FORM 10-KSB

                       SECURITIES AND EXCHANGE COMMISSION
                             Washington, D.C. 20549


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

                   For the fiscal year ended December 31, 2001
                                       OR

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

                        Commission file number 000-24675

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


            TENNESSEE                                    62-1607709
(State or other jurisdiction                (I.R.S. Employer Identification No.)
of incorporation or organization)


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

                    Issuer's telephone number (423) 926-3300


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

     Check  whether  the issuer (1) filed all  reports  required  to be filed by
Section 13 or 15(d) of the  Exchange  Act during the past 12 months (or for such
shorter period that the  registrant was required to file such reports),  and (2)
has been subject to such filing requirements for the past 90 days. Yes X No____

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

     The  registrant's  revenues for the twelve  months ended  December 31, 2001
were $16,427,596.

     The  aggregate  market  value  of  the  shares  of  Common  Stock  held  by
nonaffiliates  of the  registrant  as of March 15, 2002 is  approximately  $17.5
million.  (For purposes of this  calculation  only,  all executive  officers and
directors are classified as affiliates.)

Indicate the number of shares outstanding of each of the registrant's classes of
common stock, as of the latest practicable date.  Outstanding at March 15, 2002,
Common Stock, $1.00 par value, 1,465,512 shares.

Documents  Incorporated  by Reference:  Proxy  Statement  related to 2002 Annual
Meeting of Shareholders.



                                      -1-
<PAGE>



                                     PART I

Item 1.    Description of Business

The Company

     State of Franklin Bancshares, Inc. (State of Franklin) is a registered bank
holding  company  organized  under the laws of Tennessee  and  headquartered  in
Johnson City, Tennessee.  State of Franklin Savings Bank (The Savings Bank) is a
wholly owned  subsidiary  through  which we conduct our banking  operations.  On
December 31,  2001,  we had  consolidated  total  assets of  approximately  $258
million.  State of Franklin Leasing  Corporation is a wholly owned subsidiary of
State of Franklin which engages in equipment lease  financing.  The Savings Bank
offers  title  services  through its wholly owned  subsidiary  John Sevier Title
Services,  Inc.  In  early  2002,  State  of  Franklin  Real  Estate,  Inc.  was
incorporated as a subsidiary of the Savings Bank for the purpose of selling real
estate.

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

The Savings Bank

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

Services

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

Markets

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

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

                                      -2-
<PAGE>


Net Interest Income

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

<TABLE>
<CAPTION>

                                                             2001                               2000
                                                --------------------------------------------------------------------
(Fully taxable equivalent)                                  Interest      Average               Interest     Average
(Dollars in thousands)                          Average      Income/      Yields/    Average     Income/     Yields/
                                                Balance      Expense       Rate      Balance     Expense      Rate
                                                -------      -------       ----      -------     -------      ----
Assets:

Interest-earning assets:
<S>                                             <C>            <C>          <C>     <C>          <C>          <C>
Loans net of unearned income................    $140,343       $11,466      8.17%   $127,088     $10,951      8.62%
Investment Securities.......................      61,282         4,409      7.19%     40,255       2,795      6.94%
Other earning assets .......................       2,150           143      6.65%      1,509         110      7.29%
Federal funds sold..........................       8,286           262      3.16%        888          54      6.14%
                                                   -----           ---                   ---          --
    Total interest-earning assets/interest
  income....................................     212,061        16,280      7.68%    169,740      13,910      8.20%
                                                 -------        ------      ----     -------      ------      ----
Cash and due from banks.....................       3,038                               2,512
Other assets................................       6,993                               6,198
Allowance for loan losses...................      (1,245)                               (895)
                                                  ------                                ----
    Total...................................    $220,847                            $177,555
                                                ========                            ========

Liabilities and stockholders' equity:

Interest-bearing liabilities:

Interest-bearing checking deposits..........     $ 7,580        $  153      2.02%    $ 6,460      $  132      2.04%
Savings.....................................      24,643           934      3.79%     23,185       1,105      4.84%
Money Market................................      47,453         1,982      4.18%     22,496       1,159      5.15%
Time certificates...........................      86,156         4,885      5.67%     83,091       5,054      6.08%
Borrowed funds..............................      26,988         1,379      5.11%     18,428       1,160      6.30%
Subordinated Debentures                              307            17      5.54%         --          --        --
                                                 -------         -----               -------       -----
    Total interest-bearing
    liabilities/interest expense............     193,127         9,350      4.84%    153,660       8,610      5.60%
                                                 -------         -----      ----     -------       -----      ----
Non-interest bearing demand  deposits.......       9,074                               7,091
Other liabilities...........................         825                               1,043
Stockholders' equity........................      17,821                              15,761
                                                  ------                              ------
    Total...................................    $220,847                            $177,555
                                                ========                            ========
Net interest earnings.......................                    $6,930                            $5,300
                                                                ======                            ======
Net interest on interest-earning assets.....                                3.27%                             3.12%

Return on average assets....................                                0.89%                             0.78%
Return on average equity....................                               10.98%                             8.75%
Cash dividends declared.....................                                  --                                --
Dividend payout ratio.......................                                  --                                --
</TABLE>

                                      -3-
<PAGE>
     The  following  table  summarizes  changes  in  interest  income,  interest
expense, and the interest rate differential aggregated by the changes in volumes
and rates:
<TABLE>
<CAPTION>

                                                              December 31, 2001               December 31, 2000
                                                                   Versus                          Versus
                                                              December 31, 2000               December 31, 1999
                                                             Increase (Decrease)             Increase (Decrease)
                                                             Change Due to: (1)              Change Due to: (1)
                                                             ------------------              ------------------
    (Dollars in thousands)                                 Volume      Rate     Total      Volume     Rate      Total
                                                           ------      ----     -----      ------     ----      -----
<S>                                                         <C>       <C>         <C>      <C>         <C>      <C>
    Increase (decrease) in: (2)
    Loans, net of unearned income....................       $1,083    ($568)      $515     $2,358      $373     $2,731
    U.S. Treasury and other U.S. government agency
    securities.......................................        1,513      101      1,614        794       114        908
    Other earning assets ............................           43      (10)        33         (9)       18          9
    Federal funds sold...............................          234      (26)       208       (232)       63       (169)
                                                            ------    -----      -----     ------      ----      -----
             Total interest income...................        2,872     (502)     2,370      2,911       568      3,479
                                                             -----     ----      -----      -----       ---      -----


    Increase (decrease) in: (2)
    Interest-bearing checking deposits...............           23       (2)        21         23        (2)        21
    Savings deposits.................................           55     (226)      (171)      (833)      (34)      (867)
    Money Market.....................................        1,042     (219)       823        441        87        528
    Time certificates................................          174     (343)      (169)     1,832       272      2,104
    Borrowed funds...................................          437     (218)       219         --        --         --
    Subordinated Debentures..........................           17       --         17        572        82        654
                                                            ------    -----       ----     ------      ----     ------
             Total interest expense..................        1,748   (1,008)       740      2,035       405      2,440
                                                            ------   ------       ----     ------      ----     ------
    Increase (decrease) in net interest income.......                         $  1,630                        $  1,039
                                                                              ========                        ========
</TABLE>


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

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

                                      -4-
<PAGE>

Liability and Asset Management

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

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

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

     The  following  table is an interest  sensitivity  profile for the State of
Franklin  Bancshares  as of December 31, 2001 and 2000.  The table  represents a
static point in time and does not  consider  other  variables,  such as changing
spread  relationships  or  interest  rate  levels.  "Net  repricing  gap" is the
difference between total earning assets and total  interest-bearing  liabilities
repricing  in any  given  period  and  "cumulative  gap"  is the  sum of the net
repricing gap from period to period.  Interest-bearing demand, savings and money
market  account  deposits are  presented  as  repricing  in the earliest  period
presented.

                                      -5-
<PAGE>

<TABLE>
<CAPTION>

                                                                             December 31, 2001
                                                ------------------------------------------------------------------
                                                             After 3 months    After 12
                                                   Within        within        months         After
                                                  3 months     12 months   within 5 years    5 years         Total
                                                  --------     ---------   --------------    -------         -----
<S>                                                <C>            <C>           <C>          <C>          <C>
       (Dollars in thousands)
       Earning assets:
       Loans.........................              $33,755        $11,572       $39,219      $57,093      $141,639
       Investment securities:
            Available for sale.......                  794                       17,531       45,456        63,780
            Held to maturity.........                                             1,963        7,714         9,677
       Federal funds sold............               28,590                                                  28,590
       Interest-bearing deposits.....                   58                                                      58
       Federal Home Loan Bank stock..                2,161                                                   2,161
                                                     -----                                                   -----
                Total earning assets.              $65,358       $ 11,572       $58,713     $110,263      $245,905
                                                   =======       ========       =======     ========      ========
       Interest-bearing liabilities:
       Interest-bearing deposits.....             $157,056        $20,658        $3,890         $317      $181,921
       Long-term debt................                                                         30,241        30,241
       Subordinated debentures.......                8,000                                                   8,000
                                                     -----                                                   -----
       Total interest-bearing liabilities         $165,056        $20,658        $3,890     $ 30,558      $220,162
                                                  ========        =======        ======     ========      ========
       Net repricing gap.............            $(99,698)        $(9,086)      $54,823      $79,705       $25,744

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




                                                                             December 31, 2000
                                                ------------------------------------------------------------------
                                                             After 3 months    After 12
                                                   Within        within        months         After
                                                  3 months     12 months   within 5 years    5 years         Total
                                                  --------     ---------   --------------    -------         -----
       (Dollars in thousands)
       Earning assets:
       Loans.........................              $34,017         $6,233       $60,426      $35,744      $136,420
       Investment securities:
            Available for sale.......                3,071                        8,508       27,136        38,715
            Held to maturity.........                                             2,000       11,989        13,989
       Federal funds sold............                2,525                                                   2,525
       Interest-bearing deposits.....                  227                                                     227
       Federal Home Loan Bank stock..                1,525                                                   1,525
                                                     -----                                                   -----
                Total earning assets.              $41,365       $  6,233       $70,934      $74,869      $193,401
                                                   =======       ========       =======      =======      ========
       Interest-bearing liabilities:
       Interest-bearing deposits.....              $80,349        $55,227       $17,002                   $152,578
       Short-term debt...............               12,660                                                  12,660
       Long-term debt................                                                         11,819        11,819
                                                                                              ------        ------
       Total interest-bearing liabilities          $93,009        $55,227       $17,002    $  11,819      $177,057
                                                   =======        =======       =======    =========      ========
       Net repricing gap.............             $(51,644)      $(48,994)      $53,932      $63,050       $16,344

       Rate sensitivity gap:
       Net repricing gap as a percentage
          of total earning assets....               (26.84)%       (25.46)%       28.03%       32.77%         8.49%
       Cumulative gap................             $(51,644)     $(100,638)     $(46,706)     $16,344       $16,344
       Cumulative gap as a percentage of
          total earning assets.......               (26.84)%       (52.30)%      (24.27)%       8.49%         8.49%
</TABLE>

                                      -6-
<PAGE>



     Management has made the following assumptions in the above analysis:

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

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

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

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


Deposits

     We offer a full range of depositor  accounts and services to both consumers
and  businesses.  None of these deposits were brokered.  Our primary  sources of
funds are interest-bearing  deposits. The following table sets forth our deposit
structure at December 31, 2001 and 2000 (in thousands).
<TABLE>
<CAPTION>

                                                                                  2001            2000
                                                                                  ----            ----
     Non interest-bearing deposits:
<S>                                                                            <C>               <C>
     Individuals, partnerships and corporations........................        $17,027           $7,810
     Certified and official checks.....................................          1,189            1,694
                                                                                 -----            -----
       Total non interest-bearing deposits.............................         18,216            9,504

     Interest-bearing deposits:
     Interest-bearing demand accounts..................................         54,533           38,489
     Savings accounts..................................................         41,603           16,657
     Certificates of deposit, less than $100,000.......................         63,547           73,952
     Certificates of deposit, greater than $100,000....................         22,238           23,480
                                                                                ------           ------
       Total interest-bearing deposits.................................        181,921          152,578
                                                                               -------          -------
       Total deposits..................................................       $200,137         $162,082
                                                                               =======          =======
</TABLE>

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

                                                                                     December 31,
                                                                ----------------------------------------------------
                                                                         2001                          2000
                                                                --------------------            --------------------
     (Dollars in thousands)
<S>                                                             <C>           <C>               <C>           <C>
     Non interest-bearing deposits.....................         0.00%         $9,074            0.00%         $7,091
     Savings deposits..................................         3.79%         24,643            4.77%         23,185
     Money market deposits ............................         4.18%         47,453            5.15%         22,496
     Time deposits.....................................         5.67%         86,156            6.08%         83,091
     Interest-bearing demand deposits..................         2.02%          7,580            2.04%          6,460
                                                                            --------                        --------
              Total deposits...........................                     $174,906                        $142,323
                                                                            ========                        ========
</TABLE>


     At  December  31,  2001 and  2000,  time  deposits  greater  than  $100,000
aggregated  approximately  $22.2 million and $23.5  million,  respectively.  The
following table  indicates,  as of December 31, 2001 and 2000, the dollar amount
of  deposits  of  $100,000  or more by the time  remaining  until  maturity  (in
thousands):


                                      -7-
<PAGE>

<TABLE>
<CAPTION>
                                            2001                                           2000
                                            ----                                           ----
                                                   1 Year                                           1 Year
                          3 Months     3 to 12    through                 3 Months      3 to 12    through
                           or less      Months    5 years       Total      or less       Months    5 years      Total
                           -------      ------    -------       -----      -------       ------    -------      -----
<S>                         <C>        <C>         <C>        <C>           <C>         <C>         <C>       <C>
     Time certificates      $4,128     $15,589     $2,521     $22,238       $6,851      $12,140     $4,489    $23,480
</TABLE>



Assets


     Our  management  considers  many  criteria  in managing  assets,  including
creditworthiness,  diversification and structural characteristics,  maturity and
interest rate sensitivity.  The following table sets forth our earning assets by
category at December 31, 2001 and 2000.

      (In Thousands)                                    2001          2000
                                                      --------      --------
      Investment securities:
        Available for sale...................         $ 63,780      $ 38,715
        Held to maturity.....................            9,677        13,989
      Short-term interest-bearing deposits...               58           227
      Federal funds sold.....................           28,590         2,525
      Federal Home Loan Bank stock...........            2,162         1,525
      Loans:
        Real estate..........................           95,708        86,675
        Commercial and other.................           46,072        49,866
                                                        ------        ------
          Total loans........................          141,780       136,541
         Less unearned income................              141           121
                                                       -------       -------
        Loans, net of unearned income........          141,639       136,420
                                                       -------       -------
      Total earning assets ..................         $245,906      $193,401
                                                       =======       =======


Investment Portfolio

     For a  description  of  the  composition  of  the  carrying  value  of  our
investment  portfolio  at  December  31,  2001  and  2000,  see  Note  10 to the
Consolidated Financial Statements attached hereto.

     The following  table  presents the maturity  distribution  of the amortized
cost and estimated market value of our investment portfolio at December 31, 2001
and 2000. The weighted  average tax equivalent  yields on these  instruments are
presented based on final maturity.

<TABLE>
<CAPTION>

                                                              2001                                    2000
                                                              ----                                    ----
                                                Amortized    Estimated     Weighted    Amortized    Estimated     Weighted
                                                   Cost    Market Value  Average Yield    Cost    Market Value  Average Yield
                                                    ----   ------------  -------------    ----    ------------  -------------
     (Dollars in thousands)
      Held to maturity:
      ----------------
<S>                                               <C>           <C>          <C>      <C>           <C>            <C>
      Obligations of U.S. Government
      agencies:
        Due after 1 year but within 5 years        $  --         $  --            --     $1,999       $ 1,988         6.31%

        Due after 5 years but within 10              834           833          6.38%    11,990        11,805         6.57%
      years................................
        Due after 10 years but within 15           4,491         4,451          6.54%        --            --           --
      years................................

      U.S. Agency Collateralized Mortgage
      Obligations :
        Due after 1 year but within 5 years       $1,963        $1,963          6.52%     $  --         $  --           --
        Due after 5 years but within 10
      years................................        2,389         2,389          5.59%        --            --           --
                                                --------      --------                  -------      --------
           Total held to maturity..........     $  9,677      $  9,636         6.29%    $13,989      $ 13,793         6.53%
                                                ========      ========                  =======      ========
      Available for sale:
      ------------------

      Obligations of U.S. Government
      agencies:

        Due after 1 year but within 5 years        $  --         $  --            --      $ 998         $ 991         6.06%
        Due after 5 years but within 10
      years...............................         6,888         7,070          6.71%    18,772        18,654         6.84%
        Due after 10 years but within 15
      years................................        1,230         1,204          6.42%     1,924         1,957         7.38%
        Due after 15 years but within 20
      years................................        3,369         3,428          7.79%     1,764         1,873         6.97%
        Due after 20 years.................        1,084         1,032          7.80%        --            --           --

                                      -8-
<PAGE>

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

      Municipal Securities:

        Due within 1 year ................           120           121          5.98%        --            --           --
        Due after 1 year but within 5 years          530           545          6.22%       510           513         6.46%
        Due after 5 years but within 10
      years...............................         2,109         2,095          5.96%       770           782         6.84%
        Due after 10 years but within 15
      years................................       10,888        10,615          6.40%     2,023         2,032         7.22%
        Due after 15 years but within 20
      years................................        5,090         4,863          7.12%       747           779         8.97%
        Due after 20 years.................        1,508         1,448          7.16%        --            --           --

      Equity Securities (Preferred Stock
         In U S Government Agencies):

        Callable after 1 year but within 5
      years...............................        17,000        16,986          7.23%     7,000         7,052         7.95%
        Callable after 5 year but within 10
      years................................        5,933         5,894          8.03%     1,000         1,010         7.88%

      Other Securities:
        Due within 1 year .................          674           674          3.27%     3,071         3,071         6.09%
        Due after 5 years but within 10
      years..............................          3,000         2,912          7.00%        --            --           --
        Due after 10 year but within 15
      years...............................         2,100         1,990          7.25%        --            --           --
        Due after 20 years.................        2,558         2,613          5.63%        15            15           --
                                                --------      --------                  -------      --------
           Total available for sale........      $64,371       $63,780          6.92%   $38,579       $38,714         7.08%
                                                ========      ========                  =======      ========
</TABLE>


Investment Policy

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


Loan Portfolio

     The following  table sets forth the  composition  of our loan portfolio and
loans held for sale at December 31, 2001 and 2000.
<TABLE>
<CAPTION>

                                                                       2001           2000
                                                                  -------------- --------------
     (In Thousands)
     Real estate loans:
<S>                                                                    <C>               <C>
       Construction and land development........................       $  14,668         $  762
       Secured by residential properties........................          72,903         77,846
       Commercial real estate loans.............................           8,137          7,802
                                                                           -----          -----
          Total real estate loans...............................          95,708         86,410
     Commercial and industrial loans............................          26,780         27,751
     Installment loans..........................................          19,091         21,841
     Other consumer loans.......................................               0            390
     All other loans............................................              60             28
                                                                           -----          -----
         Total loans............................................        $141,639       $136,420
                                                                        ========       ========
</TABLE>


     The following tables set forth the maturities of the loan portfolio and its
sensitivity to interest rate changes at December 31, 2001:

                                      -9-
<PAGE>

<TABLE>
<CAPTION>

                                                      One Year            One Through                Over
     (In Thousands)                                    or Less             Five Years          Five Years          Total
                                                       -------             ----------          ----------          -----
<S>                                                   <C>                       <C>                 <C>          <C>
     Real estate construction loans                   $ 14,668                  $  --               $  --        $14,668
     Commercial and industrial loans....                15,322                  8,837               2,621         26,780

     All other loans....................                15,337                 30,382              54,472        100,191
                                                        ------                 ------              ------        -------
       Total loans......................              $ 45,327                $39,219             $57,093       $141,639
                                                      ========                =======             =======       ========
</TABLE>

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

     Real estate and commercial and industrial  loans maturing after one year as
of December 31, 2001 (in thousands):

       Fixed rate...........................................         $20,640
       Floating rate........................................          48,032

       Other loans maturing after one year:

       Fixed rate...........................................          19,348
       Floating rate........................................           8,292
                                                                       -----
                Total loans maturing after one year.........        $ 96,312
                                                                    ========


Lending Policy

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

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

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

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

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

                                      -10-
<PAGE>

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

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


Loan Review and Nonperforming Assets

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

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

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

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

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

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

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

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

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

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

     At December 31, 2001 the Company had non-accrual loans totaling  $2,840,000
and no restructured  loans.  Loans 90

                                      -11-
<PAGE>

days or more past due totaled  $881,000 for the same period.  We have  increased
the provision for loan losses during 2001 to cover anticipated losses associated
with  non-accrual  and past  due  loans.  The  Company  has no loans to  foreign
borrowers  and  we  are  not  aware  of  any  additional   problems  that  would
significantly  increase  the  amount or number of  problem  loans in the  coming
months.

Credit Risk Management and Reserve for Loan and Lease Losses

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

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

     The reserve for loan and lease losses is increased by provisions charged to
operating  expense.  The reserve is reduced by charging off loans or portions of
loans  at the  time  they are  deemed  by  management  to be  uncollectible  and
increased  when  loans or  leases  previously  charged  off are  recovered.  The
resulting reserve for loan and lease losses is viewed by management as a single,
unallocated  reserve  available  for all loans or  leases.  Rules  and  formulas
relative to the  adequacy  of the  reserve,  although  useful as  guidelines  to
management,  are not rigidly applied.  The reserve for loan and lease losses was
$1,473,855  at year end 2001, or 1.06% of loans and leases  outstanding,  net of
unearned income,  compared to $1,062,511 or 0.78% at year end 2000. During 2001,
net charge-offs  and recoveries  were $179,000.  Management does not foresee any
events that will  significantly  increase loan losses in the coming months.  The
following table presents data related to the Company's  consolidated reserve for
loan and lease losses for the years ended December 31, 2001 and 2000.

<TABLE>
<CAPTION>

                                                                                             2001          2000
                                                                                        ------------- -------------
(Dollars In thousands)
<S>                                                                                            <C>             <C>
Balance at beginning of period.......................................................          $1,063          $810
Charge offs:
  Commercial ........................................................................              30            --
  Real estate mortgage..............................................................              150            40
  Installment loans to individuals...................................................               1            10
                                                                                               ------        ------
Recoveries:
  Commercial ........................................................................               2            --
  Real estate mortgage...............................................................              --            --
  Installment loans to individuals...................................................              --            --
                                                                                               ------        ------
Net charge offs......................................................................             179            50
Additions to reserve charged to operations...........................................             590           303
                                                                                               ------        ------
Balance at end of period.............................................................          $1,474        $1,063
                                                                                               ======        ======

Ratio of net charge offs during the period to average loans and leases outstanding               0.13%         0.04%
during the period....................................................................
Average allowance for loan and lease losses to average total loans and leases........            0.89%         0.70%
</TABLE>

     At December 31, 2001 and 2000,  the allowance for loan and lease losses was
allocated as follows:

                                      -12-
<PAGE>

<TABLE>
<CAPTION>

                                                               2001                                 2000
                                                               ----                                 ----
              (Dollars in thousands)
                                                            Percent of loans in each              Percent of loans in each
                                                    Amount  Category to total loans       Amount  Category to total loans
                                                    ------  -----------------------       ------  -----------------------
<S>                                                   <C>             <C>                   <C>           <C>
     Commercial..............................         $442            30%                   $319          30%
     Real estate mortgage....................          811            55%                    585          55%
     All other ..............................          221            15%                    159          15%
                                                    ------           ---                  ------         ---
        Total................................       $1,474           100%                 $1,063         100%
                                                    ======           ===                  ======         ===
</TABLE>



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

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


<TABLE>
<CAPTION>

     Nonperforming assets (Dollars in thousands):                                           December 31,
                                                                                    --------------------------
                                                                                             2001         2000
                                                                                    -------------  -----------
<S>                                                                                       <C>            <C>
     Non-accrual loans.............................................................       $ 2,840        $ 984
     Restructured loans............................................................            --           --
     Other loans past due 90 days or more to principal or interest payments........           881          194
     Nonperforming loans as a percentage of net loans before allowance for loan
     losses........................................................................          2.04%        0.72%
     Allowance for loan losses as a percentage of nonperforming loans..............            52%         108%
</TABLE>


Capital Resources/Liquidity

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

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

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

                                                     2001              2000
                                              ----------------- ----------------
     Average loans and leases to average
     deposits...............................         80.2%            89.3%


Impact of Inflation and Changing Prices

     The consolidated  financial statements and related  consolidated  financial
data presented  herein have been prepared in accordance with generally  accepted
accounting  principles  which require the measurement of financial  position and
operating results in terms of historical dollars without considering the changes
in the relative  purchasing  power of money over time and due to inflation.  The
impact of inflation on our operations is reflected in increased operating costs.
Unlike most  industrial  companies,  virtually all of our assets and liabilities
are  monetary in nature.  As a result,  interest  rates have a more  significant

                                      -13-
<PAGE>

impact on our  performance  than the  effects  of general  levels of  inflation.
Interest  rates do not  necessarily  move in the same  direction  or in the same
magnitude as the price of goods and services.

Capital Adequacy

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

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

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

Our consolidated capital ratios are set forth below.
<TABLE>
<CAPTION>

                                                                         December 31,       December 31,
                                                                                2001               2000
                                                                                ----               ----
     (Dollars in thousands)
     Capital:
     Tier I capital:
<S>                                                                           <C>               <C>
              Stockholders' common equity.................                    $ 18,739          $ 17,225
              Qualifying interest in subordinated
              debentures .................................                       6,306                --
              Less unrealized (loss) gain in securities ..                        (368)               90
              Less disallowed intangibles.................                        (236)               --
                                                                                ------            ------
                       Total Tier I capital...............                      25,224            17,135

     Tier II capital:
              Qualifying interest in subordinated
              debentures .................................                       1,694             1,063
              Qualifying allowance for loan losses........                       1,474             1,063
                                                                                 -----             -----
                       Total capital......................                      28,392            18,198
     Risk-adjusted assets.................................                     166,708           128,576
     Quarterly average assets.............................                     233,494           194,936

     Ratios:
     Tier I capital to risk-adjusted assets.....................                 15.13%            13.33%
     Tier II capital to risk-adjusted assets....................                   .88%              .83%
     Total capital to risk-adjusted assets......................                 17.03%            14.15%
     Leverage-- Tier I capital to quarterly  average assets
     less  disallowed intangibles...............................                 10.80%             8.79%
</TABLE>


     On December  31, 2001 and 2000,  we exceeded  the  regulatory  minimums and
qualified as a well-capitalized institution under the regulations.

Supervision and Regulation

General

     As a Tennessee-chartered,  federally-insured savings bank, the Savings Bank
is subject to extensive  regulation.  Lending  activities and other  investments
must  comply with  various  statutory  and  regulatory  requirements,  including
prescribed minimum capital standards.  The Savings Bank is regularly examined by
the FDIC and the Tennessee Department of Financial

                                      -14-
<PAGE>

Institutions and files periodic reports  concerning its activities and financial
conditions with its regulators.  The Savings Bank's relationship with depositors
and  borrowers  is also  regulated to a great extent by both federal law and the
laws of the State of  Tennessee,  especially in such matters as the ownership of
accounts and the form and content of mortgage documents.

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

Tennessee Supervision and Regulation

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

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

Federal Regulation

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

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

     At December  31, 2001,  our deposit base for purposes of FDIC  premiums was
$209 million.  We paid FDIC  insurance  premiums of $12,374 in 1999,  $27,840 in
2000, and $30,832 in 2001.

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

                                      -15-
<PAGE>

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

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

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

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

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

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

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

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

     o    internal controls, information systems and internal audit systems;
     o    loan documentation;
     o    credit underwriting;
     o    interest rate risk exposure;
     o    asset growth; and
     o    compensation, fees and benefits.

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

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

     FDIC capital  regulations  require  higher  capital  levels for banks which
exhibit  more than a moderate  degree of risk or exhibit  other  characteristics
which necessitate that higher than minimum levels of capital be maintained.  Any
insured  bank with a Tier 1  capital  to total  assets  ratio of less than 2% is
deemed to be operating in an unsafe and unsound condition pursuant

                                      -16-
<PAGE>

to Section  8(a) of the Federal  Deposit  Insurance  Act unless the insured bank
enters into a written  agreement,  to which the FDIC is a party,  to correct its
capital deficiency.  Insured banks operating with Tier 1 capital levels below 2%
(and  which  have not  entered  into a  written  agreement)  are  subject  to an
insurance removal action. Insured banks operating with lower than the prescribed
minimum  capital  levels  generally  will not receive  approval of  applications
submitted to the FDIC. Also, inadequately capitalized state nonmember banks will
be subject to such administrative action as the FDIC deems necessary.

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

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

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

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

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

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

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

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

     (4)  acquiring or retaining the voting  shares of a depository  institution
          if certain  requirements  are met.  State law also  provides  that the
          Savings  Bank may invest in any  investment  permissible  by federally
          chartered  savings  banks,   subject  to  the  restrictions  for  such
          entities.

     FDIC regulations  implementing  Section 24 of the Federal Deposit Insurance
Act  provide  that  an  insured  state-chartered  bank  may  not,  directly,  or
indirectly  through a subsidiary,  engage as "principal" in any activity that is
not  permissible

                                      -17-
<PAGE>

for a national bank unless the FDIC has determined  that such  activities  would
pose no risk to the  insurance  fund of which it is a member  and the bank is in
compliance  with  applicable  regulatory  capital   requirements.   Any  insured
state-chartered  bank or savings  bank  directly  or  indirectly  engaged in any
activity that is not permitted for a national bank must cease the  impermissible
activity.

     Loans-to-One-Borrower.  The aggregate amount of loans that we are permitted
to make under  applicable  regulations  to any one borrower,  including  related
entities, is the greater of 25% of unimpaired capital with Board approval. Based
on the Savings Bank's capitalization of $17.2 million, our loans-to-one borrower
limit is approximately $4.3 million.

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

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

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

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

Change in Control Restrictions

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

     Other. While not directly  restricting  efforts to acquire control of State
of Franklin,  certain other  characteristics  of our organization may discourage
attempts  to acquire  control  of us. Our  By-Laws  provide  that  approximately
one-third of our

                                      -18-
<PAGE>

Board of Directors are elected each year, thereby making it more difficult for a
potential  acquirer to gain control of State of Franklin by electing the members
of the Board of  Directors  than it would be if  directors  were elected at more
frequent  intervals or if a greater  percentage of directors were elected at any
one time.

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

Regulation of Bank Holding Companies

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

Dividends

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

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

     Tennessee law requires that  dividends be paid only from retained  earnings
(or undivided  profits),  except that dividends may be paid from capital surplus
with the prior,  written  consent of the  Department of Financial  Institutions.
Tennessee laws  regulating  savings banks require  certain  charges  against and
transfers from an  institution's  undivided  profits  account  before  undivided
profits can be made  available  for the  payment of  dividends.  The  Department
generally  prohibits a newly chartered  institution from paying dividends during
its first three years of operation without the Department's prior approval.

Monetary Policy

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

Capital Adequacy

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

                                      -19-
<PAGE>

Recent Legislation

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

     On December 19, 1991,  President Bush signed the Federal Deposit  Insurance
Corporation's  Improvement Act of 1991 ("FDICIA"),  the principal initial effect
of which was to permit the Bank  Insurance  Fund (the "BIF") to borrow up to $30
billion from the U.S. Treasury (to be repaid through deposit insurance  premiums
over 15 years) and to permit the BIF to borrow working  capital from the Federal
Financing Bank in an amount up to 90 percent of the value of the assets the FDIC
has acquired from failed banks, which it is estimated would yield  approximately
$40 billion in working  capital.  The bill followed a year-long effort initiated
by the Bush Administration to enact major banking legislation. Virtually none of
the Administration's  major systemic proposals,  including nationwide interstate
banking and  branching  or ownership of  financial  institutions  by  commercial
entities,  were  included in the final  bill.  However,  a number of  additional
pervasive supervisory measures, some of which are described below, were included
in the FDICIA.  The effect of these measures will be to a great extent dependent
on the manner in which bank regulatory authorities choose to enforce regulations
which have been recently issued pursuant to the FDICIA.

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

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


Employees

     At  December  31,  2000,  we had a total of 54  employees  with 42 of those
employed on a full-time basis.

Item 2.  Description of Property

     We operate at five  locations  with our  principal  office  located at 1907
North Roan Street, Johnson City, Washington County,  Tennessee. The Savings Bank
owns the land and the approximately 36,000 square foot building at our principal
office, 18,000 feet of which is leasable space. This property serves as the main
office of the Savings  Bank.  The Savings Bank also operates  branch  offices at
3300 Browns Mill Road and 612 West Walnut Street,  Johnson City, Tennessee;  and
240 West Center Street,  Kingsport,  Sullivan County,  Tennessee.  An additional
full service branch at 4409 Fort Henry Drive in Kingsport was opened in November
2000.  The  Savings  Bank  owns  the land and the  buildings  in both  Kingsport
locations. The West Walnut branch is also owned by the Savings Bank. The Savings
Bank leases the Browns Mill Road office from Allen and Allen.  Charles E. Allen,
Jr.,  chairman and chief  financial  officer of the Savings Bank, and Charles E.
Allen,  Sr.,  M.D., a director of the Savings Bank,  are principals of Allen and
Allen.  The  lease  was  negotiated  at arm's  length  and was  approved  by the
Tennessee Department of Financial  Institutions and the FDIC. Rent for the 2,625
square  foot  building  for three  years will be $35,190  annually.  This amount
includes taxes, insurance and maintenance costs.

     All facilities have improvements including  drive-through tellers,  vaults,
night depository and certain facilities have safe deposit boxes.

                                      -20-
<PAGE>

Item 3.  Legal Proceedings

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

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

     None.


                                      -21-
<PAGE>


                                     PART II

Item 5.  Market for Common Equity and Related Stockholder Matters

     There is no established  public  trading  market for our Common Stock.  Our
management  is aware that isolated  transactions  in the Common Stock occur from
time to time.  To the best of  management's  knowledge  of  transactions  in the
Common Stock of State of Franklin  Bancshares  during 2001,  prices  ranged from
$15.00 to $16.20 per share.

     There were 1,159  holders of record of the Common  Stock as of December 31,
2001.

     On December 18, 2001,  the Company  issued  debentures to State of Franklin
Statutory Trust I (Trust), a business trust subsidiary of the Company. The Trust
purchased  the  debentures  with the proceeds  from the sale of trust  preferred
securities  issued  by the  Trust in a  private  placement.  We  guaranteed  the
preferred securities.  The proceeds from the sale of the debentures will be used
to support the Company's  current capital  position  allowing for future growth.
For  more  information,  see  notes  1 and  14  to  the  Consolidated  Financial
Statements included elsewhere in this report.

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


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

General

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


FOR THE YEAR ENDED  DECEMBER  31, 2001  COMPARED TO THE YEAR ENDED  DECEMBER 31,
2000

EARNINGS REVIEW

     Total net income of State of Franklin for the year ended  December 31, 2001
was  $1,957,411,  an increase of $577,724 over the year ended  December 31, 2000
total net  income of  $1,379,687.  Earnings  per  share  was $1.36  compared  to
earnings per share of $1.00 in 2000.  Return on average assets was 0.89% and the
return on average equity was 10.98% for the year ended December 31, 2001.

     Operating  results  in  2001  reflected  higher  net  interest  income  and
noninterest  income.  Net  interest  income of $6.3  million  for the year ended
December 31, 2001 was up 21% over the 2000 period.  During 2001,  earning assets
grew 27% while interest bearing liabilities and capital securities grew 28%. The
2001  provision  for  possible  loan  losses was  $589,902.  Noninterest  income
increased $204,631, or 36%, with other fees and service charges and net gains on
loans sold primarily  responsible  for the increase over the year ended December
31, 2000.  Noninterest expense was $3.9 million for the 2001 period, an increase
of 15% over the previous year,  primarily  resulting from increased salaries and
benefits, equipment, occupancy, and data processing expenses associated with the
overall growth of State of Franklin.

Net Interest Income and Margin

     Net interest income increased $1,092,082 or 21% for the year ended December
31, 2001 to $6.3 million  compared to $5.2  million for the year ended  December
31,  2000.  While  growth in  average  loans  slowed to $13.6  million,  or 11%,
primarily due to lower interest rates and refinancing activity moving loans into
the secondary  market,  average  investments  increased  $21.1 million,  or 53%.
Growth  in the  investment  portfolio  came  mainly  from  purchases  of  agency
preferred  stocks with dividends which are 70% tax exempt and tax free municipal
securities.  The taxable  equivalent  yield on earning assets  declined 52 basis
points to 7.68% during 2001.

     Average deposits increased by 23% or $32.6 million to $174.9 million during
2001   compared   to  $142.3   million  in  2000.   The  rate  paid  on  average
interest-bearing  liabilities  decreased 76 basis  points  during the year ended
December 31, 2001 to 4.84%.  Consequently,  the taxable  equivalent net interest
margin based on average earning assets increased 15 basis points to 3.27% during
2001 compared to 3.12% during the prior year ended December 31, 2000.

                                      -22-
<PAGE>

Provision for Loan Losses

     During the year ended  December 31, 2001,  the  provision for possible loan
losses was  $589,902.  There were  $178,558 in net  charge-offs  during the year
ended  December 31, 2001 and $50,402 for the year ended  December 31, 2000.  The
allowance  for possible  loan losses  represented  1.06% of total loans,  net of
mortgage  loans  held-for-sale,  at  December  31,  2001,  compared  to 0.78% at
December 31, 2000.

Provision for Income Taxes

     For the year ended  December 31, 2001,  the  provision for income taxes was
$581,715,  a decline of $76,407 from 2000.  The decline was primarily due to the
increase in tax free  municipal  income and the tax benefit from the increase in
dividends on agency preferred stocks.

Noninterest Income

     State of Franklin's  noninterest  income was $776,208 during the year ended
December  31,  2001,  an increase of  $204,631 or 36% over the  comparable  2000
period.  The  increase was  attributable  to increases in other fees and service
charges,  net gains on loans sold, and insurance  commission  income of $46,155,
$165,001, and $1,737, respectively, which were partially offset by a decrease in
net rental income of $8,262.

Noninterest Expense

     Noninterest expense totaled $3.9 million for the period ending December 31,
2001, an increase of $508,104, or 15%. Noninterest expense to average assets was
1.79% for the period  ending  December  31, 2001  compared to 1.94% for the same
period a year ago.  Compensation and related benefits of $1.8 million  accounted
for 46% of the total noninterest expense compared to $1.6 million or 46% for the
year  ended  December  31,  2000.  Occupancy,   furniture  and  equipment,   and
advertising expenses increased $33,866, $72,097, and $38,684,  respectively, due
mainly to the addition of the Colonial  Heights  Branch and  operational  system
upgrades.  Data processing  expense increased  $61,678,  or 17%, while all other
noninterest expense categories increased $43,122, or 5.2%.


BALANCE SHEET REVIEW

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

Investment Securities

     Investment  securities  totaled  $73.5  million at December 31,  2001.  The
investment  portfolio at year end consisted of $18.1 million in debt  securities
issued by the U. S.  Government  or Federal  Agencies,  $4.6  million in Federal
Agency  collateralized  mortgage  obligations,  $22.9 million in preferred stock
issued by Federal Agencies, $19.7 million in securities issued by state, county,
or municipalities, and $8.2 million in corporate securities.

At December 31, 2001, securities categorized as available-for-sale totaled $63.8
million while the  held-to-maturity  securities totaled $9.7 million compared to
$38.7  million in  available-for-sale  and $14  million in  held-to-maturity  at
December 31, 2000. At December 31, 2001,  the  available-for-sale  portfolio had
gross unrealized  losses of $590,802 while our  held-to-maturity  securities had
$40,510 in unrealized  losses due to changes in market rates.  Due to the credit
quality of these investments, no realized losses are expected.

Loans

     Loans  outstanding  totaled  $141.6  million at  December  31,  2001.  This
represented  an increase of 4% from the December 31, 2000  outstanding  loans of
$136.4  million.  First  mortgage loans were $54.6 million at December 31, 2001,
compared  with $54.7  million at December  31,  2000.  Real estate  construction
lending  totaled  $20.2 million and $24.5 million at December 31, 2001 and 2000,
respectively. Commercial loans increased to $56 million at December 31, 2001, an
increased

                                      -23-
<PAGE>

10% from $50.9  million at December  31,  2000.  Consumer  loans at December 31,
2001,  increased to $12.5  million,  or 25%,  over $10.1 million at December 31,
2000.


Non-Performing Assets

     Nonaccrual  loans  totaled  $2,840,000 at December 31, 2001 and $984,000 at
December 31, 2000.  Loans past due 90 days or more were $881,000 at December 31,
2000 and $194,000 at December  31, 2000.  The  allowance  for possible  loan and
lease  losses was  $1,473,855  and  $1,062,511  at  December  31, 2001 and 2000,
respectively.  Management  believes the  allowance  for possible  loan and lease
losses is adequate to provide for potential loan and lease losses.


Deposits

     Total  deposits at  December  31, 2001 of $200.1  million,  represented  an
increase of $38.1 million or a 23% increase from $162.1  million at December 31,
2000. Non-interest bearing demand deposits totaled $18.2 million at December 31,
2001,  an increase  of $8.7  million or 92% from  December  31,  2000.  Interest
bearing deposits increased $29.3 million to $181.9 million at December 31, 2001.


Capital

     Equity capital at December 31, 2001 was $18.8 million,  an increase of $1.6
million from $17.2 million at December 31, 2000.  Tier 1 capital for the Company
increased  to  $25.2  million  primarily  due to $6.3  million  in  subordinated
debentures.  On December 18, 2001,  the Company  issued  debentures  to State of
Franklin  Statutory Trust I (Trust), a business trust subsidiary of the Company.
The Trust  purchased  the  debentures  with the proceeds  from the sale of trust
preferred  securities issued by the Trust in a private placement.  We guaranteed
the  preferred  securities.  For  more  information,  see  notes 1 and 14 to the
Consolidated Financial Statements included elsewhere in this report. The capital
levels of the  Company  as of  December  31,  2001  include  adjustment  for the
subordinated   debentures  issued  in  December  of  2001,  subject  to  certain
limitations. Federal Reserve guidelines limit the amount of cumulative preferred
securities  which  can be  included  in Tier 1  capital  to 25% of total  Tier 1
capital.  As of December 31, 2001,  approximately  $6.3 million of $8 million of
debentures  were  included as Tier 1 capital of the Company  with the  remaining
$1.7 million included as Tier 2 capital,  component of total risk-based capital.
At  December  31,  2001,  all capital  ratios  were in excess of the  regulatory
minimums,  with State of Franklin's Tier 1, total  risk-based and leverage ratio
of 15.10%, 17.01% and 10.78%, respectively.


Liquidity

     The purpose of liquidity  management  is to ensure that there is sufficient
cash  flow to  satisfy  demands  for  credit,  deposit  withdrawals,  and  other
corporate needs.  Traditional  sources of liquidity include asset maturities and
growth in core  deposits.  Other sources of funds such as securities  sold under
agreements  to  repurchase,   negotiable   certificates  of  deposit  and  other
liabilities   are  sources  of  liquidity   which  State  of  Franklin  has  not
significantly  used.  State of Franklin  had unused  sources of liquidity in the
form of  unused  federal  funds  lines of credit  and a line of  credit  for the
Federal Home Loan Bank of Cincinnati totaling $47 million at December 31, 2000.


Effects of Inflation and Changing Prices

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

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


                                      -24-
<PAGE>



Item 7. Financial Statements

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






                       State of Franklin Bancshares, Inc.
                             JOHNSON CITY, TENNESSEE

                              INDEX TO AUDIT REPORT

                           December 31, 2001 and 2000

Audited Consolidated Financial Statements:

Independent Auditor's Report                                                  26
Consolidated Statements of Financial Condition                                27
Consolidated Statements of Income                                             28
Consolidated Statements of Changes in Stockholders' Equity                    29
Consolidated Statements of Cash Flows                                      30-31
Notes to Consolidated Financial Statements                                 32-48
Statement of Management Responsibility                                        49














                                      -25-
<PAGE>




                         (BAYLOR AND BACKUS LETTER HEAD)






                          INDEPENDENT AUDITOR'S REPORT



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

    We have  audited  the  accompanying  consolidated  statements  of  financial
    condition of State of Franklin  Bancshares,  Inc. (a Tennessee  corporation)
    and  subsidiaries  as of  December  31,  2001  and  2000,  and  the  related
    consolidated  statements of income, changes in stockholders' equity and cash
    flows  for  the  years  ended  December  31,  2001,  2000  and  1999.  These
    consolidated  financial  statements  are  the  responsibility  of  State  of
    Franklin Bancshares,  Inc.'s management. Our responsibility is to express an
    opinion on these consolidated financial statements based on our audits.

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

    In our opinion,  the  consolidated  financial  statements  referred to above
    present fairly, in all material respects, the financial position of State of
    Franklin Bancshares, Inc. and subsidiaries as of December 31, 2001 and 2000,
    and the results of their operations and their cash flows for the years ended
    December 31,  2001,  2000 and 1999 in  conformity  with  generally  accepted
    accounting principles.



    BAYLOR AND BACKUS
    Certified Public Accountants

    Johnson City, Tennessee

    March 14, 2002




                                      -26-
<PAGE>

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

State of Franklin Bancshares, Inc.
Consolidated Statements of Financial Condition
December 31, 2001 and 2000
<TABLE>
<CAPTION>

                                                                            2001                  2000
                                                                    ----------------      ----------------
Assets
<S>                                                                        <C>                   <C>
Cash and Due from Banks                                                    5,252,689             4,715,833
Federal Funds Sold                                                        28,590,000             2,525,000
Short-Term Interest-Bearing Deposits                                          57,649               227,422
                                                                       -------------        --------------
   Total Cash and Cash Equivalents                                        33,900,338             7,468,255
                                                                       -------------         -------------
Investments - Held-To-Maturity
  (Estimated Market 2001 - $9,636,374 and 2000 - $13,792,610)              9,676,885            13,989,368
Investments - Available-for-Sale                                          63,780,481            38,729,467
Loans Held for Sale                                                        2,548,370               264,922

Loans and Leases Receivable                                              139,090,332           136,155,217
  Less: Allowance for Loan and Lease Loss                                 (1,473,855)           (1,062,511)
                                                                       -------------         -------------
Loans and Leases Receivable, Net                                         137,616,477           135,092,706
                                                                       -------------         -------------

Accrued Interest Receivable, Net                                           1,364,280             1,542,443
Land, Buildings and Equipment at Cost Less
  Accumulated Depreciation of $1,260,895 in 2001
  and $883,607 in 2000                                                     5,319,180             5,395,933
Prepaid Expense and Accounts Receivable                                      119,647                77,379
FHLB Stock                                                                 2,161,700             1,524,500
Other Real Estate Owned and Repossessed Property                             452,988                    --
Trust Preferred Placement Fee, Net                                           236,000                    --
Deferred Tax Assets                                                          709,103               313,815
                                                                      --------------        --------------
Total Assets                                                             257,885,449           204,398,788
                                                                      ==============        ==============

Liabilities and Stockholders' Equity

Liabilities:
Interest-Free Deposits                                                    18,216,284             9,503,943
Interest-Bearing Deposits                                                181,920,790           152,578,447
Advances by Borrowers for Taxes and Insurance                                 99,414               107,235
Accrued Interest on Deposits                                                 179,897               188,408
Accounts Payable and Accrued Expenses                                        420,784               296,388
Notes Payable                                                                     --               571,637
FHLB Short-Term Advances                                                          --            12,660,000
FHLB Long-Term Advances                                                   30,240,995            11,246,679
Deferred Gain on REO                                                          21,448                21,448
                                                                      --------------        --------------
Total Liabilities                                                        231,099,612           187,174,185
                                                                      --------------        --------------
Guaranteed Preferred Beneficial Interest in
     Subordinated Debentures                                               8,000,000                    --
                                                                      --------------        --------------
Stockholders' Equity:
Common Stock, $1.00 Par Value,
  Authorized: 10,000,000 Shares; Issued: 1,465,512 Shares
    at December 31, 2001 and at December 31, 2000                          1,465,512             1,465,512
Paid-In Capital                                                           14,251,461            14,251,461
Accumulated Other Comprehensive Income                                      (368,029)               89,678
Retained Earnings                                                          4,526,987             2,569,575
Less: Employee Stock Ownership                                            (1,090,094)           (1,151,623)
                                                                      --------------        --------------
Total Stockholders' Equity                                                18,785,837            17,224,603
                                                                      --------------        --------------
         Total Liabilities and Stockholders' Equity                      257,885,449           204,398,788
                                                                      ==============        ==============
</TABLE>

                                      -27-
<PAGE>

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

State of Franklin Bancshares, Inc.
Consolidated Statements of Income
For the Years Ended December 31, 2001, 2000, and 1999

<TABLE>
<CAPTION>

                                                                     2001             2000              1999
                                                           --------------   --------------      ------------
Interest Income
<S>                                                            <C>              <C>                <C>
Interest on Loans                                              11,466,414       10,951,017         8,220,542
Other Interest Income                                           4,184,974        2,869,360         2,211,555
                                                               ----------      -----------       -----------
         Total Interest Income                                 15,651,388       13,820,377        10,432,097
                                                               ----------      -----------       -----------
Interest Expense
Interest on Deposits                                            7,953,344        7,450,364         5,663,933
Other Interest Expense                                          1,396,049        1,160,101           506,556
                                                               ----------      -----------       -----------
         Total Interest Expense                                 9,349,393        8,610,465         6,170,489
                                                               ----------      -----------       -----------
Net Interest Income before Provision for Loan Losses            6,301,995        5,209,912         4,261,608
Provision for Loan Losses                                        (589,902)        (302,609)         (181,429)
                                                               ----------      -----------       -----------
         Net Interest Income after Provision for Loan Losses    5,712,093        4,907,303         4,080,179
                                                               ----------      -----------       -----------
Other Income
Other Fees and Service Charges                                    426,630          380,476           277,474
Net Gain on Loans Sold                                            227,598           62,597           101,762
Net Gain on Sale and Maturity of Securities                            --               --            12,724
Insurance Commission Income                                        42,073           40,336            39,534
Rental Income, Net                                                 79,907           88,169           110,493
                                                               ----------      -----------       -----------
         Total Other Income                                       776,208          571,578           541,987
                                                               ----------      -----------       -----------
Other Expenses
Compensation and Related Benefits                               1,831,580        1,572,923         1,275,949
Occupancy Expenses                                                338,670          304,804           278,804
Furniture and Equipment Expenses                                  343,994          271,897           258,480
Advertising                                                       137,069           98,385           147,032
Data Processing Expense                                           431,070          369,392           320,692
Other                                                             866,792          823,670           746,307
                                                               ----------      -----------       -----------
         Total Other Expenses                                   3,949,175        3,441,071         3,027,264
                                                               ----------      -----------       -----------
Income before Income Taxes                                      2,539,126        2,037,810         1,594,902
Provision for Income Taxes                                       (581,715)        (658,123)         (507,805)
                                                               ----------      -----------       -----------
Net Income                                                      1,957,411        1,379,687         1,087,097
                                                               ==========      ===========       ===========

Basic Earnings per Share                                             1.42             1.04              0.97
                                                                     ====             ====              ====

Diluted Earnings per Share                                           1.36             1.00              0.95
                                                                     ====             ====              ====
</TABLE>

                                      -28-
<PAGE>

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

State of Franklin Bancshares, Inc.
Consolidated Statements of Changes in Stockholders' Equity
For the Years Ended December 31, 2001, 2000, and 1999

<TABLE>
<CAPTION>

                                                                                 Accumulated
                                                         Common                      Other                 Employee
                                              Common     Stock        Paid-In  Comprehensive   Retained      Stock-
                                               Stock  Subscribed      Capital        Income    Earnings   Ownership         Total
                                          ----------  ----------    -----------    ---------  ---------  ----------    ----------

<S>                                       <C>             <C>       <C>              <C>       <C>        <C>         <C>
Balance at December 31, 1998               1,180,152       6,996     10,905,359       39,820    102,792    (664,820)   11,570,299
                                                                                                                       ----------
Net Proceeds
  from Sale of Stock                         121,367      (6,996)     1,338,371           --         --          --     1,452,742
                                                                                                                       ----------
ESOP Shares Allocated                             --          --             --           --         --      38,205        38,205
                                                                                                                       ----------
Comprehensive Income
   Other Comprehensive Income,
     Net of Tax:
     Unrealized Losses on Securities
       Available-For-Sale:
       Unrealized Holding Losses
         Arising During the Period
           (Net of $339,205 Income Tax)           --          --             --     (658,456)        --          --      (658,456)
       Less: Reclassification Adjustment
           (Net of $4,326 Income Tax)             --          --             --        8,398         --          --         8,398
                                                                                                                       ----------
                                                                                                                         (650,058)
   Net Income                                     --          --             --           --  1,087,097          --     1,087,097
                                                                                                                       ----------
         Total Comprehensive Income               --          --             --           --         --          --       437,039
                                           ---------       -----     ----------       ------    -------    --------    ----------
Balance at December 31, 1999               1,301,519          --     12,243,730     (610,238) 1,189,889    (626,615)   13,498,285
                                           =========       =====     ==========      =======  =========    ========    ==========
Net Proceeds
  from Secondary Stock Offering              163,993          --      2,007,731           --         --          --     2,171,724
                                                                                                                       ----------
ESOP Shares Allocated                             --          --             --           --         --      74,986        74,986
                                                                                                                       ----------
Additional ESOP Shares Issued                     --          --             --           --         --    (599,994)     (599,994)
                                                                                                                       ----------
Comprehensive Income
   Other Comprehensive Income,
     Net of Tax:
     Unrealized Gains on Securities
       Available-For-Sale:
       Unrealized Holding Gains
         Arising During the Period
           (Net of $360,563 Income Tax)           --          --             --      699,915         --          --       699,915

Net Income                                        --          --             --           --  1,379,687          --     1,379,687
                                                                                                                       ----------
         Total Comprehensive Income               --          --             --           --         --          --     2,079,602
                                           ---------       -----     ----------       ------    -------    --------    ----------
Balance at December 31, 2000               1,465,512          --     14,251,461       89,677  2,569,576  (1,151,623)   17,224,603

ESOP Shares Allocated                             --          --             --           --         --      61,529        61,529
                                                                                                                       ----------
Comprehensive Income
   Other Comprehensive Income,
     Net of Tax:
     Unrealized Gains on Securities
       Available-For-Sale:
       Unrealized Holding Losses
         Arising During the Period
           (Net of $278,776 Income Tax)           --          --             --     (401,015)        --          --      (401,015)
       Less: Reclassification Adjustment
           (Net of $34,746 Income Tax)            --          --             --      (56,691)        --          --       (56,691)
                                                                                                                       ----------
                                                                                                                         (457,706)
Net Income                                        --          --             --           --  1,957,411          --     1,957,411
                                                                                                                       ----------
         Total Comprehensive Income               --          --             --           --         --          --     1,499,705
                                           ---------       -----     ----------       ------    -------    --------    ----------
Balance at December 31, 2001               1,465,512          --     14,251,461     (368,029) 4,526,987  (1,090,094)   18,785,837
                                           =========       =====     ==========     ========  =========  ==========    ==========
</TABLE>

                                      -29-
<PAGE>



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


State of Franklin Bancshares, Inc.
Consolidated Statements of Cash Flows
For the Years Ended December 31, 2001, 2000, and 1999
<TABLE>
<CAPTION>

                                                                     2001              2000               1999
                                                          ---------------    --------------     --------------
Cash Flows from Operating Activities
<S>                                                             <C>                <C>               <C>
Net Income                                                      1,957,411          1,379,686         1,087,097
Items Not Affecting Cash and Cash Equivalents:
   Depreciation                                                   379,945            275,989           260,484
   (Increase) Decrease in Accrued Interest                        178,163           (271,004)         (585,476)
   Deferred Tax Assets                                           (169,678)           (74,874)          (71,570)
   Provisions for Loan Losses                                     589,902            302,609           181,429
   (Increase) Decrease in Prepaid Expenses
     and Accounts Receivable                                      (42,268)               528            78,597
   Increase (Decrease) in Interest Payable                         (8,511)            92,674            (8,035)
   Increase (Decrease) in Accounts Payable
     and Accrued Expenses                                         124,396           (192,242)          293,103
   Increase in Deferred Loan Fees, Net                             20,323             48,072             4,993
   (Gain) on Sale of Investments                                       --                 --           (12,724)
   Discount Accretion                                            (487,399)           (62,403)          (10,046)
   Earned ESOP Shares                                             105,528             74,986            38,205
   FHLB Stock Dividends                                          (137,200)          (106,800)          (75,800)
   (Increase) Decrease in Loans Available-For-Sale             (2,283,448)           188,640         1,173,838
                                                             ------------       ------------       -----------
       Net Cash Provided  by Operating Activities                 227,164          1,655,861         2,354,095
                                                             ------------       ------------       -----------
Cash Flows from Investing Activities
Purchase of Held-to-Maturity Investments                       (9,676,728)                --       (13,987,813)
Purchase of Available-for-Sale Investments                    (42,792,458)       (17,658,492)      (17,041,379)
Proceeds from Maturities of Held-to-Maturity Investments       14,000,000                 --                --
Proceeds from Sale of Available-for-Sale Investments                   --            504,171           255,734
Proceeds from Maturities of Available-for-Sale Investments     17,490,740          1,002,305         6,595,000
Principal Payments on Mortgage-Backed Securities
  Available-for-Sale                                                   --                --             35,965
(Increase) in Loans Receivable, Net                            (3,582,986)       (21,813,918)      (29,217,319)
Purchases of Premises and Equipment                              (303,191)        (1,613,680)         (201,375)
Purchase of FHLB Stock                                           (500,000)                --          (870,700)
                                                             ------------       ------------       -----------
       Net Cash Used by Investing Activities                  (25,364,623)       (39,579,614)      (54,431,887)
                                                             ------------       ------------       -----------
</TABLE>








                                 (continued...)

                                      -30-
<PAGE>




State of Franklin Bancshares, Inc.
Consolidated Statements of Cash Flows
For the Years Ended December 31, 2001, 2000, and 1999
<TABLE>
<CAPTION>

                                                                            2001                2000               1999
                                                                  --------------      --------------     --------------
Cash Flows from Financing Activities
<S>                                                                   <C>                 <C>                <C>
Net Increase in Deposits                                              38,054,684          29,844,764         35,873,550
Net Increase (Decrease) in Advances by Borrowers
  for Taxes and Insurance                                                 (7,821)            (10,137)            18,588
Issuance of Common Stock, Net                                                 --           2,171,724          1,452,742
ESOP Shares Purchased                                                         --            (599,994)                --
Net proceeds from the issuance of guaranteed preferred
  beneficial interests in subordinated debentures                      7,760,000                  --                 --
Proceeds from FHLB Advances                                           21,995,733          10,813,972          4,092,707
Repayment of FHLB Advances                                           (15,661,417)                 --                 --
Repayment of Debt                                                       (571,637)            (54,978)           (61,310)
                                                                  --------------      --------------     --------------
       Net Cash Provided by Financing Activities                      51,569,542          42,165,351         41,376,277
                                                                  --------------      --------------     --------------
       Net Increase (Decrease) in Cash and Cash Equivalents           26,432,083           4,241,598        (10,701,515)

Cash and Cash Equivalents at Beginning of Period                       7,468,255           3,226,657         13,928,172
                                                                  --------------      --------------     --------------
       Cash and Cash Equivalents at End of Period                     33,900,338           7,468,255          3,226,657
                                                                  ==============      ==============     ==============

Supplemental Schedule of Noncash Investing and Financing Activities:

(Decrease) in Unrealized Gain on Securities
   Available-For-Sale, Net of Deferred Tax Liability                    (504,400)           (699,916)          (650,058)
                                                                  ==============      ==============     ==============
   Acquisition of Real Estate Property through
   Foreclosure of Related Loan                                           449,988                  --             80,973
                                                                  ==============      ==============     ==============
Origination of Mortgage Loan to Finance
   the Sale of Foreclosed Real Estate                                         --                  --             81,000
                                                                  ==============      ==============     ==============

Supplemental Disclosures of Cash Flow Information:

Cash Paid During the Period for:

     Taxes                                                               714,077           1,162,389            275,960
                                                                  ==============      ==============     ==============
     Interest                                                          9,357,904           8,517,791          6,178,524
                                                                  ==============      ==============     ==============
</TABLE>




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

                                      -31-
<PAGE>

State of Franklin Bancshares, Inc.
Notes to Consolidated Financial Statements
For the Years Ended December 31, 2001, 2000, and 1999

Note 1    Summary of Significant Accounting Policies

          Incorporation and Operations

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

          State of  Franklin  Savings  Bank  (Savings  Bank),  headquartered  in
          Johnson City,  Tennessee,  was  incorporated on February 15, 1996, and
          was the first Tennessee Chartered Stock Savings Bank under the Savings
          Bank  Chartering  Act of 1991 (Savings Bank Act).  The Savings  Bank's
          application to the Federal  Deposit  Insurance  Corporation  (FDIC) to
          obtain  federal  deposit  insurance  for the  Savings  Bank's  deposit
          accounts  under the Bank Insurance Fund (BIF) was approved on February
          9,  1996.   The  Tennessee   Department   of  Financial   Institutions
          (Department)  approved the Savings Bank's registration on February 15,
          1996.

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

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

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

          On December  18,  2001,  State of  Franklin  Bancshares,  Inc.  issued
          debentures to State of Franklin  Statutory Trust I (Trust), a business
          trust  subsidiary of the Company.  The Trust  purchased the debentures
          with the proceeds from the sale of trust preferred  securities  issued
          by the  Trust in a  private  placement.  The  Company  guaranteed  the
          preferred  securities.   The  documents  governing  these  securities,
          including  the  Indenture  under  which the  debentures  were  issued,
          restrict  the  Company's  right to pay a dividend on its common  stock
          under  certain  circumstances,  prohibits  the  issue of any  class of
          common or preferred stock senior to the debentures  during their term,
          and  give  the  holders  of the  preferred  securities  preference  on
          liquidation   over  the  holders  of  the   Company's   common  stock.
          Specifically,  the Company  may not declare or pay a cash  dividend on
          its common stock if (a) an event of default has occurred as defined in
          the Indenture,  (b) the Company is in default under its Guarantee,  or
          (c) the Company has exercised its right under the  debentures  and the
          preferred  securities  to  extend  the  interest  payment  period.  In
          addition,  if any of these conditions have occurred and until they are
          cured,  the Company is restricted  from  redeeming or  purchasing  any
          shares of its common stock  except  under very limited  circumstances.
          The  Company's  net  consolidated   principal   obligation  under  the
          debentures, the preferred securities, and the Guarantee is $8,000,000.
          The securities are redeemable at par after December 2006.

          State of Franklin Savings Bank's primary market area is Washington and
          Sullivan  Counties  and their  immediate  vicinity in  Tennessee.  The
          Savings Bank has three  branches in Johnson City,  Tennessee,  and two
          branches in Kingsport, Tennessee.

          The  principal  business  of the  Savings  Bank is to  accept  savings
          deposits  from  the  general  public  and  to  invest  such  funds  in
          residential  mortgage  loans and,  to a lesser  extent,  consumer  and
          commercial  loans.  The  Savings  Bank  provides  a  wide  variety  of
          financial services to its customers.

          A summary of significant accounting policies of the Company follows:

          Basis of Financial Statement Presentation

          The  consolidated  financial  statements  include the  accounts of the
          Company and its subsidiaries.  All significant  intercompany  accounts
          and  transactions  have been eliminated.  The  consolidated  financial
          statements  of the  Company  have been  prepared  in  conformity  with
          generally  accepted  accounting  principles  and  reflect  the accrual
          method  of  accounting.   In  preparing  the  consolidated   financial
          statements,  management is required to make estimates and  assumptions
          that affect the reported  amounts of assets and  liabilities as of the
          date of the consolidated financial statements and the reported amounts
          of revenues and expenses during the reporting  period.  Actual results
          could differ significantly from those estimates.

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

          While  management  uses available  information to recognize  losses on
          loans,  future  additions to the allowances may be necessary  based on
          changes  in  local  economic  conditions.   In  addition,   regulatory
          agencies,   as  an  integral  part  of  their   examination   process,
          periodically review the

                                      -32-
<PAGE>

State of Franklin Bancshares, Inc.
Notes to Consolidated Financial Statements
For the Years Ended December 31, 2001, 2000, and 1999

Note 1    Continued

          Savings  Bank's  allowances  for losses on loans.  Such  agencies  may
          require the Savings Bank to recognize additions to the allowance based
          on their judgments about information  available to them at the time of
          their examination.  A substantial  portion of the Savings Bank's loans
          is secured by real estate in local markets.  Accordingly, the ultimate
          collectibility  of a  substantial  portion of the Savings  Bank's loan
          portfolio is susceptible to changes in local market conditions.

          Cash and Cash Equivalents

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

          Land, Buildings and Equipment

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

          Loans Receivable

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

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

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

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

          Investment and Mortgage-Backed Securities

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

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

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

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

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

                                      -33-
<PAGE>

State of Franklin Bancshares, Inc.
Notes to Consolidated Financial Statements
For the Years Ended December 31, 2001, 2000, and 1999

Note 1    Continued

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

          Federal Home Loan Bank Stock

          Federal  Home Loan Bank  (FHLB)  stock is a  required  investment  for
          institutions  that are members of the Federal  Home Loan Bank  system.
          The required  investment in the common stock is recalculated  annually
          and based on a predetermined formula. FHLB stock is carried at cost on
          the consolidated  statements of financial  condition.  At December 31,
          2001, the bank owned $2,161,700 in FHLB stock and the minimum required
          investment was $2,024,500.

          Foreclosed Real Estate

          Foreclosed real estate includes both formally  foreclosed property and
          in-substance  foreclosed property.  In-substance foreclosed properties
          are those  properties  for which the  institution  has taken  physical
          possession,  regardless of whether formal foreclosure proceedings have
          taken place.

          At the time of foreclosure,  foreclosed real estate is recorded at the
          lower of the  carrying  amount or fair value less cost to sell,  which
          becomes the property's new basis. Any write-downs based on the asset's
          fair value at date of  acquisition  are charged to the  allowance  for
          loan losses. After foreclosure,  these assets are carried at the lower
          of  their  new cost  basis  or fair  value  less  cost to sell.  Costs
          incurred  in  maintaining   foreclosed   real  estate  and  subsequent
          adjustments  to the  carrying  amount of the  property are included in
          income (loss) on foreclosed real estate.

          Income Taxes

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

          Dividends

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

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

          Reclassifications

          In  instances  where  required,   amounts  reported  in  prior  years'
          financial  statements  included  herein have been  reclassified to put
          them on a comparable basis to the amounts reported in the December 31,
          2001 consolidated financial statements.

Note 2    Land, Buildings and Equipment

     Fixed assets at December 31, 2001, 2000 and 1999 are summarized as follows:

<TABLE>
<CAPTION>
                                                               2001                2000                  1999
                                                          -------------        -------------        --------------
<S>                                                           <C>                  <C>                     <C>
         Land                                                 1,450,000            1,450,000               850,000
         Buildings and Leasehold Improvements                 3,040,756            2,941,388             2,296,821
         Furniture, Fixtures and Equipment                    2,091,976            1,888,152             1,519,039
                                                              ---------            ---------             ---------
                                                              6,582,732            6,279,540             4,665,860
         Less: Accumulated Depreciation                       1,263,552              883,607               607,618
                                                              ---------           ----------            ----------
                                                              5,319,180            5,395,933             4,058,242
                                                              =========            =========             =========
</TABLE>

                                      -34-
<PAGE>

State of Franklin Bancshares, Inc.
Notes to Consolidated Financial Statements
For the Years Ended December 31, 2001, 2000, and 1999

Note 3   Loans and Leases Receivable

     Loans and leases  receivable at December 31, 2001, 2000 and 1999 consist of
the following:

<TABLE>
<CAPTION>

                                                                          2001              2000             1999
                                                                    ----------------  ---------------    --------------
<S>                                                                       <C>              <C>               <C>
              First Mortgage Loans                                        54,554,665       54,716,151        43,715,282
              Construction Loans                                          20,163,050       24,454,126        23,525,380
              Consumer Loans                                              12,536,061       10,204,760         9,952,066
              Participation Loans, Net                                       503,354          533,676           533,676
              Commercial Loans                                            56,028,216       50,931,829        41,919,362
              Credit Line Advances                                           710,137          392,295           419,062
              Direct Finance Leases                                        1,342,242        1,461,095           904,705
                                                                    ----------------  ---------------    --------------
                Gross Loans and Leases Receivable                        145,837,725      142,693,932       120,969,533
                                                                    ----------------  ---------------    --------------

              Less:
                Undisbursed Portion of Loans in Process                   (6,606,444)      (6,418,089)       (6,457,206)
                Net Deferred Loan Origination Fees                          (140,949)        (120,626)          (72,554)
                Accumulated General Loan and Lease Loss Allowance         (1,473,855)      (1,062,511)         (810,303)
                                                                    ----------------  ---------------    --------------
                                                                          (8,221,248)      (7,601,226)       (7,340,063)
                                                                    ----------------  ---------------    --------------
              Loans and Leases Receivable - Net                          137,616,477      135,092,706       113,629,470
                                                                    ================  ===============    ==============


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


                                                                           2001              2000              1999
                                                                    ----------------   --------------    --------------
                Balance - Beginning of Period                              1,062,511          810,303           630,324
                Provision for Losses                                         589,902          302,609           181,429
                Actual Loan and Lease Losses                                (178,558)         (50,401)           (1,450)
                                                                    ----------------  ---------------    --------------
                Balance - End of Period                                    1,473,855        1,062,511           810,303
                                                                    ================  ===============    ==============
</TABLE>

     The gross  amount of  participation  loans  serviced  by State of  Franklin
     Savings Bank was  $1,006,596  at December 31, 2001 and was  $1,067,240  for
     years ending December 31, 2000 and 1999.


Note 4    Supervision and Regulation

General

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

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

                                      -35-
<PAGE>

State of Franklin Bancshares, Inc.
Notes to Consolidated Financial Statements
For the Years Ended December 31, 2001, 2000, and 1999

Note 4    Continued

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

          Tennessee Supervision and Regulation

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

          Federal Regulation

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

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

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

          Quantitative  measures  established  by regulation  to ensure  capital
          adequacy  require the Savings  Bank to  maintain  minimum  amounts and
          ratios (set forth in the table below) of Total  Risk-Based  and Tier 1
          capital (as defined in the  regulations) to  risk-weighted  assets (as
          defined),  and Tier 1 capital  (as  defined)  to  average  assets  (as
          defined).  Management  believes,  as of December  31,  2001,  that the
          Savings Bank meets all capital  adequacy  requirements  to which it is
          subject.

          As of December 31, 2001,  the most recent  notification  from the FDIC
          categorized the Savings Bank as well-capitalized  under the regulatory
          framework for prompt corrective action. The "prompt corrective action"
          regulations  established  five categories of depository  institutions:
          (1)    well-capitalized,     (2)    adequately    capitalized,     (3)
          under-capitalized,   (4)  significantly  under-capitalized,   and  (5)
          critically  under-capitalized.  Each category  relates to the level of
          capital  for  the   depository   institution.   A   "well-capitalized"
          institution  meets the minimum  level  required by  regulation  (i.e.,
          total risk-based  capital ratio of 10% or greater, a Tier 1 risk-based
          capital ratio of 6% or greater and a leverage ratio of 5% or greater).
          To be categorized as well-capitalized,  the Savings Bank must maintain
          minimum  total  risk-based,  Tier 1  risk-based,  and Tier 1  leverage
          ratios as set forth in the table.  There are no  conditions  or events
          since that  notification  that  management  believes  have changed the
          institution's category.

          The  capital  levels of the Company as of  December  31, 2001  include
          adjustment for the subordinated debentures issued in December of 2001,
          subject to certain  limitations.  Federal Reserve guidelines limit the
          amount of  cumulative  preferred  securities  which can be included in
          Tier 1 capital  to 25% of total  Tier 1 capital.  As of  December  31,
          2001,  approximately  $6,300,000 of the  $8,000,000 of the  debentures
          were  included  as Tier 1 capital of the  Company  with the  remaining
          $1,700,000  included as Tier 2 capital,  component of total risk-based
          capital.
                                      -36-
<PAGE>

State of Franklin Bancshares, Inc.
Notes to Consolidated Financial Statements
For the Years Ended December 31, 2001, 2000, and 1999

Note 4   Continued

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

                                                                                                For Capital
                                                                                             Adequacy Purposes
                                                                                               And To Be Well
                                                                                             Capitalized Under
                                                                                             Prompt Corrective
                                                                         Actual               Action Provisions
                                                                   ------------------        ------------------
               In Thousands                                        Amount       Ratio        Amount       Ratio
         ---------------------------------                         ------------------        ------------------
<S>                                                                <C>          <C>          <C>          <C>
         As of December 31, 2001:
                Total Risk-Based Capital
                  (to Risk-Weighted Assets)                        18,680       11.25%      >16,602       10.0%
                                                                                            -
                Tier 1 Capital
                  (to Risk-Weighted Assets)                        17,244       10.39%      > 9,961        6.0%
                                                                                            -
                Tier 1 Capital
                  (to Adjusted Total Assets)                       17,244        7.44%      >11,588        5.0%
                                                                                            -

         As of December 31, 2000:
                Total Risk-Based Capital
                  (to Risk-Weighted Assets)                        16,355       12.78%      >12,802       10.0%
                                                                                            -
                Tier 1 Capital
                  (to Risk-Weighted Assets)                        15,325       11.97%      > 7,681        6.0%
                                                                                            -
                Tier 1 Capital
                  (to Adjusted Total Assets)                       15,325        7.93%      > 9,665        5.0%
                                                                                            -

     The capital ratios for State of Franklin Bancshares, Inc. are as follows:


                                                                                                For Capital
                                                                                             Adequacy Purposes
                                                                                               And To Be Well
                                                                                             Capitalized Under
                                                                                             Prompt Corrective
                                                                         Actual               Action Provisions
                                                                   ------------------        ------------------
               In Thousands                                        Amount       Ratio        Amount       Ratio
         ---------------------------------                         ------------------        ------------------
         As of December 31, 2001:
                Total Risk-Based Capital
                  (to Risk-Weighted Assets)                        28,392       17.03%      >16,671       10.0%
                                                                                            -
                Tier 1 Capital
                  (to Risk-Weighted Assets)                        25,224       15.13%      >10,003        6.0%
                                                                                            -
                Tier 1 Capital
                  (to Adjusted Total Assets)                       25,224       10.80%      >11,675        5.0%
                                                                                            -
         As of December 31, 2000:
                Total Risk-Based Capital
                  (to Risk-Weighted Assets)                        18,197       14.15%      >12,858       10.0%
                                                                                            -
                Tier 1 Capital
                  (to Risk-Weighted Assets)                        17,135       13.33%      > 7,715        6.0%
                                                                                            -
                Tier 1 Capital
                  (to Adjusted Total Assets)                       17,135        8.79%      > 9,747        5.0%
                                                                                            -
</TABLE>


Note 5    Employee and Director Benefit Plans

          Employee Stock Ownership Plan

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

                                      -37-
<PAGE>

State of Franklin Bancshares, Inc.
Notes to Consolidated Financial Statements
For the Years Ended December 31, 2001, 2000, and 1999

Note 5    Continued

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

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

          In November 2001, the ESOP loans were  consolidated  into a seven year
          term loan from the  Company in the amount of  $1,071,093  with a fixed
          interest  rate of 6.00%.  Note  payments  are $15,218 per month for 83
          months plus a final  principal  payment of $24,092.  The note  balance
          outstanding  at December 31, 2001 was  $1,046,094.  Also,  in November
          2001,  the Company  granted a $300,000  line of credit to the ESOP for
          the  purchase  of  additional  shares  of stock in the  Company  as it
          becomes available.  The interest rate for balances  outstanding on the
          line of credit is 6% with a five year term.  Interest is paid  monthly
          with principal  payments made as funds are available.  At December 31,
          2001,  the  outstanding  balance  advanced  on the line of credit  was
          $44,000.

          Shares owned by the ESOP at December 31, 2001  totaled  151,528.  ESOP
          shares  are  maintained  in a  suspense  account  until  released  and
          allocated to  participants'  accounts.  The release of shares from the
          suspense  account  is  based  on the  principal  paid  in the  year in
          proportion  to the total of  current  year and  remaining  outstanding
          debt. Allocation of released shares to participants'  accounts is done
          as of December 31. Shares  allocated and remaining in suspense were as
          follows:



                                                           December 31,
                                                      2001                2000
                                              ------------         -----------
         Number of Shares
              Released and Allocated                43,654              26,431
              Committed to be Released               5,687               5,554
              Suspense                              88,814              98,957

         Fair Value
              Released and Allocated               707,195             396,465
              Committed to be Released             351,049              83,310
              Suspense                           1,438,787           1,484,355


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



                                                            December 31,
                                                      2001                2000
                                                 ---------           ---------

        Compensation Expense                       264,000             186,000
        Contributions                              264,000             186,000



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

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

                                      -38-
<PAGE>

State of Franklin Bancshares, Inc.
Notes to Consolidated Financial Statements
For the Years Ended December 31, 2001, 2000, and 1999


Note 5    Continued

          Stock Option Plans

          On December 21, 1996, the Savings  Bank's Board of Directors  approved
          the Stock  Option  Plan for  Directors  and the Stock  Option Plan for
          Management.  A total of 15% of the  original  stock  offering  (91,500
          shares) was reserved for these plans.  These plans were  retroactively
          amended after year end.

          Under  the  amended  stock  option  plan  for the  outside  directors,
          one-third of the total shares were granted to the outside directors as
          compensation  for directors' fees over the next five years.  Beginning
          when the Savings  Bank had annual  profitability,  the  options  begin
          vesting at 20% per year to each director. This totals 2,346 shares per
          director.  The  exercise  price of the  options is $10 per share.  The
          vested  portion of the options may be exercised at any time.  There is
          no  termination  date on the options,  but in the event of death,  the
          estate must exercise the options within twelve months.  If the Savings
          Bank is sold or merged, the options become 100% vested.

          Under the stock  option  plan for  management,  the  remaining  61,000
          shares  were  granted to  management  as an  incentive  in the Savings
          Bank's  performance.  The  options  retroactively  began to vest after
          three consecutive  quarters of profitability.  The options vest at 20%
          per year for five years.  The exercise price of the options is $10 per
          share. The vested portion of the options may be exercised at any time.
          There  is no  termination  date on the  options,  but in the  event of
          death,  the estate must exercise the options within twelve months.  If
          the  individual  leaves the service of the Savings  Bank,  the options
          must be exercised  within three months,  although this requirement may
          be waived by the board.  If the  Savings  Bank is sold or merged,  the
          options become 100% vested.

          The stock option plans for outside  directors and for management  were
          amended,  effective  April 17,  1998 and again  June 23,  2000,  for a
          portion  of  the  secondary   offerings  (75,192  and  60,546  shares,
          respectively).  Approximately one-third of these shares were allocated
          to outside  directors  and the remaining to  management.  The exercise
          price of these  options was set at $11 per share for  options  granted
          April 17, 1998 and $13.50 for options granted June 23, 2000. The other
          terms  of these  options  are the  same as the  terms of the  original
          options.

          An  additional  stock  incentive  plan was started  October 15,  1999.
          34,000 stock options were granted to employees  with an exercise price
          of $13.50.  These  options  vest over five years and expire  after ten
          years. There are significant  restrictions  imposed based on continued
          employment.

<TABLE>
<CAPTION>

                                                                             Awarded And                     Weighted Average
                                                                             Unexercised         Vested       Exercise Price
                                                                               Options          Options         Per Share
                                                                              -------------------------------------------
 December 31, 2000
<S>                                                            <C>              <C>              <C>               <C>
Options Granted - Outside Directors                    January 1, 2000          50,006           35,001            $10.50
                                                       During 2000              23,508                             $13.50
Options Granted - Management                           January 1, 2000         145,128           73,476            $11.16
                                                       During 2000              37,038               --            $13.50
                                                                              --------          -------
Options Outstanding                                    December 31, 2000       255,680          108,477
                                                                              ========          =======

 December 31, 2001

Options Granted - Outside Directors                    January 1, 2001          73,514           49,707            $11.46
                                                       During 2001               2,500               --            $16.20
Options Granted - Management                           January 1, 2001         182,166          109,910            $11.64
                                                       During 2001                  --               --
                                                                              --------         --------
Options Outstanding                                    December 31, 2001       258,180          159,617
                                                                              ========         ========
</TABLE>


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

                                      -39-
<PAGE>


State of Franklin Bancshares, Inc.
Notes to Consolidated Financial Statements
For the Years Ended December 31, 2001, 2000, and 1999

Note 6   Deposits

         Savings deposit balances are summarized as follows:
<TABLE>
<CAPTION>

                                                        December 31, 2001                           December 31, 2000
                                                  ------------------------------            ------------------------------
                                                 Average                                   Average
                                                  Rate       Amount       Percent           Rate      Amount       Percent
                                                  ----       ------       -------           ----      ------       -------
<S>                                               <C>      <C>             <C>              <C>     <C>             <C>
              Passbook                            2.60     41,603,020      20.79            4.68    16,657,166      10.28
              Interest-Free Checking               --      18,216,284       9.10             --      9,503,943       5.86
              NOW                                 2.00      8,512,548       4.26            2.00     7,465,557       4.61
              Money Market Deposit                2.21     46,020,212      22.99            5.51    31,022,840      19.14
                                                         ------------    -------                  ------------    -------

                                                          114,352,064      57.14                    64,649,506      39.89
                                                         ------------    -------                  ------------    -------

              Fixed Term Certificate Accounts
                Balances $100,000 or Greater      4.45     22,237,766      11.11            6.38    23,480,179      14.48
                Balances Less than $100,000       4.32     63,547,244      31.75            6.36    73,952,705      45.63
                                                         ------------    -------                  ------------    -------

                                                           85,785,010      42.86                    97,432,884      60.11
                                                         ------------    -------                  ------------    -------

                                                          200,137,074     100.00                   162,082,390     100.00
                                                         ============    =======                  ============    =======
</TABLE>

     The contractual  maturity of certificate  accounts at December 31, 2001 and
2000, is as follows:

       Year Ending December 31, 2001             Year Ending December 31, 2000

        2002             77,330,432               2001            81,572,541
        2003              5,968,854               2002            13,728,541
        2004              1,323,611               2003             1,810,104
        2005              1,162,113               2004               321,698
        2006 and After           --               2005 and After          --
                         ----------                               ----------

                         85,785,010                               97,432,884
                         ==========                               ==========


Note 7   Accrued Interest Receivable, Net

<TABLE>
<CAPTION>

                                                                        2001                   2000
                                                                    -------------         -------------
<S>                                                                       <C>                   <C>
  Loans (net of allowance for uncollected interest)                       736,968               826,044
  Investment Securities                                                   627,238               703,354
  Cash and Due from Banks                                                      74                   517
                                                                   --------------         -------------
                                                                        1,364,280             1,529,915
                                                                   ==============         =============
</TABLE>

Note 8    Federal Home Loan Bank Advances

          Advances  from FHLB are  summarized  as follows for the periods  ended
          December 31, 2001 and 2000:

<TABLE>
<CAPTION>
          Contractual Maturity
          --------------------
                                                                                  2001                  2000
                                                                               ----------           -----------
<S>                                                                                                 <C>
          Short-Term (Rate Floats Daily) (Within One Year)                           --              12,660,000
          Convertible Fixed Rate (Within 10 Years)                             30,000,000            11,000,000
          Matched-Funding (30-Year Amortizing)                                    240,995               246,679

          Weighted Average Rate                                                      4.95%                 6.07%
</TABLE>

          The  convertible  fixed rate advances have an original  maturity of 10
          years with an option  held by FHLB to convert to a variable  rate tied
          to 3-month LIBOR  beginning 1 to 3 years from the original issue date.
          If converted to a variable  rate the bank  maintains the option to pay
          off the  advance or continue at the  variable  rate over the  original
          contractual maturity of the advance.

          The Savings Bank pledges as collateral for these  borrowings  selected
          qualifying  mortgage  loans (as defined)  under an agreement  with the
          FHLB.  Loans pledged at December 31, 2001 and 2000 were  approximately
          $45,370,000 and $35,860,000, respectively.

                                      -40-
<PAGE>

State of Franklin Bancshares, Inc.
Notes to Consolidated Financial Statements
For the Years Ended December 31, 2001, 2000, and 1999

Note  9  Other Noninterest Expense

          Other  noninterest  expense  amounts are summarized as follows for the
          periods ended December 31, 2001, 2000 and 1999:
<TABLE>
<CAPTION>

                                                                                  2001           2000            1999
                                                                             ---------      ---------       ---------
Other Noninterest Expense:
<S>                                                                             <C>            <C>             <C>
               Seminars and Education Expenses                                  24,807         48,826          42,550
               Insurance Expense                                                49,342         56,591          42,237
                    Professional Expenses and Supervisory Examinations         134,063        141,214         118,729
               Office Supplies and Postage                                     127,699        136,832         156,513
               Telephone                                                        87,853         89,058         114,625
               Other                                                           443,028        351,149         271,658
                                                                             ---------      ---------       ---------

                                                                               866,792        823,670         746,312
                                                                             =========      =========       =========
</TABLE>

Note 10   Investment Securities

          The   amortized   cost  and  fair  value  of   investment   securities
          held-to-maturity and available-for-sale at December 31, 2001 and 2000,
          by contractual  maturity,  are shown below. Expected maturities differ
          from contractual maturities because issuers may have the right to call
          or prepay obligations without call or prepayment penalties.
<TABLE>
<CAPTION>

 December 31, 2001:
                                                                                        Gross           Gross       Estimated
                                                                       Amortized      Unrealized      Unrealized       Market
                                                                         Cost           Gains          Losses         Value
    Available-for-Sale:
       United States Government Agency Securities Maturing:
<S>                                                                    <C>              <C>                          <C>
          After five years but within ten years                        6,887,788        182,113              --      7,069,901
          After ten years but within fifteen years                     1,229,796             --          26,021      1,203,775
          After fifteen years but within twenty years                  3,369,059        163,867         104,876      3,428,050
          After twenty years                                           1,083,563             --          51,443      1,032,120

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

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

       Equity Securities (Preferred Stock in
          U S Government Agencies):
          Callable after 1 year but within five years                 17,000,000         62,610          77,028     16,985,582
          Callable after five years but within ten years               5,933,450         28,000          67,201      5,894,249
       Other
          Within one year                                                673,487             --              --        673,487
          After five years but within ten years                        3,000,000             --          87,733      2,912,267
          After ten years but within fifteen years                     2,100,000             --         110,284      1,989,716
          After twenty years                                           2,558,474         75,311          20,714      2,613,071
                                                                     -----------       --------     -----------    -----------
                 Total Available-for-Sale                             64,371,284        563,330       1,154,132     63,780,482
                                                                     ===========       ========     ===========    ===========
    Held-to-Maturity:

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

       U S Agency Collateralized Mortgage Obligations:
          After one year but within five years                         1,962,981             --              --      1,962,981
          After five years but within ten years                        2,388,716             --              --      2,388,716
                                                                     -----------       --------     -----------    -----------
                 Total Held-to-Maturity                                9,676,885             --          40,510      9,636,375
                                                                     ===========       ========     ===========    ===========
</TABLE>

                                      -41-
<PAGE>

State of Franklin Bancshares, Inc.
Notes to Consolidated Financial Statements
For the Years Ended December 31, 2001, 2000, and 1999

Note 10  Continued
<TABLE>
<CAPTION>
 December 31, 2000:
                                                                                          Gross          Gross       Estimated
                                                                       Amortized        Unrealized     Unrealized      Market
                                                                          Cost            Gains          Losses         Value
                                                                          ----            -----          ------         -----
     Available-for-Sale:
        United States Government Agency Securities Maturing:
<S>                                                                      <C>                              <C>          <C>
           After one year but within five years                          998,166             --           7,088        991,078
           After five years but within ten years                      18,771,856         44,900         162,495     18,654,261
           After ten years but within fifteen years                    1,923,946         48,719          15,858      1,956,807
           After fifteen years but within twenty years                 1,763,598        109,422              --      1,873,020

         Municipal Securities Maturing:
           After one year but within five years                          510,000          2,658              --        512,658
           After five years but within ten years                         770,000         12,405              --        782,405
           After ten years but within fifteen years                    2,022,990          9,352              --      2,032,342
           After fifteen years but within twenty years                   747,345         31,539              --        778,884

        Equity Securities (Preferred Stock in
           U S Government Agencies):
           Callable after 1 year but within five years                 7,000,000         52,321              --      7,052,321
           Callable after five years but within ten years              1,000,000         10,000              --      1,010,000
        Other
           Within one year                                             3,070,691             --              --      3,070,691
                                                                     -----------       --------         -------     ----------
                  Total Available-for-Sale                            38,578,592        321,316         185,441     38,714,467
                                                                     ===========       ========         =======     ==========
     Held-to-Maturity:

        United States Government Agency Securities Maturing:
           After one year but within five years                        1,999,598             --          12,384      1,987,214
           After five years but within ten years                      11,989,770          4,171         188,544     11,805,397
                                                                     -----------       --------         -------     ----------
                  Total Held-to-Maturity                              13,989,368          4,171         200,928     13,792,611
                                                                     ===========       ========         =======     ==========
</TABLE>

          Gross proceeds from sales of investment securities  available-for-sale
          for the periods ended  December 31, 2001,  2000, and 1999 were $0, $0,
          and $6,630,965,  respectively,  resulting in gross gains of $0, $0 and
          $12,724,  respectively.  No proceeds were  generated from the sales of
          held-to-maturity investments.

Note 11   Legal Proceedings

          The Company and its subsidiaries  are  periodically  involved in legal
          proceedings  that are  generally  incidental to their  businesses.  At
          December 31, 2001, there were no legal  proceedings that were expected
          to have a material impact on the Company's financial statements.

Note 12   Related Party Transactions

          The  Savings  Bank has granted  loans to its  executive  officers  and
          directors.  Management  believes  that  such  loans  were  made in the
          ordinary  course of  business  with  normal  credit  terms,  including
          interest  rates and collateral and do not represent more than a normal
          risk of collection.  Loan balances to executive officers and directors
          at December 31, 2001, 2000 and 1999 were as follows:

<TABLE>
<CAPTION>
                                                                               2001              2000              1999
                                                                               ----              ----              ----
<S>                                                                         <C>               <C>              <C>
          Loan Balances at the Beginning of the Period                      1,788,928         2,702,537        2,826,000
          New Loans                                                         1,278,794           898,963          202,812
          Repayments                                                       (1,323,966)       (1,812,572)        (326,275)
                                                                            ---------         ---------       ----------

          Loan Balances at the End of the Period                            1,743,756         1,788,928        2,702,537
                                                                            =========         =========        =========
</TABLE>

          Executive  officers and  directors  have lines of credit that have not
          been  used in the  amount  of  $613,240,  $781,127,  and  $323,209  at
          December 31, 2001, 2000, and 1999, respectively.

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

               The Savings  Bank  leases the Browns Mill Office in Johnson  City
               from the partnership.  The monthly lease payments were $2,550 per
               month  from the  beginning  of 1999,  increasing  to $2,932 as of
               September 1, 1999 and extending to August 31, 2002.

                                      -42-
<PAGE>

State of Franklin Bancshares, Inc.
Notes to Consolidated Financial Statements
For the Years Ended December 31, 2001, 2000, and 1999

Note 13   Commitments

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

                                                   December 31, 2001                          December 31, 2000
                                         ------------------------------------        -------------------------------------
                                           Fixed      Variable                        Fixed       Variable
                                            Rate        Rate          Total            Rate          Rate          Total
                                            ----        ----          -----            ----          ----          -----
<S>                                                   <C>           <C>              <C>                           <C>
         Mortgage Loans to Originate          --      4,147,789     4,147,789        271,200             --        271,200
         Construction Loans                9,000      6,590,750     6,599,750        469,185      5,924,394      6,393,579
         Unsecured Lines of Credit            --        415,255       415,255             --        978,359        978,359
         Overdraft Protection Accounts   400,928             --       400,928        370,852             --        370,852
         Home Equity Lines of Credit          --      2,707,566     2,707,566             --      4,969,611      4,969,611
         Commercial Loans                     --      6,782,053     6,782,053             --      5,370,550      5,370,550
                                         -------     ----------    ----------      ---------    -----------     ----------
                                         409,928     20,643,413    21,053,341      1,111,237     17,242,914     18,354,151
                                         =======     ==========    ==========      =========     ==========     ==========
</TABLE>


          Commitments  under  standby  letters of credit  totaled  approximately
          $75,000 and $67,500 December 31, 2001 and 2000, respectively.

          At December  31,  2001,  the Savings Bank had an unused line of credit
          for funds  purchases and daylight  overdrafts  with one bank. The line
          totals  $2,000,000  and has a  variable  interest  rate  based  on the
          lending  bank's daily  federal  funds rate.  The Savings Bank also has
          available  lines of  credit  with the  Federal  Home  Loan Bank in the
          amount of $29,759,000.

          The  Savings  Bank is  engaged  in the sale of  mortgage  loans on the
          secondary  market.  These loans are sold outright and are not serviced
          by the Savings Bank.  The gain on the sale of these  mortgage loans is
          as follows:
<TABLE>
<CAPTION>
                                                            2001              2000             1999
                                                  --------------      ------------     ------------
<S>                                                   <C>                <C>              <C>
               Selling Price                          18,333,321         7,359,346        8,832,597
               Less: Carrying Value                   17,985,843         7,244,050        8,690,751
                         Loan Cost                       119,880            52,699           40,084
                                                  --------------      ------------     ------------
               Net Gain on Loans Sold                    227,598            62,597          101,762
                                                  ==============      ============     ============
</TABLE>

          At December 31, 2001,  2000,  and 1999,  the Savings Bank had mortgage
          loans  committed  to  be  sold  totaling  $2,548,370,   $264,922,  and
          $453,562,  respectively.  Commitments to originate loans to be sold on
          the  secondary  market  were  $1,968,281,  $486,384,  and  $416,050 at
          December 31, 2001, 2000, and 1999, respectively.

          The Savings Bank leases office space at the Browns Mill Road,  Johnson
          City,  branch location under an operating lease which was scheduled to
          expire on August  31,  1999  with an  option to renew and  extend  for
          another  three years.  The Savings Bank  exercised  the option and the
          lease has been  extended  until August 31, 2002.  The Savings Bank has
          two  automobile  leases that expire on April 4, 2003 and July 8, 2003.
          The Savings  Bank also leases  storage  space at the Browns Mill Road,
          Johnson City, branch location under a month-to-month operating lease.

          Management  expects as operating leases expire in the normal course of
          business,  they  will be  renewed  or  replaced  by  leases  on  other
          properties at current market rental rates at the time of renewal.

          Approximate minimum future rentals to be paid under the cancelable and
          noncancelable  leases for five years  subsequent  to December 31, 2001
          are as follows:

<TABLE>
<CAPTION>

                                                                 Noncancelable          Cancelable
                   Years Ended                                      Leases-               Leases-
                   December 31,                                Building & Auto           Building
                   ------------                                ---------------           --------
<S>                   <C>                                            <C>                  <C>
                      2002                                           55,099               1,680
                      2003                                           44,330               1,680
                      2004                                           35,190               1,680
                      2005                                           35,190               1,680
                      2006                                           35,190               1,680
                                                                  ---------               -----
                      Total Minimum Future Rentals                  204,999               8,400
                                                                  =========               =====
</TABLE>

                                      -43-
<PAGE>

State of Franklin Bancshares, Inc.
Notes to Consolidated Financial Statements
For the Years Ended December 31, 2001, 2000, and 1999

Note 14   Guaranteed Preferred Beneficial Interest in Subordinated Debentures

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

Note 15   Fair Value of Financial Instruments

          The fair value of  financial  instruments  is disclosed to comply with
          SFAS No. 107,  Disclosure  about Fair Value of Financial  Instruments.
          The following  tables present  estimates of fair value for the Savings
          Bank's financial instruments at December 31, 2001 and 2000:


<TABLE>
<CAPTION>

                                                                                      Carrying             Fair
                                                                                       Amount              Value
                                                                                       ------              -----
         December 31, 2001:

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

         Financial Liabilities:
              Deposits                                                              200,137,074         200,779,922
              Advance Payments by Borrowers for Taxes and Insurance (Escrows)            99,414              99,414
              Accrued Interest on Deposits                                              179,897             179,897
              FHLB Advances                                                          30,240,995          30,884,560
              Preferred Beneficial Interest in Subordinated Debentures                8,000,000           8,000,000

         December 31, 2000:

         Financial Assets:
              Cash and Cash Equivalents                                               7,468,255           7,468,255
              Investment Securities                                                  52,703,835          52,642,953
              Loans                                                                 136,420,139         136,420,139
              Accrued Interest Receivable                                             1,542,443           1,542,443

         Financial Liabilities:
              Deposits                                                              162,082,390         162,243,761
              Advance Payments by Borrowers for Taxes and Insurance (Escrows)           107,235             107,235
              Accrued Interest on Deposits                                              188,408             188,408
              Notes Payable                                                             571,637             488,154
              FHLB Advances                                                          23,906,679          23,937,013
</TABLE>

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

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

                                      -44-
<PAGE>

State of Franklin Bancshares, Inc.
Notes to Consolidated Financial Statements
For the Years Ended December 31, 2001, 2000, and 1999

Note 15  Continued

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

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

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

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

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

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

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

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

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

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

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

                                      -45-
<PAGE>

State of Franklin Bancshares, Inc.
Notes to Consolidated Financial Statements
For the Years Ended December 31, 2001, 2000, and 1999


Note 16  Federal Income Tax

          A  reconciliation  between the effective income tax expense or benefit
          and the amount computed by multiplying the projected statutory federal
          income tax rate for the period ended December 31, 2001,  2000 and 1999
          is as follows:

<TABLE>
<CAPTION>
                                                                          2001            2000               1999
                                                                       ---------        ---------          --------
<S>                                                                     <C>              <C>               <C>
         Computed "Expected" Tax (Expense)                              (876,586)        (686,109)         (602,076)
         Bad Debt Deduction                                             (203,855)         (88,028)           68,490
         Amortization of Organization Expense                              3,953           18,902            23,232
         Other                                                            (1,672)          (1,821)          (23,223)
         FHLB Dividends                                                   49,643           37,290            25,772
         Tax Free Interest                                               153,183            6,936                --
         FHLMC Dividends                                                 293,619           54,707             5,760
                                                                       ---------        ---------          --------
         Provision for Income Taxes                                     (581,715)        (658,123)         (507,805)
                                                                       =========        =========          ========

         Current Income Tax (Expense)                                   (702,598)        (721,546)         (579,375)
         Deferred Income Tax Benefit                                     120,883           63,423            71,570
                                                                       ---------        ---------          --------
         Provision for Income Taxes                                     (581,715)        (658,123)         (507,805)
                                                                       =========        =========          ========

         Deferred Tax Assets and Liabilities:
              Due to Net Operating Loss Carryforward                          --               --             3,517
              Due to Unrealized (Gains) Losses on Investments             22,969          (51,633)          314,365
              Due to FHLB Dividends                                     (128,391)         (77,147)          (26,294)
              Due to Reserve for Loan and Lease Losses                   600,949)         403,754           307,915
              Other                                                       13,576           38,841                --
                                                                       ---------        ---------          --------

         Deferred Tax Assets - Net                                       709,103          313,815           599,503
                                                                       =========        =========          ========
</TABLE>

          The holding  company had a net operating loss  carryforward of $10,435
          for 1999.

          In  assessing  the  realizability  of the related  deferred tax asset,
          management  considers  whether  it is more  likely  than not that some
          portion or all of the  deferred  tax asset will not be  realized.  The
          ultimate  realization  of deferred  tax assets is  dependent  upon the
          existence of, or generation  of,  taxable  income in the periods which
          those temporary  differences are deductible.  Management considers the
          projected future taxable income and tax planning  strategies in making
          this  assessment.  Based upon the projection for future taxable income
          over the  periods  which  the  deferred  tax asset is  deductible,  at
          December 31, 2001, management believes it is more likely than not that
          the  Savings  Bank  will  realize  the  benefits  of these  deductible
          differences.


Note 17   Comprehensive Income

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

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

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

                                      -46-
<PAGE>

State of Franklin Bancshares, Inc.
Notes to Consolidated Financial Statements
For the Years Ended December 31, 2001, 2000, and 1999

Note 18   Earnings Per Share

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

          Earnings per Share Computation:
                                                                      2001               2000                1999
                                                                ------------        ------------       ------------
<S>                                                                <C>                 <C>                <C>
         Net Income                                                1,957,411           1,379,687          1,087,097
         Average Basic Shares Outstanding                          1,374,709           1,329,958          1,123,721

         Basic Earnings Per Share                                       1.42                1.04               0.97
                                                                ============        ============       ============

         Net Income                                                1,957,411           1,379,687          1,087,097
         Average Basic Shares Outstanding                          1,374,709           1,329,958          1,123,721
         Dilutive Effect Due to Stock Options                         65,572              42,873             24,828
                                                                ------------        ------------       ------------

         Average Shares Outstanding, as Adjusted                   1,440,281           1,372,831          1,148,549

         Diluted Earnings Per Share                                     1.36                1.00               0.95
                                                                ============        ============       ============
</TABLE>

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

         Statement of Financial Position
                                                                                   December 31,        December 31,
                                                                                      2001                 2000
                                                                                 --------------       -------------
         Assets:
<S>                                                                                   <C>                 <C>
         Cash and Cash Equivalents                                                    8,541,730           1,314,064
         Investments - Available-for-Sale                                               514,297             494,462
         Investment in State of Franklin Leasing                                        623,724             550,287
         Investment in State of Franklin Savings Bank                                16,828,873          15,436,047
         Investment in State of Franklin Statutory Trust I                              248,000                  --
         Interest Receivable                                                              5,414                  --
         Trust Preferred Placement Cost, net of amortization                            236,000                  --
         Deferred Tax Assets                                                              3,099               3,099
                                                                                 --------------       -------------
                Total Assets                                                         27,001,137          17,797,959
                                                                                 ==============       =============
         Liabilities:

         Notes Payable                                                                       --             571,637
         Accounts Payable and Accrued Expenses                                           13,993               1,719
                                                                                 --------------       -------------
                Total Liabilities                                                        13,993             573,356
                                                                                 --------------       -------------
         Guaranteed Preferred Beneficial Interest
             In Subordinated Debentures                                               8,248,000                  --
                                                                                 --------------       -------------
         Stockholders' Equity:

         Common Stock, $1.00 Par Value,
            Authorized: 10,000,000 Shares; Issued: 1,465,512 Shares                   1,465,512           1,465,512
         Paid-In Capital                                                             14,251,461          14,251,461
         Accumulated Other Comprehensive Income                                        (414,722)             89,678
         Retained Earnings                                                            4,526,987           2,569,575
         Less: Employee Stock Ownership                                              (1,090,094)         (1,151,623)
                                                                                 --------------       -------------
                Total Stockholders' Equity                                           18,739,144          17,224,603
                                                                                 --------------       -------------
                    Total Liabilities and Stockholders' Equity                       27,001,137          17,797,959
                                                                                 ==============       =============
</TABLE>

                                      -47-
<PAGE>

State of Franklin Bancshares, Inc.
Notes to Consolidated Financial Statements
For the Years Ended December 31, 2001, 2000, and 1999

Note 19  Continued
<TABLE>
<CAPTION>
         Statement of Income
                                                                                   Period Ended        Period Ended
                                                                                   December 31,        December 31,
                                                                                           2001                2000
                                                                                 --------------       -------------
<S>                                                                                      <C>                 <C>
         Interest Income                                                                 69,969              50,659

         Interest Expense                                                               (17,184)                 --
         Other Operating Expenses                                                       (74,144)            (60,343)
                                                                                 --------------       -------------

         Income (Loss) before Income Taxes and Equity
           in Undistributed Earnings of Subsidiaries                                    (21,359)             (9,684)
         Provision for Income Taxes (Benefit)                                            (8,108)             (3,676)
                                                                                 --------------       -------------

         Income (Loss) before Equity in Undistributed Earnings of Subsidiaries          (13,251)             (6,008)

         Equity in undistributed Earnings of Subsidiaries                             1,970,662           1,385,695
                                                                                 --------------       -------------

         Net Income                                                                   1,957,411           1,379,687
                                                                                 ==============       =============


         Statement of Cash Flows

                                                                                   Period Ended        Period Ended
                                                                                   December 31,        December 31,
                                                                                           2001                2000
                                                                                 --------------       -------------
         Cash Flows from Operating Activities
                Net Income                                                            1,957,411           1,379,687
                Items Not Affecting Cash and Cash Equivalents:
                  Equity in Undistributed Earnings of Subsidiaries                   (1,970,662)         (1,385,695)
                  Increase (Decrease) in Accounts Payable                                12,274             (11,810)
                  Amortization Expense                                                    4,000                  --
                  Earned ESOP Shares                                                     61,529              74,986
                  (Increase) in Accounts Receivable                                      (5,414)                 --
                                                                                 --------------       -------------

                    Net Cash Provided by Operating Activities                            59,138              57,168
                                                                                 --------------       -------------

         Cash Flows from Investing Activities
                Purchase of Available-for-Sale Investments                              (19,835)            (26,991)
                Investment in Subsidiary                                               (248,000)         (1,700,000)
                                                                                 --------------       -------------

                    Net Cash Used by Investing Activities                              (267,835)        ( 1,726,991)
                                                                                 --------------       -------------

         Cash Flows from Financing Activities
                      Net proceeds from the issuance of guaranteed preferred
                  beneficial interests in subordinated debentures                     8,008,000                  --
                Issuance of Common Stock, Net                                                --           2,171,724
                ESOP Shares Purchased                                                        --            (599,994)
                Repayments of Debt                                                     (571,637)            (54,978)
                                                                                 --------------       -------------

                    Net Cash Provided by Financing Activities                         7,436,363           1,516,752
                                                                                 --------------       -------------

                    Net Increase (Decrease) in Cash and Cash Equivalents              7,227,666            (153,071)

         Cash and Cash Equivalents at Beginning of Period                             1,314,064           1,467,135
                                                                                 --------------       -------------

                    Cash and Cash Equivalents at End of Period                        8,541,730           1,314,064
                                                                                 ==============       =============
</TABLE>

                                      -48-
<PAGE>

State of Franklin Bancshares, Inc.

Statement of Management Responsibility

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

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

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

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

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

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





Charles E. Allen, Jr.                                         Randal R. Greene

Chairman of the Board of Directors                            President
  and Chief Executive Officer



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

                                      -49-
<PAGE>


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

     None

                                    PART III

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

     This item is incorporated by reference to the sections entitled  "Incumbent
Directors (Terms Expiring 2004),"  "Incumbent  Directors (Terms Expiring 2003),"
"Information  about  the  Board of  Directors"  and  "Section  16(a)  Beneficial
Ownership  Reporting  Compliance" of State of Franklin's Proxy Statement related
to its 2002 Annual Meeting of Shareholders.

Item 10. Executive Compensation.

     This item is incorporated by reference to the section  entitled  "Executive
Compensation" of State of Franklin's Proxy Statement  related to its 2002 Annual
Meeting of Shareholders.

Item 11. Security Ownership of Certain Beneficial Owners and Management

     This item is  incorporated  by reference to the section  entitled "State of
Franklin Stock Ownership" of State of Franklin's Proxy Statement  related to its
2002 Annual Meeting of Shareholders.

Item 12. Certain Relationships and Related Transactions

     This  item  is   incorporated   by  reference   to  the  section   entitled
"Transactions  with  Executive  Officers,  Directors  and  Others"  of  State of
Franklin's Proxy Statement related to its 2002 Annual Meeting of Shareholders.

Item 13. Exhibits and Reports on Form 8-K

(1)  Exhibits

         Exhibit No.       Description
         -----------       -----------
         3.1*              Charter of State of Franklin Bancshares, Inc.
         3.2*              Bylaws of State of Franklin Bancshares, Inc.
         21                Subsidiaries of State of Franklin Bancshares, Inc.
         23                Consent of Baylor and Backus
         -------------------
         *        Incorporated  herein by  reference  to the  Registrant's  Form
                  10-KSB,  filed with the Securities and Exchange  Commission on
                  March 28, 1999 (File number 000-24675).

(2) Reports on Form 8-K

     No reports on Form 8-K were filed  during the quarter  ended  December  31,
2001.

                                      -50-
<PAGE>


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

                       STATE OF FRANKLIN BANCSHARES, INC.


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

                       Date: March 28, 2002

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


     Signature                           Capacity                               Date
     ---------                           --------                               ----
<S>                                     <C>                                    <C>
     /s/ Chares E. Allen, Jr.             Chairman of the Board, Director       March 28, 2002
     ------------------------------------(principal executive, financial,
     Chares E. Allen, Jr.                 and accounting officer)

     /s/ Randal R. Greene                President, Director                    March 28, 2002
     ------------------------------------
     Randal R. Greene

     /s/ Steven Gross                    Director                               March 28, 2002
     ------------------------------------
     Steven Gross

     /s/ Donald R. Jeanes                Director                               March 28, 2002
     ------------------------------------
     Donald R. Jeanes

     /s/ Henry J. Williams, M.D.         Director                               March 28, 2002
     ------------------------------------
     Henry J. Williams, M.D.

     /s/ Kenneth E. Cutshall, M.D.       Director                               March 28, 2002
     ------------------------------------
     Kenneth E. Cutshall, M.D.

     /s/ Charles E. Allen, Sr.           Director                               March 28, 2002
     ------------------------------------
     Charles E. Allen, Sr.

     /s/ Richard S. Venable              Director                               March 28, 2002
     ------------------------------------
     Richard S. Venable

     /s/ Verrill M. Norwood, Jr.         Director                               March 28, 2002
     ------------------------------------
     Verrill M. Norwood, Jr.

     /s/ Cameron E. Perry                Director                               March 28, 2002
     ------------------------------------
     Cameron E. Perry

     /s/ Vance W. Cheek                  Director                               March 28, 2002
     ------------------------------------
     Vance W. Cheek

     /s/ Alan R. Hubbard                 Director                               March 28, 2002
     ------------------------------------
     Alan R. Hubbard
</TABLE>


<PAGE>

                                                                      Exhibit 21
                              Subsidiaries of State of Franklin Bancshares, Inc.


     State of Franklin  Savings Bank, a  Tennessee-chartered  savings bank, is a
wholly-owned  subsidiary of State of Franklin  Bancshares,  Inc., as is State of
Franklin  Leasing  Corporation,  a  Tennessee  corporation.  John  Sevier  Title
Services,  Inc., a Tennessee corporation,  is a wholly owned subsidiary of State
of Franklin  Savings  Bank.  State of Franklin  Real  Estate,  Inc., a Tennessee
corporation,  is a wholly owned  subsidiary  of State of Franklin  Savings Bank.
State of Franklin Statutory Trust I, a Connecticut business trust, is a business
trust subsidiary of State of Franklin Bancshares, Inc.















<PAGE>
                                                                      EXHIBIT 23

                          CONSENT OF BAYLOR AND BACKUS

We  hereby  consent  to the  incorporation  by  reference  in  the  Registration
Statement on Form S-8 (No. 333-63187) of State of Franklin  Bancshares,  Inc. of
our report dated March 14, 2002 which appears in  Registrant's  Annual Report on
Form 10-KSB for the year ended December 31, 2001.



BAYLOR AND BACKUS

Johnson City, Tennessee
March 28, 2001