##### Table of Contents



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549
   FORM 10-K / A Amendment No. 1 [X]
    
    Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the fiscal year ended December 31, 2003
 OR [  ]
    
    Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
   Commission file number:
0-25141   MetroCorp Bancshares, Inc.  Texas
    
    76-0579161(State or other jurisdiction of
    
    (I.R.S. Employerincorporation or organization)
    
    Identification No.)
 9600 Bellaire Boulevard, Suite 252
Houston, Texas 77036
(Address of principal executive offices including zip code) (713) 776-3876
(Registrants telephone number, including area code)   Securities registered pursuant to Section 12(b) of the Act:
None Securities registered pursuant to Section 12(g) of the Act:
Common Stock, par value $1.00 per share
(Title of class)   Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.  Yes  [  ]  No  [X] Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). Yes  [  ]  No  [X] Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to
the best of registrants knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [  ] As of March 5, 2004, the number of outstanding shares of Common Stock was
7,162,990. The aggregate market value of the shares of Common Stock held by
non-affiliates, based on the closing price of the Common Stock on the Nasdaq
National Market System on June 30, 2003, the last business day of the
registrants most recently completed second quarter, of $12.15 per share, was
approximately $60.0 million. Documents Incorporated
by Reference:  None




---



TABLE OF CONTENTS  PART IItem 1. BusinessItem 6. Selected Consolidated Financial DataItem 7. Managements Discussion and Analysis of Financial Condition and Results of OperationsItem 8. Financial Statements and Supplementary DataItem 9A. Controls and ProceduresPART IVItem 15. Exhibits, Financial Statement Schedules, and Reports on Form 10-KSIGNATURESEXHIBIT ENDEXConsent of PricewaterhouseCoopers LLPConsent of Deloitte & Touche LLPCertification of CEO pursuant to Rule 13a-14aCertification of Acting CFO pursuant to Rule 13a-14aCertification of CEO pursuant to Section 906Certification of Acting CFO pursuant to Section 906    Table of Contents  Explanatory Note The purpose of this Amendment No. 1 to the Annual Report on Form 10-K of
MetroCorp Bancshares, Inc. (the Company) for the year ended December 31, 2003
(the Original Form 10-K) is to restate the Companys audited consolidated
financial statements as of December 31, 2003 and 2002 and for each of the years
in the three years period ended December 31, 2003 and to revise related
disclosures in the Original Form 10-K. This restatement is described in detail
in Note 2 to the accompanying audited consolidated financial statements. The Company restated its consolidated financial statements as of December
31, 2003 and 2002 and for the years ended December 31, 2003, 2002, and 2001 to
correct the amortization of deferred loan fees, net of costs, to interest
income and to adjust accruals of other noninterest expense. The restatement
increased net income by $402,000, $181,000, and $277,000 for the years ended
December 31, 2003, 2002, and 2001, respectively, and increased retained
earnings by $2.2 million, $1.8 million, $1.6 million, and $1.3 million at
December 31, 2003, 2002, 2001, and 2000 respectively. The restatement resulted from a review of the Companys application of
FASB Statement No. 91, Accounting for Nonrefundable Fees and Costs Associated
with Originating or Acquiring Loans and Initial Direct Costs of Leases. Loan
fees net of the associated costs should be recognized over the life of
the related loan as an adjustment to yield. The Company recently discovered
that $4.0 million of net deferred loan fees were not being amortized to
interest income. These net deferred fees were not entered into the Companys
loan system, and therefore, amortization was not calculated each period.
Accordingly, the restatement reflects the amortization of these net deferred
fees which resulted in an increase to income of $357,000, $327,000, and $321,000
for the years ended December 31, 2003, 2002 and 2001, respectively.
Additionally, in connection with the restatement for net deferred fees, the
Company adjusted accruals of other noninterest expense previously deemed
immaterial which resulted in an increase to net income of $63,000 in 2003 and a
decrease to net income of $146,000 and $44,000 in 2002 and 2001, respectively. As a result of the restatement, the Company has determined it to be
necessary to amend the Original Form 10-K to reflect the amortization of such
net deferred loan fees. This Amendment No. 1 amends and restates in its
entirety Part I, Item 1; Part II, Items 6, 7, 8 and 9a; and Part IV, Item 15 of
the Original Form 10-K. This Amendment No. 1 continues to reflect
circumstances as of the date of the filing of the Original Form 10-K and does
not reflect events occurring after the filing of the Original Form 10-K, or
modify or update those disclosures in any way, except as required to reflect
the effects of the restatement as described in Note 2 to the accompanying
consolidated financial statements. 2




---



##### Table of Contents



PART I Special Cautionary Notice Regarding Forward-Looking Statements Statements and financial discussion and analysis contained in this Annual
Report on Form 10-K and documents incorporated herein by reference that are not
historical facts are forward-looking statements made pursuant to the safe
harbor provisions of the Private Securities Litigation Reform Act of 1995.
Forward-looking statements describe the Companys future plans, strategies and
expectations, are based on assumptions and involve a number of risks and
uncertainties, many of which are beyond the Companys control. The important
factors that could cause actual results to differ materially from the results,
performance or achievements expressed or implied by the forward-looking
statements include, without limitation:  
    
    changes in interest rates and market prices, which could reduce the
Companys net interest margins, asset valuations and expense
expectations;  
    
    changes in the levels of loan prepayments and the resulting effects
on the value of the Companys loan portfolio;  
    
    changes in local economic and business conditions which adversely
affect the ability of the Companys customers to transact profitable
business with the Company, including the ability of borrowers to repay
their loans according to their terms or a change in the value of the
related collateral;  
    
    increased competition for deposits and loans adversely affecting rates and terms;  
    
    the Companys ability to identify suitable acquisition candidates;  
    
    the timing, impact and other uncertainties of the Companys ability
to enter new markets successfully and capitalize on growth
opportunities;  
    
    increased credit risk in the Companys assets and increased
operating risk caused by a material change in commercial, consumer
and/or real estate loans as a percentage of the total loan portfolio;  
    
    the failure of assumptions underlying the establishment of and
provisions made to the allowance for loan losses;  
    
    changes in the availability of funds resulting in increased costs
or reduced liquidity;  
    
    increased asset levels and changes in the composition of assets and
the resulting impact on our capital levels and regulatory capital
ratios;  
    
    the Companys ability to acquire, operate and maintain cost
effective and efficient systems without incurring unexpectedly
difficult or expensive but necessary technological changes;  
    
    the loss of senior management or operating personnel and the
potential inability to hire qualified personnel at reasonable
compensation levels; and  
    
    changes in statutes and government regulations or their
interpretations applicable to bank holding companies and our present
and future banking and other subsidiaries, including changes in tax
requirements and tax rates. All written or oral forward-looking statements attributable to the Company
are expressly qualified in their entirety by these cautionary statements. The
Company undertakes no obligation to publicly update or otherwise revise any
forward-looking statements, whether as a result of new information, future
events or otherwise, unless the securities laws require it to do so. 3




---



##### Table of Contents



Item 1.Business General MetroCorp Bancshares, Inc. (the Company) was incorporated as a business
corporation under the laws of the State of Texas in 1998 to serve as a holding
company for MetroBank, National Association (the Bank). The Companys
headquarters are located at 9600 Bellaire Boulevard, Suite 252, Houston, Texas
77036, and its telephone number is (713) 776-3876. The Companys internet
website address is www.metrobank-na.com. The Company makes available, free of
charge, on or through its website its annual report on Form 10K, quarterly
reports on Form 10-Q, current reports on Form 8-K and all amendments to those
reports as soon as reasonably practicable after such material is filed with or
furnished to the Securities and Exchange Commission. The information found on
the Companys website is not a part of this or any other report. The Companys mission is to enhance shareholder value by maximizing
profitability and operating as the premier commercial bank in each community
that it serves. The Company operates branches in niche markets by providing
personalized service to the communities in Houston and Dallas. In the past,
the Company has strategically opened each of its 14 banking offices in an area
with large multicultural concentrations and intends to pursue branch
opportunities in multicultural markets with significant small and medium-sized
business activity. The Bank was organized in 1987 by Don J. Wang, the Companys current
Chairman of the Board, and five other Asian-American small business owners,
four of whom currently serve as directors of the Company and the Bank. The
organizers perceived that the financial needs of various ethnic groups in
Houston were not being adequately served and sought to provide modern banking
products and services that accommodated the cultures of the businesses
operating in these communities. In 1989, the Company expanded its service
philosophy to Houstons Hispanic community by acquiring from the Federal
Deposit Insurance Corporation (the FDIC) the assets and liabilities of a
community bank located in a primarily Hispanic section of Houston. This
acquisition broadened the Companys market and increased its assets from
approximately $30.0 million to approximately $100.0 million. Other than this
acquisition, the Company has accomplished its growth internally through the
establishment of de novo branches in various market areas. Since the Banks
formation in 1987, it has established 11 branches in the greater Houston
metropolitan area. In 1996, the Bank expanded into the Dallas metropolitan
area, and with the success of the first Dallas area branch, opened two
additional branch offices in 1998 and 1999, respectively. Business Management believes that quality products and services, cross-selling
initiatives, relationship building, and outstanding customer service are all
key elements to a successful retail banking endeavor. The Company intends to
focus more attention on its retail banking initiatives in 2004. To achieve its
goals, the Company has recently added an experienced senior officer to its
management team to implement strategies throughout the 14-branch network.
Specific goals include but are not limited to: (1) building solid customer
relationships through cross-selling products and services, (2) targeting new
mainstream markets to diversify the customer base, (3) ensuring that delivery
systems for the Banks products and services are effective and will produce the
desired results, (4) reviewing the Banks product mix to ensure that customer
needs and demands are being met with existing products, and (5) studying the
effectiveness of the Banks customer service activities and implement
enhancements, where applicable, to make certain that customer inquiries are
being addressed timely and effectively. In connection with the Companys approach to community banking, the
Company offers products designed to appeal to its customers and further enhance
profitability. The Company believes that it has developed a reputation as the
premier provider of financial products and services to small and medium-sized
businesses and consumers located in the communities that it serves. Each of
its product lines is an outgrowth of the Companys expertise in meeting the
particular needs of its customers. The Companys principal lines of business
are the following: Commercial and Industrial Loans.The primary lending focus of the
Company is to small and medium-sized businesses in a variety of
industries. Its commercial lending emphasis includes loans to
wholesalers, manufacturers and business service companies. The Company
makes available to businesses a broad range of short and medium-term
commercial lending products for working capital (including inventory and
accounts receivable), purchases of equipment and machinery and business
expansion (including acquisitions of real estate and improvements). As
of December 31, 2003, the 4




---



##### Table of Contents



Companys commercial and industrial loan portfolio totaled $332.5
million or 59.4% of the gross loan portfolio. At that date, the Company
had a concentration of loans in the hotel and motel industry of $66.1
million. Hotel and motel lending was originally targeted by the Company
because of managements particular expertise in this industry and a
perception that it was an under-served market. More recently, the
Company has broadened its lending strategy in efforts to further
diversify its portfolio to other industries. Commercial Mortgage Loans.The Company originates commercial
mortgage loans to finance the purchase of real property, which generally
consists of developed real estate. The Companys commercial mortgage
loans are collateralized by first liens on real estate, typically have
variable rates and amortize over a 15 to 20 year period, with balloon
payments due at the end of five to seven years. As of December 31, 2003,
the Company had a commercial mortgage portfolio of $178.3 million or
31.8% of the gross loan portfolio. Construction Loans.The Company originates loans to finance the
construction of residential and non-residential properties. The majority
of the Companys residential construction loans are for single-family
dwellings, which are under earnest money contracts. The Company also
originates loans to finance the construction of commercial properties
such as multi-family, office, industrial, warehouse and retail centers.
As of December 31, 2003, the Company had a real estate construction
portfolio of $24.6 million or 4.4% of the gross loan portfolio, of which,
$12.7 million was residential and $11.9 million was commercial. Residential Mortgage Brokerage and Lending.The Company uses its
existing branch network to offer a complete line of single-family
residential mortgage products. The Company solicits and receives a fee
to process residential mortgage loans, which are underwritten and
pre-sold to third party mortgage companies. The Company does not fund or
service the loans underwritten by third party mortgage companies. The
Company also originates five to seven year balloon residential mortgage
loans with a 15-year amortization to its existing customers on a select
basis, which loans are retained in the Companys portfolio. As of
December 31, 2003, the residential mortgage portfolio totaled $14.3
million or 2.6% of the gross loan portfolio. Government Guaranteed Small Business Lending.The Company has
developed an expertise in several government guaranteed lending programs
in order to provide credit enhancement to its commercial and industrial
and mortgage portfolios. As a Preferred Lender under the United States
Small Business Administration (the SBA) federally guaranteed lending
program, the Companys pre-approved status allows it to quickly respond
to customers needs. Depending upon prevailing market conditions, the
Company may sell the guaranteed portion of these loans into the secondary
market, yet retain servicing of these loans. The Company specializes in
SBA loans to minority-owned businesses. As of December 31, 2003, the
Company had $92.0 million in the retained portion of its SBA loans,
approximately $59.4 million of which was guaranteed by the SBA. For the
SBAs fiscal year ended September 30, 2003, the Company was ranked as the
third largest SBA loan originator in the 32-county Houston SBA District
in terms of dollar volume produced. Another source of government
guaranteed lending provided by the Company is Business and Industrial
loans (B&I Loans) which are collateralized by the U.S. Department of
Agriculture (the USDA) and are available to borrowers in areas with a
population of less than 50,000. As of December 31, 2003, the Companys
USDA portfolio totaled $2.9 million. The Company also offers guaranteed
loans through the Overseas Chinese Credit Guaranty Fund (OCCGF), which
is sponsored by the government of Taiwan. These loans are for people of
Chinese decent or origin, who are not mainland Chinese by birth and who
reside overseas. As of December 31, 2003, the Companys OCCGF
portfolio totaled $4.1 million. Trade Finance.Since its inception in 1987, the Company has
originated trade finance loans and letters of credit to facilitate export
and import transactions for small and medium-sized businesses. In this
capacity, the Company has worked with the Export Import Bank of the
United States (the Ex-Im Bank), an agency of the U.S. Government which
provides guarantees for trade finance loans. At December 31, 2003, the
Companys aggregate trade finance portfolio commitments totaled
approximately $7.3 million. The Company offers a variety of loan and deposit products and services to
retail customers through its branch network in Houston and Dallas. Loans to
retail customers include residential mortgage loans, residential construction
loans, automobile loans, lines of credit and other personal loans. Retail
deposit products and services include checking and savings accounts, money
market accounts, time deposits, ATM cards, debit cards and online banking. 5




---



##### Table of Contents



On December 20, 2001, in collaboration with the Mexican Consulate of
Houston, the Company introduced the Matricula Checking account as a service to
the Hispanic community in the greater Houston metropolitan area. Using an
official Matricula card issued by the consulate as identification, a Mexican
national can open this account. Matricula Checking was the first account of
this type in the Houston area. It addresses a significant social issue:
Immigrants are typically unable to obtain acceptable identification and lack
basic banking services. With this account, customers have a safe and secure
place to keep their money, eliminating the need to carry or hide large sums of
cash. The account allows the holder to write checks, execute transactions and
make affordable wire transfers. Account holders can also designate individuals
in Mexico to have limited ATM access to their account. As of December 31,
2003, the Companys aggregate Matricula Checking portfolio totaled
approximately $1.8 million. Restatement of Financial Statements The Company restated its consolidated financial statements as of December
31, 2003 and 2002 and for the years ended December 31, 2003, 2002, and 2001 to
correct the amortization of deferred loan fees, net of costs, to interest
income and to adjust accruals of other noninterest expense. The restatement
increased net income by $402,000, $181,000, and $277,000 for the years ended
December 31, 2003, 2002, and 2001, respectively, and increased retained
earnings by $2.2 million, $1.8 million, $1.6 million, and $1.3 million at
December 31, 2003, 2002, 2001, and 2000 respectively. The restatement resulted from a review of the Companys application of
FASB Statement No. 91, Accounting for Nonrefundable Fees and Costs Associated
with Originating or Acquiring Loans and Initial Direct Costs of Leases. Loan
fees net of the associated costs should be recognized over the life of
the related loan as an adjustment to yield. The Company recently discovered
that $4.0 million of net deferred loan fees were not being amortized to
interest income. These net deferred fees were not entered into the Companys
loan system, and therefore, amortization was not calculated each period.
Accordingly, the restatement reflects the amortization of those net deferred
fees which resulted in an increase to income of $357,000, $327,000
and $321,000 for the years ended December 31, 2003, 2002 and 2001,
respectively. Additionally, in connection with the restatement for net deferred fees,
the Company adjusted accruals of other noninterest expense previously deemed
immaterial which resulted in an increase to net income of $63,000 in
2003 and a decrease to net income of $146,000 and $44,000 in 2002 and
2001, respectively. See Note 2 to the consolidated financial statements. As a result, all amounts
disclosed herein impacted by the restatement have been restated
accordingly. Competition The banking business is highly competitive, and the profitability of the
Company depends principally on the Companys ability to compete in the market
areas in which its banking operations are located. The Company competes with
other commercial banks, savings banks, savings and loan associations, credit
unions, finance companies, mutual funds, insurance companies, brokerage and
investment banking firms, asset-based non-bank lenders and certain other
non-financial entities, including retail stores which may maintain their own
credit programs and certain governmental organizations which may offer more
favorable financing. The Company has been able to compete effectively with
other financial institutions by emphasizing customer service, technology and
responsive decision-making. Additionally, management believes the Company
remains competitive by establishing long-term customer relationships, building
customer loyalty and providing a broad line of products and services designed
to address the specific needs of its customers. In addition, the enactment of the Gramm-Leach-Bliley Act, which breaks
down the barriers between financial institutions, securities firms and
insurance companies, may significantly change the competitive environment in
which the Company and the Bank conduct business. See   Supervision and
Regulation  The Company  Financial Modernization. Employees As of December 31, 2003, the Company had 299 full-time equivalent
employees, 45 of whom were officers of the Bank classified as Vice President or
above. The Company considers its relations with employees to be satisfactory. Supervision and Regulation The supervision and regulation of bank holding companies and their
subsidiaries is intended primarily for the protection of depositors, the
deposit insurance funds of the FDIC and the banking system as a whole, and not
for the protection of the bank holding company shareholders or creditors. The
banking agencies have broad enforcement power over bank holding companies and
banks including the power to impose substantial fines and other penalties for
violations of laws and regulations. 6




---



##### Table of Contents



The following description summarizes some of the laws to which the Company
and the Bank are subject. References herein to applicable statutes and
regulations are brief summaries thereof, do not purport to be complete, and are
qualified in their entirety by reference to such statutes and regulations. The Company The Company is a bank holding company registered under the Bank Holding
Company Act, as amended, (the BHCA), and it is subject to supervision,
regulation and examination by the Board of Governors of the Federal Reserve
System (Federal Reserve Board). The BHCA and other federal laws subject bank
holding companies to particular restrictions on the types of activities in
which they may engage, and to a range of supervisory requirements and
activities, including regulatory enforcement actions for violations of laws and
regulations. Regulatory Restrictions on Dividends; Source of Strength.It is the
policy of the Federal Reserve Board that bank holding companies should pay cash
dividends on common stock only out of income available over the past year and
only if prospective earnings retention is consistent with the organizations
expected future needs and financial condition. The policy provides that bank
holding companies should not maintain a level of cash dividends that undermines
the bank holding companys ability to serve as a source of strength to its
banking subsidiaries. Under Federal Reserve Board policy, a bank holding company is expected to
act as a source of financial strength to each of its banking subsidiaries and
commit resources to their support. Such support may be required at times when,
absent this Federal Reserve Board policy, a holding company may not be inclined
to provide it. As discussed below, a bank holding company in certain
circumstances could be required to guarantee the capital plan of an
undercapitalized banking subsidiary. In the event of a bank holding companys bankruptcy under Chapter 11 of
the U.S. Bankruptcy Code, the trustee will be deemed to have assumed and is
required to cure immediately any deficit under any commitment by the debtor
holding company to any of the federal banking agencies to maintain the capital
of an insured depository institution, and any claim for breach of such
obligation will generally have priority over most other uncollateralized
claims. Scope of Permissible Activities. Except as provided below, the Company is
prohibited from acquiring a direct or indirect interest in or control of more
than 5% of the voting shares of any company which is not a bank or bank holding
company and from engaging directly or indirectly in activities other than those
of banking, managing or controlling banks or furnishing services to its
subsidiary banks, except the Company may engage in and may own shares of
companies engaged in certain activities found by the Federal Reserve to be so
closely related to banking or managing and controlling banks as to be a proper
incident thereto. These activities include, among others, operating a
mortgage, finance, credit card or factoring company; performing certain data
processing operations; providing investment and financial advice; acting as an
insurance agent for certain types of credit-related insurance; leasing personal
property on a full-payout, non-operating basis; and providing certain stock
brokerage and investment advisory services. In approving acquisitions or the
addition of activities, the Federal Reserve considers whether the acquisition
or the additional activities can reasonably be expected to produce benefits to
the public, such as greater convenience, increased competition, or gains in
efficiency, that outweigh such possible adverse effects as undue concentration
of resources, decreased or unfair competition, conflicts of interest or unsound
banking practices. However, the Gramm-Leach-Bliley Act, effective in 2001, amended the BHC
Act and granted certain expanded powers to bank holding companies. The
Gramm-Leach-Bliley Act permits bank holding companies to become financial
holding companies and thereby affiliate with securities firms and insurance
companies and engage in other activities that are financial in nature. The
Gramm-Leach-Bliley Act defines financial in nature to include securities
underwriting, dealing and market making; sponsoring mutual funds and investment
companies; insurance underwriting and agency; merchant banking activities; and
activities that the Federal Reserve has determined to be closely related to
banking. No regulatory approval will be required for a financial holding
company to acquire a company, other than a bank or savings association, engaged
in activities that are financial in nature or incidental to activities that are
financial in nature, as determined by the Federal Reserve Under the Gramm-Leach-Bliley Act, a bank holding company may become a
financial holding company if each of its subsidiary banks is well capitalized
under the Federal Deposit Insurance Corporation Improvement Act (FDICIA)
prompt corrective action provisions, is well managed, and has at least a
satisfactory rating under the Community Reinvestment Act of 1977 (CRA) by
filing a declaration that the bank holding company wishes to become a financial
holding company. The Gramm-Leach-Bliley Act defines financial in nature to
include securities underwriting, dealing and market making; sponsoring mutual
funds and investment companies; 7




---



##### Table of Contents



insurance underwriting and agency; merchant banking activities; and
activities that the Federal Reserve Board has determined to be closely related
to banking. Subsidiary banks of a financial holding company must remain well
capitalized and well managed in order to continue to engage in activities that
are financial in nature without regulatory actions or restrictions, which could
include divestiture of the financial in nature subsidiary or subsidiaries. In
addition, a financial holding company may not acquire a company that is engaged
in activities that are financial in nature unless each of its subsidiary banks
has a CRA rating of satisfactory or better. Presently, the Company has no
plans to become a financial holding company. While the Federal Reserve Board will serve as the umbrella regulator for
financial holding companies and has the power to examine banking organizations
engaged in new activities, regulation and supervision of activities which are
financial in nature or determined to be incidental to such financial activities
will be handled along functional lines. Accordingly, activities of
subsidiaries of a financial holding company will be regulated by the agency or
authorities with the most experience regulating that activity as it is
conducted in a financial holding company. Safe and Sound Banking Practices.Bank holding companies are not
permitted to engage in unsafe and unsound banking practices. The Federal
Reserve Boards Regulation Y, for example, generally requires a holding company
to give the Federal Reserve Board prior notice of any redemption or repurchase
of its own equity securities, if the consideration to be paid, together with
the consideration paid for any repurchases or redemptions in the preceding
year, is equal to 10% or more of the companys consolidated net worth. The
Federal Reserve Board may oppose the transaction if it believes that the
transaction would constitute an unsafe or unsound practice or would violate any
law or regulation. Prior approval of the Federal Reserve Board would not be
required for the redemption or purchase of equity securities for a bank holding
company that would be well capitalized both before and after such transaction,
well-managed and not subject to unresolved supervisory issues. The Federal Reserve Board has broad authority to prohibit activities of
bank holding companies and their non-banking subsidiaries which represent
unsafe and unsound banking practices or which constitute violations of laws or
regulations, and can assess civil money penalties for certain activities
conducted on a knowing and reckless basis, if those activities caused a
substantial loss to a depository institution. The penalties can be as high as
$1.0 million for each day the activity continues. Anti-Tying Restrictions.Bank holding companies and their affiliates are
prohibited from tying the provision of certain services, such as extensions of
credit, to other services offered by a holding company or its affiliates. Capital Adequacy Requirements.The Federal Reserve Board has adopted a
system using risk-based capital guidelines to evaluate the capital adequacy of
bank holding companies. Under the guidelines, specific categories of assets
are assigned different risk weights, based generally on the perceived credit
risk of the asset. These risk weights are multiplied by corresponding asset
balances to determine a risk-weighted asset base. The guidelines require a
minimum total risk-based capital ratio of 8.0% (of which at least 4.0% is
required to consist of Tier 1 capital elements). Total capital is the sum of
Tier 1 and Tier 2 capital. As of December 31, 2003, the Companys ratio of
Tier 1 capital to total risk-weighted assets was 12.73% and its ratio of total
capital to total risk-weighted assets was 13.98%. In addition to the risk-based capital guidelines, the Federal Reserve
Board uses a leverage ratio as an additional tool to evaluate the capital
adequacy of bank holding companies. The leverage ratio is a companys Tier 1
capital divided by its average total consolidated assets. Certain highly rated
bank holding companies may maintain a minimum leverage ratio of 3.0%, but other
bank holding companies may be required to maintain a leverage ratio of at least
4.0%. As of December 31, 2003, the Companys leverage ratio was 9.08%. The federal banking agencies risk-based and leverage ratios are minimum
supervisory ratios generally applicable to banking organizations that meet
certain specified criteria. The federal bank regulatory agencies may set
capital requirements for a particular banking organization that are higher than
the minimum ratios when circumstances warrant. Federal Reserve Board
guidelines also provide that banking organizations experiencing internal growth
or making acquisitions will be expected to maintain strong capital positions
substantially above the minimum supervisory levels, without significant
reliance on intangible assets. Imposition of Liability for Undercapitalized Subsidiaries.Bank
regulators are required to take prompt corrective action to resolve problems
associated with insured depository institutions whose capital declines below
certain levels. In the event an institution becomes undercapitalized, it
must submit a capital restoration plan. The capital restoration plan will not
be accepted by the regulators unless each company having control of the
undercapitalized institution guarantees the subsidiarys compliance with the
capital restoration plan up to a 8




---



##### Table of Contents



certain specified amount. Any such guarantee from a depository
institutions holding company is entitled to a priority of payment in
bankruptcy. The aggregate liability of the holding company of an undercapitalized bank
is limited to the lesser of 5% of the institutions assets at the time it
became undercapitalized or the amount necessary to cause the institution to be
adequately capitalized. The bank regulators have greater power in situations
where an institution becomes significantly or critically undercapitalized
or fails to submit a capital restoration plan. For example, a bank holding
company controlling such an institution can be required to obtain prior Federal
Reserve Board approval of proposed dividends, or might be required to consent
to a consolidation or to divest the troubled institution or other affiliates. Acquisitions by Bank Holding Companies.The BHCA requires every bank
holding company to obtain the prior approval of the Federal Reserve Board
before it may acquire all or substantially all of the assets of any bank, or
ownership or control of any voting shares of any bank, if after such
acquisition it would own or control, directly or indirectly, more than 5% of
the voting shares of such bank. In approving bank acquisitions by bank holding
companies, the Federal Reserve Board is required to consider the financial and
managerial resources and future prospects of the bank holding company and the
banks concerned, the convenience and needs of the communities to be served, and
various competitive factors. Control Acquisitions.The Change in Bank Control Act prohibits a person
or group of persons from acquiring control of a bank holding company unless
the Federal Reserve Board has been notified and has not objected to the
transaction. Under a rebuttable presumption established by the Federal Reserve
Board, the acquisition of 10% of more of a class of voting stock of a bank
holding company with a class of securities registered under Section 12 of the
Exchange Act, such as the Company, would, under the circumstances set forth in
the presumption, constitute acquisition of control of the Company. In addition, any entity is required to obtain the approval of the Federal
Reserve Board under the BHCA before acquiring 25% (5% in the case of an
acquirer that is a bank holding company) or more of the outstanding Common
Stock of the Company, or otherwise obtaining control or a controlling
influence over the Company. The Bank The Bank is a nationally chartered banking association, the deposits of
which are insured by the Bank Insurance Fund (BIF) of the FDIC. The Banks
primary regulator is the Office of the Comptroller of the Currency (the OCC).
By virtue of the insurance of its deposits, however, the Bank is also subject
to supervision and regulation by the FDIC. Such supervision and regulation
subjects the Bank to special restrictions, requirements, potential enforcement
actions, and periodic examination by the OCC. Because the Federal Reserve
Board regulates the bank holding company parent of the Bank, the Federal
Reserve Board also has supervisory authority, which directly affects the Bank. Financial Modernization.Under the Gramm-Leach-Bliley Act, a national
bank may establish a financial subsidiary and engage, subject to limitations on
investment, in activities that are financial in nature, other than insurance
underwriting, insurance company portfolio investment, real estate development,
real estate investment, annuity issuance and merchant banking activities. To
do so, a bank must be well capitalized, well managed and have a CRA rating of
satisfactory or better. National banks with financial subsidiaries must remain
well capitalized and well managed in order to continue to engage in activities
that are financial in nature without regulatory actions or restrictions, which
could include divestiture of the financial in nature subsidiary or
subsidiaries. In addition, a bank may not acquire a company that is engaged in
activities that are financial in nature unless the bank has a CRA rating of
satisfactory or better. Branching.The establishment of a branch must be approved by the OCC,
which considers a number of factors, including financial history, capital
adequacy, earnings prospects, character of management, needs of the community
and consistency with corporate powers. Restrictions on Transactions with Affiliates and Insiders.Transactions
between the Bank and its non-banking affiliates, including the Company, are
subject to Section 23A of the Federal Reserve Act. An affiliate of a bank is
any company or entity that controls, is controlled by, or is under common
control with the bank. In general, Section 23A imposes limits on the amount of
such transactions, and also requires certain levels of collateral for loans to
affiliated parties. It also limits the amount of advances to third parties
which are collateralized by the securities or obligations of the Company or its
non-banking subsidiaries. Affiliate transactions are also subject to Section 23B of the Federal
Reserve Act which generally requires that certain transactions between the Bank
and its affiliates be on terms substantially the same, or at least as 9




---



##### Table of Contents



favorable to the Bank, as those prevailing at the time for comparable
transactions with or involving other nonaffiliated persons. The Federal
Reserve has also issued Regulation W which codifies prior regulations under
Sections 23A and 23B of the Federal Reserve Act and interpretive guidance with
respect to affiliate transactions. The restrictions on loans to directors, executive officers, principal
shareholders and their related interests (collectively referred to herein as
insiders) contained in the Federal Reserve Act and Regulation O apply to all
insured depository institutions and their subsidiaries. These restrictions
include limits on loans to one borrower and conditions that must be met before
such a loan can be made. There is also an aggregate limitation on all loans to
insiders and their related interests. These loans cannot exceed the
institutions total unimpaired capital and surplus, and the OCC may determine
that a lesser amount is appropriate. Insiders are subject to enforcement
actions for knowingly accepting loans in violation of applicable restrictions. Restrictions on Distribution of Subsidiary Bank Dividends and Assets.
Dividends paid by the Bank have provided a substantial part of the Companys
operating funds and for the foreseeable future it is anticipated that dividends
paid by the Bank to the Company will continue to be the Companys principal
source of operating funds. Capital adequacy requirements serve to limit the
amount of dividends that may be paid by the Bank. Until capital surplus equals
or exceeds capital stock, a national bank must transfer to surplus 10% of its
net income for the preceding four quarters in the case of an annual dividend or
10% of its net income for the preceding two quarters in the case of a quarterly
or semiannual dividend. At December 31, 2003, the Banks capital surplus
exceeded its capital stock. Without prior approval, a national bank may not
declare a dividend if the total amount of all dividends, declared by the bank
in any calendar year exceeds the total of the banks retained net income for
the current year and retained net income for the preceding two years. Under
federal law, the Bank cannot pay a dividend if, after paying the dividend, the
Bank will be undercapitalized. The OCC may declare a dividend payment to be
unsafe and unsound even though the Bank would continue to meet its capital
requirements after the dividend. Because the Company is a legal entity separate and distinct from its
subsidiaries, its right to participate in the distribution of assets of any
subsidiary upon the subsidiarys liquidation or reorganization will be subject
to the prior claims of the subsidiarys creditors. In the event of a
liquidation or other resolution of an insured depository institution, the
claims of depositors and other general or subordinated creditors are entitled
to a priority of payment over the claims of holders of any obligation of the
institution to its shareholders, arising as a result of their status as
shareholders, including any depository institution holding company (such as the
Company) or any shareholder or creditor thereof. Examinations.The OCC periodically examines and evaluates insured banks.
Based upon such an evaluation, the OCC may revalue the assets of the
institution and require that it establish specific reserves to compensate for
the difference between the OCC-determined value and the book value of such
assets. Audit Reports.Insured institutions with total assets of $500 million or
more must submit annual audit reports prepared by independent auditors to
federal regulators. In some instances, the audit report of the institutions
holding company can be used to satisfy this requirement. Auditors must receive
examination reports, supervisory agreements, and reports of enforcement
actions. In addition, financial statements prepared in accordance with
accounting principles generally accepted in the U.S., managements
certifications concerning responsibility for the financial statements, internal
controls and compliance with legal requirements designated by the OCC, and an
attestation by the auditor regarding the statements of management relating to
the internal controls must be submitted. For institutions with total assets of
more than $3 billion, independent auditors may be required to review quarterly
financial statements. The Federal Deposit Insurance Corporation Improvement
Act of 1991 (FDICIA) requires that independent audit committees be formed,
consisting of outside directors only. The committees of such institutions must
include members with experience in banking or financial management, must have
access to outside counsel, and must not include representatives of large
customers. Capital Adequacy Requirements.Similar to the Federal Reserve Boards
requirements for bank holding companies, the OCC has adopted regulations
establishing minimum requirements for the capital adequacy of national banks.
The OCC may establish higher minimum requirements if, for example, a bank has
previously received special attention or has a high susceptibility to interest
rate risk. The OCCs risk-based capital guidelines generally require national banks
to have a minimum ratio of Tier 1 capital to total risk-weighted assets of 4.0%
and a ratio of total capital to total risk-weighted assets of 8.0%. As of
December 31, 2003, the Banks ratio of Tier 1 capital to total risk-weighted
assets was 11.98% and its ratio of total capital to total risk-weighted assets
was 13.23%. The OCCs leverage guidelines require national banks to maintain Tier 1
capital of no less than 4.0% of average total assets, except in the case of
certain highly rated banks for which the requirement is 3.0% of average 10




---



##### Table of Contents



total assets unless a higher leverage capital ratio is warranted by the
particular circumstances or risk profile of the depository institution. As of
December 31, 2003, the Banks ratio of Tier 1 capital to average total assets
(leverage ratio) was 8.54%. Corrective Measures for Capital Deficiencies.The federal banking
regulators are required to take prompt corrective action with respect to
capital-deficient institutions. Agency regulations define, for each capital
category, the levels at which institutions are well capitalized, adequately
capitalized, under capitalized, significantly under capitalized and
critically under capitalized. A well capitalized bank has a total
risk-based capital ratio of 10.0% or higher; a Tier 1 risk-based capital ratio
of 6.0% or higher; a leverage ratio of 5.0% or higher; and is not subject to
any written agreement, order or directive requiring it to maintain a specific
capital level for any capital measure. An adequately capitalized bank has a
total risk-based capital ratio of 8.0% or higher; a Tier 1 risk-based capital
ratio of 4.0% or higher; a leverage ratio of 4.0% or higher (3.0% or higher if
the bank was rated a composite 1 in its most recent examination report and is
not experiencing significant growth); and does not meet the criteria for a well
capitalized bank. A bank is under capitalized if it fails to meet any one of
the ratios required to be adequately capitalized. In addition to requiring undercapitalized institutions to submit a capital
restoration plan, agency regulations authorize broad restrictions on certain
activities of undercapitalized institutions including asset growth,
acquisitions, branch establishment, and expansion into new lines of business.
With certain exceptions, an insured depository institution is prohibited from
making capital distributions, including dividends, and is prohibited from
paying management fees to control persons if the institution would be
undercapitalized after any such distribution or payment. As an institutions capital decreases, the OCCs enforcement powers become
more severe. A significantly undercapitalized institution is subject to
mandated capital raising activities, restrictions on interest rates paid and
transactions with affiliates, removal of management, and other restrictions.
The OCC has only very limited discretion in dealing with a critically
undercapitalized institution and is virtually required to appoint a receiver or
conservator. Banks with risk-based capital and leverage ratios below the required
minimums may also be subject to certain administrative actions, including the
termination of deposit insurance upon notice and hearing, or a temporary
suspension of insurance without a hearing in the event the institution has no
tangible capital. Deposit Insurance Assessments.The Bank must pay assessments to the FDIC
for federal deposit insurance protection. The FDIC has adopted a risk-based
assessment system as required by FDICIA. Under this system, FDIC-insured
depository institutions pay insurance premiums at rates based on their risk
classification. Institutions assigned to higher-risk classifications (that is,
institutions that pose a greater risk of loss to their respective deposit
insurance funds) pay assessments at higher rates than institutions that pose a
lower risk. An institutions risk classification is assigned based on its
capital levels and the level of supervisory concern the institution poses to
the regulators. In addition, the FDIC can impose special assessments in
certain instances. The FDIC established a process for raising or lowering all rates for
insured institutions semi-annually if conditions warrant a change. Under this
new system, the FDIC has the flexibility to adjust the assessment rate schedule
twice a year without seeking prior public comment, but only within a range of
five cents per $100 above or below the assessment schedule adopted. Changes in
the rate schedule outside the five-cent range above or below the current
schedule can be made by the FDIC only after a full rulemaking with opportunity
for public comment. On September 30, 1996, President Clinton signed into law an act that
contained a comprehensive approach to recapitalizing the Savings Association
Insurance Fund (SAIF) and to assure the payment of the Financing
Corporations (FICO) bond obligations. Under this act, banks insured under
the BIF are required to pay a portion of the interest due on bonds that were
issued by FICO to help shore up the ailing Federal Savings and Loan Insurance
Corporation in 1987. The BIF rate was required to equal one-fifth of the SAIF
rate through year-end 1999, or until the insurance funds were merged, whichever
occurred first. Thereafter, BIF and SAIF payers will be assessed pro rata for
the FICO bond obligations. With regard to the assessment for the FICO
obligation, for the first quarter of 2004, the BIF and SAIF rates were .00154%
of deposits. Enforcement Powers.The FDIC and the other federal banking agencies have
broad enforcement powers, including the power to terminate deposit insurance,
impose substantial fines and other civil and criminal penalties, and appoint a
conservator or receiver. Failure to comply with applicable laws, regulations
and supervisory agreements could subject the Company or its banking
subsidiaries, as well as officers, directors and other institution-affiliated
parties of these organizations, to administrative sanctions and potentially
substantial civil money penalties. The appropriate federal banking agency may
appoint the FDIC as conservator or receiver 11




---



##### Table of Contents



for a banking institution (or the FDIC may appoint itself, under certain
circumstances) if any one or more of a number of circumstances exist,
including, without limitation, the fact that the banking institution is
undercapitalized and has no reasonable prospect of becoming adequately
capitalized; fails to become adequately capitalized when required to do so;
fails to submit a timely and acceptable capital restoration plan; or materially
fails to implement an accepted capital restoration plan. Brokered Deposit Restrictions.Adequately capitalized institutions (as
defined for purposes of the prompt corrective action rules described above)
cannot accept, renew or roll over brokered deposits except with a waiver from
the FDIC, and are subject to restrictions on the interest rates that can be
paid on such deposits. Undercapitalized institutions may not accept, renew, or
roll over brokered deposits. Cross-Guarantee Provisions.The Financial Institutions Reform, Recovery
and Enforcement Act of 1989 (FIRREA) contains a cross-guarantee provision
which generally makes commonly controlled insured depository institutions
liable to the FDIC for any losses incurred in connection with the failure of a
commonly controlled depository institution. Community Reinvestment Act.The CRA and the regulations issued thereunder
are intended to encourage banks to help meet the credit needs of their service
area, including low and moderate-income neighborhoods, consistent with the safe
and sound operations of the banks. These regulations also provide for
regulatory assessment of a banks record in meeting the needs of its service
area when considering applications to establish branches, merger applications
and applications to acquire the assets and assume the liabilities of another
bank. FIRREA requires federal banking agencies to make public a rating of a
banks performance under the CRA. In the case of a bank holding company, the
CRA performance record of the banks involved in the transaction are reviewed in
connection with the filing of an application to acquire ownership or control of
shares or assets of a bank or to merge with any other bank holding company. An
unsatisfactory record can substantially delay or block the transaction. Consumer Laws and Regulations.In addition to the laws and regulations
discussed herein, the Bank is also subject to certain consumer laws and
regulations that are designed to protect consumers in transactions with banks.
While the list set forth herein is not exhaustive, these laws and regulations
include the Truth in Lending Act, the Truth in Savings Act, the Electronic
Funds Transfer Act, the Expedited Funds Availability Act, the Equal Credit
Opportunity Act, and the Fair Housing Act, among others. These laws and
regulations mandate certain disclosure requirements and regulate the manner in
which financial institutions must deal with customers when taking deposits or
making loans to such customers. The Bank must comply with the applicable
provisions of these consumer protection laws and regulations as part of their
ongoing customer relations. Privacy.In addition to expanding the activities in which banks and bank
holding companies may engage, the Gramm-Leach-Bliley Act imposes new
requirements on financial institutions with respect to customer privacy. The
Gramm-Leach-Bliley Act generally prohibits disclosure of customer information
to non-affiliated third parties unless the customer has been given the
opportunity to object and has not objected to such disclosure. Financial
institutions are further required to disclose their privacy policies to
customers annually. Financial institutions, however, will be required to comply
with state law if it is more protective of customer privacy than the
Gramm-Leach-Bliley Act. The privacy provisions became effective on July 1,
2002. The Gramm-Leach-Bliley Act contains a variety of other provisions
including a prohibition against ATM surcharges unless the customer has first
been provided notice of the imposition and amount of the fee. USA Patriot Act of 2002.The Uniting and Strengthening America by
Providing Appropriate Tools Required to Intercept and Obstruct Terrorism (USA
Patriot) Act of 2002 was enacted in October 2002. The USA Patriot Act is
intended to strengthen the ability of U.S. law enforcement and the intelligence
communities to work cohesively to combat terrorism on a variety of fronts. The
potential impact of the USA Patriot Act on financial institutions of all kinds
is significant and wide ranging. The USA Patriot Act contains a broad range of
anti-money laundering and financial transparency laws and requires various
regulations, including: (i) due diligence requirements for financial
institutions that administer, maintain, or manage private bank accounts or
correspondent accounts for non-U.S. persons; (ii) standards for verifying
customer identification at account opening; (iii) rules to promote cooperation
among financial institutions, regulators and law enforcement entities in
identifying parties that may be involved in terrorism or money laundering; (iv)
reports by nonfinancial trades and business filed with the Treasury
Departments Financial Crimes Enforcement Network for transactions exceeding
$10,000; and (v) filing of suspicious activities reports involving securities
by brokers and dealers if they believe a customer may be violating U.S. laws
and regulations. 12




---



##### Table of Contents



Instability of Regulatory Structure Various legislation and proposals to overhaul the bank regulatory system
and limit the investments that a depository institution may make with insured
funds, is from time to time introduced in Congress. Such legislation may
change banking statutes and the operating environment of the Company and its
banking subsidiaries in substantial and unpredictable ways. The Company cannot
determine the ultimate effect that potential legislation, if enacted, or
implementing regulations with respect thereto, would have upon the financial
condition or results of operations of the Company or its subsidiaries. Expanding Enforcement Authority One of the major additional burdens imposed on the banking industry by
FDICIA is the increased ability of banking regulators to monitor the activities
of banks and their holding companies. In addition, the Federal Reserve Board
and OCC possess extensive authority to police unsafe or unsound practices and
violations of applicable laws and regulations by depository institutions and
their holding companies. For example, the FDIC may terminate the deposit
insurance of any institution which it determines has engaged in an unsafe or
unsound practice. The agencies can also assess civil money penalties, issue
cease and desist or removal orders, seek injunctions, and publicly disclose
such actions. FDICIA, FIRREA and other laws have expanded the agencies
authority in recent years, and the agencies have not yet fully tested the
limits of their powers. Effect of Monetary Policy The policies of regulatory authorities, including the monetary policy of
the Federal Reserve Board, have a significant effect on the operating results
of bank holding companies and their subsidiaries. Among the means available to
the Federal Reserve Board to affect the money supply are open market operations
in U.S. Government securities, changes in the discount rate or federal funds
rate on member bank borrowings, and changes in reserve requirements against
member bank deposits. These means are used in varying combinations to
influence overall growth and distribution of bank loans, investments and
deposits, and their use may affect interest rates charged on loans or paid for
deposits. Federal Reserve Board monetary policies have materially affected the
operating results of commercial banks in the past and are expected to continue
to do so in the future. The nature of future monetary policies and the effect
of such policies on the business and earnings of the Company and its
subsidiaries cannot be predicted. 13




---



##### Table of Contents



PART II Item 6.Selected Consolidated Financial Data The following Selected Consolidated Financial Data of the Company should
be read in conjunction with the consolidated financial statements of the
Company, and the accompanying notes, appearing elsewhere in this Annual Report
on Form 10-K/A, and the information contained in Item 7, Managements
Discussion and Analysis of Financial Condition and Results of Operations. The
selected historical consolidated financial data as of and for each of the five
years ended December 31, 2003 is derived from the companys consolidated
financial statements which have been audited by independent accountants.
Certain prior year amounts have been reclassified to conform with the 2003
presentation. The following Selected Consolidated Financial Data has been
restated to correct the amortization of net deferred loan fees and accruals of
other noninterest expense. See Note 2 to the consolidated financial
statements. Years Ended December 31,2003
    
    2002
    
    2001
    
    2000
    
    1999(Dollars in thousands, except per share data)Income Statement Data (Restated) (4):Interest income
    
    $
    43,287
    
    
    $
    47,980
    
    
    $
    54,940
    
    
    $
    63,036
    
    
    $
    53,073Interest expense
    
    
    12,134
    
    
    
    14,628
    
    
    
    23,799
    
    
    
    27,276
    
    
    
    21,026Net interest income
    
    
    31,153
    
    
    
    33,352
    
    
    
    31,141
    
    
    
    35,760
    
    
    
    32,047Provision for loan losses
    
    
    5,690
    
    
    
    3,853
    
    
    
    3,799
    
    
    
    7,508
    
    
    
    5,550Net interest income after provision for loan losses
    
    
    25,463
    
    
    
    29,499
    
    
    
    27,342
    
    
    
    28,252
    
    
    
    26,497Noninterest income
    
    
    8,927
    
    
    
    8,967
    
    
    
    8,660
    
    
    
    7,032
    
    
    
    6,088Noninterest expense
    
    
    28,545
    
    
    
    25,051
    
    
    
    24,452
    
    
    
    26,090
    
    
    
    21,322Income before provision for income taxes
    
    
    5,845
    
    
    
    13,415
    
    
    
    11,550
    
    
    
    9,194
    
    
    
    11,263Provision for income taxes
    
    
    1,735
    
    
    
    4,445
    
    
    
    3,696
    
    
    
    3,242
    
    
    
    3,806Net income
    
    $
    4,110
    
    
    $
    8,970
    
    
    $
    7,854
    
    
    $
    5,952
    
    
    $
    7,457Per Share Data (Restated) (4):Net income:Basic
    
    $
    0.58
    
    
    $
    1.28
    
    
    $
    1.12
    
    
    $
    0.85
    
    
    $
    1.05Diluted
    
    
    0.57
    
    
    
    1.25
    
    
    
    1.11
    
    
    
    0.85
    
    
    
    1.05Book value
    
    
    10.95
    
    
    
    10.84
    
    
    
    9.52
    
    
    
    8.60
    
    
    
    7.52Tangible book value
    
    
    10.95
    
    
    
    10.84
    
    
    
    9.52
    
    
    
    8.60
    
    
    
    7.52Cash dividends
    
    
    0.24
    
    
    
    0.24
    
    
    
    0.24
    
    
    
    0.24
    
    
    
    0.24Weighted average shares outstanding (in thousands):Basic
    
    
    7,089
    
    
    
    7,024
    
    
    
    6,998
    
    
    
    6,972
    
    
    
    7,114Diluted
    
    
    7,213
    
    
    
    7,154
    
    
    
    7,059
    
    
    
    6,973
    
    
    
    7,114Balance Sheet Data (Period End) (Restated) (4):Total assets
    
    $
    867,016
    
    
    $
    841,945
    
    
    $
    743,706
    
    
    $
    737,938
    
    
    $
    661,425Securities
    
    
    262,264
    
    
    
    264,418
    
    
    
    176,230
    
    
    
    143,759
    
    
    
    110,065Total loans
    
    
    557,137
    
    
    
    530,571
    
    
    
    495,441
    
    
    
    485,518
    
    
    
    496,930Allowance for loan losses
    
    
    10,448
    
    
    
    10,150
    
    
    
    8,903
    
    
    
    9,271
    
    
    
    7,537Total deposits
    
    
    724,941
    
    
    
    691,361
    
    
    
    642,751
    
    
    
    625,906
    
    
    
    544,436Other borrowings
    
    
    54,173
    
    
    
    65,774
    
    
    
    25,195
    
    
    
    25,573
    
    
    
    55,636Total shareholders equity
    
    
    78,373
    
    
    
    76,224
    
    
    
    66,809
    
    
    
    60,004
    
    
    
    53,414Balance Sheet Data (Average) (Restated) (4):Total assets
    
    $
    852,946
    
    
    $
    791,297
    
    
    $
    728,607
    
    
    $
    698,800
    
    
    $
    621,064Securities
    
    
    251,828
    
    
    
    222,752
    
    
    
    159,416
    
    
    
    127,865
    
    
    
    119,952Total loans
    
    
    551,287
    
    
    
    506,901
    
    
    
    476,134
    
    
    
    487,439
    
    
    
    457,284Allowance for loan losses
    
    
    10,595
    
    
    
    9,238
    
    
    
    9,315
    
    
    
    8,589
    
    
    
    6,720Total deposits
    
    
    708,575
    
    
    
    656,824
    
    
    
    626,970
    
    
    
    590,217
    
    
    
    501,808Other borrowings
    
    
    60,309
    
    
    
    53,056
    
    
    
    25,570
    
    
    
    42,757
    
    
    
    58,037Total shareholders equity
    
    
    76,333
    
    
    
    71,452
    
    
    
    64,329
    
    
    
    54,114
    
    
    
    53,462Performance Ratios (Restated) (4):Return on average assets
    
    
    0.48
    %
    
    
    1.13
    %
    
    
    1.08
    %
    
    
    0.85
    %
    
    
    1.20
    %Return on average equity
    
    
    5.38
    
    
    
    12.55
    
    
    
    12.21
    
    
    
    11.00
    
    
    
    13.95Net interest margin
    
    
    3.81
    
    
    
    4.44
    
    
    
    4.56
    
    
    
    5.42
    
    
    
    5.40Efficiency ratio (1)
    
    
    71.22
    
    
    
    59.20
    
    
    
    61.44
    
    
    
    60.97
    
    
    
    55.91
 14




---



##### Table of Contents



Years Ended December 31,2003
    
    2002
    
    2001
    
    2000
    
    1999(Dollars in thousands, except per share data)Asset Quality Ratios (Restated) (4):Nonperforming assets to total loans and other real estate
    
    
    5.05
    %
    
    
    3.53
    %
    
    
    1.12
    %
    
    
    0.61
    %
    
    
    1.42
    %Nonperforming assets to total assets
    
    
    3.26
    
    
    
    2.23
    
    
    
    0.75
    
    
    
    0.40
    
    
    
    1.06Net loan charge-offs to total loans
    
    
    0.97
    
    
    
    0.49
    
    
    
    0.84
    
    
    
    1.19
    
    
    
    0.83Allowance for loan losses to total loans
    
    
    1.88
    
    
    
    1.91
    
    
    
    1.80
    
    
    
    1.91
    
    
    
    1.52Allowance for loan losses to nonperforming loans (2)
    
    
    40.64
    
    
    
    57.71
    
    
    
    196.06
    
    
    
    416.67
    
    
    
    115.03Capital Ratios (Restated) (4):Leverage ratio (3)
    
    
    9.08
    %
    
    
    8.78
    %
    
    
    9.11
    %
    
    
    8.56
    %
    
    
    8.93
    %Average shareholders equity to average total assets
    
    
    8.95
    
    
    
    9.03
    
    
    
    8.82
    
    
    
    7.73
    
    
    
    8.60Tier-1
risk-based capital ratio - period end
    
    
    12.73
    
    
    
    12.98
    
    
    
    12.77
    
    
    
    11.97
    
    
    
    11.60Total
risk-based capital ratio - period end
    
    
    13.98
    
    
    
    14.24
    
    
    
    14.03
    
    
    
    13.23
    
    
    
    12.85
   (1)
    
    Calculated by dividing total noninterest expense by net interest income plus noninterest income.(2)
    
    Nonperforming loans consist of nonaccrual loans, loans contractually past due 90 days or more and restructured loans.(3)
    
    The leverage ratio is calculated by dividing Tier 1 capital by average assets at period end.(4)
    
    See Note 2 to the consolidated financial statements. 
 Item 7.Managements Discussion and Analysis of Financial Condition and Results of Operations Managements Discussion and Analysis of Financial Condition and Results of
Operations of the Company analyzes the major elements of the Companys balance
sheets and statements of operations. This section should be read in
conjunction with the Companys Consolidated Financial Statements and
accompanying notes and other detailed information appearing elsewhere in this
document. For the Years Ended December 31, 2003, 2002 and 2001 Restatement of Financial
Statements The Company restated its financial statements for the years ended December
31, 2003, 2002, and 2001 to correct the amortization of net deferred loan fees to
interest income and to adjust accruals of other noninterest expense. The
restatement increased net income by $402,000, $181,000, and $277,000 for the
years ended December 31, 2003, 2002, and 2001, respectively, and increase
retained earnings by $2.2 million, $1.8 million, $1.6 million, and $1.3 million
at December 31, 2003, 2002, 2001, and 2000 respectively. The restatement resulted from a review of the Companys application of
FASB Statement No. 91, Accounting for Nonrefundable Fees and Costs Associated
with Originating or Acquiring Loans and Initial Direct Costs of Leases. Loan
fees net of the associated costs should be recognized over the life of
the related loan as an adjustment to yield. The Company recently discovered
that $4.0 million of net deferred loan fees were not being amortized to
interest income. These net deferred fees were not entered into the Companys
loan system, and therefore, amortization was not calculated each period.
Accordingly, the restatement reflects the amortization of these net deferred
fees which resulted in an increase to income of $357,000, $327,000, and $321,000
for the years ended December 31, 2003, 2002 and 2001, respectively.
Additionally, in connection with the restatement for net deferred fees, the
Company adjusted accruals of other noninterest expense previously deemed
immaterial which resulted in an increase to net income of $63,000 in 2003 and a
decrease to net income of $146,000 and $44,000 in 2002 and 2001,
respectively. See Note 2 to the consolidated financial
statements. As
a result, all amounts disclosed herein impacted by the restatement have been restated
accordingly. Overview The Company, primarily through the Bank, generates earnings from several
sources. First, the Bank attracts customer deposits through its fourteen
branches located in Houston and Dallas. The types of deposits vary from
noninterest-bearing demand deposit transaction accounts to interest-bearing NOW
and money market transaction accounts, savings accounts, and various termed
time deposits such as certificates of deposit (CDs) and individual
retirement accounts (IRAs). With the funds attracted from the communities
surrounding the branches, the Bank originates loans to individuals and small
businesses to finance business operations, purchases of real estate, or other
business opportunities. The Banks net interest income represents the
difference between the interest income earned on loans and securities and the
interest expense paid on customer deposits and other borrowed funds. Interest
rate fluctuations, as well as changes in the amount and type of earning assets
and liabilities, combine to affect net interest income. This represents the
primary source of income generated by the Bank during each fiscal year and can
be found on the Statement of Income under net interest income. To complement net interest income, the Bank also earns fee income from
both deposits and loans through service fees and charges collected from
customers. Generally, the Bank receives the greater portion of its fees from
its deposit customers in the form of service fees, NSF fees, and other fees for
services provided to the 15




---



##### Table of Contents



customer. Loan fees excluding deferred loan origination fees are generally
earned from late charges, administrative document and processing fees, and
other loan-related type fees. The fees collected by the Bank may be found on
the Statement of Income under noninterest income. The Bank may also generate earnings through the sale of loans and
securities which are categorized on the Balance Sheet as held-for-sale or
available-for-sale. While it is not uncommon to see such gains, they are
generally not consistent throughout the year. This inconsistency is directly
related to the availability and/or the market for these types of assets that
the bank might want to sell. Offsetting these earnings are operating expenses referred to as
noninterest expense. Because banking is a very people intensive industry,
the largest of the Banks operating expenses is salaries and benefits. Total
assets at December 31, 2003 were $867.0 million, an increase of $25.1
million or 3.0% compared to $841.9 million at December 31, 2002. Total loans
at December 31, 2003 were $557.1 million, an increase of $26.5 million or 5.0%
compared to $530.6 million at December 31, 2002. Investment securities at
December 31, 2003 were $262.3 million, down $2.1 million or 0.8% from $264.4
million at December 31, 2002. Total deposits at December 31, 2003 were $724.9
million, an increase of $33.5 million or 4.9% compared to $691.4 million at
December 31, 2002. Other borrowings at December 31, 2003 were $54.2 million,
down $11.6 million or 17.6% compared to $65.8 million at December 31, 2002. Total assets at December 31, 2002 were $841.9 million, an increase of
$98.2 million or 13.2% compared to $743.7 million at December 31, 2001. Growth
in loans and investment securities accounted for the majority of the Companys
asset growth during this period, increasing to $530.6 million and $264.4
million, respectively, at December 31, 2002 from $495.4 million and $176.2
million, respectively, at December 31, 2001. Supporting this growth was an
increase in deposits and other borrowings to $691.4 million and $65.8 million,
respectively, at December 31, 2002 from $642.8 million and $25.2 million,
respectively, at December 31, 2001, an increase of $48.6 million and $40.6
million, respectively. Shareholders equity at December 31, 2002 was $76.2
million, an increase of $9.4 million or 14.1% compared with $66.8 million at
December 31, 2001. Net income for the years ended December 31, 2003, 2002, and 2001 was $4.1
million, $9.0 million, and $7.9 million, respectively. Diluted earnings per
common share for the years ended December 31, 2003, 2002, and 2001 were $0.57,
$1.25, and $1.11, respectively. The Companys returns on average assets for
the years ended December 31, 2003, 2002, and 2001 were 0.48%, 1.13%, and 1.08,
respectively. The Companys returns on average equity for the same periods
were 5.38%, 12.55%, and 12.21%, respectively. The 2003 decreases in net
income, diluted earnings per share, return on average assets, and return on
average equity was primarily the result of lower net interest income, a higher
provision for loan losses, and lower of cost or market adjustments on loans
held-for-sale. The 2003 provision for loan losses was $5.7 million, up $1.8 million or
46.2% compared to $3.9 million in 2002. In 2003, management determined an
additional provision was needed primarily due to the results of continued asset
quality risk assessment procedures and a 5.0% increase in the loan portfolio.
The loan review process involves the grading of each loan by its respective
loan officer. Depending on the grade, a loan will be 16




---



##### Table of Contents



aggregated with other loans of similar grade and a loss factor is applied to
the total loans in each group to establish the required level of allowance for
loan losses. In June 2003 the Company transferred the status of approximately $13.1
million in hospitality-related loans to held-for-sale. While the Company has
not historically made such transfers, the high concentration of these loans was
deemed necessary to reduce the Companys exposure to credit risk. In August
2003, an additional $3.9 million in hospitality-related loans was transferred
to held-for-sale. Results of Operations Net Interest Income Net interest income represents the amount by which interest income on
interest-earning assets, including securities and loans, exceeds interest
expense incurred on interest-bearing liabilities, including deposits and other
borrowed funds. Interest income in 2003, was 9.9% lower than interest income in 2002, and
interest expense in 2003 was 17.0% lower than interest expense in 2002. Net
interest income for 2003 was 6.8 % lower than net interest income in 2002
primarily due to a decrease in the yield on earning assets of 112 basis points
that was partially offset by a decrease in the cost of interest-bearing
liabilities of 57 basis points. The lower net interest income in 2003,
compared to 2002, primarily reflects the current low interest rate environment,
refinancing activity on existing loans, and lower yields on new earning assets
(both loans and investments). The Federal Reserves interest rate reductions
in November 2002 and June 2003 contributed to the lower yields. However, the
effect of interest rate floors on approximately 64.7% of the loan portfolio
helped to soften the decline in yield on earning assets. The loans with
interest rate floors had a weighted average yield of approximately 5.88% at
December 31, 2003 compared to approximately 61.3% of the loan portfolio with
interest rate floors that had a weighted average yield of approximately 6.58%
at December 31, 2002. 2003 versus 2002.Net interest income in 2003 was $31.2 million compared with
$33.4 million in 2002, a decrease of $2.2 million or 6.6%. The decrease in net
interest income for 2003 was primarily due to a decrease of $4.8 million in
interest income that was partially offset by a decrease of $2.5 million in
interest expense. The net interest spread is the difference between the yield
on earning assets and the cost of interest-bearing liabilities. The net
interest spread in 2003 decreased 51 basis points to 3.34% compared to 3.85% in
2002. The decrease in the net interest spread reflects a decrease of 108 basis
points in the average yield on earning assets that was partially offset by a
decrease of 57 basis points in the average rate paid for interest-bearing
liabilities. The net interest margin is the difference between the yield on
earning assets and the cost of earning assets. The cost of earning assets is
annualized interest expense divided by average earning assets. The net
interest margin in 2003 decreased 63 basis points to 3.81% compared to 4.44% in
2002 and primarily reflects the 108 basis point decline in earning asset yield
that was partially offset by a decline in the cost of earning assets of 45
basis points. Interest income in 2003 was $43.3 million compared with $48.0 million in
2002, a decrease of $4.7 million or 9.8%. The decrease in interest income for
2003 was primarily due to the lower interest rate economy, a lower yield on
loans as a result of refinancing, increased nonaccrual loan balances, and lower
yields on the investment portfolio. Approximately 85.1% of the loans in the
loan portfolio have variable interest rates tied to the prime rate and are,
therefore, sensitive to interest rate movement. However, at December 31, 2003
approximately 64.7% of the loans in the loan portfolio had interest rate floors
with a weighted average yield of 5.88%. This was down 70 basis points from
6.58% at December 31, 2002, primarily as a result of new loans with floors at
lower interest rates in addition to refinanced floor rates on pre-existing
loans. These floor rates helped to partially offset the decline in loan
interest rate yield. The average yield on the total loan portfolio for 2003
was 6.29%, down 106 basis points compared to 7.35% in 2002. The average yield
on the investment portfolio for 2003 was 3.23%, down 115 basis points compared
to 4.38% in 2002. The yield on average earning assets for 2003 was 5.30%, down
108 basis points compared to 6.38% in 2002. Interest expense in 2003 was $12.1 million compared to $14.6 million in
2002, a decrease of $2.5 million or 17.0%. The decrease in interest expense
for 2003 was also primarily the result of lower interest rates paid for
interest-bearing liabilities in 2003. The average cost of interest-bearing
liabilities for 2003 was 1.96%, down 57 basis points compared to 2.53% in 2002. 2002 versus 2001.Net interest income in 2002 was $33.4 million compared
with $31.1 million in 2001, an increase of $2.3 million or 7.4%. The increase
in net interest income for 2002 was primarily due to a decrease of $9.1 million
in interest expense partially offset by a decrease of $6.7 million in interest
income. The net interest spread in 2002 improved 18 basis points to 3.85%
compared to 3.67% in 2001. The increase in the net interest 17




---



##### Table of Contents



spread reflects a decrease of 185 basis points in the average rate paid on
interest-bearing liabilities that was partially offset by a decrease of 167
basis points in the average yield on interest-earning assets. Interest rate
floors on approximately 61.3% of the loan portfolio helped curtail the decrease
in the average yield on total loans. The net interest margin in 2002 decreased
12 basis points to 4.44% compared to 4.56% in 2001 and was primarily due to the
refinancing of existing loans and the origination of new loans both at lower
interest rates. The Federal Reserves 50 basis point interest rate reduction
in November 2002 partially contributed to this decrease. Interest income in 2002 was $48.0 million compared with $54.9 million in
2001, a decrease of $6.9 million or 12.6%. The decrease in interest income in
2002 was primarily due to the lower interest rate economy, a lower yield on
loans as a result of refinancing, increased nonaccrual loan balances, and lower
yields on the investment portfolio. Approximately 84.0% of the loans in the
loan portfolio had variable interest rates tied to the prime rate and were,
therefore, sensitive to interest rate movement. However, at December 31, 2002
approximately 61.3% of the loans in the loan portfolio had interest rate floors
with a weighted average yield of 6.58%. This was down 117 basis points from
7.75% at December 31, 2001, primarily as a result of new loans with floors at
lower interest rates in addition to refinanced floor rates on pre-existing
loans. These floor rates helped to partially offset the decline in interest
rate yield and therefore, curtail the decline in interest income. The average
yield on the total loan portfolio for 2002 was 7.35%, down 177 basis points
compared to 9.12% in 2001. The average yield on the investment portfolio for
2002 was 4.38%, down 120 basis points compared to 5.58% in 2001. The yield on
average earning assets for 2002 was 6.38%, down 167 basis points compared to
8.05% in 2001. Interest expense in 2002 was $14.6 million compared to $23.8 million in
2001, a decrease of $9.2 million or 38.5%. The decrease in interest expense
for 2002 was also primarily the result of lower interest rates paid for
deposits in 2002. The average cost of interest-bearing liabilities for 2002
was 2.53%, down 185 basis points compared to 4.38% in 2001. 18




---



##### Table of Contents



The following table presents for the periods indicated the total dollar
amount of interest income from average interest-earning assets and the
resulting yields, as well as the interest expense on average interest-bearing
liabilities, expressed both in dollars and rates. No tax-equivalent
adjustments were made and all average balances are average daily balances.
Nonaccrual loans have been included in the table as loans carrying a zero
yield. Years Ended December 31,2003
    
    2002
    
    2001Average
    
    Interest
    
    Average
    
    Average
    
    Interest
    
    Average
    
    Average
    
    Interest
    
    AverageOutstanding
    
    Earned/
    
    Yield/
    
    Outstanding
    
    Earned/
    
    Yield/
    
    Outstanding
    
    Earned/
    
    Yield/Balance
    
    Paid
    
    Rate
    
    Balance
    
    Paid
    
    Rate
    
    Balance
    
    Paid
    
    Rate(Dollars in thousands)AssetsInterest-earning assets:Total loans
    
    $
    551,287
    
    
    $
    34,691
    
    
    
    6.29
    %
    
    $
    506,901
    
    
    $
    37,256
    
    
    
    7.35
    %
    
    $
    476,134
    
    
    $
    43,415
    
    
    
    9.12
    %Taxable securities
    
    
    227,054
    
    
    
    7,321
    
    
    
    3.22
    
    
    
    195,649
    
    
    
    9,080
    
    
    
    4.64
    
    
    
    132,366
    
    
    
    8,356
    
    
    
    6.31Tax-exempt securities
    
    
    20,095
    
    
    
    997
    
    
    
    4.96
    
    
    
    23,362
    
    
    
    1,160
    
    
    
    4.97
    
    
    
    23,491
    
    
    
    1,177
    
    
    
    5.01Federal funds sold and other temporary investments
    
    
    18,854
    
    
    
    278
    
    
    
    1.47
    
    
    
    25,843
    
    
    
    484
    
    
    
    1.87
    
    
    
    50,715
    
    
    
    1,992
    
    
    
    3.93Total interest-earning assets
    
    
    817,290
    
    
    
    43,287
    
    
    
    5.30
    %
    
    
    751,755
    
    
    
    47,980
    
    
    
    6.38
    %
    
    
    682,706
    
    
    
    54,940
    
    
    
    8.05
    %Less allowance for loan losses
    
    
    (10,595
    )
    
    
    
    
    
    
    
    
    
    
    (9,238
    )
    
    
    
    
    
    
    
    
    
    
    (9,315
    )Total interest-earning assets, net of allowance for
loan losses
    
    
    806,695
    
    
    
    
    
    
    
    
    
    
    
    742,517
    
    
    
    
    
    
    
    
    
    
    
    673,391Noninterest-earning assets
    
    
    46,251
    
    
    
    
    
    
    
    
    
    
    
    48,780
    
    
    
    
    
    
    
    
    
    
    
    55,216Total assets
    
    $
    852,946
    
    
    
    
    
    
    
    
    
    
    $
    791,297
    
    
    
    
    
    
    
    
    
    
    $
    728,607Liabilities and shareholders equityInterest-bearing liabilities:Interest-bearing demand deposits
    
    $
    73,987
    
    
    $
    460
    
    
    
    0.62
    %
    
    $
    71,059
    
    
    $
    837
    
    
    
    1.18
    %
    
    $
    54,694
    
    
    $
    1,209
    
    
    
    2.21
    %Saving and money market accounts
    
    
    111,867
    
    
    
    885
    
    
    
    0.79
    
    
    
    110,372
    
    
    
    1,378
    
    
    
    1.25
    
    
    
    102,268
    
    
    
    2,322
    
    
    
    2.27Time deposits
    
    
    371,500
    
    
    
    8,942
    
    
    
    2.41
    
    
    
    342,707
    
    
    
    10,595
    
    
    
    3.09
    
    
    
    360,370
    
    
    
    19,003
    
    
    
    5.27Federal funds purchased
    
    
    55
    
    
    
    1
    
    
    
    1.82
    
    
    
    162
    
    
    
    4
    
    
    
    2.47
    
    
    
    1
    
    
    
    
    
    
    
    Other borrowings
    
    
    60,255
    
    
    
    1,846
    
    
    
    3.06
    
    
    
    52,894
    
    
    
    1,814
    
    
    
    3.43
    
    
    
    25,570
    
    
    
    1,265
    
    
    
    4.95Total interest-bearing liabilities
    
    
    617,664
    
    
    
    12,134
    
    
    
    1.96
    %
    
    
    577,194
    
    
    
    14,628
    
    
    
    2.53
    %
    
    
    542,903
    
    
    
    23,799
    
    
    
    4.38
    %Noninterest-bearing liabilities:Noninterest-bearing demand deposits
    
    
    151,221
    
    
    
    
    
    
    
    
    
    
    
    132,686
    
    
    
    
    
    
    
    
    
    
    
    109,638Other liabilities
    
    
    7,728
    
    
    
    
    
    
    
    
    
    
    
    9,965
    
    
    
    
    
    
    
    
    
    
    
    11,737Total liabilities
    
    
    776,613
    
    
    
    
    
    
    
    
    
    
    
    719,845
    
    
    
    
    
    
    
    
    
    
    
    664,278Shareholders equity
    
    
    76,333
    
    
    
    
    
    
    
    
    
    
    
    71,452
    
    
    
    
    
    
    
    
    
    
    
    64,329Total liabilities and shareholders equity
    
    $
    852,946
    
    
    
    
    
    
    
    
    
    
    $
    791,297
    
    
    
    
    
    
    
    
    
    
    $
    728,607Net interest income
    
    
    
    
    
    $
    31,153
    
    
    
    
    
    
    
    
    
    
    $
    33,352
    
    
    
    
    
    
    
    
    
    
    $
    31,141Net interest spread
    
    
    
    
    
    
    
    
    
    
    3.34
    %
    
    
    
    
    
    
    
    
    
    
    3.85
    %
    
    
    
    
    
    
    
    
    
    
    3.67
    %Net interest margin
    
    
    
    
    
    
    
    
    
    
    3.81
    %
    
    
    
    
    
    
    
    
    
    
    4.44
    %
    
    
    
    
    
    
    
    
    
    
    4.56
    %
 19




---



##### Table of Contents



The following table presents the dollar amount of changes in interest
income and interest expense for the major components of interest-earning assets
and interest-bearing liabilities and distinguishes between changes in
outstanding balances and changes in interest rates. For purposes of this
table, changes attributable to both rate and volume have been allocated to each
accordingly. Years Ended December 31,2003 vs 2002
    
    2002 vs 2001Increase
    
    
    
    
    
    Increase(Decrease)
    
    
    
    
    
    (Decrease)Due to
    
    
    
    
    
    Due toVolume
    
    Rate
    
    Total
    
    Volume
    
    Rate
    
    Total(Dollars in thousands)Interest-earning assets:Loans
    
    $
    3,262
    
    
    $
    (5,827
    )
    
    $
    (2,565
    )
    
    $
    2,805
    
    
    $
    (8,964
    )
    
    $
    (6,159
    )Taxable securities
    
    
    1,457
    
    
    
    (3,216
    )
    
    
    (1,759
    )
    
    
    3,995
    
    
    
    (3,271
    )
    
    
    724Tax exempt securities
    
    
    (162
    )
    
    
    (1
    )
    
    
    (163
    )
    
    
    (6
    )
    
    
    (11
    )
    
    
    (17
    )Federal funds sold and other temporary investments
    
    
    (131
    )
    
    
    (75
    )
    
    
    (206
    )
    
    
    (977
    )
    
    
    (531
    )
    
    
    (1,508
    )Total
increase (decrease) in interest income
    
    
    4,426
    
    
    
    (9,119
    )
    
    
    (4,693
    )
    
    
    5,817
    
    
    
    (12,777
    )
    
    
    (6,960
    )Interest-bearing liabilities:Interest-bearing demand deposits
    
    
    34
    
    
    
    (411
    )
    
    
    (377
    )
    
    
    362
    
    
    
    (734
    )
    
    
    (372
    )Saving and money market accounts
    
    
    19
    
    
    
    (512
    )
    
    
    (493
    )
    
    
    184
    
    
    
    (1,128
    )
    
    
    (944
    )Time deposits
    
    
    890
    
    
    
    (2,543
    )
    
    
    (1,653
    )
    
    
    (931
    )
    
    
    (7,477
    )
    
    
    (8,408
    )Fed funds purchased
    
    
    (3
    )
    
    
    (0
    )
    
    
    (3
    )
    
    
    
    
    
    
    4
    
    
    
    4Other borrowings
    
    
    252
    
    
    
    (220
    )
    
    
    32
    
    
    
    1,352
    
    
    
    (803
    )
    
    
    549Total increase (decrease) in interest expense
    
    
    1,192
    
    
    
    (3,686
    )
    
    
    (2,494
    )
    
    
    967
    
    
    
    (10,138
    )
    
    
    (9,171
    )Increase (decrease) in net interest income
    
    $
    3,234
    
    
    $
    (5,433
    )
    
    $
    (2,199
    )
    
    $
    4,850
    
    
    $
    (2,639
    )
    
    $
    2,211
 Provision for Loan Losses Provisions for loan losses are charged to income to bring the Companys
allowance for loan losses to a target level based on the factors discussed
under  - Financial Condition- Allowance for Loan Losses. The 2003 provision for loan losses was $5.7 million, up by $1.8 million or
46.2% compared to $3.9 million in 2002. In 2003, management determined an
additional provision was needed primarily due to the results of continued asset
quality risk assessment procedures and a 5.0% increase in the loan portfolio.
The loan review process involves the grading of each loan by its respective
loan officer. Depending on the grade, a loan will be aggregated with other
loans of similar grade and a loss factor is applied to the total loans in each
group to establish the required level of allowance for loan losses. Grades of
1-10 are applied to each loan where grades of 7-10 require the most allowance
for loan losses. Factors utilized in the grading process include but are not
limited to historical performance, current status, collateral value, and
financial strength of the borrower. Oversight of the loan grades is vested
with the Loan Review/Compliance Officer. Differences of opinion are resolved
among the loan officer, compliance officer, and the chief credit officer. The ratio of the allowance for loan losses to total loans at December 31,
2003 was 1.88% compared with 1.91% and 1.80% at December 31, 2002 and 2001,
respectively. The Company strives to maintain its allowance for loan losses at
target levels commensurate with probable losses inherent in the loan portfolio.
Management conducts ongoing risk assessments that may, from time to time,
necessitate varying levels of allowance for loan losses based on these risk
assessments. Noninterest Income For the years ended December 31, 2003, 2002 and 2001, noninterest income
was $8.9 million, $9.0 million, and $8.7 million, respectively, reflecting a
decrease of approximately $40,000 in 2003 compared to 2002, and an increase of
$307,000 or 3.5% in 2002 compared to 2001. The service fees category of
noninterest income includes monthly account service charge assessments,
non-sufficient funds charges, and all other traditional non-lending bank
service fees. Service fees for 2003 were $6.5 million, down $126,000 primarily
due to less NSF related activity. Other loan-related fees for 2003 were $1.0
million, down $74,000 compared to $1.1 million in 2002 primarily due to a
decrease in mortgage brokerage fees of $187,000 that was partially offset by
increases in late charges and SBA servicing fees of $48,000 and $36,000,
respectively. The gain on sale of SBA loans in 2003 was approximately
$460,000, an increase of $139,000 compared with 2002. In addition,
gain on the sale of loans held-for-sale in 2003 was approximately
$140,000. The Company had no loans held-for-sale in 2002 or 2001. 20




---



##### Table of Contents



The following table presents the major categories of noninterest income: Years Ended December 31,2003
    
    2002
    
    2001(Dollars in thousands)Service fees
    
    $
    6,544
    
    
    $
    6,670
    
    
    $
    6,360Other loan-related fees
    
    
    1,009
    
    
    
    1,083
    
    
    
    936Letters of credit commissions and fees
    
    
    516
    
    
    
    610
    
    
    
    655Gain on sale of investment securities, net
    
    
    165
    
    
    
    34
    
    
    
    189Gain on sale of loans
    
    
    600
    
    
    
    322
    
    
    
    127Other noninterest income
    
    
    93
    
    
    
    248
    
    
    
    393Total noninterest income
    
    $
    8,927
    
    
    $
    8,967
    
    
    $
    8,660
 Noninterest Expense For the years ended December 31, 2003, 2002 and 2001, noninterest expense
was $28.5 million, $25.1 million, and $24.5 million, respectively, reflecting
an increase of approximately $3.4 million or 13.5% in 2003 compared to 2002,
and an increase of $600,000 or 2.5% in 2002 compared to 2001. The increase in total noninterest expense in 2003 compared to 2002 was
primarily due to $589,000 in higher employee salaries and benefits expense as a
result of annual salary adjustments and $2.1 million in lower of cost or market
adjustments on loans held-for-sale. Legal and professional fees in 2003,
compared to 2002, increased approximately $987,000 as a result of increased
costs related to matters concerning problem assets. Occupancy and equipment
expense in 2003, compared to 2002, increased approximately $272,000 and was
primarily the result of additional leased space in the corporate offices. The increase in total noninterest expense in 2002 compared to 2001 was
primarily due to higher employee salaries and benefits expense as a result of
increased staffing levels in lending operations and compliance functions in
addition to the full-year effect of executive level additions made during the
third and fourth quarters of 2001. With the exception of losses incurred on
net foreclosed assets, generally, all other categories of noninterest expense
decreased in 2002 compared to 2001. In June 2003, the Company transferred the status of approximately $13.1
million in hospitality-related loans to held-for-sale. While the Company has
not historically made such transfers, the high concentration of these loans was
deemed necessary to reduce the Companys exposure to credit risk. In August
2003, an additional $3.9 million composed of two restaurant loans totaling $2.6
million and an office building loan of $1.3 million, was transferred to
held-for-sale. Approximately $11.0 million of the loans-held-for-sale were
sold during 2003 and a gain of approximately $139,000 was recognized. The
remaining $6.0 million were held-for-sale at December 31, 2003 and are carried
at the lower of cost or market. During 2003, the Company recorded lower of
cost or market adjustments of $2.1 million on the loans held-for-sale. The
Company may consider future transfers with concentrations in hospitality and
other related loans that may expose the Company to potential losses. The efficiency ratio is a measure designed to show how well a company
utilizes its resources and manages its expenses. The efficiency ratio is
calculated by dividing noninterest expense by net interest income plus
noninterest income. The Companys efficiency ratio for 2003 was 71.22% and
reflects the impact of the lower of cost or market adjustments on loans
held-for-sale and the decline in the net interest margin. The Companys
efficiency ratio for 2002 was 59.20%, an improvement compared to 61.44% for
2001, primarily as a result of higher net interest income and higher
noninterest income. Salaries and employee benefits for the years ended December 31, 2003, 2002
and 2001 was $14.1 million, $13.5 million, and $12.2 million, respectively,
reflecting an increase of $589,000 or 4.4% in 2003 compared to 2002 and a $1.3
million or 10.7% increase in 2002 compared to 2001. The increase in 2003
versus 2002 primarily reflected the result of annual salary adjustments. The
increase in 2002 versus 2001 primarily reflected the full-year effect of
increased staffing levels in lending operations and compliance functions in
addition to the full-year effect of executive level additions made during the
third and fourth quarters of 2002. Total full-time equivalent employees
(FTE) at December 31, 2003, 2002 and 2001 were 299, 309, and 298,
respectively. Non-staff expenses for 2003, 2002 and 2001 were $14.4 million, $11.5
million, and $12.3 million, respectively, reflecting an increase of $2.9
million in 2003 compared to 2002 and a decrease of $738,000 in 2002 compared to
2001. 21




---



##### Table of Contents



The $2.9 million increase in non-staff expense during 2003 compared to
2002 was primarily due to the $2.1 million in lower of cost or market
adjustments on loans held-for-sale. Legal and professional fees increased
approximately $987,000 as a result of increased costs related to matters
concerning problem assets. Occupancy and equipment expense increased
approximately $272,000 and was primarily the result of additional lease space
in the corporate offices. The $738,000 decrease in non-staff expense during 2002 compared to 2001
was primarily due to lower legal and professional fees of $395,000, lower
occupancy expense of $100,000, and lower other noninterest expense of $555,000,
that was partially offset by higher net real estate expense of $415,000. The following table presents the major categories of noninterest expense: Years Ended December 31,2003
    
    2002
    
    2001(Dollars in thousands)Employee compensation and benefits
    
    $
    14,109
    
    
    $
    13,520
    
    
    $
    12,183Non-staff expenses:Lower of cost of market adjustment loan held-for-sale
    
    
    2,149
    
    
    
    
    
    
    
    Occupancy and equipment
    
    
    5,361
    
    
    
    5,089
    
    
    
    5,189Foreclosed assets, net
    
    
    248
    
    
    
    624
    
    
    
    209Data processing
    
    
    99
    
    
    
    94
    
    
    
    86Legal and professional fees
    
    
    1,555
    
    
    
    568
    
    
    
    963Advertising
    
    
    244
    
    
    
    314
    
    
    
    426Printing and supplies
    
    
    597
    
    
    
    572
    
    
    
    526Telecommunicaitons
    
    
    500
    
    
    
    578
    
    
    
    623Other noninterest expense
    
    
    3,683
    
    
    
    3,692
    
    
    
    4,247Total non-staff expenses
    
    
    14,436
    
    
    
    11,531
    
    
    
    12,269Total noninterest expenses
    
    $
    28,545
    
    
    $
    25,051
    
    
    $
    24,452
 Income Taxes Income tax expense includes the regular federal income tax at the
statutory rate plus the income tax component of the Texas franchise tax. The
amount of federal income tax expense is influenced by the amount of taxable
income, the amount of tax-exempt income, the amount of non-deductible interest
expense and the amount of other non-deductible expenses. Taxable income for
the income tax component of the Texas franchise tax is the federal pre-tax
income, plus certain officers salaries, less interest income on federal
securities. Income tax expense is influenced by the level and mix of taxable and
tax-exempt income and the amount of non-deductible interest and other expenses.
Income tax expense for 2003 was $1.7 million, down approximately $2.7 million
or 61.4% from income tax of $4.4 million in 2002. Income tax expense for 2002
was up approximately $749,000 or 20.3% from income tax expense of $3.7 million
in 2001. The effective income tax rates in 2003, 2002 and 2001 were 29.7%,
33.1%, and 32.0%, respectively. The effective income tax rate in 2003 was
lower due to a higher percentage of non-taxable income, primarily from
tax-exempt securities, to pre-tax income. The Texas franchise tax was $185,000, $57,000, and $345,800, in 2003,
2002, and 2001, respectively. In 2002, the Company received a franchise tax
refund as a result of a franchise tax audit conducted on tax years 1999, 2001,
and 2002. 22




---



##### Table of Contents



Impact of Inflation The effects of inflation on the local economy and on the Companys
operating results have been relatively modest for the past several years.
Since substantially all of the Companys assets and liabilities are monetary in
nature, such as cash, securities, loans and deposits, their values are less
sensitive to the effects of inflation than to changing interest rates, which do
not necessarily change in accordance with inflation rates. The Company tries
to control the impact of interest rate fluctuations by managing the
relationship between its interest rate sensitive assets and liabilities. See
-Financial Condition - Interest Rate Sensitivity and Liquidity. Financial Condition Loan Portfolio Total loans, which include approximately $6.0 million in loans
held-for-sale, were $557.1 million at December 31, 2003, up $26.5 million or
5.0% from $530.6 million at December 31, 2002. The increase in 2003
represented growth of $7.1 million in commercial and industrial loans, $18.8
million in real estate loans, and $161,000 in consumer and other loans. Total
loans were $530.6 million at December 31, 2002, an increase of $35.2 million or
7.1% from $495.4 million at December 31, 2001. The $35.2 million increase in
2002 compared to 2001 reflected increases of $12.5 million in commercial and
industrial loans, $23.3 million in real estate loans, that was partially offset
by a decrease of $1.1 million in consumer and other loans. For the years ended December 31, 2003, 2002, and 2001, the ratios of total
loans to total deposits were 76.9%, 76.7%, and 77.1%, respectively. For the
same periods, total loans represented 64.3%, 63.0%, and 66.6%, of total assets,
respectively. The following table summarizes the loan portfolio of the Company by type
of loan: As of December
31,2003
    
    2002
    
    2001
    
    2000
    
    1999Amount
    
    Percent
    
    Amount
    
    Percent
    
    Amount
    
    Percent
    
    Amount
    
    Percent
    
    Amount
    
    Percent(Dollars in thousands)Commercial and industrial
    
    $
    332,480
    
    
    
    59.36
    %
    
    $
    325,424
    
    
    
    60.94
    %
    
    $
    312,899
    
    
    
    62.67
    %
    
    $
    298,134
    
    
    
    60.92
    %
    
    $
    298,150
    
    
    
    59.55
    %Real estate mortgageResidential
    
    
    14,315
    
    
    
    2.56
    
    
    
    7,326
    
    
    
    1.37
    
    
    
    7,833
    
    
    
    1.57
    
    
    
    10,141
    
    
    
    2.07
    
    
    
    10,934
    
    
    
    2.18Commercial
    
    
    178,290
    
    
    
    31.83
    
    
    
    165,608
    
    
    
    31.01
    
    
    
    131,022
    
    
    
    26.24
    
    
    
    128,242
    
    
    
    26.20
    
    
    
    126,363
    
    
    
    25.24192,605
    
    
    
    34.39
    
    
    
    172,934
    
    
    
    32.38
    
    
    
    138,855
    
    
    
    27.81
    
    
    
    138,383
    
    
    
    28.27
    
    
    
    137,297
    
    
    
    27.42Real estate constructionResidential
    
    
    12,652
    
    
    
    2.26
    
    
    
    10,589
    
    
    
    1.99
    
    
    
    5,962
    
    
    
    1.19
    
    
    
    7,542
    
    
    
    1.54
    
    
    
    11,348
    
    
    
    2.27Commercial
    
    
    11,906
    
    
    
    2.12
    
    
    
    14,805
    
    
    
    2.76
    
    
    
    30,215
    
    
    
    6.05
    
    
    
    32,059
    
    
    
    6.55
    
    
    
    28,661
    
    
    
    5.7224,558
    
    
    
    4.38
    
    
    
    25,394
    
    
    
    4.75
    
    
    
    36,177
    
    
    
    7.24
    
    
    
    39,601
    
    
    
    8.09
    
    
    
    40,009
    
    
    
    7.99Consumer and other
    
    
    10,447
    
    
    
    1.87
    
    
    
    10,286
    
    
    
    1.93
    
    
    
    11,364
    
    
    
    2.28
    
    
    
    11,986
    
    
    
    2.45
    
    
    
    11,550
    
    
    
    2.31Factored receivables
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,297
    
    
    
    0.27
    
    
    
    13,700
    
    
    
    2.73Gross loans
    
    
    560,090
    
    
    
    100.00
    %
    
    
    534,038
    
    
    
    100.00
    %
    
    
    499,295
    
    
    
    100.00
    %
    
    
    489,401
    
    
    
    100.00
    %
    
    
    500,706
    
    
    
    100.00
    %Less: unearned discounts,
interest and
net deferred fees
    
    
    (2,954
    )
    
    
    
    
    
    
    (3,467
    )
    
    
    
    
    
    
    (3,854
    )
    
    
    
    
    
    
    (3,883
    )
    
    
    
    
    
    
    (3,776
    )Total loans
    
    $
    557,136
    
    
    
    
    
    
    $
    530,571
    
    
    
    
    
    
    $
    495,441
    
    
    
    
    
    
    $
    485,518
    
    
    
    
    
    
    $
    496,930
 Each of the following principal product lines is an outgrowth of the
Companys expertise in meeting the particular needs of the small and
medium-sized businesses and consumers in the multicultural communities it
serves: Commercial and Industrial Loans.The primary lending focus of the Company
is on loans to small and medium-sized businesses in a wide variety of
industries. The Companys commercial lending emphasis includes loans to
wholesalers, manufacturers and business service companies. A broad range of
short and medium-term commercial lending products are made available to
businesses for working capital (including inventory and accounts receivable),
purchases of equipment and machinery and business expansion (including
acquisitions of real estate and improvements). Generally, the Companys
commercial loans are underwritten on the basis of the borrowers ability to
service such debt as reflected by cash flow projections. Commercial loans are
generally collateralized by business assets, which may include accounts
receivable and inventory, certificates of deposit, securities, real estate,
guarantees or other collateral. The Company also generally obtains personal
guarantees from the principals of the business. Working capital loans are
primarily collateralized by short-term assets, whereas term loans are primarily
collateralized by long-term assets. As a result, commercial loans involve 23




---



##### Table of Contents



additional complexities, variables and risks and require more thorough
underwriting and servicing than other types of loans. Indigenous to
individuals in the Asian business community is the desire to own the building
and land which houses their businesses. Accordingly, while a loan may be
principally driven and classified by the type of business operated, real estate
is frequently the primary source of collateral. As of December 31, 2003,
approximately $229.4 million or 68.9% of the commercial and industrial loan
portfolio was collateralized by real estate. The Company continually monitors real estate value trends and takes
into consideration changes in market trends in its underwriting standards. As
of December 31, 2003, the Companys commercial and industrial loan portfolio
totaled $332.5 million or 59.4% of the gross loan portfolio. Commercial Mortgage Loans.In addition to commercial loans, the Company
makes commercial mortgage loans to finance the purchase of real property, which
generally consists of developed real estate. The Companys commercial mortgage
loans are collateralized by first liens on real estate, typically have variable
rates and amortize over a 15 to 20 year period with balloon payments due at the
end of five to seven years. Payments on loans collateralized by such
properties are dependent on the successful operation or management of the
properties. Accordingly, repayment of these loans may be subject to adverse
conditions in the real estate market or the economy to a greater extent than
other types of loans. In underwriting commercial mortgage loans, consideration
is given to the propertys historical cash flow, current and projected
occupancy, location and physical condition. The underwriting analysis also
includes credit checks, appraisals, environmental impact reports and a review
of the financial condition of the borrower. As of December 31, 2003, the
Company had a commercial mortgage portfolio of $178.3 million or 31.8% of the
gross loan portfolio. Construction Loans.The Company makes loans to finance the construction
of residential and non-residential properties. The substantial majority of the
Companys residential construction loans are for single-family dwellings that
are pre-sold or are under earnest money contracts. The Company also originates
loans to finance the construction of commercial properties such as
multi-family, office, industrial, warehouse and retail centers. Construction
loans involve additional risks attributable to the fact that loan funds are
advanced upon the security of a project under construction, and the project is
of uncertain value prior to its completion. Because of uncertainties inherent
in estimating construction costs, the market value of the completed project and
the effects of governmental regulation on real property, it can be difficult to
accurately evaluate the total funds required to complete a project and the
related loan to value ratio. As a result of these uncertainties, construction
lending often involves the disbursement of substantial funds with repayment
dependent, in part, on the success of the ultimate project rather than the
ability of a borrower or guarantor to repay the loan. If the Company is forced
to foreclose on a project prior to completion, there is no assurance that the
Company will be able to recover all of the unpaid portion of the loan. In
addition, the Company may be required to fund additional amounts to complete a
project and may have to hold the property for an indeterminable period of time.
While the Company has underwriting procedures designed to identify what it
believes to be acceptable levels of risks in construction lending, no assurance
can be given that these procedures will prevent losses from the risks described
above. As of December 31, 2003, the Company had a real estate construction
portfolio of $24.6 million or 4.4% of the gross loan portfolio, of which $12.7
million was residential and $11.9 million was commercial. Residential Mortgage Brokerage and Lending.The Company uses its existing
branch network to offer a complete line of single-family residential mortgage
products through third party mortgage companies. The Company specializes in
mortgages that conform with government sponsored programs, such as those
offered by Fannie Mae. The Company solicits and receives a fee to process
these residential mortgage loans, which are then underwritten and pre-sold to
third party mortgage companies. The Company does not fund or service these
loans. The volume of residential mortgage loans processed by the Company and
pre-sold to third party mortgage companies in 2003 was $20.0 million. Since
the Company does not fund these loans, there is no interest rate or credit risk
to the Company. The Company also makes five to seven year balloon residential
mortgage loans primarily collateralized by non-owner occupied residential
properties, which are retained in the Companys residential mortgage portfolio.
At December 31, 2003, the Companys residential mortgage portfolio totaled
$14.3 million. Government Guaranteed Small Business Lending.The Company has developed
an expertise in several government guaranteed lending programs in order to
provide credit enhancement to its commercial and industrial and mortgage
portfolio. As a Preferred Lender under the federally guaranteed SBA lending
program, the Companys pre-approved status allows it to quickly respond to
customers needs. Under this program, the Company originates and funds SBA 7-A
and 504 chapter loans qualifying for federal guarantees of 75% to 90% of
principal and accrued interest. Depending upon prevailing market conditions,
the Company may sell the guaranteed portion of these loans into the secondary
market with servicing retained. The Company specializes in SBA loans to
minority-owned businesses. As of December 31, 2003, the Company had $94.2
million in the retained portion of SBA loans, approximately $60.9 million of
which was guaranteed by the SBA. These loans are included in most all types of
loans such as commercial and industrial, real estate mortgage, and real estate
construction. 24




---



##### Table of Contents



For the SBAs fiscal year ended September 30, 2003, the Company was the
third largest SBA loan originator in the 32-county Houston SBA District in
terms of dollar volume. SBA loan originations were $25.7 million and $19.1
million for the years ended December 31, 2003 and 2002, respectively. Another
source of government guaranteed lending is B&I loans which are collateralized
by the U.S. Department of Agriculture and are available to borrowers in areas with a population of less than 50,000. The
Company also offers guaranteed loans through the OCCGF, which is sponsored by
the government of Taiwan. These loans are for people of Chinese decent or
origin, who are not mainland Chinese by birth and reside overseas. As of
December 31, 2003, the Companys OCCGF portfolio totaled $4.1 million. Trade Finance.Since its inception in 1987, the Company has originated
trade finance loans and letters of credit to facilitate export and import
transactions for small and medium-sized businesses. In this capacity, the
Company has worked with the Ex-Im Bank, an agency of the U.S. Government which
provides guarantees for trade finance loans. Trade finance credit facilities
rely heavily on the quality of the business customers accounts receivable and
the ability to perform the underlying transaction which, if monitored and
controlled properly, limits the financial risks to the Company associated with
this short-term financing. To mitigate the risk of nonpayment, the Company
generally obtains a governmental guaranty or credit insurance from a
governmental agency such as the Ex-Im Bank. As of December 31, 2003, the
Companys aggregate trade finance portfolio commitments totaled approximately
$7.3 million. Consumer Loans.The Company offers a wide variety of loan products to
retail customers through its branch network in Houston and Dallas. Loans to
retail customers include residential mortgage loans, residential construction
loans, automobile loans, lines of credit and other personal loans. The terms
of these loans typically range from 12 to 60 months depending on the nature of
the collateral and the size of the loan. The Company selectively extends credit for the purpose of establishing
long-term relationships with its customers. The Company mitigates the risks
inherent in lending by focusing on businesses and individuals with demonstrated
payment history, historically favorable profitability trends and stable cash
flows. In addition to these primary sources of repayment, the Company looks to
tangible collateral and personal guarantees as secondary sources of repayment.
Lending officers are provided with detailed underwriting policies covering all
lending activities in which the Company is engaged and that require all lenders
to obtain appropriate approvals for the extension of credit. The Company also
maintains documentation requirements and extensive credit quality assurance
practices in order to identify credit portfolio weaknesses as early as possible
so any exposures that are discovered may be reduced. Inherent in all lending is the risk of nonpayment. The types of
collateral required, the terms of the loans and the underwriting practices
discussed under each category above are all designed to minimize the risk of
nonpayment. In addition, as further risk protection, the Company rarely makes
loans at its legal lending limit. Although the Companys legal loan limit is
$11.8 million to one borrower, the Company generally does not make loans larger
than $6.0 million to one borrower. Loans are approved by lending officers
pursuant to a lending authorization schedule which is based on each loan
officers credit experience and portfolio. The Banks Loan Committee approves
loans between $1.5 million and $2.0 million. The Directors Credit Committee
approves loans over $2.0 million. Control systems and procedures are in place
to ensure all loans are approved in accordance with credit policies. The
Companys policies and procedures, discussed under Nonperforming Assets, are
designed to minimize the risk of nonpayment with respect to outstanding loans. 25




---



##### Table of Contents



The following table summarizes the industry concentrations (greater than
25% of capital) of the Companys loan portfolio at the dates
indicated, which includes gross loans of
$6.0 million held-for-sale at December 31, 2003: As of December 31,2003
    
    2002
    
    2001(Dollars in thousands)Hotels/motels
    
    $
    66,062
    
    
    $
    82,015
    
    
    $
    87,991Retail centers
    
    
    112,380
    
    
    
    103,623
    
    
    
    100,649Restaurants
    
    
    31,524
    
    
    
    33,094
    
    
    
    36,160Apartment buildings
    
    
    14,868
    
    
    
    14,941
    
    
    
    13,362Convenience stores/gasoline stations
    
    
    26,983
    
    
    
    27,383
    
    
    
    31,556All other
    
    
    308,273
    
    
    
    272,982
    
    
    
    229,577Gross loans
    
    $
    560,090
    
    
    $
    534,038
    
    
    $
    499,295
 The contractual maturity ranges of the commercial and industrial, real
estate, and consumer loan portfolios and the amount of such loans with
predetermined interest rates and floating rates in each maturity range as of
December 31, 2003 are summarized in the following table: As of December 31, 2003One
    
    After OneYear or
    
    Through
    
    After FiveLess
    
    Five Years
    
    Years
    
    Total(Dollars in thousands)Commercial and industrial
    
    $
    74,573
    
    
    $
    162,614
    
    
    $
    95,293
    
    
    $
    332,480Real estate mortgage:Residential
    
    
    5,263
    
    
    
    6,472
    
    
    
    2,580
    
    
    
    14,315Commercial
    
    
    25,556
    
    
    
    137,248
    
    
    
    15,486
    
    
    
    178,290Real estate construction:Residential
    
    
    8,909
    
    
    
    3,743
    
    
    
    
    
    
    
    12,652Commercial
    
    
    
    
    
    
    9,528
    
    
    
    2,378
    
    
    
    11,906Consumer
    
    
    1,592
    
    
    
    8,319
    
    
    
    536
    
    
    
    10,447Total
    
    $
    115,893
    
    
    $
    327,924
    
    
    $
    116,273
    
    
    $
    560,090Loans with a predetermined interest rate
    
    $
    27,384
    
    
    $
    42,172
    
    
    $
    13,880
    
    
    $
    83,436Loans with a floating interest rate
    
    
    88,509
    
    
    
    285,752
    
    
    
    102,393
    
    
    
    476,654Total
    
    $
    115,893
    
    
    $
    327,924
    
    
    $
    116,273
    
    
    $
    560,090
 Nonperforming Assets The Company believes that it has adequate loan procedures in place. These
procedures include the approval of lending policies and underwriting guidelines
by the Board of Directors, review of the loan portfolio by the Companys
internal loan review department (formally approved by the Board of Directors in
the fourth quarter of 2002 and established in January 2003), review of the loan
portfolio by an independent external loan review company as necessary, approval
from the Directors Credit Committee for large credit relationships, and
policy/administrative oversight by the Directors Loan Committee. The loan
review department reports credit risk grade changes on a monthly basis to
management and the Board of Directors. Facilitating the loan review process,
loan review and problem resolution personnel were added during the first and
second quarters of 2002. The Company performs monthly and quarterly
concentration analyses based on industries, collateral types, business lines,
large credit sizes and officer portfolio loads. There can be no assurance,
however, that the Companys loan portfolio will not become subject to
increasing pressures from deteriorating borrowers financial condition due to
general economic and other factors. While future deterioration in the loan
portfolio is possible, management is continuing its risk assessment and
resolution program. In addition, management is focusing its attention on
minimizing the Banks credit risk through more diversified business development
avenues. The Company generally places a loan on nonaccrual status and ceases
accruing interest when, in the opinion of management, full payment of loan
principal or interest is in doubt. All loans past due 90 days are placed on
nonaccrual status unless the loan is both well collateralized and in the
process of collection. Cash payments received while a loan is classified as
nonaccrual are recorded as a reduction of principal as long as 26




---



##### Table of Contents



significant doubt exists as to collection of the principal. In addition to
nonaccrual loans, the Company evaluates on an ongoing basis additional loans
which are potential problem loans as to risk exposure in determining the
adequacy of the allowance for loan losses. The Company reviews the real estate values, and when necessary, orders new
appraisals on loans collateralized by real estate when loans are renewed, prior
to foreclosure and at other times as necessary, particularly in problem loan
situations. In instances where updated appraisals reflect reduced collateral
values, an evaluation of the borrowers overall financial condition is made to
determine the need, if any, for possible write-downs or appropriate additions
to the allowance for loan losses. The Company records other real estate at
fair value at the time of acquisition less estimated costs to sell. A loan is considered impaired based on current information and events, if
it is probable that the Company will be unable to collect the scheduled
payments of principal or interest when due according to the contractual terms
of the loan agreement. The measurement of impaired loans is based on the
present value of expected future cash flows discounted at the loans effective
interest rate or the loans observable market price or based on the fair value
of the collateral if the loan is collateral-dependent. In addition to the Companys loan review process described in the
preceding paragraphs, the OCC periodically examines and evaluates national
banks. Based upon such an examination, the OCC may revalue the assets of the
institution and require that it charge-off certain assets, establish specific
reserves to compensate for the difference between the OCC-determined value and
the book value of such assets or take other regulatory action designed to
lessen the risk in the asset portfolio. The OCC is currently conducting its
annual examination of the Bank and while no such actions have been taken by the
OCC, no assurance can be provided that such actions will not occur in the
future. The OCC examination did not result in any adjustments to the allowance
for loan losses. 2003 versus 2002.Total nonperforming assets at December 31, 2003 and
2002 were $28.3 million and $18.8 million, respectively, an increase of $9.5
million. Nonaccrual loans at December 31, 2003 and 2002 were $25.4 million and
$17.2 million, respectively, an increase of $8.2 million. The increase in
nonperforming assets in 2003 compared to 2002 was primarily related to an $8.2
million increase in nonaccrual loans. The largest loan included in nonaccrual
loans at December 31, 2003 was a $5.3 million hotel loan which was placed on
nonaccrual status in the fourth quarter of 2003. The second largest is a $3.7
million commercial loan to a wholesale food distributor that was added to
nonaccrual status in the third quarter of 2002. While each of these loans are
continuing to make payments, they have been placed on nonaccrual status due to
uncertainty of future cash flows and the ability of the borrower to service the
debt. A restaurant loan in the amount of $3.6 million was added to nonaccrual
status in 2003 and is not current due to lack of payments. Had the total of
nonaccrual loans remained on an accrual basis, interest in the amount of
approximately $1.0 million and $657,000 would have been recorded on these loans
during the years ended December 31, 2003 and 2002, respectively. 2002 versus 2001.Total nonperforming assets at December 31, 2002 and
2001 were $18.8 million and $5.5 million, respectively, an increase of $13.3
million. Nonacccrual loans at December 31, 2002 and 2001 were $17.2 million
and $3.8 million, respectively, an increase of $13.4 million. The increase in
nonperforming assets and nonaccrual loans primarily occurred during the first
quarter of 2002 with approximately $9.0 million added to nonaccrual loans as
part of an identification process that represents an integral part of an
overall effort to improve credit quality. The largest of these loans were a
$3.2 million hotel loan, a $1.2 million entertainment facility, and two
restaurant loans of $1.4 million and $1.3 million. The $1.3 million restaurant
loan paid off in July 2002 and the $1.4 million loan was paid off in January
2003. During the third quarter of 2002, a $5.1 million commercial loan to a
wholesale food distributor was added to nonaccrual status. During the fourth
quarter of 2002, a $1.1 million hotel loan and a $1.0 million convenience store
loan were added to nonaccrual status. Had these nonaccrual loans remained on
an accrual basis, interest in the amount of approximately $657,000 and $202,000
would have been recorded on these loans during the years ended December 31,
2002 and 2001, respectively. Included in total nonperforming assets are the portions guaranteed by the
SBA, OCCGF and Ex-Im Bank, which totaled $3.3 million at December 31, 2003 and
2002. Nonperforming assets, net of their guaranteed portions, were $25.0
million and $15.5 million, for the same periods, respectively. The ratios for
net nonperforming assets to total loans and other real estate were 4.46% and
2.91% at December 31, 2003 and 2002, respectively. The ratios for net
nonperforming assets to total assets were 2.88% and 1.84%, for the same
periods, respectively. 27




---



##### Table of Contents



The following table presents information regarding nonperforming assets at
the periods indicated: As of December 31,2003
    
    2002
    
    2001
    
    2000
    
    1999(Dollars in thousands)Nonaccrual loans
    
    $
    25,442
    
    
    $
    17,209
    
    
    $
    3,758
    
    
    $
    2,225
    
    
    $
    6,552Accruing loans 90 days or more past due
    
    
    264
    
    
    
    380
    
    
    
    783
    
    
    
    
    
    
    
    Other real estate (ORE) and other assets repossessed (OAR)
    
    
    2,585
    
    
    
    1,190
    
    
    
    969
    
    
    
    757
    
    
    
    490Total nonperforming assets
    
    
    28,291
    
    
    
    18,779
    
    
    
    5,510
    
    
    
    2,982
    
    
    
    7,042Less: nonperforming loans guaranteed by the SBA, Ex-Im Bank,
or the OCCGF
    
    
    (3,323
    )
    
    
    (3,310
    )
    
    
    (1,833
    )
    
    
    (1,049
    )
    
    
    (1,821
    )Net nonperforming assets
    
    $
    24,968
    
    
    $
    15,469
    
    
    $
    3,677
    
    
    $
    1,933
    
    
    $
    5,221Total nonperforming assets to total loans and ORE/OAR
    
    
    5.05
    %
    
    
    3.53
    %
    
    
    1.11
    %
    
    
    0.61
    %
    
    
    1.42
    %Total nonperforming assets to total assets
    
    
    3.26
    %
    
    
    2.23
    %
    
    
    0.74
    %
    
    
    0.40
    %
    
    
    1.06
    %Net nonperforming assets to total loans and ORE/OAR
    
    
    4.46
    %
    
    
    2.91
    %
    
    
    0.71
    %
    
    
    0.40
    %
    
    
    1.05
    %Net nonperforming assets to total assets
    
    
    2.88
    %
    
    
    1.84
    %
    
    
    0.49
    %
    
    
    0.26
    %
    
    
    0.79
    %
 Allowance for Loan Losses The allowance for loan losses is a reserve established through charges to
earnings in the form of a provision for loan losses. Management has
established an allowance for loan losses which it believes is adequate to
absorb estimated losses inherent in the Companys loan portfolio. Based on an
evaluation of the loan portfolio, management presents a quarterly review of the
allowance for loan losses to the Companys Board of Directors, indicating any
change in the allowance since the last review and any recommendations as to
adjustments in the allowance. In making its evaluation, management considers
the diversification by industry of the Companys commercial loan portfolio, the
effect of changes in the local real estate market on collateral values, the
results of recent regulatory examinations, the effects on the loan portfolio of
current economic indicators and their probable impact on borrowers, the amount
of charge-offs for the period, the amount of nonperforming loans and related
collateral security and the evaluation of its loan portfolio by the independent
loan review function. Charge-offs occur when loans are deemed to be
uncollectible in whole or in part. The Company follows a loan review program to evaluate the credit risk in
the loan portfolio as discussed under Nonperforming Assets. Through the loan
review process, the Company maintains an internally classified loan list which,
along with the delinquency list of loans, helps management assess the overall
quality of the loan portfolio and the adequacy of the allowance for loan
losses. Loans classified as substandard are those loans with clear and
defined weaknesses such as a highly-leveraged position, unfavorable financial
ratios, uncertain repayment sources or poor financial condition, which may
jeopardize recoverability of the debt. Loans classified as doubtful are
those loans which have characteristics similar to substandard loans but with an
increased risk that a loss may occur, or at least a portion of the loan may
require a charge-off if liquidated at present. Although loans classified as
substandard do not duplicate loans classified as doubtful, both substandard and
doubtful loans include some loans that are delinquent at least 30 days or on
nonaccrual status. Loans classified as loss are those loans which are in the
process of being charged off. In addition to the internally classified loan list and delinquency list of
loans, the Company maintains a separate watch list which further aids the
Company in monitoring loan portfolios. Watch list loans show warning elements
where the present status portrays one or more deficiencies that require
attention in the short-term or where pertinent ratios of the loan account have
weakened to a point where more frequent monitoring is warranted. These loans
do not have all of the characteristics of a classified loan (substandard or
doubtful) but do show weakened elements compared with those of a satisfactory
credit. The Company reviews these loans to assist in assessing the adequacy of
the allowance for loan losses. In order to determine the adequacy of the allowance for loan losses,
management establishes specific allowances for loans which management believes
require reserves greater than those allocated according to their classification
or the delinquent status of specific loans. Management then considers the risk
classification or delinquency status of the remaining portfolio and other
factors, such as collateral value, portfolio composition, trends in economic
conditions and the financial strength of borrowers. The Company then charges
to operations a provision for loan losses to maintain the allowance for loan
losses at a level determined by the foregoing methodology. The Company allocates the allowance for loan losses according to
managements assessments of risk inherent in the portfolio. In addition, on
July 6, 2002, the Securities and Exchange Commission released Staff Accounting
Bulletin (SAB) No. 102, Selected Loan Loss Allowance Methodology and
Documentation Issues, 28




---



##### Table of Contents



which requires companies to have adequate documentation on the development and
application of a systematic methodology in determining allowance for loan
losses. The following table presents an analysis of the allowance for loan losses
and other related data: As of and for the Years Ended December 31,2003
    
    2002
    
    2001
    
    2000
    
    1999(Dollars in thousands)Average total loans outstanding
    
    $
    551,287
    
    
    $
    506,901
    
    
    $
    476,134
    
    
    $
    487,439
    
    
    $
    457,284Total loans outstanding at end of period
    
    $
    557,137
    
    
    $
    530,571
    
    
    $
    495,441
    
    
    $
    485,518
    
    
    $
    496,930Allowance for loan losses at beginning of period
    
    $
    10,150
    
    
    $
    8,903
    
    
    $
    9,271
    
    
    $
    7,537
    
    
    $
    6,119Provision for loan losses
    
    
    5,690
    
    
    
    3,853
    
    
    
    3,799
    
    
    
    7,508
    
    
    
    5,550Charge-offs:Commercial and industrial
    
    
    (5,173
    )
    
    
    (2,721
    )
    
    
    (4,075
    )
    
    
    (1,479
    )
    
    
    (3,563
    )Real estate - mortgage
    
    
    (755
    )
    
    
    (271
    )
    
    
    
    
    
    
    (23
    )
    
    
    (32
    )Real estate - construction
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Consumer and other
    
    
    (193
    )
    
    
    (132
    )
    
    
    (201
    )
    
    
    (5,524
    )
    
    
    (807
    )Total charge-offs
    
    
    (6,121
    )
    
    
    (3,124
    )
    
    
    (4,276
    )
    
    
    (7,026
    )
    
    
    (4,402
    )Recoveries:Commercial and industrial
    
    
    593
    
    
    
    450
    
    
    
    54
    
    
    
    901
    
    
    
    94Real estate - mortgage
    
    
    100
    
    
    
    20
    
    
    
    11
    
    
    
    8
    
    
    
    Real estate - construction
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Consumer and other
    
    
    36
    
    
    
    48
    
    
    
    44
    
    
    
    343
    
    
    
    176Total recoveries
    
    
    729
    
    
    
    518
    
    
    
    109
    
    
    
    1,252
    
    
    
    270Net loan charge-offs
    
    
    (5,392
    )
    
    
    (2,606
    )
    
    
    (4,167
    )
    
    
    (5,774
    )
    
    
    (4,132
    )Allowance for loan losses at end of period
    
    $
    10,448
    
    
    $
    10,150
    
    
    $
    8,903
    
    
    $
    9,271
    
    
    $
    7,537Ratio of allowance to end of period total loans
    
    
    1.88
    %
    
    
    1.91
    %
    
    
    1.80
    %
    
    
    1.91
    %
    
    
    1.52
    %Ratio of net loan charge-offs to end of period total loans
    
    
    0.97
    %
    
    
    0.49
    %
    
    
    0.84
    %
    
    
    1.19
    %
    
    
    0.83
    %Ratio of allowance to end of period nonperforming loans
    
    
    40.64
    %
    
    
    57.71
    %
    
    
    196.06
    %
    
    
    416.67
    %
    
    
    115.03
    %
 For the years ended December 31, 2003, 2002, and 2001, net loan charge-offs
were $5.4 million, $2.6 million, and $4.2 million, respectively. The
significant charge-offs for the year 2003 were primarily related to the
hospitality industry where approximately $3.0 million was charged off. The
largest charge-off in this category was $1.9 million on a hospitality loan that
was subsequently foreclosed and as of March 2, 2004 has a sale pending. The
second largest charge-off in this category was approximately $659,000 on a
hospitality loan that was subsequently transferred to loans held-for-sale.
Approximately $612,000 in charge-offs was related to the wholesale trade
business, where the largest charge-off was $404,000. Charge-offs related to
the restaurant business were approximately $448,000, with the largest
charge-off being $220,000. The significant charge-offs for the year 2002 were related to the
restaurant and grocery categories. Approximately $1.0 million in charge-offs
was related to full-service restaurants and approximately $572,000 was related
to the grocery category. The largest individual charge-off for 2002 totaled
approximately $250,000. Of the $4.2 million in charge-offs in 2001, $3.0
million was charged-off in the fourth quarter following a significant review of
the loan portfolio. The significant charge-offs included in the $3.0 million
were related to twelve credits, with the two largest being commercial operating
lines of credit of $1.0 million and $900,000. The ratios of net loan charge-offs to total loans outstanding for the
years ended December 31, 2003, 2002, and 2001, were 0.97%, 0.49%, and 0.84%,
respectively. The Company seeks recovery on its charge-offs through all
available channels. At December 31, 2003, 2002, and 2001, the allowance for
loan losses aggregated $10.4 million, $10.2 million, and $8.9 million,
respectively, or 1.88%, 1.91%, and 1.80% of total loans, respectively. 29




---



##### Table of Contents



The following table describes the allocation of the allowance for loan
losses among various categories of loans and certain other information. The
allocation is made for analytical purposes and is not necessarily indicative of
the categories in which future losses may occur. The total allowance is
available to absorb losses from any segment of the credit portfolio. As of December 31,2003
    
    2002
    
    2001
    
    2000
    
    1999Percent
    
    
    
    
    
    Percent
    
    
    
    
    
    Percent
    
    
    
    
    
    Percent
    
    
    
    
    
    Percentof Loans
    
    
    
    
    
    of Loans
    
    
    
    
    
    of Loans
    
    
    
    
    
    of Loans
    
    
    
    
    
    of Loansto Gross
    
    
    
    
    
    to Gross
    
    
    
    
    
    to Gross
    
    
    
    
    
    to Gross
    
    
    
    
    
    to GrossAmount
    
    Loans
    
    Amount
    
    Loans
    
    Amount
    
    Loans
    
    Amount
    
    Loans
    
    Amount
    
    Loans(Dollars in thousands)Balance of allowance for loan
losses applicable to:Commercial and industrial
    
    $
    6,281
    
    
    
    59.36
    %
    
    $
    6,383
    
    
    
    60.94
    %
    
    $
    5,054
    
    
    
    62.67
    %
    
    $
    4,814
    
    
    
    60.92
    %
    
    $
    3,783
    
    
    
    59.55
    %Real estate - mortgage
    
    
    2,460
    
    
    
    34.39
    
    
    
    2,285
    
    
    
    32.38
    
    
    
    1,947
    
    
    
    27.81
    
    
    
    758
    
    
    
    28.27
    
    
    
    823
    
    
    
    27.42Real estate - construction
    
    
    267
    
    
    
    4.38
    
    
    
    355
    
    
    
    4.75
    
    
    
    274
    
    
    
    7.24
    
    
    
    230
    
    
    
    8.09
    
    
    
    204
    
    
    
    7.99Consumer and other
    
    
    101
    
    
    
    1.87
    
    
    
    136
    
    
    
    1.93
    
    
    
    686
    
    
    
    2.28
    
    
    
    444
    
    
    
    2.45
    
    
    
    357
    
    
    
    2.31Factored receivables
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    20
    
    
    
    0.27
    
    
    
    243
    
    
    
    2.73Unallocated
    
    
    1,339
    
    
    
    
    
    
    
    991
    
    
    
    
    
    
    
    942
    
    
    
    
    
    
    
    3,005
    
    
    
    
    
    
    
    2,127
    
    
    
    Total allowance for loan losses
    
    $
    10,448
    
    
    
    100.00
    %
    
    $
    10,150
    
    
    
    100.00
    %
    
    $
    8,903
    
    
    
    100.00
    %
    
    $
    9,271
    
    
    
    100.00
    %
    
    $
    7,537
    
    
    
    100.00
    %
 The level of allowance for loan losses has remained relatively constant in
2003 and 2002 even though net charge-offs have increased. This is primarily
due to loans being charged down to their collateral value where there has been
no further deterioration. In addition, the Company has observed a slowing in
the migration of loans requiring charge-off. While nonaccrual loans increased
in 2003, no corresponding increase in the allowance for loan losses was
required since collateral values were able to support the loan balances. Also,
many of the loans on nonaccrual are paying as agreed but were placed on
nonaccrual due to the uncertainty that the borrowers will continue making loan
payments. Securities The Company uses its securities portfolio primarily as a source of income
and secondarily as a source of liquidity. At December 31, 2003, the fair value
of securities net of the Federal Home Loan Bank (FHLB) and Federal Reserve
Bank stock was $257.1 million, a decrease of $3.0 million or 1.1% from the fair
value of net securities at December 31, 2002. The decrease in 2003 was
primarily the result of excess liquidity created from increased deposits that
was reinvested into loans rather than securities. At December 31, 2002, the
fair value of securities net of FHLB and Federal Reserve Bank stock totaled
$260.0 million, an increase of $86.9 million or 50.2% from $173.1 million at
December 31, 2001. The increase in 2002 was primarily due to liquidity created
from increased deposits and loan prepayments in excess of loan funding
requirements. At the date of purchase, the Company is required to classify debt and
equity securities into one of three categories: held-to-maturity, trading or
available-for-sale. At each reporting date, the appropriateness of the
classification is reassessed. Investments in debt securities are classified as
held-to-maturity and measured at amortized cost in the financial statements
only if management has the positive intent and ability to hold those securities
to maturity. The Company does not have a trading account. Investments not
classified as either held-to-maturity or trading are classified as
available-for-sale and measured at fair value in the financial statements with
unrealized gains and losses reported, net of tax, as a component of accumulated
other comprehensive income in shareholders equity until realized. On January
1, 2001, the Company reclassified its held-to-maturity investment securities to
the available-for-sale category as allowed under SFAS 133. The adoption of
SFAS 133 allowed this one-time reclassification of securities between
held-to-maturity and available-for-sale. 30




---



##### Table of Contents



The following table presents the amortized cost of securities classified
as available-for-sale and their approximate fair values as of the date shown: As of December 31, 2003
    
    As of December 31, 2002Gross
    
    Gross
    
    
    
    
    
    
    
    
    
    Gross
    
    GrossAmortized
    
    Unrealized
    
    Unrealized
    
    
    
    
    
    Amortized
    
    Unrealized
    
    UnrealizedCost
    
    Gain
    
    Loss
    
    Fair Value
    
    Cost
    
    Gain
    
    Loss
    
    Fair Value(Dollars in thousands)U.S. Treasury securities and obligations
of U.S. government agencies
    
    $
    4,965
    
    
    $
    
    
    
    $
    (12
    )
    
    $
    4,953
    
    
    $
    2,488
    
    
    $
    50
    
    
    $
    
    
    
    $
    2,538Obligations of state and political
subdivisions
    
    
    18,925
    
    
    
    1,249
    
    
    
    
    
    
    
    20,174
    
    
    
    22,059
    
    
    
    591
    
    
    
    (2
    )
    
    
    22,648Mortgage-backed securities and
collateralized mortgage obligations
    
    
    209,323
    
    
    
    1,170
    
    
    
    (1,254
    )
    
    
    209,239
    
    
    
    180,599
    
    
    
    2,862
    
    
    
    (151
    )
    
    
    183,310Other debt securities
    
    
    1,096
    
    
    
    3
    
    
    
    (10
    )
    
    
    1,089
    
    
    
    2,378
    
    
    
    33
    
    
    
    (20
    )
    
    
    2,391Investment in an ARM and CRA funds
    
    
    21,739
    
    
    
    73
    
    
    
    (203
    )
    
    
    21,609
    
    
    
    48,982
    
    
    
    169
    
    
    
    
    
    
    
    49,151FHLB/Federal Reserve Bank Stock
    
    
    5,200
    
    
    
    
    
    
    
    
    
    
    
    5,200
    
    
    
    4,380
    
    
    
    
    
    
    
    
    
    
    
    4,380Total securities
    
    $
    261,248
    
    
    $
    2,495
    
    
    $
    (1,479
    )
    
    $
    262,264
    
    
    $
    260,886
    
    
    $
    3,705
    
    
    $
    (173
    )
    
    $
    264,418
 As of December 31, 2001Gross
    
    GrossAmortized
    
    Unrealized
    
    UnrealizedCost
    
    Gain
    
    Loss
    
    Fair Value(Dollars in thousands)U.S. Treasury securities and obligations
of U.S. government agencies
    
    $
    2,453
    
    
    $
    122
    
    
    $
    
    
    
    $
    2,575Obligations of state and political
subdivisions
    
    
    25,045
    
    
    
    183
    
    
    
    (589
    )
    
    
    24,639Mortgage-backed securities and
collateralized mortgage obligations
    
    
    138,696
    
    
    
    1,561
    
    
    
    (671
    )
    
    
    139,586Other debt securities
    
    
    3,229
    
    
    
    20
    
    
    
    (57
    )
    
    
    3,192Investment in an ARM and CRA funds
    
    
    3,094
    
    
    
    1
    
    
    
    
    
    
    
    3,095FHLB/Federal Reserve Bank Stock
    
    
    3,143
    
    
    
    
    
    
    
    
    
    
    
    3,143Total securities
    
    $
    175,660
    
    
    $
    1,887
    
    
    $
    (1,317
    )
    
    $
    176,230
 The following table summarizes the contractual maturity of investment
securities at amortized cost and their weighted average yields. No
tax-equivalent adjustments were made. As of December 31, 2003After One Year
    
    After Five YearsWithin One
    
    But Within Five
    
    But Within TenYear
    
    Years
    
    Years
    
    After Ten Years
    
    TotalAmount
    
    Yield
    
    Amount
    
    Yield
    
    Amount
    
    Yield
    
    Amount
    
    Yield
    
    Amount
    
    Yield(Dollars in thousands)U.S. Treasury securities and obligations of
U.S. government agencies
    
    $
    
    
    
    
    
    %
    
    $
    4,965
    
    
    
    4.37
    %
    
    $
    
    
    
    
    
    %
    
    $
    
    
    
    
    
    %
    
    $
    4,965
    
    
    
    4.37
    %Obligations of state and political
subdivisions
    
    
    185
    
    
    
    4.86
    
    
    
    3,321
    
    
    
    5.14
    
    
    
    2,140
    
    
    
    4.74
    
    
    
    13,279
    
    
    
    5.13
    
    
    
    18,925
    
    
    
    5.09Mortgage-backed securities and
collateralized mortgage obligations
    
    
    
    
    
    
    
    
    
    
    2,650
    
    
    
    4.93
    
    
    
    52,413
    
    
    
    4.16
    
    
    
    154,260
    
    
    
    3.81
    
    
    
    209,324
    
    
    
    3.91Other debt securities
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    53
    
    
    
    4.97
    
    
    
    1,043
    
    
    
    4.60
    
    
    
    1,096
    
    
    
    4.62Investment in ARM and CRA funds
    
    
    18,430
    
    
    
    3.60
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    3,309
    
    
    
    4.55
    
    
    
    21,739
    
    
    
    3.75FHLB and Federal Reserve Bank stock (1)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    5,200
    
    
    
    3.00
    
    
    
    5,200
    
    
    
    3.00Total securities
    
    $
    18,615
    
    
    
    3.61
    %
    
    $
    10,936
    
    
    
    4.74
    %
    
    $
    54,606
    
    
    
    4.18
    %
    
    $
    177,091
    
    
    
    3.90
    %
    
    $
    261,248
    
    
    
    3.98
    %
   (1)
    
    FHLB and Federal Reserve Bank stock do not have
maturities. 31




---



##### Table of Contents



The following table summarizes the fair value and classification of
securities: As of December 31,2003
    
    2002
    
    2001(Dollars in thousands)Available-for-sale
    
    $
    262,264
    
    
    $
    264,418
    
    
    $
    176,230Held-to maturity
    
    
    
    
    
    
    
    
    
    
    Total securities
    
    $
    262,264
    
    
    $
    264,418
    
    
    $
    176,230
 The securities portfolio includes mortgage-backed securities which have
been developed by pooling a number of real estate mortgages and are principally
issued by federal agencies such as Fannie Mae, Freddie Mac and Ginnie Mae.
These securities are deemed to have high credit ratings, and certain minimum
levels of regular monthly cash flows of principal and interest are insured or
guaranteed by the issuing agencies. Included in the Companys mortgage-backed
securities at December 31, 2003, 2002 and 2001, were $77.7 million, $100.2
million, and $89.2 million, respectively, in agency-issued collateral mortgage
obligations (CMOs). As of December 31, 2003, 2002 and 2001, 73.7%, 80.2%, and 81.1%,
respectively, of the mortgage-backed securities held by the Company had final
maturities of more than ten years. However, unlike U.S. Treasury and U.S.
Government agency securities, which have a lump sum payment at maturity,
mortgage-backed securities provide cash flows from regular principal and
interest payments and principal prepayments throughout the lives of the
securities. Mortgage-backed securities which are purchased at a premium will
generally suffer decreasing net yields as interest rates drop because
homeowners tend to refinance their mortgages. Thus, the premium paid must be
amortized over a shorter period. Therefore, securities purchased at a discount
will obtain higher net yields in a decreasing interest rate environment. As
interest rates rise, the opposite will generally be true. During a period of
increasing interest rates, fixed rate mortgage-backed securities do not tend to
experience heavy prepayments of principal and consequently, the average life of
this security will not be unduly shortened. Additionally, the value of
mortgage-backed securities generally decreases as interest rates increase. At
December 31, 2003, approximately $9.0 million or 4.3% of the Companys
mortgage-backed securities earn interest at floating rates and reprice within
one year, and accordingly are less susceptible to declines in value should
interest rates increase. CMOs are bonds that are backed by pools of mortgages. The pools can be Ginnie
Mae, Fannie Mae, or Freddie Mac pools or they can be private-label pools. The
CMOs are designed so that the mortgage collateral will generate a cash flow
sufficient to provide for the timely repayment of the bonds. The mortgage
collateral pool can be structured to accommodate various desired bond repayment
schedules, provided that the collateral cash flow is adequate to meet scheduled
bond payments. This is accomplished by dividing the bonds into classes to
which payments on the underlying mortgage pools are allocated in different
order. The bonds cash flow, for example can be dedicated to one class of
bondholders at a time, thereby increasing call protection to bondholders. In
private-label CMOs, losses on underlying mortgages are directed to the most
junior of all classes and then to the classes above in order of increasing
seniority, which means that the senior classes have enough credit protection to
be given the highest credit rating by the rating agencies. Deposits The Companys lending and investing activities are funded principally by
deposits. At December 31, 2003, 49.9% of the Companys total deposits were
interest-bearing certificates of deposit (CDs), 26.8% were interest-bearing
savings, NOW, and money market accounts and 23.3% were noninterest-bearing
demand deposit accounts. Total deposits at December 31, 2003 were $724.9
million compared with $691.4 million at December 31, 2002 and $642.8 million at
December 31, 2001. This represents annual increases over the two-year period
of $33.5 million or 4.9% and $48.6 million or 7.6%, respectively. Average noninterest-bearing demand deposits for the year ended December
31, 2003 were $151.2 million, an increase of $18.5 million or 13.9%, compared
with $132.7 million for the same period in 2002. Average
noninterest-bearing demand deposits for the year ended December 31, 2002
compared with the same period in 2001 increased $23.1 million or 21.1% from
$109.6 million. Average interest-bearing deposits for the year ended December 31, 2003
were $557.4 million, an increase of $33.3 million or 6.4%, compared with $524.1
million for the same period in 2002. Average interest-bearing deposits for the
year ended December 31, 2002 compared with the same period in 2001 increased
$6.8 million or 1.3% from $517.3 million. 32




---



##### Table of Contents



Average total deposits for the year ended December 31, 2003 were $708.6
million, an increase of $51.8 million or 7.9%, compared with $656.8 million for
the same period in 2002. Average total deposits for the year ended December
31, 2002 compared with the same period in 2001 increased $29.9 million or 4.8%. The increases in deposits during 2003 and 2002 were primarily the result
of continued relationship banking initiatives. The Companys ratio of
average noninterest-bearing demand deposits to average total deposits for the
years ended December 31, 2003, 2002 and 2001 was 21.3%, 20.2%, and 17.5%,
respectively. As part of its effort to cross-sell its products and services, the Company
actively solicits time deposits from existing customers. In addition, the
Company receives time deposits from government municipalities and utility
districts as well as from corporations seeking to place deposits in
minority-owned businesses, such as the Company. These time deposits typically
renew at maturity and have provided a stable source of funds. The Company
believes that based on its historical experience its large time deposits have
core-type characteristics. In pricing its time deposits, the Company seeks to
be competitive but typically prices near the middle of a given market. The average daily balances and weighted average rates paid on deposits for
each of the years ended December 31, 2003, 2002 and 2001 are presented below: Years Ended December 31,2003
    
    2002
    
    2001Amount
    
    Rate
    
    Amount
    
    Rate
    
    Amount
    
    Rate(Dollars in thousands)Interest-bearing deposits:Money market checking
    
    $
    73,987
    
    
    
    0.62
    %
    
    $
    71,059
    
    
    
    1.18
    %
    
    $
    54,694
    
    
    
    2.21
    %Savings and money market deposits
    
    
    111,867
    
    
    
    0.79
    
    
    
    110,372
    
    
    
    1.25
    
    
    
    102,268
    
    
    
    2.27Time deposits less than $100,000
    
    
    169,314
    
    
    
    2.19
    
    
    
    176,941
    
    
    
    2.69
    
    
    
    182,588
    
    
    
    5.13Time deposits $100,000 and over
    
    
    202,186
    
    
    
    2.59
    
    
    
    165,766
    
    
    
    3.52
    
    
    
    177,782
    
    
    
    5.42Total interest-bearing deposits
    
    
    557,354
    
    
    
    1.85
    
    
    
    524,138
    
    
    
    2.44
    
    
    
    517,332
    
    
    
    4.36Non interest-bearing deposits
    
    
    151,221
    
    
    
    
    
    
    
    132,686
    
    
    
    
    
    
    
    109,638
    
    
    
    Total deposits
    
    $
    708,575
    
    
    
    1.45
    %
    
    $
    656,824
    
    
    
    1.95
    %
    
    $
    626,970
    
    
    
    3.59
    %
 The following table sets forth the amount of the Companys time deposits
that are $100,000 or greater by time remaining until maturity: As ofDecember 31, 2003(Dollars in thousands)Three months or less
    
    $
    44,829Over three through six months
    
    
    37,295Over six through 12 months
    
    
    65,241Over 12 months
    
    
    46,544Total
    
    $
    193,909
 Other Borrowings Other borrowings include $25.0 million of loans from the FHLB of Dallas,
maturing in September 2008. The loans bear interest at an average rate of
4.99% per annum until the fifth anniversary at which time they may be repaid or
the interest rate may be renegotiated. Other borrowings also include several FHLB advances obtained in 2002 and
2003 to acquire mortgage-related securities in order to increase earning
assets. These borrowings were $28.3 million at December 31, 2003 with
maturities ranging from one month to five years and carried a weighted average
interest rate of 1.52%. Additionally, the Company had several unused, uncollateralized lines of
credit with correspondent banks totaling $15.0 million at December 31, 2003,
2002, and 2001, respectively. 33




---



##### Table of Contents



The following table presents the categories of other borrowings by the
Company: As of December 31,2003
    
    2002
    
    2001(Dollars in thousands)Federal funds purchased:on December 31,
    
    $
    
    
    
    $
    
    
    
    $
    average during the year
    
    
    55
    
    
    
    162
    
    
    
    1maximum month end balance during the year
    
    
    
    
    
    
    
    
    
    
    FHLB notes:on December 31,
    
    $
    53,300
    
    
    $
    65,200
    
    
    $
    25,000average during the year
    
    
    59,667
    
    
    
    52,343
    
    
    
    25,000maximum month end balance during the year
    
    
    69,300
    
    
    
    69,700
    
    
    
    25,000Other short-term borrowings:on December 31,
    
    $
    873
    
    
    $
    574
    
    
    $
    195average during the year
    
    
    587
    
    
    
    551
    
    
    
    570maximum month end balance during the year
    
    
    873
    
    
    
    713
    
    
    
    555
 At December 31, 2003, the following table presents the payments due by
period for the Companys contractual borrowing obligations (other than deposit
obligations with no stated maturities): After One
    
    After ThreeWithin One
    
    But Within
    
    But Within
    
    After FiveYear
    
    Three Years
    
    Five Years
    
    Years
    
    Total(Dollars in thousands)Certificates of deposit
    
    $
    292,978
    
    
    $
    61,177
    
    
    $
    7,359
    
    
    $
    67
    
    
    $
    361,581Federal Reserve TT&L
    
    
    873
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    873Short-term borrowings
    
    
    28,300
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    28,300Long-term borrowings
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    25,000
    
    
    
    25,000Total borrowing obligations
    
    
    322,151
    
    
    
    61,177
    
    
    
    7,359
    
    
    
    25,067
    
    
    
    415,754Operating lease obligations
    
    
    944
    
    
    
    1,290
    
    
    
    655
    
    
    
    1,082
    
    
    
    3,971Total contractual obligations
    
    $
    323,095
    
    
    $
    62,467
    
    
    $
    8,014
    
    
    $
    26,149
    
    
    $
    419,725
 Interest Rate Sensitivity and Market Risk As a financial institution, the Companys primary component of market risk
is interest rate volatility, primarily in the prime lending rate. Fluctuations
in interest rates will ultimately impact both the level of income and expense
recorded on most of the Companys assets and liabilities, and the market value
of all interest-earning assets and interest-bearing liabilities, other than
those which have a short term to maturity. Based upon the nature of the
Companys operations, the Company is not subject to foreign exchange or
commodity price risk. The Company does not own any trading assets. The Companys Funds Management Policy provides management with the
necessary guidelines for effective funds management, and the Company has
established a measurement system for monitoring its net interest rate
sensitivity position. The Company manages its sensitivity position within
established guidelines. Interest rate risk is managed by the Asset and Liability Committee
(ALCO) which is composed of senior officers of the Company, in accordance
with policies approved by the Companys Board of Directors. Interest rate risk
is the potential of economic losses due to future interest rate changes. These
economic losses can be reflected as a loss of future net interest income and/or
a loss of current fair market values. The objective is to measure the effect
on net interest income and to adjust the balance sheet to minimize the inherent
risk while at the same time maximizing income. Management realizes certain
risks are inherent, and that the goal is to identify, monitor, manage or
exploit the risks. The ALCO formulates strategies based on appropriate levels of interest
rate risk. In determining the appropriate level of interest rate risk, the
ALCO considers the impact on earnings and capital of the current outlook on
interest rates, potential changes in interest rates, regional economies,
liquidity, business strategies and other factors. The ALCO meets regularly to
review, among other things, the sensitivity of assets and liabilities to
interest rate changes, the book and market values of assets and liabilities,
unrealized gains and losses, purchase 34




---



##### Table of Contents



and sale activities, commitments to
originate loans and the maturities of investments and borrowings.
Additionally, the ALCO reviews liquidity, cash flow flexibility, maturities of
deposits and consumer and commercial deposit activity. Management uses two
methodologies to manage interest rate risk: (i) an analysis of
relationships between interest-earning assets and interest-bearing liabilities
and (ii) an interest rate shock simulation model. The Company has
traditionally managed its business to reduce its overall exposure to changes in
interest rates, however, under current policies of the Companys Board of
Directors, management has been given some latitude to increase the Companys
interest rate sensitivity position within certain limits if, in managements
judgment, it will enhance profitability. As a result, changes in market
interest rates may have a greater impact on the Companys financial performance
in the future than they have had historically. An interest rate sensitive asset or liability is one that, within a
defined time period, either matures or experiences an interest rate change in
line with general market interest rates. The management of interest rate risk
is performed by analyzing the maturity and repricing relationships between
interest-earning assets and interest-bearing liabilities at specific points in
time (GAP) and by analyzing the effects of interest rate changes on net
interest income over specific periods of time by projecting the performance of
the mix of assets and liabilities in varied interest rate environments.
Interest rate sensitivity reflects the potential effect on net interest income
of a movement in interest rates. A company is considered to be asset
sensitive, or having a positive GAP, when the amount of its interest-earning
assets maturing or repricing within a given period exceeds the amount of its
interest-bearing liabilities also maturing or repricing within that time
period. Conversely, a company is considered to be liability sensitive, or
having a negative GAP, when the amount of its interest-bearing liabilities
maturing or repricing within a given period exceeds the amount of its
interest-earning assets also maturing or repricing within that time period.
During a period of rising interest rates, a negative GAP would tend to
adversely affect net interest income, while a positive GAP would tend to result
in an increase in net interest income. The following table sets forth an interest rate sensitivity analysis for
the Company at December 31, 2003: Volumes Subject to RepricingGreater0-30
    
    31-180
    
    181-365
    
    1-3
    
    3-5
    
    5-10
    
    than 10days
    
    days
    
    days
    
    years
    
    years
    
    years
    
    years
    
    Total(Dollars in thousands)Interest-earning assets:Securities
    
    $
    34,466
    
    
    $
    50,491
    
    
    $
    46,401
    
    
    $
    50,726
    
    
    $
    37,490
    
    
    $
    28,943
    
    
    $
    8,547
    
    
    $
    257,064Total loans
    
    
    463,748
    
    
    
    22,480
    
    
    
    17,433
    
    
    
    34,454
    
    
    
    6,725
    
    
    
    1,809
    
    
    
    38
    
    
    
    546,688Federal funds sold and other temporary
investments
    
    
    36,927
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    36,927Total interest-bearing assets
    
    
    535,141
    
    
    
    72,971
    
    
    
    63,835
    
    
    
    85,180
    
    
    
    44,215
    
    
    
    30,752
    
    
    
    8,585
    
    
    
    840,679Interest-bearing liabilities:Demand, money market and savings deposits
    
    
    
    
    
    
    17,484
    
    
    
    17,484
    
    
    
    60,223
    
    
    
    40,795
    
    
    
    58,279
    
    
    
    
    
    
    
    194,264Time deposits
    
    
    33,800
    
    
    
    141,677
    
    
    
    117,500
    
    
    
    61,177
    
    
    
    7,359
    
    
    
    67
    
    
    
    
    
    
    
    361,581Federal funds purchased
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Other borrowings
    
    
    2,973
    
    
    
    23,700
    
    
    
    2,500
    
    
    
    
    
    
    
    25,000
    
    
    
    
    
    
    
    
    
    
    
    54,173Total interest-bearing liabilities
    
    
    36,773
    
    
    
    182,861
    
    
    
    137,484
    
    
    
    121,400
    
    
    
    73,154
    
    
    
    58,346
    
    
    
    
    
    
    
    610,018Period GAP
    
    $
    498,368
    
    
    $
    (109,890
    )
    
    $
    (73,650
    )
    
    $
    (36,220
    )
    
    $
    (28,939
    )
    
    $
    (27,594
    )
    
    $
    8,585
    
    
    $
    230,661Cumulative GAP
    
    $
    498,369
    
    
    $
    388,479
    
    
    $
    314,829
    
    
    $
    278,609
    
    
    $
    249,670
    
    
    $
    222,076
    
    
    $
    230,661Period GAP to total assets
    
    
    59.33
    %
    
    
    (13.08
    )%
    
    
    (8.77
    )%
    
    
    (4.31
    )%
    
    
    (3.44
    )%
    
    
    (3.28
    )%
    
    
    1.02
    %Cumulative GAP to total assets
    
    
    59.33
    %
    
    
    46.24
    %
    
    
    37.48
    %
    
    
    33.17
    %
    
    
    29.72
    %
    
    
    26.44
    %
    
    
    27.46
    %Cumulative interest-earnimg assets to
cumulative interest-bearing liabilities
    
    
    1,455.25
    %
    
    
    276.88
    %
    
    
    188.16
    %
    
    
    158.22
    %
    
    
    145.26
    %
    
    
    136.40
    %
    
    
    137.81
    %
 The preceding table provides Company management with repricing data within
given time frames. The purpose of this information is to assist management in
the elements of pricing and of matching interest sensitive assets with interest
sensitive liabilities within time frames. The table indicates a positive GAP
on a cumulative basis for the three time periods covering the next 365 days of
$495.5 million (1-30 days), $385.5 million (31-180 days) and $311.7 million
(181-365 days), respectively. With this condition, the Company is susceptible
to a decrease in net interest income should market interest rates decrease.
GAP reflects a one-day position that is continually changing and is not
indicative of the Companys position at any other time. While the GAP position
is a useful tool in measuring interest rate risk and contributes toward
effective asset and liability management, it is difficult to predict the effect
of changing interest rates solely on that measure, without accounting for
alterations in the maturity or repricing characteristics of the balance sheet
that occur during changes in market interest rates. For example, the GAP
position reflects only the prepayment assumptions pertaining to the current 35




---



##### Table of Contents



rate environment. Assets tend to prepay more rapidly during periods of
declining interest rates than during periods of rising interest rates. Because
of this and other risk factors not contemplated by the GAP position, an
institution could have a matched GAP position in the current rate environment
and still have its net interest income exposed to increased rate risk. The
Companys Rate Committee and the ALCO review the Companys interest rate risk
position on a weekly and monthly basis, respectively. The Company applies an economic value of equity (EVE) methodology to
gauge its interest rate risk exposure as derived from its simulation model.
Generally, EVE is the discounted present value of the difference between
incoming cash flows on interest-earning assets and other investments and
outgoing cash flows on
interest-bearing liabilities. The application of the methodology attempts to
quantify interest rate risk by measuring the change in the EVE that would
result from a theoretical instantaneous and sustained 100 or 200 basis point
shift in market interest rates. Presented below, as of December 31, 2003, is an analysis of the Companys
interest rate risk as measured by changes in EVE for a 200 basis point increase
and a 100 basis point decrease in market interest rates: EVE as a % ofPresent Value of Assets$ Change in EVEChange in Rates
    
    (Dollars in thousands)
    
    % Change in EVE
    
    EVE Ratio
    
    Change-100 bp
    
    ($
    9,073
    )
    
    
    (8.98
    %)
    
    
    10.60
    %
    
    (105) bp0 bp
    
    
    
    
    
    
    
    
    
    
    11.65
    %
    
    
    +200 bp
    
    $
    8,537
    
    
    
    8.45
    %
    
    
    12.63
    %
    
    98 bp
 The percentage change in EVE as a result of a 100 basis point decrease in
interest rates at December 31, 2003 was (8.98)% compared with (10.24)% as of
December 31, 2002. The percentage change in EVE as a result of a 200 basis
point increase in interest rates on December 31, 2003 of 8.45% compared with
7.53% as of December 31, 2002. In 2003, the investment portfolio experienced a significant amount of
mortgage-backed security prepayments and agency security calls as a result of
interest rate declines. The proceeds from these cash flows were generally
invested in shorter-term securities resulting in a shortening in the
weighted-average life of the portfolio. The shorter duration should mitigate
future portfolio price depreciation as interest rates increase. Management believes that the EVE methodology overcomes three shortcomings
of the typical maturity GAP methodology. First, it does not use arbitrary
repricing intervals and accounts for all expected future cash flows. Second,
because the EVE method projects cash flows of each financial instrument under
different interest rate environments, it can incorporate the effect of embedded
options on an institutions interest rate risk exposure. Third, it allows
interest rates on different instruments to change by varying amounts in
response to a change in market interest rates, resulting in more accurate
estimates of cash flows. As with any method of gauging interest rate risk, however, there are
certain shortcomings inherent to the EVE methodology. The model assumes
interest rate changes are instantaneous parallel shifts in the yield curve. In
reality, rate changes are rarely instantaneous. The use of the simplifying
assumption that short-term and long-term rates change by the same degree may
also misstate historical rate patterns which rarely show parallel yield curve
shifts. Further, the model assumes that certain assets and liabilities of
similar maturity or repricing will react identically to changes in rates. In
reality, the market value of certain types of financial instruments may adjust
in anticipation of changes in market rates, while any adjustment in the
valuation of other types of financial instruments may lag behind the change in
general market rates. Additionally, the EVE methodology does not reflect the
full impact of contractual restrictions on changes in rates for certain assets,
such as adjustable rate loans. When interest rates change, actual loan
prepayments and actual early withdrawals from time deposits may deviate
significantly from the assumptions used in the model. Finally, this
methodology does not measure or reflect the impact that higher rates may have
on the ability of adjustable rate loan clients to service their debt. All of
these factors are considered in monitoring the Companys exposure to interest
rate risk. The prime rate in effect for December 31, 2003 and December 31, 2002 was
4.00% and 4.25% respectively. In November 2002, the Federal Reserve lowered
interest rates 50 basis points, and another 25 basis points in June 2003. Liquidity Liquidity involves the Companys ability to raise funds to support asset
growth or reduce assets to meet deposit withdrawals and other payment
obligations, to maintain reserve requirements and otherwise to operate the
Company on an ongoing basis. The Companys liquidity needs are met primarily
by financing activities, which consist mainly of growth in deposits,
supplemented by available-for-sale investment securities, other 36




---



##### Table of Contents



borrowings and
earnings through operating activities. Although access to purchased funds from
correspondent banks is available and has been utilized on occasion to take
advantage of investment opportunities, the Company does not generally rely on
these external funding sources. The cash and federal funds sold position,
supplemented by amortizing investments along with payments and maturities
within the loan portfolio, have historically created an adequate liquidity
position. The Company uses federal funds purchased and other borrowings as funding
sources and in its management of interest rate risk. Federal funds purchased
generally represent overnight borrowings. Other
borrowings principally consist of U.S. Treasury tax note option accounts that
have maturities of 14 days or less and borrowings from the FHLB. FHLB advances may be utilized from time to time as either a short-term
funding source or a longer-term funding source. FHLB advances can be
particularly attractive as a longer-term funding source to balance interest
rate sensitivity and reduce interest rate risk. The Company is eligible for
several borrowing programs through the FHLB. The first, a short-term borrowing
program, requires delivery of eligible securities for collateral. Maturities
under this program range from one to 365 days. The Company currently maintains
most of its investment securities in safekeeping at the FHLB of Dallas. Under another borrowing program, long-term borrowings are available to the
Company from the FHLB. These borrowings have maturities greater than one year
and are collateralized first by FHLB stock, second by the Companys one to four
family mortgage loans and third by the Companys investment securities in
safekeeping at the FHLB. Borrowings collateralized by the Companys one to
four family mortgage loans are limited to 75% of the loan value. At December
31, 2003, the Company had $53.3 million in borrowings under this program. Off-Balance Sheet Arrangements The Bank is party to financial instruments with off-balance sheet risk in
the normal course of business to meet the financing needs of its customers.
These financial instruments include various guarantees, commitments to extend
credit and standby letters of credit. Additionally, these instruments may
involve, to varying degrees, credit risk in excess of the amount recognized in
the statement of financial condition. The Banks maximum exposure to credit
loss under such arrangements is represented by the contractual amount of those
instruments. The Bank applies the same credit policies and collateralization
guidelines in making commitments and conditional obligations as it does for
on-balance sheet instruments. Unfunded loan commitments including unfunded
lines of credit at December 31, 2003 and 2002 aggregated approximately $87.7
million and $74.9 million, respectively. Commitments under standby and
commercial letters of credit at December 31, 2003 and 2002 totaled $14.9
million and $10.4 million, respectively. Operating leases at December 31, 2003
and 2002 totaled $4.0 million and $3.3 million, respectively. The contractual amount of the Companys financial instruments with
off-balance sheet risk expiring by period at December 31, 2003 is presented
below After One
    
    After ThreeWithin One
    
    But Within
    
    But Within
    
    After FiveYear
    
    Three Years
    
    Five Years
    
    Years
    
    Total(Dollars in thousands)Unfunded loan commitments
including unfunded lines of
credit
    
    $
    87,706
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    87,706Standby letters of credit
    
    
    7,215
    
    
    
    115
    
    
    
    
    
    
    
    
    
    
    
    7,330Commercial letters of credit
    
    
    7,527
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    7,527Operating leases
    
    
    944
    
    
    
    1,290
    
    
    
    656
    
    
    
    1,082
    
    
    
    3,972Total financial instruments
with off-balance sheet risk
    
    $
    103,392
    
    
    $
    1,405
    
    
    $
    656
    
    
    $
    1,082
    
    
    $
    106,535
 Capital Resources Capital management consists of providing equity to support both current
and future operations. The Company is subject to capital adequacy requirements
imposed by the Federal Reserve Board and the Bank is subject to capital
adequacy requirements imposed by the OCC. Both the Federal Reserve Board and
the OCC have adopted risk-based capital requirements for assessing bank holding
company and bank capital adequacy. These standards define capital and
establish minimum capital requirements in relation to assets and off-balance
sheet exposure, adjusted for credit risk. The risk-based capital standards
currently in effect are designed to make regulatory capital requirements more
sensitive to differences in risk profiles among bank holding companies and
banks, to account for off-balance sheet exposure and to minimize disincentives
for holding liquid assets. Assets and off-balance sheet items are assigned to
broad risk categories, each with appropriate relative risk weights. 37




---



##### Table of Contents



The
resulting capital ratios represent capital as a percentage of total
risk-weighted assets and off-balance sheet items. The risk-based capital standards of the Federal Reserve Board require all
bank holding companies to have Tier 1 capital of at least 4.0% and total
risk-based capital (Tier 1 and Tier 2) of at least 8.0% of total risk-adjusted
assets. Tier 1 capital generally includes common shareholders equity and
qualifying perpetual
preferred stock together with related surpluses and retained earnings, less
deductions for goodwill and various other intangibles. Tier 2 capital may
consist of a limited amount of intermediate-term preferred stock, a limited
amount of term subordinated debt, certain hybrid capital instruments and other
debt securities, perpetual preferred stock not qualifying as Tier 1 capital,
and a limited amount of the general valuation allowance for loan losses. The
sum of Tier 1 capital and Tier 2 capital is total risk-based capital. The Federal Reserve Board has also adopted guidelines which supplement the
risk-based capital guidelines with a minimum ratio of Tier 1 capital to average
total consolidated assets (leverage ratio) of 3.0% for institutions with well
diversified risk, including no undue interest rate exposure; excellent asset
quality; high liquidity; good earnings; and that are generally considered to be
strong banking organizations, rated composite 1 under applicable federal
guidelines, and that are not experiencing or anticipating significant growth.
Other banking organizations are required to maintain a leverage ratio of at
least 4.0%. These rules further provide that banking organizations
experiencing internal growth or making acquisitions will be expected to
maintain capital positions substantially above the minimum supervisory levels
and comparable to peer group averages, without significant reliance on
intangible assets. Pursuant to FDICIA, each federal banking agency revised its risk-based
capital standards to ensure that those standards take adequate account of
interest rate risk, concentration of credit risk and the risks of
nontraditional activities, as well as reflect the actual performance and
expected risk of loss on multifamily mortgages. The Bank is subject to capital
adequacy guidelines of the OCC that are substantially similar to the Federal
Reserve Boards guidelines. Also pursuant to FDICIA, the OCC has promulgated
regulations setting the levels at which an insured institution such as the Bank
would be considered well capitalized, adequately capitalized as,
undercapitalized, significantly undercapitalized and critically
undercapitalized. The Bank is classified well capitalized for purposes of
the OCCs prompt corrective action regulations. See BusinessSupervision and
RegulationThe Company and The Bank. Shareholders equity at December 31, 2003 was $78.4 million, an increase
of $2.2 million or 2.9% compared to shareholders equity of $76.2 million at
December 31, 2002. This increase was primarily the result of net income of
$4.1 million, common and treasury stock issuances of $150,000, and an increase
in paid-in capital of $1.3 million that was partially offset by a reduction in
the net unrealized gain on securities of approximately $1.7 million and
dividend payments of $1.7 million. 38




---



##### Table of Contents



The following table provides a comparison of the Companys and the Banks
leverage and risk-weighted capital ratios as of December 31, 2003 to the
minimum and well-capitalized regulatory standards: Minimum Required
    
    To be Well Capitalized
    
    Actualfor Capital
    
    under Prompt Corrective
    
    Ratio atAdequacy Purposes
    
    Action Provisions
    
    December 31, 2003The CompanyLeverage ratio
    
    
    4.00
    %(1)
    
    
    N/A
    
    
    
    9.08
    %Tier 1 risk-based capital ratio
    
    
    4.00
    %
    
    
    N/A
    
    
    
    12.73
    %Risk-based capital ratio
    
    
    8.00
    %
    
    
    N/A
    
    
    
    13.98
    %The BankLeverage ratio
    
    
    4.00
    %(2)
    
    
    5.00
    %
    
    
    8.54
    %Tier 1 risk-based capital ratio
    
    
    4.00
    %
    
    
    6.00
    %
    
    
    11.98
    %Risk-based capital ratio
    
    
    8.00
    %
    
    
    10.00
    %
    
    
    13.23
    %
   (1)
    
    The Federal Reserve Board may require the Company to maintain a
leverage ratio above the required minimum.(2)
    
    The OCC may require the Bank to maintain a leverage ratio above the
required minimum. Critical Accounting Policies The Company has established various accounting policies which govern the
application of accounting principles generally accepted in the United States in
the preparation of the Companys financial statements. Certain accounting
policies involve significant judgments and assumptions by management which have
a material impact on the carrying value of certain assets and liabilities;
management considers such accounting policies to be critical accounting
policies. The judgments and assumptions used by management are based on
historical experience and other factors, which are believed to be reasonable
under the circumstances. Because of the nature of the judgments and
assumptions made by management, actual results could differ from these
judgments and estimates which could have a material impact on the carrying
values of assets and liabilities and the results of operations of the Company.
The Company believes the allowance for loan losses is a critical accounting
policy that requires the most significant judgments and estimates used in the
preparation of its consolidated financial statements. In estimating the
allowance for loan losses, management reviews effect of changes in the local
real estate market on collateral values, the effect of current economic
indicators on the loan portfolio and their probable impact on borrowers and
increases or decreases in nonperforming and impaired loans. Changes in these
factors may cause managements estimate of the allowance to increase or
decrease and result in adjustments to the Companys provision for loan losses.
SeeFinancial Condition  Allowance for Loan Losses. The Company believes that loans held-for-sale and the related lower of
cost or market adjustment is also a critical accounting policy that requires
significant judgments and estimates in preparation of its consolidated
financial statements. In estimating the requirement for market adjustments,
management utilizes outside sources to determine the market value of the loans
held-for-sale through solicitation of market bids or indications of market
value. Decreases in market value will be reflected in the consolidated
statement of income under noninterest expense as Lower of Cost or Market
Adjustment. New Accounting Pronouncements On November 25, 2002, the FASB issued FASB Interpretation (FIN) No. 45,
Guarantors Accounting and Disclosure Requirements for Guarantees, Including
Indirect Guarantees of Indebtedness of Others.FIN No. 45 considers standby
letters of credit, excluding commercial letters of credit and other lines of
credit, a guarantee of the Bank. The Bank enters into a standby letter of
credit to guarantee performance of a customer to a third party. These
guarantees are primarily issued to support public and private borrowing
arrangements. The credit risk involved is represented by the contractual
amounts of those instruments. Under the standby letters of credit, the Bank is
required to make payments to the beneficiary of the letters of credit upon
request by the beneficiary so long as all performance criteria have been met.
Most guarantees extend up to one year. At December 31, 2003 the maximum
potential amount of future payments is $7.3 million. The Company has recorded
a liability of approximately $2,542 at December 31, 2003, for the fair value of
the Companys potential obligations, which represents the unamortized portion
of the letter of credit fees. See Note 12  Off-Balance Sheet Risk for a
discussion of significant guarantees that have been entered into by the
Company. 39




---



##### Table of Contents



On December 24, 2003, the FASB issued FIN No. 46R, Consolidation of
Variable Interest Entities,which addresses consolidation by business
enterprises of variable Interest entities. FIN No. 46R clarifies the
application of ARB No. 51, Consolidated Financial Statements,to certain
entities in which equity investors do not have the characteristics of a
controlling financial interest or do not have sufficient equity at risk for the
entity to finance its activities without additional subordinated financial
support from other parties. The Company has determined the impact of this
interpretation will not have any effect on its financial condition or results
of operations. On April 30, 2003, the FASB approved SFAS No. 149, an amendment to SFAS
No. 133, Accounting for Derivative Instruments and Hedging Activities.This
statement amends and clarifies financial accounting and reporting for
derivative instruments, including certain derivative instruments embedded in
other contracts (collectively referred to as derivatives) and for hedging
activities under SFAS No. 133. The provisions of this statement were effective
for contracts entered into or modified after June 30, 2003 and for hedging
relationships designated after June 30, 2003. The adoption of SFAS No. 149 did
not have a material effect on the Companys financial condition or results of
operations. On May 15, 2003, the FASB approved SFAS No. 150, Accounting for Certain
Financial Instruments with Characteristics of both Liabilities and Equity.
This statement changes the accounting for certain financial instruments that,
under previous guidance, could be classified as equity or mezzanine equity,
but now is requiring those instruments to be classified as liabilities (or
assets in some circumstances) in the statement of financial condition.
Further, SFAS No. 150 requires disclosure regarding the terms of those
instruments and settlement alternatives. This statement is generally effective
for all such financial instruments entered into or modified after May 31, 2003,
and otherwise is effective at the beginning of the first interim period
beginning after June 15, 2003, except for manadatorily redeemable financial
instruments of non-public entities. It is not expected that this statement
will have a material effect on the Companys financial condition or results of
operations. On October 29, 2003, the FASB deferred certain provisions of this
statement. 
 Item 8. Financial Statements and Supplementary Data Reference is made to the financial statements, the reports thereon, the
notes thereto and supplementary data commencing at page 45 of this
Form 10-K/A,
which financial statements, reports, notes and data are incorporated herein by
reference. 40




---



##### Table of Contents



Quarterly Financial Data The following table represents previously reported and restated summarized
data for each of the quarters in fiscal 2003 and 2002 (in thousands, except per
share data): 2003 (Previously Reported)
    
    2002 (Previously Reported)Fourth
    
    Third
    
    Second
    
    First
    
    Fourth
    
    Third
    
    Second
    
    FirstQuarter
    
    Quarter
    
    Quarter
    
    Quarter
    
    Quarter
    
    Quarter
    
    Quarter
    
    QuarterInterest income
    
    $
    11,032
    
    
    $
    10,749
    
    
    $
    10,966
    
    
    $
    11,091
    
    
    $
    11,865
    
    
    $
    12,298
    
    
    $
    12,354
    
    
    $
    11,687Interest expense
    
    
    2,740
    
    
    
    2,956
    
    
    
    3,189
    
    
    
    3,249
    
    
    
    3,532
    
    
    
    3,610
    
    
    
    3,596
    
    
    
    3,891Net interest income
    
    
    8,292
    
    
    
    7,793
    
    
    
    7,777
    
    
    
    7,842
    
    
    
    8,333
    
    
    
    8,688
    
    
    
    8,758
    
    
    
    7,796Provision for loan losses
    
    
    300
    
    
    
    575
    
    
    
    4,015
    
    
    
    800
    
    
    
    1,533
    
    
    
    750
    
    
    
    970
    
    
    
    600Net interest income after
provision for loan losses
    
    
    7,992
    
    
    
    7,218
    
    
    
    3,762
    
    
    
    7,042
    
    
    
    6,800
    
    
    
    7,938
    
    
    
    7,788
    
    
    
    7,196Noninterest income
    
    
    2,034
    
    
    
    2,429
    
    
    
    2,170
    
    
    
    2,294
    
    
    
    2,261
    
    
    
    2,440
    
    
    
    2,297
    
    
    
    2,476Noninterest expense
    
    
    7,358
    
    
    
    7,798
    
    
    
    8,028
    
    
    
    6,520
    
    
    
    6,023
    
    
    
    6,519
    
    
    
    6,892
    
    
    
    6,623Income before income taxes
    
    
    2,668
    
    
    
    1,849
    
    
    
    (2,096
    )
    
    
    2,816
    
    
    
    3,038
    
    
    
    3,859
    
    
    
    3,193
    
    
    
    3,049Provision
(benefit) for income taxes
    
    
    860
    
    
    
    504
    
    
    
    (742
    )
    
    
    907
    
    
    
    1,060
    
    
    
    1,329
    
    
    
    1,003
    
    
    
    958Net income
    
    $
    1,808
    
    
    $
    1,345
    
    
    $
    (1,354
    )
    
    $
    1,909
    
    
    $
    1,978
    
    
    $
    2,530
    
    
    $
    2,190
    
    
    $
    2,091Earnings per share:Basic
    
    $
    0.25
    
    
    $
    0.19
    
    
    $
    (0.19
    )
    
    $
    0.27
    
    
    $
    0.28
    
    
    $
    0.36
    
    
    $
    0.31
    
    
    $
    0.30Diluted
    
    $
    0.24
    
    
    $
    0.19
    
    
    $
    (0.19
    )
    
    $
    0.27
    
    
    $
    0.28
    
    
    $
    0.35
    
    
    $
    0.30
    
    
    $
    0.29Weighted average shares outstanding:Basic
    
    
    7,154
    
    
    
    7,132
    
    
    
    7,037
    
    
    
    7,033
    
    
    
    7,031
    
    
    
    7,026
    
    
    
    7,020
    
    
    
    7,020Diluted
    
    
    7,242
    
    
    
    7,215
    
    
    
    7,037
    
    
    
    7,196
    
    
    
    7,179
    
    
    
    7,147
    
    
    
    7,140
    
    
    
    7,140Dividends per common share
    
    $
    0.06
    
    
    $
    0.06
    
    
    $
    0.06
    
    
    $
    0.06
    
    
    $
    0.06
    
    
    $
    0.06
    
    
    $
    0.06
    
    
    $
    0.06
 2003 (Restated)
    
    2002 (Restated)Fourth
    
    Third
    
    Second
    
    First
    
    Fourth
    
    Third
    
    Second
    
    FirstQuarter
    
    Quarter
    
    Quarter
    
    Quarter
    
    Quarter
    
    Quarter
    
    Quarter
    
    QuarterInterest income
    
    $
    10,852
    
    
    $
    10,695
    
    
    $
    10,814
    
    
    $
    10,926
    
    
    $
    11,781
    
    
    $
    12,140
    
    
    $
    12,093
    
    
    $
    11,459Interest expense
    
    
    2,740
    
    
    
    2,956
    
    
    
    3,189
    
    
    
    3,249
    
    
    
    3,532
    
    
    
    3,610
    
    
    
    3,596
    
    
    
    3,891Net interest income
    
    
    8,112
    
    
    
    7,739
    
    
    
    7,625
    
    
    
    7,677
    
    
    
    8,249
    
    
    
    8,530
    
    
    
    8,497
    
    
    
    7,568Provision for loan losses
    
    
    300
    
    
    
    575
    
    
    
    4,015
    
    
    
    800
    
    
    
    1,533
    
    
    
    750
    
    
    
    970
    
    
    
    600Net interest income after provision for loan losses
    
    
    7,812
    
    
    
    7,164
    
    
    
    3,610
    
    
    
    6,877
    
    
    
    6,716
    
    
    
    7,780
    
    
    
    7,527
    
    
    
    6,968Noninterest income
    
    
    2,034
    
    
    
    2,429
    
    
    
    2,170
    
    
    
    2,294
    
    
    
    2,261
    
    
    
    2,440
    
    
    
    2,297
    
    
    
    2,476Noninterest expense
    
    
    7,007
    
    
    
    7,556
    
    
    
    7,732
    
    
    
    6,250
    
    
    
    6,025
    
    
    
    6,230
    
    
    
    6,500
    
    
    
    6,295Income before income taxes
    
    
    2,839
    
    
    
    2,037
    
    
    
    (1,952
    )
    
    
    2,921
    
    
    
    2,952
    
    
    
    3,990
    
    
    
    3,324
    
    
    
    3,149Provision
(benefit) for income taxes
    
    
    917
    
    
    
    568
    
    
    
    (693
    )
    
    
    943
    
    
    
    1,031
    
    
    
    1,374
    
    
    
    1,048
    
    
    
    992Net income
    
    $
    1,922
    
    
    $
    1,469
    
    
    $
    (1,259
    )
    
    $
    1,978
    
    
    $
    1,921
    
    
    $
    2,616
    
    
    $
    2,276
    
    
    $
    2,157Earnings per share:Basic
    
    $
    0.27
    
    
    $
    0.21
    
    
    $
    (0.18
    )
    
    $
    0.28
    
    
    $
    0.27
    
    
    $
    0.37
    
    
    $
    0.32
    
    
    $
    0.31Diluted
    
    $
    0.27
    
    
    $
    0.20
    
    
    $
    (0.17
    )
    
    $
    0.27
    
    
    $
    0.27
    
    
    $
    0.37
    
    
    $
    0.32
    
    
    $
    0.30Weighted average shares outstanding:Basic
    
    
    7,154
    
    
    
    7,132
    
    
    
    7,037
    
    
    
    7,033
    
    
    
    7,031
    
    
    
    7,026
    
    
    
    7,020
    
    
    
    7,020Diluted
    
    
    7,242
    
    
    
    7,215
    
    
    
    7,037
    
    
    
    7,196
    
    
    
    7,179
    
    
    
    7,147
    
    
    
    7,140
    
    
    
    7,140Dividends per common share
    
    $
    0.06
    
    
    $
    0.06
    
    
    $
    0.06
    
    
    $
    0.06
    
    
    $
    0.06
    
    
    $
    0.06
    
    
    $
    0.06
    
    
    $
    0.06
 
 Item 9A. Controls and Procedures Evaluation
of disclosure controls and procedures.As of the end of the
period covered by this report and as of August 26, 2004, the Company carried out an evaluation, under the
supervision and with the participation of our management, including our Chief
Executive Officer and Chief Financial Officer, of the effectiveness of the
design and operation of our disclosure controls and procedures. Based
on the most recent
evaluation, the Companys Chief Executive Officer and Chief Financial Officer
concluded that the Companys disclosure controls and procedures (as defined in
Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934 (the
Exchange Act)) are not effective (solely due to the
material weakness discussed in the paragraph below) to ensure that information required to be
disclosed by the Company in reports that it files or submits under the Exchange
Act is recorded, processed, summarized and reported to the Companys management
within the time periods specified in the Securities and Exchange Commissions
rules and forms. 41




---



##### Table of Contents



A
material weakness in internal control was discovered related to net deferred
loan fees. Approximately $4.0 million of deferred loan fees, net
of costs, were not being
amortized to interest income because not all deferred fees were entered into
the Companys loan system. No procedure was in place to insure all relevant
loan data was entered into the Companys loan system. Additionally, a
reconciliation of the net deferred loan fees entered in the loan
system compared to
the general ledger balance was not being performed. The lack of such
preventative and detective controls allowed this accounting error to occur and
escape detection. Procedures and controls that have subsequently been
implemented are: (a) closing officers and loan processors have been instructed
to ensure the net deferred loan fees are entered to the
Companys on-line loan system to facilitate the
automated amortization of the net deferred loan fees over the life of the loan; (b) daily
reconciliation of general ledger accounts with the loan system are performed by
a processor in the loan servicing department and monitored by the department
supervisor; and (c) the internal audit department will include an annual
examination of this specific function and report the results to the Audit Committee. As a result of the material weakness identified, the financial statements
were restated. See Note 2 to the consolidated financial statements. Changes
in internal controls over financial reporting. Other than the
procedures and controls identified above, there were no
changes in the Companys internal controls over financial reporting during the
last fiscal quarter that materially affected, or is reasonably likely to
materially affect, the Companys internal control over financial reporting. 
 PART IV 
 Item 15. Exhibits, Financial Statement Schedules, and Reports on Form 10-K Consolidated Financial Statements and Financial Statement Schedules Reference is made to the Consolidated Financial Statements, the reports
thereon, the notes thereto and supplementary data commencing at page
45 of this
Annual Report on Form 10-K/A. Set forth below is a list of such Consolidated
Financial Statements: Report of Independent Registered Public Accounting FirmReport of
Independent Registered Public Accounting FirmConsolidated
Balance Sheets (Restated) as of December 31, 2003 and 2002Consolidated Statements of Income (Restated) for the Years Ended December 31, 2003, 2002, and 2001Consolidated Statements of Comprehensive Income (Restated) for the Years Ended December 31, 2003, 2002, and 2001Consolidated Statements of Changes in Shareholders Equity (Restated) for the Years Ended December 31, 2003, 2002, and 2001Consolidated Statements of Cash Flows (Restated) for the Years Ended December 31, 2003, 2002, and 2001Notes to Consolidated Financial Statements
 Financial Statement Schedules All supplemental schedules are omitted as inapplicable or because the
required information is included in the Consolidated Financial Statements or
notes thereto. Exhibits ExhibitNumber
    
    Description3.1
    
    Amended and Restated Articles of Incorporation of the Company
(incorporated herein by reference to Exhibit 3.1 to the
Companys Registration Statement on Form S-1 (Registration
No. 333-62667) (the Registration Statement)).3.2
    
    Amended and Restated Bylaws of the Company (incorporated
herein by reference to Exhibit 3.2 to the Registration
Statement).4
    
    Specimen form of certificate evidencing the Common Stock
(incorporated herein by reference to Exhibit 4 to the
Registration Statement).10.1
    
    Agreement and Plan of Reorganization by and among MetroCorp
Bancshares, Inc., MC Bancshares of Delaware, Inc. and
MetroBank, N.A. (incorporated herein by reference to Exhibit
10.1 to the
 42




---



##### Table of Contents



ExhibitNumber
    
    DescriptionRegistration Statement).10.2
    
    Form of Director Stock Option Agreement (incorporated herein
by reference to Exhibit 10.2 to the Registration Statement).10.3
    
    MetroCorp Bancshares, Inc. Non-Employee Director Stock Bonus
Plan (incorporated herein by reference to Exhibit 10.3 to the
Registration Statement).10.4
    
    MetroCorp Bancshares, Inc. 1998 Employee Stock Purchase Plan
(incorporated herein by reference to Exhibit 10.4 to the
Registration Statement).10.5
    
    MetroCorp Bancshares, Inc. 1998 Stock Incentive Plan
(incorporated herein by reference to Exhibit 10.5 to the
Registration Statement).10.6
    
    First Amendment to the MetroCorp Bancshares, Inc. 1998
Employee Stock Purchase Plan (incorporated herein by
reference to Exhibit 10.6 to the Companys Annual Report on
Form 10-K for the year ended December 31, 1998).10.7
    
    First Amendment to the MetroCorp Bancshares, Inc.
Non-Employee Director Stock Bonus Plan (incorporated herein
by reference to Exhibit 4.5 to the Companys Registration
Statement on Form S-8 (Registration Number 333-94327)).10.8
    
    Second Amendment to the MetroCorp Bancshares, Inc.
Non-Employee Director Stock Bonus Plan (incorporated herein
by reference to Exhibit 4.6 to the Companys Registration
Statement on Form S-8 (Registration Number 333-94327)).10.9
    
    Employment Agreement between MetroCorp Bancshares, Inc. and
Allen D. Brown (incorporated herein by reference to Exhibit
10.9 to the Companys Annual Report on Form 10-K for the year
ended December 31, 2003).21
    
    Subsidiaries of MetroCorp Bancshares, Inc. (incorporated
herein by reference to Exhibit 21 to the Registration
Statement).23.1*
    
    Consent of PricewaterhouseCoopers LLP.23.2*
    
    Consent of Deloitte & Touche
LLP.31.1*
    
    Certification of Chief Executive Officer pursuant to
Rule 13a-14(a) of the Securities Exchange Act of 1934, as
amended.31.2*
    
    Certification of Acting Chief Financial Officer pursuant
to Rule 13a-14(a) of the Securities Exchange Act of 1934, as
amended.32.1*
    
    Certification of Chief Executive
Officer pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.32.2*
    
    Certification of Acting Chief Financial Officer pursuant to
18 U.S.C. Section 1350, as adopted pursuant to Section 906 fo
the Sarbanes Oxley Act of 2002.
   *
    
    Filed herewith.
    
    Management contract or compensatory plan or arrangement. Reports on Form 8-K The following
report on Form 8-K was furnished during the quarter ended
December 31, 2003: Current
report on Form 8-K filed October 29, 2003 in connection with the release of
the Companys earnings for the third quarter of 2003. 43




---



##### Table of Contents



SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed
on its behalf by the undersigned, thereunto duly authorized, in the City of
Houston, on August 27, 2004. METROCORP BANCSHARES, INC.By:
    
    /s/ George M. LeeGeorge M. LeeChief Executive Officer(Principal Executive Officer)
 Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed by the following persons in the indicated capacities on
August 27, 2004. Signature
    
    Title/s/ Don J. Wang
    
    Chairman of the BoardDon J. Wang/s/ George M. Lee
    
    Chief Executive Officer (Principal Executive Officer)George M. Lee/s/ Kevin Shu
    
    Acting Chief Financial Officer(Principal Financial Officer / Principal Accounting Officer)Kevin Shu/s/ David Tai
    
    DirectorDavid TaiDirectorTiong L. Ang/s/ Helen F. Chen
    
    DirectorHelen F. Chen/s/ Tommy F. Chen
    
    DirectorTommy F. Chen/s/ May P. Chu
    
    DirectorMay P. Chu/s/ Shirley
L. Clayton
    
    DirectorShirley
L. Clayton/s/ John Lee
    
    DirectorJohn Lee/s/ Edward A. Monto
    
    DirectorEdward A. Monto/s/ Charles L. Roff
    
    DirectorCharles L. Roff/s/ Joe Ting
    
    DirectorJoe Ting/s/
Daniel B. Wright
    
    DirectorDaniel
B. Wright
 44




---



##### Table of Contents



INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
METROCORP BANCSHARES, INC. AND SUBSIDIARIES PageReport of Independent Registered Public Accounting Firm
    
    
    46Report of
Independent Registered Public Accounting Firm
    
    
    47Consolidated Balance Sheets (Restated) as of December 31, 2003 and 2002
    
    
    48Consolidated Statements of Income (Restated) for the Years Ended December 31, 2003, 2002, and 2001
    
    
    49Consolidated Statements of Comprehensive Income (Restated) for the Years Ended
December 31, 2003, 2002, and 2001
    
    
    50Consolidated Statements of Changes in Shareholders Equity (Restated) for the Years Ended
December 31, 2003, 2002, and 2001
    
    
    51Consolidated Statements of Cash Flows (Restated) for the Years Ended
December 31, 2003, 2002, and 2001
    
    
    52Notes to Consolidated Financial Statements
    
    
    53
 45




---



##### Table of Contents



REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Board of Directors and Shareholders of
MetroCorp Bancshares, Inc. In our opinion, the accompanying consolidated balance sheets as of December 31,
2003 and 2002 and the related consolidated statements of income, comprehensive
income, changes in shareholders equity and cash flows present fairly, in all
material respects, the consolidated financial position of MetroCorp Bancshares,
Inc. and subsidiaries (the Company) at December 31, 2003 and 2002, and the
consolidated results of their operations and their cash flows for the years
then ended in conformity with accounting principles generally accepted in the
United States of America. These financial statements are the responsibility of
the Companys management; our responsibility is to express an opinion on these
financial statements based on our audits. We conducted our audits of these
statements in accordance with the standards of the Public Company Accounting
Oversight Board of United States, which require that we plan and perform the
audit to obtain reasonable assurance about whether the financial statements are
free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements,
assessing the accounting principles used and significant estimates made by
management, and evaluating the overall financial statement presentation. We
believe that our audits provide a reasonable basis for our opinion. As described in Note 2 to the consolidated financial statements, the Company
restated its financial statements for the years ended December 31, 2003 and
2002. /s/ PricewaterhouseCoopers LLP March 12, 2004, except for Note 2 for which the date is August 26, 2004
Houston, Texas 46




---



##### Table of Contents



REPORT OF INDEPENDENT
REGISTERED PUBLIC ACCOUNTING FIRM To the Board of Directors and Shareholders of
MetroCorp Bancshares, Inc.
Houston, Texas We have audited the accompanying consolidated statements of income,
shareholders equity and cash flows of MetroCorp Bancshares, Inc. and
subsidiary (the Company) for the year ended December 31, 2001. These
financial statements are the responsibility of the Companys management. Our
responsibility is to express an opinion on these financial statements based on
our audit. We conducted our audit in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on
a test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used
and significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audit provides a
reasonable basis for our opinion. In our opinion, such consolidated financial statements present fairly, in all
material respects, the results of their operations and their cash flows for the
year ended December 31, 2001 in conformity with accounting principles generally
accepted in the United States of America. As discussed in Note 2, the accompanying consolidated financial statements have
been restated. /s/ Deloitte & Touche LLP March 20, 2002 (August 26, 2004 as to Note 2)
Houston, Texas 47




---



##### Table of Contents



METROCORP BANCSHARES, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except share amounts) December 31,2003
    
    2002(Restated -Note 2)ASSETSCash and due from banks
    
    $
    26,347
    
    
    $
    30,195Federal funds sold and other temporary investments
    
    
    10,580
    
    
    
    7,991Total cash and cash equivalents
    
    
    36,927
    
    
    
    38,186Securities available-for-sale, at fair value
    
    
    257,064
    
    
    
    260,038Other investments
    
    
    5,200
    
    
    
    4,380Loans, net of allowance for loan losses of $10,448 and $10,150 respectively
    
    
    540,658
    
    
    
    520,421Loans, held-for-sale
    
    
    6,030
    
    
    
    Accrued interest receivable
    
    
    3,452
    
    
    
    3,391Premises and equipment, net
    
    
    5,674
    
    
    
    5,841Deferred tax asset
    
    
    4,664
    
    
    
    3,652Customers liability on acceptances
    
    
    3,352
    
    
    
    4,080Foreclosed assets, net
    
    
    2,585
    
    
    
    1,190Other assets
    
    
    1,410
    
    
    
    766Total assets
    
    $
    867,016
    
    
    $
    841,945LIABILITIES AND SHAREHOLDERS EQUITYDeposits:Noninterest-bearing
    
    $
    169,097
    
    
    $
    144,544Interest-bearing
    
    
    555,844
    
    
    
    546,817Total deposits
    
    
    724,941
    
    
    
    691,361Other borrowings
    
    
    54,173
    
    
    
    65,774Accrued interest payable
    
    
    567
    
    
    
    717Acceptances outstanding
    
    
    3,352
    
    
    
    4,080Other liabilities
    
    
    5,610
    
    
    
    3,789Total liabilities
    
    
    788,643
    
    
    
    765,721Commitments
and contingencies
    
    
    
    
    
    
    Shareholders equity:Preferred
stock, $1.00 par value, 2,000,000 shares authorized; none of
which are issued and outstanding
    
    
    
    
    
    
    Common stock, $1.00 par value, 20,000,000 shares authorized;
7,306,627 shares and 7,195,927 shares are issued and 7,156,689 shares
and 7,031,882 shares are outstanding at December 31, 2003 and 2002,
respectively
    
    
    7,307
    
    
    
    7,196Additional paid-in-capital
    
    
    27,620
    
    
    
    26,344Retained earnings
    
    
    44,105
    
    
    
    41,699Accumulated other comprehensive income
    
    
    671
    
    
    
    2,354Treasury stock, at cost
    
    
    (1,330
    )
    
    
    (1,369
    )Total shareholders equity
    
    
    78,373
    
    
    
    76,224Total liabilities and shareholders equity
    
    $
    867,016
    
    
    $
    841,945
 The accompanying notes are an integral part of these consolidated financial statements. 48




---



##### Table of Contents



METROCORP BANCSHARES, INC.
CONSOLIDATED STATEMENTS OF INCOME
(In thousands, except per share amounts) Years Ended December 31,2003
    
    2002
    
    2001(Restated - Note 2)Interest Income:Loans
    
    $
    34,691
    
    
    $
    37,256
    
    
    $
    43,415Securities:Taxable
    
    
    7,321
    
    
    
    9,080
    
    
    
    8,356Tax-exempt
    
    
    997
    
    
    
    1,160
    
    
    
    1,177Federal funds sold and other investments
    
    
    278
    
    
    
    484
    
    
    
    1,992Total interest income
    
    
    43,287
    
    
    
    47,980
    
    
    
    54,940Interest expense:Time deposits
    
    
    8,942
    
    
    
    10,595
    
    
    
    19,003Demand and savings deposits
    
    
    1,345
    
    
    
    2,215
    
    
    
    3,531Other borrowings
    
    
    1,847
    
    
    
    1,818
    
    
    
    1,265Total interest expense
    
    
    12,134
    
    
    
    14,628
    
    
    
    23,799Net interest income
    
    
    31,153
    
    
    
    33,352
    
    
    
    31,141Provision for loan losses
    
    
    5,690
    
    
    
    3,853
    
    
    
    3,799Net interest income after provision for loan losses
    
    
    25,463
    
    
    
    29,499
    
    
    
    27,342Noninterest income:Service fees
    
    
    6,544
    
    
    
    6,670
    
    
    
    6,360Other loan-related fees
    
    
    1,009
    
    
    
    1,083
    
    
    
    936Letters of credit commissions and fees
    
    
    516
    
    
    
    610
    
    
    
    655Gain on sale of securities, net
    
    
    165
    
    
    
    34
    
    
    
    189Gain on sale
of loans, net
    
    
    600
    
    
    
    322
    
    
    
    127Other noninterest income
    
    
    93
    
    
    
    248
    
    
    
    393Total noninterest income
    
    
    8,927
    
    
    
    8,967
    
    
    
    8,660Noninterest expense:Salaries and employee benefits
    
    
    14,109
    
    
    
    13,520
    
    
    
    12,183Lower of cost of market adjustment on loans held-for-sale
    
    
    2,149
    
    
    
    
    
    
    
    Occupancy and equipment
    
    
    5,361
    
    
    
    5,089
    
    
    
    5,189Foreclosed assets, net
    
    
    248
    
    
    
    624
    
    
    
    209Other noninterest expense
    
    
    6,678
    
    
    
    5,818
    
    
    
    6,871Total noninterest expense
    
    
    28,545
    
    
    
    25,051
    
    
    
    24,452Income before provision for income taxes
    
    
    5,845
    
    
    
    13,415
    
    
    
    11,550Provision for income taxes
    
    
    1,735
    
    
    
    4,445
    
    
    
    3,696Net income
    
    $
    4,110
    
    
    $
    8,970
    
    
    $
    7,854Earning per common share:Basic
    
    $
    0.58
    
    
    $
    1.28
    
    
    $
    1.12Diluted
    
    $
    0.57
    
    
    $
    1.25
    
    
    $
    1.11Weighted average shares outstanding:Basic
    
    
    7,089
    
    
    
    7,024
    
    
    
    6,998Diluted
    
    
    7,213
    
    
    
    7,154
    
    
    
    7,059Dividends per common share
    
    $
    0.24
    
    
    $
    0.24
    
    
    $
    0.24
 The accompanying notes are an integral part of these consolidated financial statements. 49




---



##### Table of Contents



METROCORP BANCSHARES, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(In thousands) 2003
    
    2002
    
    2001(Restated - Note 2)Net income
    
    $
    4,110
    
    
    $
    8,970
    
    
    $
    7,854Other comprehensive income , net of tax:Unrealized gains on investment securities, net of tax:Unrealized holding gains (losses) arising during the period
    
    
    (1,576
    )
    
    
    2,000
    
    
    
    380Less -reclassification adjustment for gains included in net income
    
    
    107
    
    
    
    22
    
    
    
    125Other comprehensive income (loss)
    
    
    (1,683
    )
    
    
    1,978
    
    
    
    255Total comprehensive income
    
    $
    2,427
    
    
    $
    10,948
    
    
    $
    8,109
 The accompanying notes are an integral part of these consolidated financial statements. 50




---



##### Table of Contents



METROCORP BANCSHARES, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS EQUITY
Years ended December 31, 2003, 2002 and 2001
(In thousands) AccumulatedAdditional
    
    
    
    
    
    other
    
    TreasuryCommon stock
    
    paid-in
    
    Retained
    
    comprehensive
    
    stock, atShares
    
    At par
    
    capital
    
    earnings
    
    income(loss)
    
    cost
    
    TotalBalance at December 31, 2000 previously reported
    
    
    6,979
    
    
    $
    7,180
    
    
    $
    26,033
    
    
    $
    26,936
    
    
    $
    121
    
    
    $
    (1,569
    )
    
    $
    58,701Restatement (Note 2)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,303
    
    
    
    
    
    
    
    
    
    
    
    1,303Balance at
December 31, 2000 (Restated)
    
    
    6,979
    
    
    
    7,180
    
    
    
    26,033
    
    
    
    28,239
    
    
    
    121
    
    
    
    (1,569
    )
    
    
    60,004Issuance of common stock
    
    
    7
    
    
    
    7
    
    
    
    52
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    59Re-issuance of treasury stock
    
    
    31
    
    
    
    
    
    
    
    59
    
    
    
    
    
    
    
    
    
    
    
    257
    
    
    
    316Net income restated
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    7,854
    
    
    
    
    
    
    
    
    
    
    
    7,854Other comprehensive income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    255
    
    
    
    
    
    
    
    255Dividend ($0.24 per share)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1,679
    )
    
    
    
    
    
    
    
    
    
    
    (1,679
    )Balance at December 31, 2001 (Restated)
    
    
    7,017
    
    
    
    7,187
    
    
    
    26,144
    
    
    
    34,414
    
    
    
    376
    
    
    
    (1,312
    )
    
    
    66,809Issuance of common stock
    
    
    9
    
    
    
    9
    
    
    
    67
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    76Re-issuance of treasury stock
    
    
    37
    
    
    
    
    
    
    
    133
    
    
    
    
    
    
    
    
    
    
    
    292
    
    
    
    425Repurchase of common stock
    
    
    (31
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (349
    )
    
    
    (349
    )Net income restated
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    8,970
    
    
    
    
    
    
    
    
    
    
    
    8,970Other comprehensive income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,978
    
    
    
    
    
    
    
    1,978Dividend ($0.24 per share)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1,685
    )
    
    
    
    
    
    
    
    
    
    
    (1,685
    )Balance at December 31, 2002 (Restated)
    
    
    7,032
    
    
    
    7,196
    
    
    
    26,344
    
    
    
    41,699
    
    
    
    2,354
    
    
    
    (1,369
    )
    
    
    76,224Issuance of common stock
    
    
    111
    
    
    
    111
    
    
    
    1,075
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,186Re-issuance of treasury stock
    
    
    32
    
    
    
    
    
    
    
    146
    
    
    
    
    
    
    
    
    
    
    
    251
    
    
    
    397Repurchase of common stock
    
    
    (18
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (212
    )
    
    
    (212
    )Tax benefit from stock option
exercised
    
    
    
    
    
    
    
    
    
    
    55
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    55Net income restated
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    4,110
    
    
    
    
    
    
    
    
    
    
    
    4,110Other comprehensive loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1,683
    )
    
    
    
    
    
    
    (1,683
    )Dividend ($0.24 per share)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1,704
    )
    
    
    
    
    
    
    
    
    
    
    (1,704
    )Balance at December 31, 2003 (Restated)
    
    
    7,157
    
    
    $
    7,307
    
    
    $
    27,620
    
    
    $
    44,105
    
    
    $
    671
    
    
    $
    (1,330
    )
    
    $
    78,373
 The accompanying notes are an integral part of these consolidated financial statements. 51




---



##### Table of Contents



METROCORP BANCSHARES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands) Years ended December 31,2003
    
    2002
    
    2001(Restated - Note 2)Cash flows from operating activities:Net income
    
    $
    4,110
    
    
    $
    8,970
    
    
    $
    7,854Adjustments to reconcile net income to net cash provided by (used in)
operating activities:Depreciation
    
    
    1,337
    
    
    
    1,435
    
    
    
    1,636Provision for loan losses
    
    
    5,690
    
    
    
    3,853
    
    
    
    3,799Lower of cost or market adjustment on loans held-for-sale
    
    
    2,149
    
    
    
    
    
    
    
    Gain on securities sales, net
    
    
    (165
    )
    
    
    (34
    )
    
    
    (189
    )Gain on sale of premises and equipment
    
    
    
    
    
    
    (5
    )
    
    
    Gain on sale of loans, net
    
    
    (600
    )
    
    
    (322
    )
    
    
    (127
    )Amortization of premiums and discounts on securities
    
    
    2,251
    
    
    
    1,332
    
    
    
    39Amortization of net deferred loan fees
    
    
    (543
    )
    
    
    (340
    )
    
    
    (239
    )Deferred income taxes
    
    
    (208
    )
    
    
    48
    
    
    
    360Changes in:Loans held-for-sale
    
    
    (5,891
    )
    
    
    
    
    
    
    Accrued interest receivable
    
    
    (61
    )
    
    
    211
    
    
    
    669Accrued interest payable
    
    
    (150
    )
    
    
    (146
    )
    
    
    (953
    )Income taxes payable
    
    
    (299
    )
    
    
    (63
    )
    
    
    (1,279
    )Other liabilities
    
    
    1,885
    
    
    
    1,032
    
    
    
    (16,442
    )Other assets
    
    
    (614
    )
    
    
    2,506
    
    
    
    2,312Net cash provided by (used in) operating activities
    
    
    8,891
    
    
    
    18,477
    
    
    
    (2,560
    )Cash flows from investing activities:Purchases of securities available-for-sale
    
    
    (182,039
    )
    
    
    (179,932
    )
    
    
    (111,207
    )Proceeds from sales, maturities and principal paydowns of securities available-for-sale
    
    
    179,591
    
    
    
    93,406
    
    
    
    79,273Net change in loans
    
    
    (31,577
    )
    
    
    (38,538
    )
    
    
    (15,185
    )Proceeds from sale of foreclosed assets
    
    
    3,391
    
    
    
    659
    
    
    
    1,078Proceeds from sale of premises and equipment
    
    
    
    
    
    
    5
    
    
    
    Purchases of premises and equipment
    
    
    (1,170
    )
    
    
    (1,653
    )
    
    
    (684
    )Net cash used in investing activities
    
    
    (31,804
    )
    
    
    (126,053
    )
    
    
    (46,725
    )Cash flows from financing activities:Net change in:Deposits
    
    
    33,580
    
    
    
    48,610
    
    
    
    16,845Other borrowings
    
    
    (11,601
    )
    
    
    40,579
    
    
    
    (378
    )Proceeds from issuance of common stock
    
    
    1,186
    
    
    
    76
    
    
    
    59Treasury stock sold
    
    
    397
    
    
    
    425
    
    
    
    316Treasury stock purchased
    
    
    (212
    )
    
    
    (349
    )
    
    
    Dividends paid
    
    
    (1,696
    )
    
    
    (1,685
    )
    
    
    (1,677
    )Net cash provided by financing activities
    
    
    21,654
    
    
    
    87,656
    
    
    
    15,165Net decrease in cash and cash equivalents
    
    
    (1,259
    )
    
    
    (19,920
    )
    
    
    (34,120
    )Cash and cash equivalents at beginning of period
    
    
    38,186
    
    
    
    58,106
    
    
    
    92,226Cash and cash equivalents at end of period
    
    $
    36,927
    
    
    $
    38,186
    
    
    $
    58,106
 The accompanying notes are an integral part of these consolidated financial
statements. 52




---



##### Table of Contents



METROCORP BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. Summary of Significant Accounting Policies The consolidated financial statements of MetroCorp Bancshares, Inc. (the
Company) include the accounts of the Company and its wholly-owned subsidiary,
MetroBank, National Association (the Bank). The Bank was formed in 1987 and
is engaged in commercial banking activities through its fourteen branches in
Houston and Dallas, Texas. The accounting principles followed by the Company and the methods of
applying these principles conform with accounting principles generally accepted
in the United States and with general practices within the banking industry.
Certain principles which significantly affect the determination of financial
position, results of operations and cash flows are summarized below. Use of Estimates These financial statements are prepared in conformity with accounting
principles generally accepted in the United States of America, which require
management to make estimates and assumptions. These assumptions affect the
reported amounts of assets and liabilities and the disclosure of contingent
assets and liabilities at the date of the financial statements and the reported
amounts of revenues and expenses during the reporting period. Significant
estimates include the allowance for loan losses. Amounts are recognized when
it is probable that an asset has been impaired or a liability has been incurred
and the cost can be reasonable estimated. Actual results could differ from
those estimates. Principles of Consolidation All significant intercompany accounts and transactions are eliminated in
consolidation. Cash and Cash Equivalents Cash and cash equivalents include cash on hand, amounts due from banks,
federal funds sold, and other temporary investments with original maturities of
less than three months. Securities Investments in securities for which the Company has both the ability and
intent to hold to maturity are classified as investments held-to-maturity and
are stated at amortized cost. Amortization of premiums and accretion of
discounts are recognized as adjustments to interest income using the
effective-interest method. Investments in securities which management believes
may be sold prior to maturity are classified as investments available-for-sale
and are stated at fair value. Unrealized net gains and losses, net of the
associated deferred income tax effect, are excluded from income and reported as
a separate component of shareholders equity in Accumulated other
comprehensive income. Realized gains and losses from sales of investments
available-for-sale are recorded on the trade date and determined using the
specific identification method. Loans and Allowance for Loan Losses Loans are reported at the principal amount outstanding, reduced by
unearned discounts, net deferred loan fees, and an allowance for loan losses.
Unearned income on installment loans is recognized using the effective interest
method over the term of the loan. Interest on other loans is calculated using
the simple interest method on the daily principal amount outstanding. Loans are placed on nonaccrual status when principal or interest is past
due more than 90 days or when, in managements opinion, collection of principal
and interest is not likely to be made in accordance with a loans contractual
terms. Interest accrued but not collected at the date a loan is placed on
nonaccrual status is reversed against interest income. In addition, the
amortization of net deferred loan fees is suspended when a loan is placed on
nonaccrual status. Interest income on nonaccrual loans is recognized only to
the extent received in cash; however, where there is doubt regarding the
ultimate collectibility of 53




---



##### Table of Contents



METROCORP BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued) the loan principal, cash receipts, whether designated as principal or interest,
are thereafter applied to reduce the principal balance of the loan. Loans are
restored to accrual status only when interest and principal payments are
brought current and, in managements judgment, future payments are reasonably
assured. A loan, with the exception of groups of smaller-balance homogenous loans
that are collectively evaluated for impairment, is considered impaired when,
based on current information, it is probable that the borrower will be unable
to pay contractual interest or principal payments as scheduled in the loan
agreement. A creditor may use existing methods for recognizing interest income
on impaired loans. The Bank recognizes interest income on impaired loans
pursuant to the discussion above for nonaccrual loans. The allowance for loan losses related to impaired loans is determined
based on the difference of carrying value of loans and the present value of
expected cash flows discounted at the loans effective interest rate or, as a
practical expedient, the loans observable market price or the fair value of
the collateral if the loan is collateral dependent. Estimates of loan losses involve an exercise of judgment. While it is
possible that in the short-term the Company may sustain losses which are
substantial in relation to the allowance for loan losses, it is the judgment of
management that the allowance for loan losses reflected in the consolidated
balance sheets is adequate to absorb probable losses that exist in the current
loan portfolio. The allowance for loan losses provides for the risk of losses inherent in
the lending process. The allowance for loan losses is based on periodic
reviews and analyses of the loan portfolio which include consideration of such
factors as the risk rating of individual credits, the size and diversity of the
portfolio, economic conditions, prior loss experience and results of periodic
credit reviews of the portfolio. The allowance for loan losses is increased by
provisions for loan losses charged against income and reduced by charge-offs,
net of recoveries. In managements judgment, the allowance for loan losses is
considered adequate to absorb losses inherent in the loan portfolio. Nonrefundable Fees and Costs Associated with Lending Activities Loan origination fees net of the associated costs are recognized over the
life of the related loan as an adjustment to yield using the interest method. Generally, loan commitment fees are deferred and recognized as an
adjustment of yield by the interest method over the related loan life or, if
the commitment expires unexercised, recognized in income upon expiration of the
commitment. Premises and Equipment Premises and equipment are stated at cost, less accumulated depreciation.
For financial accounting purposes, depreciation is computed using the
straight-line method over the estimated useful lives of the assets.
Expenditures for maintenance and repairs, which do not extend the life of bank
premises and equipment, are charged to operations as incurred. Other Real Estate Other real estate consists of properties acquired through a foreclosure
proceeding or acceptance of a deed in lieu of foreclosure. These properties
are initially recorded at fair value less estimated costs to sell. On an
ongoing basis they are carried at the lower of cost or fair value minus
estimated costs to sell based on appraised value. Operating expenses, net of
related revenue and gain and losses on sale of such assets, are reported in
noninterest expense. 54




---



##### Table of Contents



METROCORP BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued) Other Borrowings Other borrowings include U.S. Treasury tax note option accounts with
maturities of 14 days or less and Federal Home Loan Bank (FHLB) borrowings. Income Taxes The Company provides for an asset and liability approach to income taxes
that requires the recognition of deferred tax assets and liabilities for the
expected future tax consequences of events that have been recognized in the
Companys financial statements or tax returns. When management determines that
it is more likely than not that a deferred tax asset will not be realized, a
valuation allowance is established. In estimating future tax consequences, all
expected future events other than enactments of changes in tax laws or rates
are considered. Earnings Per Share Basic earnings per common share is calculated by dividing net earnings
available for common shareholders by the weighted average number of common
shares outstanding during the period. Diluted earnings per share is calculated
by dividing net earnings available for common shareholders by the weighted
average number of common and potentially dilutive common shares. Stock options
can be dilutive common shares and are therefore considered in the earnings per
share calculation, if dilutive. The number of potentially dilutive common
shares is determined using the treasury stock method. Interest Rate Risk Management The operations of the Bank are subject to the risk of interest rate
fluctuations to the extent that interest-bearing assets and interest-bearing
liabilities mature or reprice at different times or in differing amounts. Risk
management activities are aimed at optimizing net interest income, given a
level of interest rate risk consistent with the Banks business strategies. Asset liability management activities are conducted in the context of the
Banks asset sensitivity to interest rate changes. This asset sensitivity
arises due to interest-earning assets repricing more frequently than
interest-bearing liabilities. For example, if interest rates are declining,
margins will narrow as assets reprice downward more quickly than liabilities.
The converse applies when interest rates are on the rise. As part of the Banks interest rate risk management, loans of
approximately $362.7 million and $316.7 million, at December 31, 2003 and 2002,
respectively, contain interest rate floors to reduce the unfavorable impact to
the Bank during interest rate declines. The weighted average interest rate on
these loans at December 31, 2003 and 2002 was 5.88% and 6.58%, respectively,
and the interest rate floors ranged from 4.00% to 10.00% and 4.75% to 11.00%,
respectively. Stock Compensation The Company grants stock options under several stock-based incentive
compensation plans. The Company applies APB Opinion 25 and related
Interpretations in accounting for such plans. The Company utilizes the
intrinsic value method for its stock compensation plans. No compensation cost
is recognized for fixed stock options in which the exercise price is equal to
or greater than the estimated market price on the date of grant. In 1995, the
Financial Accounting Standards Board (FASB) issued Statement of Financial
Accounting Standards (SFAS) No. 123 Accounting for Stock-Based Compensation,
as amended by SFAS No.198, which, if fully adopted by the Company, would change
the methods the Company applies in recognizing the cost of the plans. Adoption
of the expense recognition provisions of SFAS No. 123, as amended by SFAS No.
198, is optional and the Company has decided not to elect these provisions of
SFAS No. 123. However, pro forma disclosures as if the Company adopted the
expense recognition provisions of SFAS No. 123 are required by SFAS No. 123, as
amended by SFAS No. 148. 55




---



##### Table of Contents



METROCORP BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued) If the fair value based method of accounting under SFAS No. 123 had been
applied, the Companys net income available for common shareholders and
earnings per common share would have been reduced to the pro forma amounts
indicated below (assuming that the fair value of options granted during the
year are amortized over the vesting period) (in thousands except per share
amounts): Years Ended December 31,2003
    
    2002
    
    2001(Restated - Note 2)Net income:As reported
    
    $
    4,110
    
    
    $
    8,970
    
    
    $
    7,854Pro forma
    
    $
    4,000
    
    
    $
    8,862
    
    
    $
    7,823Stock-based compensation cost, net of income taxes:As reported
    
    $
    
    
    
    $
    
    
    
    $
    Pro forma
    
    $
    110
    
    
    $
    108
    
    
    $
    31Basic earnings per common share:As reported
    
    $
    0.58
    
    
    $
    1.28
    
    
    $
    1.12Pro forma
    
    $
    0.56
    
    
    $
    1.26
    
    
    $
    1.12Diluted earnings per common share:As reported
    
    $
    0.57
    
    
    $
    1.25
    
    
    $
    1.11Pro forma
    
    $
    0.55
    
    
    $
    1.24
    
    
    $
    1.11
 The effects of applying SFAS No. 123 in this pro forma disclosure are not
indicative of future amounts. SFAS No. 123 does not apply to awards prior to
1995, and the Company anticipates making awards in the future under its
stock-based compensation plans. The Black-Scholes option valuation model was
developed for use in estimating the fair value of traded options which have no
vesting restrictions and are fully transferable. In addition, option valuation
models require the input of highly subjective assumptions including the
expected stock price volatility. Because the Companys employee stock options
have characteristics significantly different from those of traded options, and
because changes in the subjective input assumptions can materially affect the
fair value estimate, the existing models do not necessarily provide a reliable
single measure of the fair value of its employee stock options. Off-Balance Sheet Instruments The Company has entered into off-balance sheet financial instruments
consisting of commitments to extend credit. Such financial instruments are
recorded in the financial statements when they are funded. New Accounting Pronouncements On November 25, 2002, the FASB issued FASB Interpretation (FIN) No. 45,
Guarantors Accounting and Disclosure Requirements for Guarantees, Including
Indirect Guarantees of Indebtedness of Others.FIN No. 45 considers standby
letters of credit, excluding commercial letters of credit and other lines of
credit, a guarantee of the Bank. The Bank enters into a standby letter of
credit to guarantee performance of a customer to a third party. These
guarantees are primarily issued to support public and private borrowing
arrangements. The credit risk involved is represented by the contractual
amounts of those instruments. Under the standby letters of credit, the Bank is
required to make payments to the beneficiary of the letters of credit upon
request by the beneficiary so long as all performance criteria have been met.
Most guarantees extend up to one year. At December 31, 2003 the maximum
potential amount of future payments is $7.3 million. See 
Note 13 
Off-Balance Sheet Risk for a discussion of significant guarantees that have
been entered into by the Company. The adoption of FIN No. 45 has not had a
material effect on the Companys financial condition or results of operations. On January 17, 2003, the FASB issued FIN No. 46, Consolidation of Variable
Interest Entities,which addresses consolidation by business enterprises of
variable interest entities. FIN No. 46, as amended by FIN No. 46R, clarifies
the application of ARB No. 51, Consolidated Financial Statements,to certain
entities in which equity investors do not have the characteristics of a
controlling financial interest or do not have sufficient equity at risk for the
entity to finance its activities without additional subordinated financial
support from other parties. The adoption has not had a material impact on the
Companys financial condition or results of operations. 56




---



##### Table of Contents



METROCORP BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued) On May 15, 2003, the FASB approved SFAS No. 150, Accounting for Certain
Financial Instruments with Characteristics of both Liabilities and Equity.
This statement changes the accounting for certain financial instruments that,
under previous guidance, could be classified as equity or mezzanine equity,
but now is requiring those instruments to be classified as liabilities (or
assets in some circumstances) in the statement of financial condition.
Further, SFAS No. 150 requires disclosure regarding the terms of those
instruments and settlement alternatives. This statement is generally effective
for all such financial instruments entered into or modified after May 31, 2003,
and otherwise is effective at the beginning of the first interim period
beginning after June 15, 2003, except for manadatorily redeemable financial
instruments of non-public entities. It is not expected that this statement
will have a material effect on the Companys financial condition or results of
operations. On October 29, 2003, the FASB deferred certain provisions of this
statement. Reclassifications Certain 2002 and 2001 amounts have been reclassified to conform to the
2003 presentation, and has had no impact on net income or shareholders equity. 2. Restatement The Company restated its consolidated financial statements as of December
31, 2003 and 2002 and for the years ended December 31, 2003, 2002, and 2001 to
correct the amortization of deferred loan fees, net of costs, to interest
income and to adjust accruals of other noninterest expense. The restatement
increased net income by $402,000, $181,000, and $277,000 for the years ended
December 31, 2003, 2002, and 2001, respectively, and increased retained
earnings by $2.2 million, $1.8 million, $1.6 million, and $1.3 million at
December 31, 2003, 2002, 2001, and 2000 respectively. The restatement resulted from a review of the Companys application of
FASB Statement No. 91, Accounting for Nonrefundable Fees and Costs Associated
with Originating or Acquiring Loans and Initial Direct Costs of Leases. Loan
fees net of the associated costs should be recognized over the life of
the related loan as an adjustment to yield. The Company recently discovered
that $4.0 million of net deferred loan fees were not being amortized to
interest income. These net deferred fees were not entered into the Companys
loan system, and therefore, amortization was not calculated each period.
Accordingly, the restatement reflects the amortization of these net deferred
fees which resulted in an increase to income of $357,000, $327,000, and $321,000
for the years ended December 31, 2003, 2002 and 2001, respectively.
Additionally, in connection with the restatement for net deferred fees, the
Company adjusted accruals of other noninterest expense previously deemed
immaterial which resulted in an increase to net income of $63,000 in 2003 and a
decrease to net income of $146,000 and $44,000 in 2002 and 2001, respectively. 57




---



##### Table of Contents



METROCORP BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued) The
following table reflects the previously reported amounts as of and for the years
ended December 31, 2003, 2002, and 2001 and the restated amounts: As of and For the Year EndedDecember 31, 2003
    
    December 31, 2002
    
    December 31, 2001Previously
    
    
    
    
    
    Previously
    
    
    
    
    
    PreviouslyReported
    
    Restated
    
    Reported
    
    Restated
    
    Reported
    
    Restated(In thousands, except
per share amounts)Balance Sheet:Loans, net of allowance for loan losses
    
    $
    537,305
    
    
    $
    540,658
    
    
    $
    517,609
    
    
    $
    520,421Deferred tax asset
    
    
    5,774
    
    
    
    4,664
    
    
    
    4,584
    
    
    
    3,652Total assets
    
    
    864,773
    
    
    
    867,016
    
    
    
    840,065
    
    
    
    841,945Other liabilities
    
    
    5,530
    
    
    
    5,610
    
    
    
    3,670
    
    
    
    3,789Retained earnings
    
    
    41,942
    
    
    
    44,105
    
    
    
    39,938
    
    
    
    41,699
    
    
    $
    32,834
    
    
    $
    34,414Total shareholders equity
    
    
    76,210
    
    
    
    78,373
    
    
    
    74,463
    
    
    
    76,224
    
    
    
    65,229
    
    
    
    66,809Total liabilities and shareholders equity
    
    
    864,773
    
    
    
    867,016
    
    
    
    840,065
    
    
    
    841,945Statement of Income:Interest income - loans
    
    
    35,242
    
    
    
    34,691
    
    
    
    37,987
    
    
    
    37,256
    
    
    
    43,926
    
    
    
    43,415Total interest income
    
    
    43,838
    
    
    
    43,287
    
    
    
    48,711
    
    
    
    47,980
    
    
    
    55,451
    
    
    
    54,940Net interest income
    
    
    31,704
    
    
    
    31,153
    
    
    
    34,083
    
    
    
    33,352
    
    
    
    31,652
    
    
    
    31,141Salaries and employee benefits
    
    
    15,183
    
    
    
    14,109
    
    
    
    14,746
    
    
    
    13,520
    
    
    
    13,180
    
    
    
    12,183Other noninterest expense
    
    
    6,763
    
    
    
    6,678
    
    
    
    5,543
    
    
    
    5,818
    
    
    
    6,861
    
    
    
    6,871Income before provision for income taxes
    
    
    5,237
    
    
    
    5,845
    
    
    
    13,139
    
    
    
    13,415
    
    
    
    11,130
    
    
    
    11,550Provision for income taxes
    
    
    1,529
    
    
    
    1,735
    
    
    
    4,350
    
    
    
    4,445
    
    
    
    3,553
    
    
    
    3,696Net income
    
    
    3,708
    
    
    
    4,110
    
    
    
    8,789
    
    
    
    8,970
    
    
    
    7,577
    
    
    
    7,854Earnings per common share:Basic
    
    
    0.52
    
    
    
    0.58
    
    
    
    1.25
    
    
    
    1.28
    
    
    
    1.08
    
    
    
    1.12Diluted
    
    
    0.51
    
    
    
    0.57
    
    
    
    1.23
    
    
    
    1.25
    
    
    
    1.07
    
    
    
    1.11Cash flow
statement:Cash flows
from operating activities
    
    
    8,860
    
    
    
    8,891
    
    
    
    18,443
    
    
    
    18,477
    
    
    
    (2,330
    )
    
    
    (2,560
    )Cash flows
from investing activities
    
    
    (31,773
    )
    
    
    (31,804
    )
    
    
    (126,019
    )
    
    
    (126,053
    )
    
    
    (46,955
    )
    
    
    (46,725
    )
 3. Cash and Cash Equivalents The Bank is required by the Board of Governors of the Federal Reserve
System to maintain average reserve balances.
The balance requirement is more than satisfied by the Banks vault cash. 4. Securities In the normal course of business, the Bank invests in Federal government,
Federal agency, state and municipal securities, which inherently carry interest
rate risks based upon overall economic trends and related market yield
fluctuations. Securities within the available-for-sale portfolio may be used
as part of the Companys asset/liability strategy and may be sold in response
to changes in interest rate risk, prepayment risk or other similar economic
factors. Declines in the fair value of individual available-for-sale
securities below their cost that are other than temporary would result in
write-down of the individual securities to their fair value. The related
write-downs would be included in earnings as realized losses. At December 31,
2003 and 2002, the amortized cost and fair value of securities classified as
available-for-sale is as follows: 58




---



##### Table of Contents



METROCORP BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued) As of December 31, 2003Gross
    
    GrossAmortized
    
    Unrealized
    
    Unrealized
    
    FairCost
    
    Gains
    
    Losses
    
    Value(In thousands)Available-for-sale:U.S. Treasury securities and obligations
of U.S.
government agencies
    
    $
    4,965
    
    
    $
    
    
    
    $
    (12
    )
    
    $
    4,953Obligations of state and political subdivisions
    
    
    18,925
    
    
    
    1,249
    
    
    
    
    
    
    
    20,174Mortgage-backed securities and
collateralized
mortgage obligations
    
    
    209,323
    
    
    
    1,170
    
    
    
    (1,254
    )
    
    
    209,239Other debt securities
    
    
    1,096
    
    
    
    3
    
    
    
    (10
    )
    
    
    1,089Investment in ARM and CRA funds
    
    
    21,739
    
    
    
    73
    
    
    
    (203
    )
    
    
    21,609FHLB and Federal Reserve Bank stock
(1)(2)
    
    
    5,200
    
    
    
    
    
    
    
    
    
    
    
    5,200Total securities
    
    $
    261,248
    
    
    $
    2,495
    
    
    $
    (1,479
    )
    
    $
    262,264
 As of December 31, 2002Gross
    
    GrossAmortized
    
    Unrealized
    
    Unrealized
    
    FairCost
    
    Gains
    
    Losses
    
    Value(In thousands)Available-for-sale:U.S. Treasury securities and obligations
of U.S. government agencies
    
    $
    2,488
    
    
    $
    50
    
    
    $
    
    
    
    $
    2,538Obligations of state and political subdivisions
    
    
    22,059
    
    
    
    591
    
    
    
    (2
    )
    
    
    22,648Mortgage-backed securities and
collateralized
mortgage obligations
    
    
    180,599
    
    
    
    2,862
    
    
    
    (151
    )
    
    
    183,310Other debt securities
    
    
    2,378
    
    
    
    33
    
    
    
    (20
    )
    
    
    2,391Investment in ARM and CRA funds
    
    
    48,982
    
    
    
    169
    
    
    
    
    
    
    
    49,151FHLB and Federal Reserve Bank stock
(1)(2)
    
    
    4,380
    
    
    
    
    
    
    
    
    
    
    
    4,380Total securities
    
    $
    260,886
    
    
    $
    3,705
    
    
    $
    (173
    )
    
    $
    264,418
   (1)
    
    FHLB stock held by the Bank is subject to certain restrictions under a credit policy of the FHLB
dated May 1, 1997. Redemption of FHLB stock is dependent upon repayment of borrowings from the FHLB.(2)
    
    Federal Reserve Bank stock held by the Bank is subject to certain restrictions under Federal Reserve
Bank Policy. The following sets forth information concerning sales (excluding
maturities) of available-for-sale securities (in thousands): Years ended December 31,2003
    
    2002
    
    2001Amortized cost
    
    $
    19,818
    
    
    $
    18,981
    
    
    $
    37,059Proceeds
    
    
    19,983
    
    
    
    19,015
    
    
    
    37,248Gross realized gains
    
    
    165
    
    
    
    98
    
    
    
    201Gross realized losses
    
    
    
    
    
    
    64
    
    
    
    12
 Investments carried at approximately $1.6 million and $1.8 million at
December 31, 2003 and 2002, respectively, were pledged to collateralize public
deposits and short-term borrowings of approximately $1.4 million and $1.6
million, respectively. Additionally, investments in the securities portfolio
carried at approximately $25.7 million and $34.5 million were pledged as
collateral for other borrowings at December 31, 2003 and 2002, respectively. 59




---



##### Table of Contents



METROCORP BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued) At December 31, 2003, future contractual maturities of securities are as
follows (in thousands): Securitiesavailable-for-saleAmortized
    
    Faircost
    
    valueWithin one year
    
    $
    185
    
    
    $
    186Within two to five years
    
    
    3,321
    
    
    
    3,367Within six to ten years
    
    
    7,159
    
    
    
    7,309After ten years
    
    
    14,321
    
    
    
    15,354Mortgage-backed securities and collateralized mortgage
obligations
    
    
    209,323
    
    
    
    209,239Debt securities
    
    
    234,309
    
    
    
    235,455Investment in ARM and CRA funds
    
    
    21,739
    
    
    
    21,609FHLB and Federal Reserve Bank stock
    
    
    5,200
    
    
    
    5,200Total securities
    
    $
    261,248
    
    
    $
    262,264
 The following table displays the gross unrealized losses and fair value of
investments as of December 31, 2003 that were in a continuous unrealized loss
position for the periods indicated: Less Than 12 Months
    
    Greater Than 12 Months
    
    TotalUnrealized
    
    
    
    
    
    Unrealized
    
    
    
    
    
    UnrealizedFair Value
    
    Loss
    
    Fair Value
    
    Loss
    
    Fair Value
    
    Loss(In thousands)U.S. Government agency securities
    
    $
    4,953
    
    
    $
    (12
    )
    
    $
    
    
    
    $
    
    
    
    $
    4,953
    
    
    $
    (12
    )Mortgage back securities
    
    
    96,812
    
    
    
    (1,254
    )
    
    
    
    
    
    
    
    
    
    
    96,812
    
    
    
    (1,254
    )Municipal securities
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Federal Reserve Bank stock
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Federal Home Loan Bank stock
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Other securities
    
    
    980
    
    
    
    (10
    )
    
    
    
    
    
    
    
    
    
    
    980
    
    
    
    (10
    )Investments in mutual funds
    
    
    19,227
    
    
    
    (203
    )
    
    
    
    
    
    
    
    
    
    
    19,227
    
    
    
    (203
    )Total Securities available for
sale
    
    $
    121,972
    
    
    $
    (1,479
    )
    
    $
    
    
    
    $
    
    
    
    $
    121,972
    
    
    $
    (1,479
    )
 Declines in the fair value of individual securities below their cost that
are other than temporary would result in write-downs, as a realized loss, of
the individual securities to their fair value. Management believes that based
upon the credit quality of the debt securities and the Companys intent and
ability to hold the securities until their recovery, none of the unrealized
losses on securities should be considered other than temporary. The Bank holds mortgage-backed securities which may mature at an earlier
date than the contractual maturity due to prepayments. The Bank also holds
certain securities which may be called by the issuer at an earlier date than
the contractual maturity date. The Company does not own any securities of any one issuer (other than U.S.
government and its agencies) of which aggregate adjusted cost exceeded 10% of
consolidated shareholders equity at December 31, 2003 or 2002. 5. Loans and Allowance for Loan Losses The Bank originates commercial, real estate and other loans to commercial
and individual customers throughout the markets it serves in Texas. In June 2003, the Company transferred the status of approximately $13.1
million in hospitality-related loans to held-for-sale. While the Company has
not historically made such transfers, the high concentration of these loans was
deemed necessary to reduce the Companys exposure to credit risk. In August
2003, an additional $3.9 million composed of two restaurant loans totaling $2.6
million and an office building loan of $1.3 million, was transferred to
held-for-sale. Approximately $11.0 million of the loans held-for-sale were
sold during 2003 and a gain of approximately $139,000 was recognized. The
remaining $6.0 million were held-for-sale at December 31, 2003 and are carried
at the lower of cost or market. During 2003, the Company recorded lower of
cost or market adjustments of $2.1 million on the loans held-for-sale. The
Company may consider future transfers with concentrations in hospitality and
other related loans that may expose the Company to potential losses. 60




---



##### Table of Contents



METROCORP BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued) The loan portfolio is summarized by major categories as follows (in thousands): As of December 31,2003
    
    2002(Restated - Note 2)Commercial and industrial
    
    $
    332,480
    
    
    $
    325,424Real estate-mortgage
    
    
    192,605
    
    
    
    172,934Real estate-construction
    
    
    24,558
    
    
    
    25,394Consumer and other
    
    
    10,447
    
    
    
    10,286Gross loans
    
    
    560,090
    
    
    
    534,038Unearned discounts and interest
    
    
    (864
    )
    
    
    (805
    )Deferred loan fees
    
    
    (2,090
    )
    
    
    (2,662
    )Total loans
    
    
    557,136
    
    
    
    530,571Allowance for loan losses
    
    
    (10,448
    )
    
    
    (10,150
    )Loans, net (1)
    
    $
    546,688
    
    
    $
    520,421Variable rate loans
    
    $
    476,654
    
    
    $
    447,655Fixed rate loans
    
    
    83,436
    
    
    
    86,383Gross loans
    
    $
    560,090
    
    
    $
    534,038
   (1)
    
    Includes $6.0 million in commercial loans held-for-sale. Although the Banks loan portfolio is diversified, a substantial portion
of its customers ability to service their debts is dependent primarily on the
service sectors of the economy. At December 31, 2003 and 2002, the Banks loan
portfolio consisted of concentrations in the following industries. With the
exception of the concentration in apartment buildings, all such amounts
represent a concentration greater than 25% of capital (in thousands): As of December 31,2003
    
    2002Hotels/motels
    
    $
    66,062
    
    
    $
    82,015Retail centers
    
    
    112,380
    
    
    
    103,623Restaurants
    
    
    31,524
    
    
    
    33,094Apartment buildings
    
    
    14,868
    
    
    
    14,941Convenience/gasoline stations
    
    
    26,983
    
    
    
    27,383All other
    
    
    308,273
    
    
    
    272,982Gross loans
    
    $
    560,090
    
    
    $
    534,038
 Changes in the allowance for loan losses are as follows (in thousands): As of December 31,2003
    
    2002Balance at beginning of year
    
    $
    10,150
    
    
    $
    8,903Provision for loan losses
    
    
    5,690
    
    
    
    3,853Charge-offs
    
    
    (6,121
    )
    
    
    (3,124
    )Recoveries
    
    
    729
    
    
    
    518Balance at end of year
    
    $
    10,448
    
    
    $
    10,150
 Loans for which the accrual of interest has been discontinued totaled
approximately $25.4 million and $17.2 million at December 31, 2003 and 2002,
respectively. Had these loans remained on an accrual basis, 61




---



##### Table of Contents



METROCORP BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued) interest in the
amount of approximately $1.0 million and $657,000 would have been accrued on
these loans during the years ended December 31, 2003 and 2002, respectively. Included in other assets on the balance sheet at December 31, 2003 and
2002 is $125,000 and $105,000, respectively, due from the SBA, the Export
Import Bank of the United States (Ex-Im Bank), an independent agency of the
United States Government, and the Overseas Chinese Community Guaranty Fund
(OCCGF), an agency sponsored by the government of Taiwan. These amounts
represent the guaranteed portions of loans previously charged-off. The recorded investment in loans for which impairment has been recognized
and the related specific allowance for loan losses on such loans at December
31, 2003 and 2002, is presented below (in thousands): Real Estate
    
    Commercial
    
    Consumer
    
    TotalDecember 31, 2003:Impaired loans having related allowance for loan losses
    
    $
    6,041
    
    
    $
    19,341
    
    
    $
    60
    
    
    $
    25,442Less: Allowance for loan losses
    
    
    (914
    )
    
    
    (7,956
    )
    
    
    (30
    )
    
    
    (8,900
    )Less: Guaranteed portion (SBA, OCCGF and Ex-Im Bank)
    
    
    
    
    
    
    (3,323
    )
    
    
    
    
    
    
    (3,323
    )Impaired loans, net of allowance
for loan losses and guarantees
    
    $
    5,127
    
    
    $
    8,062
    
    
    $
    30
    
    
    $
    13,219December 31, 2002:Impaired loans having related allowance for loan losses
    
    $
    
    
    
    $
    17,101
    
    
    $
    108
    
    
    $
    17,209Less: Allowance for loan losses
    
    
    
    
    
    
    (3,224
    )
    
    
    (54
    )
    
    
    (3,278
    )Less: Guaranteed portion (SBA, OCCGF and Ex-Im Bank)
    
    
    
    
    
    
    (3,310
    )
    
    
    
    
    
    
    (3,310
    )Impaired loans, net of allowance
for loan losses and guarantees
    
    $
    
    
    
    $
    10,567
    
    
    $
    54
    
    
    $
    10,621
 As of December 31, 2003 and 2002, the average recorded investment in
impaired loans was approximately $21.8 million and $13.0 million, respectively.
The related amount of interest income recognized while the loans were impaired
approximated $215,000 for the year ended December 31, 2002. No interest income
was recognized in the year ended December 31, 2003. Additionally, at December 31, 2003, loans with a value of approximately
$28.0 million were available as collateral under a blanket loan agreement with
the Federal Home Loan Bank of Dallas. 6. Premises and Equipment Premises and equipment are summarized as follows (in thousands): Estimated useful
    
    As of December 31,lives (in years)
    
    2003
    
    2002Furniture, fixtures and equipment
    
    
    3-10
    
    
    $
    12,382
    
    
    $
    11,633Building and improvements
    
    
    3-20
    
    
    
    4,379
    
    
    
    4,018Land
    
    
    
    
    
    
    1,679
    
    
    
    1,679Leasehold improvements
    
    
    5
    
    
    
    2,715
    
    
    
    2,65521,155
    
    
    
    19,985Accumulated depreciation
    
    
    
    
    
    
    (15,481
    )
    
    
    (14,144
    )Premises and equipment, net
    
    
    
    
    
    $
    5,674
    
    
    $
    5,841
 62




---



##### Table of Contents



METROCORP BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued) 7. Interest-Bearing Deposits The types of accounts and their respective balances included in
interest-bearing deposits are as follows (in thousands): As of December 31,2003
    
    2002Interest-bearing demand deposits
    
    $
    74,112
    
    
    $
    78,147Savings and money market accounts
    
    
    120,151
    
    
    
    107,722Time deposits less than $100,000
    
    
    167,672
    
    
    
    166,261Time deposits $100,000 and over
    
    
    193,909
    
    
    
    194,687Interest-bearing deposits
    
    $
    555,844
    
    
    $
    546,817
 At December 31, 2003, the scheduled maturities of time deposits are as
follows (in thousands): 2004
    
    $
    292,9782005
    
    
    33,1442006
    
    
    28,0332007
    
    
    3,1412008
    
    
    4,218After 2008
    
    
    67$
    361,581
 The Bank had no brokered deposits as of December 31, 2003 or 2002. There
were no major deposit concentrations as of December 31, 2003 or 2002. 8. Other Borrowings Other borrowings include $25.0 million of loans from the FHLB of Dallas,
maturing in September 2008. The loans bear interest at an average rate of
4.99% per annum until September 2003 after which time the FHLB may request
repayment or the interest rate may be renegotiated. Other borrowings also include several FHLB advances obtained to acquire
mortgage-related securities in order to increase earning assets. These
borrowings were $28.3 million and $65.2 million at December 31, 2003 and 2002,
respectively, with maturities ranging from one month to two years and carried a
weighted average interest rate of 1.52% and 1.85%, respectively. The following is a schedule by year of payments required on the Companys
FHLB borrowings (in thousands): Year
    
    Amount2004
    
    $
    28,3002005
    
    
    2006
    
    
    2007
    
    
    2008
    
    
    25,000After 2008
    
    
    $
    53,300
 Other short-term borrowings at December 31, 2003 and 2002 consist of
$873,000 and $574,000, respectively, in Treasury, Tax and Loan (TT&L)
payments in Company accounts for the benefit of the U.S. Treasury. These funds
typically remain in the Company for one day and are then moved to the U.S.
Treasury. Additionally, the Bank has several unused, unsecured lines of credit with
correspondent banks totaling $15.0 million at December 31, 2003 and 2002. 63




---



##### Table of Contents



METROCORP BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued) 9. Income Taxes Deferred income taxes result from differences between the amounts of
assets and liabilities as measured for income tax return and for financial
reporting purposes. The significant components of the net deferred tax asset
are as follows (in thousands): As of December 31,2003
    
    2002(Restated - Note 2)Deferred Tax Assets:Allowance for loan losses
    
    $
    3,552
    
    
    $
    3,451Net deferred loan fees
    
    
    740
    
    
    
    929Premises and equipment
    
    
    1,044
    
    
    
    1,011Recognition of interest on nonaccrual loans
    
    
    435
    
    
    
    640Gross deferred tax assets
    
    
    5,771
    
    
    
    6,031Deferred Tax Liabilities:Unrealized gains on investments securities
available-for-sale, net
    
    
    346
    
    
    
    1,201FHLB stock dividends
    
    
    403
    
    
    
    374Other
    
    
    358
    
    
    
    804Gross deferred tax liabilities
    
    
    1,107
    
    
    
    2,379Net deferred tax asset
    
    $
    4,664
    
    
    $
    3,652
 The Bank has not provided a valuation allowance for the net deferred tax
asset at December 31, 2003 and 2002 due primarily to its ability to offset
reversals of net deductible temporary differences against income taxes paid in
previous years and expected to be paid in future years. Components of the provision for income taxes are as follows (in
thousands): Years ended December 31,2003
    
    2002
    
    2001(Restated - Note 2)Current provision for federal income taxes
    
    $
    1,943
    
    
    $
    4,397
    
    
    $
    3,336Deferred federal income tax provision (benefit)
    
    
    (208
    )
    
    
    48
    
    
    
    360Total provision for income taxes
    
    $
    1,735
    
    
    $
    4,445
    
    
    $
    3,696
 A reconciliation of the provision for income taxes computed at statutory
rates compared to the actual provision for income taxes is as follows (in
thousands): Years ended December 31,2003
    
    2002
    
    2001Amount
    
    Percent
    
    Amount
    
    Percent
    
    Amount
    
    Percent(Restated - Note 2)Federal income tax expense at statutory rate
    
    $
    1,987
    
    
    
    34
    %
    
    $
    4,562
    
    
    
    34
    %
    
    $
    3,927
    
    
    
    34
    %Tax-exempt interest income
    
    
    (315
    )
    
    
    (6
    )
    
    
    (361
    )
    
    
    (3
    )
    
    
    (400
    )
    
    
    (3
    )Other, net
    
    
    63
    
    
    
    1
    
    
    
    244
    
    
    
    2
    
    
    
    169
    
    
    
    1Provision for income taxes
    
    $
    1,735
    
    
    
    29
    %
    
    $
    4,445
    
    
    
    33
    %
    
    $
    3,696
    
    
    
    32
    %
 The following sets forth the deferred tax expense (benefit) related to
other comprehensive income (loss) (in thousands): Years ended December 31,2003
    
    2002
    
    2001Unrealized gains (losses) arising during the period
    
    $
    (775
    )
    
    $
    1,020
    
    
    $
    196Less: reclassification adjustment for gains
realized in net income
    
    
    58
    
    
    
    12
    
    
    
    64$
    (833
    )
    
    $
    1,008
    
    
    $
    132
 64




---



##### Table of Contents



METROCORP BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued) 10. 401(k) Profit Sharing Plan The Company has established a defined contributory profit sharing plan
pursuant to Internal Revenue Code Section 401(k) covering substantially all
employees (the Plan). The Plan provides for pretax employee contributions of
up to 15% of annual compensation. The Company matches each participants
contributions to the Plan up to 4% of such participants salary. The Company
made contributions, before expenses, to the Plan of approximately $389,000,
$354,000, and $308,000 during the years ended December 31, 2003, 2002, and
2001, respectively. 11. Shareholders Equity The Company declared and paid dividends of $0.24 per share to the
shareholders of record during the year ended December 31, 2003 which included a
dividend declared of $0.06 per share to shareholders of record as of December
31, 2003, which was paid on January 15, 2004. The Company also paid dividends
of $0.24 per share in 2002 and 2001. The declaration and payment of dividends on the Common Stock by the
Company depends upon the earnings and financial condition of the Company,
liquidity and capital requirements, the general economic and regulatory
climate, the Companys ability to service any equity or debt obligations senior
to the Common Stock and other factors deemed relevant by the Companys Board of
Directors. The Companys Non-Employee Director Stock Bonus Plan (Non-Employee
Director Plan) authorizes the issuance of up to 60,000 shares of Common Stock
to the directors of the Company who do not serve as an officer or employee of
the Company. Under the Non-Employee Director Plan, up to 12,000 shares of
Common Stock may be issued each year for a five-year period beginning in 1998
if the Company achieves a certain return on equity ratio with no shares to be
issued if the Companys return on equity is below 13.0%. This return on equity
goal was not achieved in 2003, 2002 or 2001. As of December 31, 2003, 24,000
shares have been issued under the Non-Employee Director Plan and no additional
shares are available for issuance under this plan. The Companys 1998 Employee Stock Purchase Plan (Purchase Plan)
authorizes the offer and sale of up to 200,000 shares of Common Stock to
employees of the Company and its subsidiaries. The Purchase Plan will be
implemented through ten annual offerings. Each year the Board of Directors
determines the number of shares to be offered under the Purchase Plan; provided
that in any one year the offering may not exceed 20,000 shares plus any
unsubscribed shares from prior years. The offering price per share will be an
amount equal to 90% of the closing trading price of a share of Common Stock on
the business day immediately prior to the commencement of such offering. In
each offering, each employee may purchase a number of whole shares of Common
Stock that are equal to 20% of the employees base salary divided by the
offering price. Pursuant to the Purchase Plan, the employee pays for the
Common Stock either immediately or through a payroll deduction program over a
period of up to one year, at the employees option. The first annual offering
under the Purchase Plan began in the second quarter of 1999. As of December
31, 2003 there were 23,743 shares issued under the Purchase Plan. 12. Regulatory Matters Regulatory restrictions limit the payment of cash dividends by the Bank.
The approval of the Office of the Comptroller of the Currency (OCC) is required
for any cash dividend paid by the Bank if the total of all cash dividends
declared in any calendar year exceeds the total of its net income for that year
combined with the net addition to undivided profits for the preceding two
years. As of December 31, 2003, approximately $15.9 million was available for
payment of dividends by the Bank to the Company under applicable restrictions,
without regulatory approval. The Company and the Bank are subject to various regulatory capital
requirements administered by the federal banking agencies. Failure to meet
minimum capital requirements can initiate certain mandatory, and possibly
additional discretionary, actions by regulators that, if undertaken, could have
a direct material effect on the Companys financial statements. The
regulations require the Company to meet specific capital adequacy guidelines
that involve quantitative measures of the Companys assets, liabilities, and
certain off- 65




---



##### Table of Contents



METROCORP BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued) balance sheet items as calculated under regulatory accounting
practices. The Banks capital classification is also subject to qualitative
judgments by the regulators about components, risk weightings and other
factors. Quantitative measures established by regulation to ensure capital adequacy
require the Company and the Bank to maintain minimum amounts and ratios of
total and Tier 1 capital to risk-weighted assets, and of Tier 1 capital to
average assets. Management believes, as of December 31, 2003 that the Company
and the Bank meet all capital adequacy requirements to which it is subject. The most recent notifications from the OCC categorized the Bank as well
capitalized, as defined, under the regulatory framework for prompt corrective
action. To be categorized as adequately capitalized, the Bank must maintain
minimum total risk-based, Tier 1 risk-based and Tier leverage ratios as set
forth in the table below. There are no conditions or events since the
notifications that management believes have changed the Banks level of capital
adequacy. The Companys and the Banks actual capital amounts and ratios are
presented in the following table: Minimum
    
    To be wellrequired for
    
    capitalized undercapital adequacy
    
    prompt correctiveActual
    
    purposes
    
    action provisionsAmount
    
    Ratio
    
    Amount
    
    Ratio
    
    Amount
    
    Ratio(Restated - Note 2)(Dollars in thousands)As of December 31, 2003Total risk-based capital ratioMetroCorp Bancshares, Inc
    
    $
    85,225
    
    
    
    13.98
    %
    
    $
    48,758
    
    
    
    8.00
    %
    
    $
    N/A
    
    
    
    N/A
    %MetroBank, N.A
    
    
    80,637
    
    
    
    13.23
    
    
    
    48,757
    
    
    
    8.00
    
    
    
    60,947
    
    
    
    10.00Tier 1 risk-based capital ratioMetroCorp Bancshares, Inc
    
    
    77,572
    
    
    
    12.73
    
    
    
    24,379
    
    
    
    4.00
    
    
    
    N/A
    
    
    
    N/AMetroBank, N.A
    
    
    72,984
    
    
    
    11.98
    
    
    
    24,379
    
    
    
    4.00
    
    
    
    36,568
    
    
    
    6.00Leverage ratioMetroCorp Bancshares, Inc
    
    
    77,572
    
    
    
    9.08
    
    
    
    34,186
    
    
    
    4.00
    
    
    
    N/A
    
    
    
    N/AMetroBank, N.A
    
    
    72,984
    
    
    
    8.54
    
    
    
    34,183
    
    
    
    4.00
    
    
    
    42,729
    
    
    
    5.00As of December 31, 2002Total risk-based capital ratioMetroCorp Bancshares, Inc
    
    $
    81,079
    
    
    
    14.24
    %
    
    $
    45,552
    
    
    
    8.00
    %
    
    $
    N/A
    
    
    
    N/A
    %MetroBank, N.A
    
    
    77,914
    
    
    
    13.69
    
    
    
    45,527
    
    
    
    8.00
    
    
    
    56,908
    
    
    
    10.00Tier 1 risk-based capital ratioMetroCorp Bancshares, Inc
    
    
    73,927
    
    
    
    12.98
    
    
    
    22,776
    
    
    
    4.00
    
    
    
    N/A
    
    
    
    N/AMetroBank, N.A
    
    
    70,762
    
    
    
    12.43
    
    
    
    22,763
    
    
    
    4.00
    
    
    
    34,145
    
    
    
    6.00Leverage ratioMetroCorp Bancshares, Inc
    
    
    73,926
    
    
    
    8.78
    
    
    
    33,665
    
    
    
    4.00
    
    
    
    N/A
    
    
    
    N/AMetroBank, N.A
    
    
    70,762
    
    
    
    8.41
    
    
    
    33,662
    
    
    
    4.00
    
    
    
    42,078
    
    
    
    5.00
 The OCC periodically examines and evaluates national banks. Based upon
such an examination, the OCC may revalue the assets of the institution and
require that it charge-off certain assets, establish specific reserves to
compensate for the difference between the OCC-determined value and the book
value of such assets or take other regulatory action designed to lessen the
risk in the asset portfolio. The OCC is currently conducting its annual
examination of the Bank and while no such actions have been taken by the OCC,
no assurance can be provided that such actions will not occur in the future. 66




---



##### Table of Contents



METROCORP BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued) 13. Off-Balance Sheet Risk The
Company is party to financial instruments with off-balance sheet risk in
the normal course of business to meet the financing needs of its customers.
These financial instruments include various guarantees, commitments to extend
credit and standby letters of credit. Additionally, these instruments may
involve, to varying degrees, credit risk in excess of the amount recognized in
the statement of financial condition. The Companys maximum exposure to credit
loss under such arrangements is represented by the contractual amount of those
instruments. The Company applies the same credit policies and collateralization
guidelines in making commitments and conditional obligations as it does for
on-balance sheet instruments. Commitments to extend credit at December 31,
2003 and 2002 aggregated approximately $102.6 million and $85.4 million,
respectively. Commitments under letters of credit at December 31, 2003 and
2002 totaled $14.9 million and $10.4 million, respectively. The contractual amount of the Companys financial instruments with
off-balance sheet risk expiring by period at December 31, 2003 is presented
below: After OneWithin One
    
    But WithinYear
    
    Three Years
    
    Total(Dollars in thousands)Unfunded loan commitments including unfunded lines
of credit
    
    $
    87,706
    
    
    $
    
    
    
    $
    87,706Standby letters of credit
    
    
    7,215
    
    
    
    115
    
    
    
    7,330Commercial letters of credit
    
    
    7,527
    
    
    
    
    
    
    
    7,527Total financial instruments with off-balance sheet risk
    
    $
    102,448
    
    
    $
    115
    
    
    $
    102,563
 14. Fair Value of Financial Instruments SFAS No. 107, Disclosures About Fair Value of Financial Instruments,
requires disclosures of estimated fair values for all financial instruments and
the methods and assumptions used by management to estimate the fair value for
each type of financial instrument. The fair value of a financial instrument is
the current amount that would be exchanged between willing parties other than
in a forced liquidation. Fair value is best determined based upon quoted
market prices. However, in many instances, there are no quoted market prices
for the Companys various financial instruments. In cases where quoted market prices are not available, fair values are
based on estimates using present value or other valuation techniques. Those
techniques are significantly affected by the assumptions used, including the
discount rate and estimates of future cash flows. Accordingly, the fair value
estimates may not be realized in an immediate settlement of the instrument.
SFAS No. 107 excludes certain financial instruments and all nonfinancial
instruments from its disclosure requirements. Accordingly, the aggregate fair
value amounts presented may not necessarily represent the underlying fair value
of the Company. The following summary presents the methodologies and assumptions used to
estimate the fair value of the Companys financial instruments, required to be
valued pursuant to SFAS No. 107: Assets for Which Fair Value Approximates Carrying Value The fair values of certain financial assets and liabilities carried at
cost, including cash and due from banks, deposits with banks, federal funds
sold, due from customers on acceptances and accrued interest receivable, are
considered to approximate their respective carrying values due to their
short-term nature and negligible credit losses. Investment Securities Fair values are based upon publicly quoted market prices. See Note 3 in
Notes to Consolidated Financial Statements. 67




---



##### Table of Contents



METROCORP BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued) Loans The fair value of loans originated by the Bank is estimated by discounting
the expected future cash flows using a discount rate commensurate with the
risks involved. The loan portfolio is segregated into groups of loans with
homogeneous characteristics and expected future cash flows and interest rates
reflecting appropriate credit risk are determined for each group. An estimate
of future credit losses based on historical experience is factored into the
discounted cash flow calculation. The estimated fair value of the loan
portfolio at December 31, 2003 and 2002 was $544.4 million and $519.3 million,
respectively. Liabilities for Which Fair Value Approximates Carrying Value SFAS No. 107 requires that the fair value disclosed for deposit
liabilities with no stated maturity (i.e., demand, savings, and certain money
market deposits) be equal to the carrying value. SFAS No. 107 does not allow
for the recognition of the inherent funding value of these instruments. The
fair value of federal funds purchased, borrowed funds, acceptances outstanding,
accounts payable and accrued liabilities are considered to approximate their
respective carrying values due to their short-term nature. Time Deposits The fair values disclosed for demand deposits (e.g., interest and
noninterest checking, passbook savings, and certain types of money market
accounts) are, by definition, equal to the amount payable on demand at the
reporting date (i.e., their carrying amounts). The carrying amounts of
variable-rate, fixed-term money market accounts and certificates of deposit
(time deposits) approximate their fair values at the reporting date. Fair
values for fixed-rate time deposits are estimated using a discounted cash flow
calculation that applies interest rates currently being offered on time
deposits to a schedule of aggregated expected monthly maturities on time
deposits. The estimated fair value of time deposits at December 31, 2003 and
2002 was $364.5 million and $365.0 million, respectively. Other Borrowings The carrying amounts of Federal funds purchased, borrowings under
repurchase agreements, and other borrowings maturing within ninety days
approximate their fair values. Fair values of other borrowings are estimated
using discounted cash flow analyses based on the Companys current incremental
borrowing rates for similar types of borrowing arrangements. The estimated
fair value of other borrowings at December 31, 2003 and 2002 was $55.2 million
and $67.3 million, respectively. Off-Balance Sheet Credit-Related Instruments Fair values for off-balance-sheet, credit-related financial instruments
are based on fees currently charged to enter into similar agreements, taking
into account the remaining terms of the agreements and the counterparties
credit standing. The fair value of the Company's off-balance sheet
credit-related instruments was immaterial at December 31, 2003
and 2002. 15. Commitments and Contingencies The Bank leases certain branch premises and equipment under operating
leases which expire between 2004 through 2008 and thereafter. The Bank
incurred rental expense of approximately $867,000, $859,000, and $825,000, for
the years ended December 31, 2003, 2002 and 2001, respectively, under these
lease agreements. Future minimum lease payments at December 31, 2003 due under
these lease agreements are as follows (in thousands): 68




---



##### Table of Contents



METROCORP BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued) Year
    
    Amount2004
    
    $
    9442005
    
    
    8732006
    
    
    4172007
    
    
    3542008
    
    
    302After 2008
    
    
    1,082$
    3,972
 In September 2003 a subsidiary of the Company that is no longer active,
Advantage Finance Corporation (AFC), was served in connection with a lawsuit
based on alleged malicious prosecution and conspiracy. Also included in
the lawsuit are BDO Seidman LLP and the CIT Group/Commercial Services, Inc.
The plaintiff has filed his case in both Federal and State courts. In December
2003 the case was dismissed from Federal court and a request for dismissal from
State court is anticipated. An appeal is expected, however none has been filed
to date. Management is unable to determine whether the outcome will have a
material impact on the Companys financial statements. The lawsuit does not
seek a specified amount. 16. Parent Company Financial Information The condensed balance sheets, statements of income and statements of cash
flows for MetroCorp Bancshares, Inc. (parent only) are presented below: CONDENSED BALANCE SHEETS
(In thousands, except share amounts) As of December 31,2003
    
    2002(Restated - Note 2)ASSETSCash and due from subsidiary bank
    
    $
    4,954
    
    
    $
    3,587Investments in bank subsidiary
    
    
    73,794
    
    
    
    73,059Total assets
    
    $
    78,748
    
    
    $
    76,646LIABILITIES AND SHAREHOLDERS EQUITYOther liabilities
    
    $
    375
    
    
    $
    422Total liabilities
    
    $
    375
    
    
    $
    422Shareholders equity:Common stock, $1.00 par value, 20,000,000 shares authorized;
7,306,627 and 7,195,927 shares issued, 7,156,689 and 7,031,882
shares are outstanding at December 31, 2003 and 2002
respectively
    
    
    7,307
    
    
    
    7,196Additional
paid-in-capital
    
    
    27,620
    
    
    
    26,344Retained earnings
    
    
    44,105
    
    
    
    41,699Net accumulated other comprehensive income from
subsidiary
    
    
    671
    
    
    
    2,354Treasury stock, at cost
    
    
    (1,330
    )
    
    
    (1,369
    )Total shareholders equity
    
    
    78,373
    
    
    
    76,224Total liabilities and shareholders equity
    
    $
    78,748
    
    
    $
    76,646
 69




---



##### Table of Contents



METROCORP BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued) CONDENSED STATEMENTS OF INCOME
(In thousands) Years Ended December 31,2003
    
    2002
    
    2001(Restated - Note 2)Equity in net income of subsidiary
    
    $
    4,110
    
    
    $
    8,970
    
    
    $
    7,854Net income
    
    $
    4,110
    
    
    $
    8,970
    
    
    $
    7,854
 CONDENSED STATEMENTS OF CASH FLOWS
(In thousands) Years Ended December 31,2003
    
    2002
    
    2001(Restated - Note 2)Cash flow from operating activities:Net income
    
    $
    4,110
    
    
    $
    8,970
    
    
    $
    7,854Equity in undistributed income of subsidiary
    
    
    (2,406
    )
    
    
    (7,285
    )
    
    
    (6,175
    )Increase (decrease) in other liabilities
    
    
    
    
    
    
    (35
    )
    
    
    (92
    )Net cash provided by (used in ) operating activities
    
    
    1,704
    
    
    
    1,650
    
    
    
    1,587Cash flow from investment activities:Investment in subsidiary
    
    
    (12
    )
    
    
    
    
    
    
    Net cash provided by (used in ) investing activities
    
    
    (12
    )
    
    
    
    
    
    
    Cash flow from financing activities:Proceeds from issuance of common stock
    
    
    1,186
    
    
    
    76
    
    
    
    59Proceeds from re-issuance of treasury stock
    
    
    397
    
    
    
    425
    
    
    
    316Payment to repurchase common stock
    
    
    (212
    )
    
    
    (349
    )
    
    
    Dividends
    
    
    (1,696
    )
    
    
    (1,685
    )
    
    
    (1,679
    )Net cash provided by (used in) financing activities
    
    
    (325
    )
    
    
    (1,533
    )
    
    
    (1,304
    )Net increase (decrease) in cash and cash equivalents
    
    
    1,367
    
    
    
    117
    
    
    
    283Cash and cash equivalents at beginning of year
    
    
    3,587
    
    
    
    3,470
    
    
    
    3,187Cash and cash equivalents at end of year
    
    $
    4,954
    
    
    $
    3,587
    
    
    $
    3,470Dividends declared but not paid
    
    $
    429
    
    
    $
    422
    
    
    $
    421
 17. Related Party Transactions In the ordinary course of business, the Bank enters into transactions with
its and the Companys officers and directors and their affiliates. It is the
Banks policy that all transactions with these parties are on the same terms,
including interest rates and collateral requirements on loans, as those
prevailing at the same time for comparable transactions with unrelated parties.
At December 31, 2003 and 2002, certain of these officers and directors and
their affiliated companies were indebted to the Bank in the aggregate amounts
of approximately $2.5 million and $2.6 million, respectively. The following is an analysis of activity for the years ended December 31,
2003 and 2002 for such amounts (in thousands): 2003
    
    2002Balance at January 1,
    
    $
    2,635
    
    
    $
    4,846New loans and advances
    
    
    1,790
    
    
    
    1,190Repayments
    
    
    (1,893
    )
    
    
    (3,401
    )Balance at December 31,
    
    $
    2,532
    
    
    $
    2,635
 70




---



##### Table of Contents



METROCORP BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued) In addition, as of December 31, 2003 and 2002, the Bank held demand and
other deposits for related parties of approximately $4.5 million and $6.8
million, respectively. New Era Life Insurance Company is the agency used by the Company for the
insurance coverage the Company provides to employees of the Company and the
Bank and their dependents. The insurance coverage consists of medical, dental,
life, accidental death and dismemberment and long-term disability insurance.
The Companys Chairman is a principal shareholder in New Era Life Insurance
Company. The Company paid New Era Life Insurance Company $1.4 million and $1.2
million for such insurance coverage for the years ended December 31, 2003 and
2002, respectively. In addition to the insurance transactions, the Bank has two commercial
real estate loan participations with New Era Life Insurance Company. These
loans were originated and are being serviced by the Bank. Both loans are
contractually current on their payments. The following is an analysis of these
loans as of December 31, 2003 and 2002, respectively (in thousands): 2003
    
    2002Gross balance
    
    $
    5,268
    
    
    $
    7,558Less: participation portion sold to New Era Life Insurance Co
    
    
    (1,040
    )
    
    
    (2,310
    )Net balance outstanding
    
    $
    4,228
    
    
    $
    5,248
 The loans have interest rates which float with the prime rate and mature
in May 2005 and October 2008. The percent of the participation portions sold
to New Era Life Insurance Company varies from 8.29% to 50.00%. Guamnitz, Inc. owns the building in which the Companys corporate
headquarters and the Banks Bellaire branch are located and has entered into
lease agreements for these locations with the Company. A Company director is Chairman of the Board and the controlling shareholder of Gaumnitz, Inc. The
lease covering the Companys headquarters commenced on February 1, 2001 at a
net rent of $34,787 per month. The lease covering the Banks Bellaire branch
commenced on January 1, 2003 at a net rent of $10,853 per month. For these
respective lease agreements, the Company paid Gaumnitz, Inc. $511,000 and
$441,000 during the years ended December 31, 2003 and 2002, respectively. 18. Earnings Per Share The following data show the amounts used in computing earnings per share
(EPS) and the weighted average number of shares of diluted potential common
stock (in thousands): Years ended December 31,2003
    
    2002
    
    2001(Restated - Note 2)Net income
    
    $
    4,110
    
    
    $
    8,970
    
    
    $
    7,854Weighted average common shares in basic EPS
    
    
    7,089
    
    
    
    7,024
    
    
    
    6,998Effects of dilutive securities: Options
    
    
    124
    
    
    
    130
    
    
    
    61Weighted average common and potentially dilutive common shares used in
diluted EPS
    
    
    7,213
    
    
    
    7,154
    
    
    
    7,059Earnings per common share:Basic
    
    $
    0.58
    
    
    $
    1.28
    
    
    $
    1.12Diluted
    
    $
    0.57
    
    
    $
    1.25
    
    
    $
    1.11
 71




---



##### Table of Contents



METROCORP BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued) 19. Supplemental Statement of Cash Flow Information: Years ended December 31,2003
    
    2002
    
    2001(in thousands)Cash payments during the year for:Interest
    
    $
    12,284
    
    
    $
    14,774
    
    
    $
    24,752Income taxes
    
    
    2,000
    
    
    
    4,510
    
    
    
    4,337Noncash investing and financing activities:Dividends declared not paid
    
    
    429
    
    
    
    422
    
    
    
    421Foreclosed assets acquired
    
    
    4,583
    
    
    
    1,464
    
    
    
    1,461Loans to facilitate the sale of foreclosed assets
    
    
    300
    
    
    
    325
    
    
    
    106Transfer of held-to-maturity securities to
available-for-sale
    
    
    
    
    
    
    
    
    
    
    31,743Transfer of loans receivable to loans held-for-sale
    
    
    17,000
    
    
    
    
    
    
    
    
 20. Stock Options The Company has outstanding options issued to five of the six founding
directors of the Bank to purchase an aggregate of 100,000 shares of Common
Stock pursuant to the 1998 Director Stock Option Agreement (Found Director
Plan). Pursuant to the Founding Director Plan, each of the five participants
was granted non-qualified options to purchase 20,000 shares of Common Stock at
a price of $11.00 per share. A total of 20,000 options which were initially
granted to one of the founding directors were cancelled upon his resignation as
a director. Of the six founding directors of the Bank, the five participants
(Tommy F. Chen, May P. Chu, John Lee, David Tai, and Don J. Wang) currently
serve as directors of the Company and the Bank. The options expired on July
24, 2003 and the participants exercised their options prior to expiration. The Companys 1998 Stock Incentive Plan (Incentive Plan) authorizes the
issuance of up to 700,000 shares of Common Stock under both non-qualified and
incentive stock options and performance shares of Common Stock.
Non-qualified options and incentive stock options will be granted at no less
than the fair market value of the Common Stock and must be exercised within ten
years. Performance shares are certificates representing the right to acquire
shares of Common Stock upon the satisfaction of performance goals established
by the Company. Holders of performance shares have all of the voting, dividend
and other rights of shareholders of the Company, subject to the terms of the
award agreement relating to such shares. If the performance goals are
achieved, the performance shares will vest and may be exchanged for shares of
Common Stock. If the performance goals are not achieved, the performance
shares may be forfeited. In 2003, there were options granted to acquire 22,500
shares of common stock. As of December 31, 2003, there are options to acquire
212,000 shares of common stock outstanding under the Incentive Plan. No
performance shares have been awarded under the Incentive Plan. The options granted during 2001 and 2003 under the Incentive Plan vest 30%
in each of the two years following the date of the grant and 40% in the third
year following the date of the grant and have contractual terms of seven years.
The options granted in 2002 under the Incentive Plan vest at 20% per year.
All options are granted at a fixed exercise price. The exercise price for the
options granted under the Incentive Plan is the fair market value of the
Companys common stock on the grant date, which was $7.25 for the options
granted in 2001, and a weighted average of $11.30 for the options granted in
2002 and a weighted average of $13.05 for the options granted in 2003. Any
excess of the fair market value on the grant date over the exercise price is
recognized as compensation expense in the accompanying financial statements.
There was no compensation expense under any of the plans for the years ended
December 31, 2003, 2002 or 2001. 72




---



##### Table of Contents



METROCORP BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued) A summary of the status of the Companys stock options granted to
employees as of December 31, 2003, 2002 and 2001 and the changes during the
years ended on these dates is presented below: 2003
    
    2002
    
    2001Weighted
    
    
    
    
    
    Weighted
    
    
    
    
    
    Weighted# Shares of
    
    Average
    
    # Shares of
    
    Average
    
    # Shares of
    
    AverageUnderlying
    
    Exercise
    
    Underlying
    
    Exercise
    
    Underlying
    
    ExerciseOptions
    
    Prices
    
    Options
    
    Prices
    
    Options
    
    PricesOutstanding at beginning of the year
    
    
    300,200
    
    
    $
    10.81
    
    
    
    300,000
    
    
    $
    10.78
    
    
    
    150,700
    
    
    $
    10.03Granted
    
    
    22,500
    
    
    
    13.07
    
    
    
    1,100
    
    
    
    13.05
    
    
    
    163,900
    
    
    
    11.30Exercised
    
    
    (110,700
    )
    
    
    10.71
    
    
    
    (900
    )
    
    
    8.31
    
    
    
    (2,760
    )
    
    
    8.31Canceled
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (11,840
    )
    
    
    8.31Outstanding at end of the year
    
    
    212,000
    
    
    $
    11.10
    
    
    
    300,200
    
    
    $
    10.81
    
    
    
    300,000
    
    
    $
    10.78Exercisable at end of the year
    
    
    92,500
    
    
    $
    10.40
    
    
    
    165,200
    
    
    $
    10.51
    
    
    
    131,400
    
    
    $
    10.33Weighted average fair value of all options
granted
    
    $
    2.64
    
    
    
    
    
    
    $
    2.53
    
    
    
    
    
    
    $
    4.65
 The fair value of each stock option granted is estimated on the date of
grant using the Black-Scholes option-pricing model with the following weighted-average assumptions: Assumptions
    
    2003
    
    2002
    
    2001Expected term
    
    3 years
    
    3 years
    
    5 yearsExpected volatility
    
    
    19.00
    %
    
    
    20.00
    %
    
    
    30.00
    %Expected dividend
    
    $
    0.24
    
    
    $
    0.24
    
    
    $
    0.24Risk-free interest rate
    
    
    2.28
    %
    
    
    1.99
    %
    
    
    5.30
    %
 The following table summarizes information about stock options outstanding
at December 31, 2003: Options Outstanding
    
    Options ExercisableNumber
    
    Weighted
    
    Wgtd. Avg.
    
    Number
    
    WeightedOutstanding
    
    Average
    
    Remaining
    
    Outstanding
    
    AverageRange of Exercise Prices
    
    at 12/31/03
    
    Exercise Price
    
    Contractual Life
    
    at 12/31/03
    
    Exercise Price$7.25 - $8.31
    
    
    24,500
    
    
    $
    8.0089
    
    
    2.71 years
    
    
    24,500
    
    
    $
    8.0089$10.50 - $13.10
    
    
    187,500
    
    
    $
    11.5037
    
    
    7.66 years
    
    
    68,000
    
    
    $
    11.2674
 73




---



##### Table of Contents



EXHIBIT INDEX ExhibitNumber
    
    Description3.1
    
    Amended and Restated Articles of Incorporation of the Company
(incorporated herein by reference to Exhibit 3.1 to the
Companys Registration Statement on Form S-1 (Registration
No. 333-62667) (the Registration Statement)).3.2
    
    Amended and Restated Bylaws of the Company (incorporated
herein by reference to Exhibit 3.2 to the Registration
Statement).4
    
    Specimen form of certificate evidencing the Common Stock
(incorporated herein by reference to Exhibit 4 to the
Registration Statement).10.1
    
    Agreement and Plan of Reorganization by and among MetroCorp
Bancshares, Inc., MC Bancshares of Delaware, Inc. and
MetroBank, N.A. (incorporated herein by reference to Exhibit
10.1 to the Registration Statement).10.2
    
    Form of Director Stock Option Agreement (incorporated herein
by reference to Exhibit 10.2 to the Registration Statement).10.3
    
    MetroCorp Bancshares, Inc. Non-Employee Director Stock Bonus
Plan (incorporated herein by reference to Exhibit 10.3 to the
Registration Statement).10.4
    
    MetroCorp Bancshares, Inc. 1998 Employee Stock Purchase Plan
(incorporated herein by reference to Exhibit 10.4 to the
Registration Statement).10.5
    
    MetroCorp Bancshares, Inc. 1998 Stock Incentive Plan
(incorporated herein by reference to Exhibit 10.5 to the
Registration Statement).10.6
    
    First Amendment to the MetroCorp Bancshares, Inc. 1998
Employee Stock Purchase Plan (incorporated herein by
reference to Exhibit 10.6 to the Companys Annual Report on
Form 10-K for the year ended December 31, 1998).10.7
    
    First Amendment to the MetroCorp Bancshares, Inc.
Non-Employee Director Stock Bonus Plan (incorporated herein
by reference to Exhibit 4.5 to the Companys Registration
Statement on Form S-8 (Registration Number 333-94327)).10.8
    
    Second Amendment to the MetroCorp Bancshares, Inc.
Non-Employee Director Stock Bonus Plan (incorporated herein
by reference to Exhibit 4.6 to the Companys Registration
Statement on Form S-8 (Registration Number 333-94327)).10.9
    
    Employment Agreement between MetroCorp Bancshares, Inc. and
Allen D. Brown (incorporated herein by reference to Exhibit
10.9 to the Companys Annual Report on Form 10-K for the year
ended December 31, 2003).21
    
    Subsidiaries of MetroCorp Bancshares, Inc. (incorporated
herein by reference to Exhibit 21 to the Registration
Statement).23.1*
    
    Consent of PricewaterhouseCoopers LLP.23.2*
    
    Consent of Deloitte & Touche
LLP.31.1*
    
    Certification of Chief Executive Officer pursuant to
Rule 13a-14(a) of the Securities Exchange Act of 1934, as
amended.31.2*
    
    Certification of Acting Chief Financial Officer pursuant
to Rule 13a-14(a) of the Securities Exchange Act of 1934, as
amended.32.1*
    
    Certification of Chief Executive
Officer pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.32.2*
    
    Certification of Acting Chief Financial Officer pursuant to
18 U.S.C. Section 1350, as adopted pursuant to Section 906 fo
the Sarbanes Oxley Act of 2002.
   *
    
    Filed herewith.
    
    Management contract or compensatory plan or arrangement.