |  | - | ------- | - |  | - | ----- | 
|                                                   |  |             |          |          |  |            
|                                                   |  | 2003        |          | 2002     |  | 2001       
|                                                   |  |             |          |          |  |            
|                                                   |  |             |          | Weighted |  |             |       | Weighted |  |             |         | Weighted
|                                                   |  | # Shares of |          | Average  |  | # Shares of |       | Average  |  | # Shares of |         | Average 
|                                                   |  | Underlying  |          | Exercise |  | Underlying  |       | Exercise |  | Underlying  |         | Exercise
|                                                   |  | Options     |          | Prices   |  | Options     |       | Prices   |  | Options     |         | Prices  
|                                                   |  |             |          |          |  |             |       |          |  |             |         |         
|Outstanding at beginning of the year               |  |             | 300,200  |          |  | $           | 10.81 |          |  |             | 300,000 |          |  | $ | 10.78 |  |  |   | 150,700 |   |  | $ | 10.03 | 
|Granted                                            |  |             | 22,500   |          |  |             | 13.07 |          |  |             | 1,100   |          |  |   | 13.05 |  |  |   | 163,900 |   |  |   | 11.30 | 
|Exercised                                          |  |             | (110,700 | )        |  |             | 10.71 |          |  |             | (900    | )        |  |   | 8.31  |  |  |   | (2,760  | ) |  |   | 8.31  | 
|Canceled                                           |  |             |         |          |  |             |      |          |  |             |        |          |  |   |      |  |  |   | (11,840 | ) |  |   | 8.31  | 
|                                                   |  |             |          |          |  |             |       |          |  |             |         |          |  |   |       |  |  |   |         |   |  |   |       | 
|Outstanding at end of the year                     |  |             | 212,000  |          |  | $           | 11.10 |          |  |             | 300,200 |          |  | $ | 10.81 |  |  |   | 300,000 |   |  | $ | 10.78 | 
|                                                   |  |             |          |          |  |             |       |          |  |             |         |          |  |   |       |  |  |   |         |   |  |   |       | 
|Exercisable at end of the year                     |  |             | 92,500   |          |  | $           | 10.40 |          |  |             | 165,200 |          |  | $ | 10.51 |  |  |   | 131,400 |   |  | $ | 10.33 | 
|                                                   |  |             |          |          |  |             |       |          |  |             |         |          |  |   |       |  |  |   |         |   |  |   |       | 
|Weighted average fair value of all options granted |  | $           | 2.56     |          |  |             |       |          |  | $           | 2.53    |          |  |   |       |  |  | $ | 4.65    |   |  |   |       | 



The fair value of each stock option granted is
estimated on the date of grant using the Black-Scholes
option-pricing model with the following weighted-average
assumptions:

|                        |  |      |         |      |  |      |         |   |  |   |         |  
|----------------------- |  | ---- | ------- | ---- |  | ---- | ------- | - |  | - | ------- | -
|Assumptions             |  | 2003 |         | 2002 |  | 2001
|                        |  |      |         |      |  |     
|Expected term           |  |      | 3 years |      |  |      | 3 years |   |  |   | 5 years |  
|Expected volatility     |  |      | 19.00   | %    |  |      | 20.00   | % |  |   | 30.00   | %
|Expected dividend       |  | $    | 0.24    |      |  | $    | 0.24    |   |  | $ | 0.24    |  
|Risk-free interest rate |  |      | 2.28    | %    |  |      | 1.99    | % |  |   | 5.30    | %



The following table summarizes information about
stock options outstanding at December 31, 2003:

|                         |  |                     |         |                     |  |                  |         |             |  |                |            |  |  |  |        |  |  |   |         | 
|------------------------ |  | ------------------- | ------- | ------------------- |  | ---------------- | ------- | ----------- |  | -------------- | ---------- |  |  |  | ------ |  |  | - | ------- | 
|                         |  |                     |         |                    
|                         |  | Options Outstanding |         | Options Exercisable
|                         |  |                     |         |                    
|                         |  | Number              |         | Weighted            |  | Wgtd. Avg.       |         | Number      |  | Weighted      
|                         |  | Outstanding         |         | Average             |  | Remaining        |         | Outstanding |  | Average       
|Range of Exercise Prices |  | at 12/31/03         |         | Exercise Price      |  | Contractual Life |         | at 12/31/03 |  | Exercise Price
|                         |  |                     |         |                     |  |                  |         |             |  |               
|$7.25-$8.31              |  |                     | 24,500  |                     |  | $                | 8.0089  |             |  |                | 2.71 years |  |  |  | 24,500 |  |  | $ | 8.0089  | 
|$10.50-$13.10            |  |                     | 187,500 |                     |  | $                | 11.5037 |             |  |                | 7.66 years |  |  |  | 68,000 |  |  | $ | 11.2674 | 

83



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##### Table of Contents



EXHIBIT INDEX

|        |    |             |  |                                                                                                                                                                                                                                                 
|------- | -- | ----------- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |    |            
|Number  |    | Description
|        |    |            
|        | 3  | .1          |  | Amended and Restated Articles of Incorporation of
    the Company (incorporated herein by reference to
    Exhibit 3.1 to the Companys Registration Statement on
    Form S-1 (Registration No. 333-62667) (the
    Registration Statement)).
|        | 3  | .2          |  | Amended and Restated Bylaws of the Company
    (incorporated herein by reference to Exhibit 3.2 to the
    Registration Statement).                                                                                                             
|        | 4  |             |  | Specimen form of certificate evidencing the
    Common Stock (incorporated herein by reference to Exhibit 4
    to the Registration Statement).                                                                                                 
|        | 10 | .1          |  | Agreement and Plan of Reorganization by and among
    MetroCorp Bancshares, Inc., MC Bancshares of
    Delaware, Inc. and MetroBank, N.A. (incorporated herein by
    reference to Exhibit 10.1 to the Registration Statement).                 
|        | 10 | .2         |  | Form of Director Stock Option Agreement
    (incorporated herein by reference to Exhibit 10.2 to the
    Registration Statement).                                                                                                               
|        | 10 | .3         |  | MetroCorp Bancshares, Inc. Non-Employee
    Director Stock Bonus Plan (incorporated herein by reference to
    Exhibit 10.3 to the Registration Statement).                                                                                     
|        | 10 | .4          |  | MetroCorp Bancshares, Inc. 1998 Employee
    Stock Purchase Plan (incorporated herein by reference to
    Exhibit 10.4 to the Registration Statement).                                                                                          
|        | 10 | .5         |  | MetroCorp Bancshares, Inc. 1998 Stock
    Incentive Plan (incorporated herein by reference to
    Exhibit 10.5 to the Registration Statement).                                                                                                  
|        | 10 | .6         |  | First Amendment to the MetroCorp
    Bancshares, Inc. 1998 Employee Stock Purchase Plan
    (incorporated herein by reference to Exhibit 10.6 to the
    Companys Annual Report on Form 10-K for the year
    ended December 31, 1998).        
|        | 10 | .7         |  | First Amendment to the MetroCorp
    Bancshares, Inc. Non-Employee Director Stock Bonus Plan
    (incorporated herein by reference to Exhibit 4.5 to the
    Companys Registration Statement on Form S-8
    (Registration Number 333-94327)). 
|        | 10 | .8         |  | Second Amendment to the MetroCorp
    Bancshares, Inc. Non-Employee Director Stock Bonus Plan
    (incorporated herein by reference to Exhibit 4.6 to the
    Companys Registration Statement on Form S-8
    (Registration Number 333-94327)).
|        | 10 | .9         |  | Employment Agreement between MetroCorp
    Bancshares, Inc. and Allen D. Brown (incorporated herein by
    reference to Exhibit 10.9 to the Companys Annual
    Report on Form 10-K for the year ended December 31,
    2003).                 
|        | 21 |             |  | Subsidiaries of MetroCorp Bancshares, Inc.
    (incorporated herein by reference to Exhibit 21 to the
    Registration Statement).                                                                                                              
|        | 23 | .1*         |  | Consent of PricewaterhouseCoopers LLP.                                                                                                                                                                                                          
|        | 23 | .2*         |  | Consent of Deloitte & Touche LLP                                                                                                                                                                                                                
|        | 31 | .1*         |  | Certification of the President pursuant to
    Rule 13a-14(a) of the Securities Exchange Act of 1934, as
    amended.                                                                                                                           
|        | 31 | .2*         |  | Certification of the Chief Financial Officer
    pursuant to Rule 13a-14(a) of the Securities Exchange Act
    of 1934, as amended.                                                                                                             
|        | 32 | .1*         |  | Certification of President pursuant to 18 U.S.C.
    Section 1350, as adopted pursuant to Section 906 of
    the Sarbanes-Oxley Act of 2002.                                                                                                    
|        | 32 | .2*         |  | Certification of Chief Financial Officer pursuant
    to 18 U.S.C. Section 1350, as adopted pursuant to
    Section 906 of the Sarbanes Oxley Act of 2002.                                                                                      

---

|* | Filed herewith.
|- | ---------------

| | Management contract or compensatory plan or
    arrangement.
|- | ------------------------------------------------------------