EXHIBIT 13







PINNACLE BANKSHARES CORPORATION



2002 Annual Report



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[PHOTO]

Front Row:Herman P. Rogers, Jr., Percy O. Moore, James P. Kent, Jr., Carroll E. Shelton, William
F. OveracreBack Row:Robert H. Gilliam Jr., James E. Burton, IV, John P. Erb, A. Willard Arthur, John L. Waller, R.B. Hancock, Jr.

|BOARD OF DIRECTORS                  
|------------------------------------
|                                    
|A. Willard Arthur                   
|Chairman and Secretary              
|Marvin V. Templeton & Sons, Inc.    
|                                    
|James E. Burton, IV                 
|Vice President, Operations          
|Marvin V. Templeton & Sons, Inc.    
|                                    
|John P. Erb                         
|Assistant Superintendent            
|Campbell County Schools             
|                                    
|Robert H. Gilliam, Jr.              
|President & CEO                     
|The First National Bank of Altavista
|Pinnacle Bankshares Corporation     
|                                    
|R. B. Hancock Jr.                   
|President & Owner                   
|R.B.H., Inc. d/b/a Napa Auto Parts  
|                                    
|                                    
|James P. Kent, Jr.                  
|Partner                             
|Kent & Kent                         



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PINNACLE
BANKSHARES CORPORATION

AND SUBSIDIARY

Table of Contents



|                                                                                      |  | Page
|------------------------------------------------------------------------------------- |  | ----
|Officers and Managers                                                                 |  | 1   
|Office Locations                                                                      |  | 2   
|Selected Consolidated Financial Information                                           |  | 3   
|Presidents Letter                                                                    |  | 4   
|Managements Discussion and Analysis of Financial Condition and Results of
Operations |  | 6   
|Consolidated Balance Sheets                                                           |  | 21  
|Consolidated Statements of Income                                                     |  | 22  
|Consolidated Statements of Changes in Stockholders Equity and Comprehensive
Income   |  | 23  
|Consolidated Statements of Cash Flows                                                 |  | 24  
|Notes to Consolidated Financial Statements                                            |  | 26  
|Independent Auditors Report                                                          |  | 44  
|Shareholder Information                                                               |  | 45  



|Officers                             |  |                                                                              
|------------------------------------ |  | -----------------------------------------------------------------------------
|Pinnacle Bankshares Corporation      |  |                                                                              
|Robert H. Gilliam, Jr.               |  | President & Chief Executive Officer                                          
|Carroll E. Shelton                   |  | Vice President                                                               
|Bryan M. Lemley                      |  | Secretary, Treasurer & Chief Financial Officer                               
|Officers and Managers                |  |                                                                              
|The First National Bank of Altavista |  |                                                                              
|Robert H. Gilliam, Jr.               |  | President, Chief Executive Officer & Trust Officer                           
|Carroll E. Shelton                   |  | Senior Vice President & Chief Lending Officer                                
|Bryan M. Lemley                      |  | Vice President, Cashier & Chief Financial Officer                            
|William J. Sydnor, II                |  | Vice President & Branch Administration Officer                               
|Betty S. Adkins                      |  | Vice President & Deposit Services Manager                                    
|Lucy H. Johnson                      |  | Vice President & Data Processing Manager                                     
|Judith A. Clements                   |  | Vice President & Director of Human Resources                                 
|Frank R. Chrzanowski                 |  | Vice President & Mortgage Division Manager                                   
|Pamela R. Adams                      |  | Vice President & Mortgage Operations Manager                                 
|Cecilia L. Doyle                     |  | Vice President & Loan Administration Officer                                 
|Thomas R. Burnett, Jr.               |  | Vice President & Commercial Lending Officer                                  
|Aubrey H. Hall, III                  |  | Vice President & Business Development Officer                                
|Albert N. Fariss                     |  | Assistant Vice President & Facilities/Purchasing Manager                     
|Ronald C. Clay                       |  | Assistant Vice President & Recovery Manager                                  
|Brenda M. Eades                      |  | Assistant Vice President & Real Estate Loan Officer                          
|Tarry R. Pribble                     |  | Assistant Vice President & Collection Manager                                
|Tony J. Bowling                      |  | Assistant Vice President, Network Administrator &
Security Officer           
|Marian E. Marshall                   |  | Assistant Vice President & Branch Manager                                    
|Daniel R. Wheeler                    |  | Assistant Vice President & Branch Manager                                    
|Shawn D. Stone                       |  | Assistant Vice President & Branch Manager                                    
|Cynthia V. Dunnavant                 |  | Loan Officer, Assistant Branch Manager, Compliance & Bank Secrecy Act
Officer
|J. Mark Cook                         |  | Loan Officer & Assistant Branch Manager                                      
|Terri C. Harris                      |  | Loan Officer & Dealer Finance Manager                                        
|Doris N. Trent                       |  | Loan Officer                                                                 
|Vicki G. Greer                       |  | Internal Auditor                                                             
|Cynthia I. Gibson                    |  | Bookkeeping Manager                                                          
|Barbara H. Caldwell                  |  | Deposit Administration Manager                                               
|Marion E. Clark                      |  | Loan Administration Manager                                                  









1



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PINNACLE
BANKSHARES CORPORATION

AND SUBSIDIARY



Office Locations



ALTAVISTA



MAIN OFFICE

622
Broad Street

Altavista, Virginia 24517

Telephone: (434) 369-3000



VISTA OFFICE

1301 N. Main Street

Altavista, Virginia 24517

Telephone: (434) 369-3001



LYNCHBURG



AIRPORT OFFICE

14580 Wards Road

Lynchburg, Virginia 24502

Telephone: (434) 237-3788



BROOKVILLE PLAZA OFFICE

7805 Timberlake Road

Lynchburg, Virginia 24502

Telephone: (434) 237-7936



OLD FOREST ROAD OFFICE

3309 Old Forest Road

Lynchburg, Virginia 24501

Telephone: (434) 385-4432



FOREST



FIRST NATIONAL MORTGAGE

Route 221, Graves Mill Center

Forest, Virginia 24551

Telephone: (434) 385-8494







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PINNACLE
BANKSHARES CORPORATION

AND SUBSIDIARY



Selected Consolidated Financial Information

(In thousands, except ratios, share and per share data)



|                                                                          |  | Years ended December 31, |          
|------------------------------------------------------------------------- |  | ------------------------ | ---------
|                                                                          |  | 2002                     |          
|Income Statement Data:                                                    |  |                          |          
|Net interest income                                                       |  | $                        | 7,096    
|Provision for loan losses                                                 |  |                          | 429      
|Noninterest income                                                        |  |                          | 1,756    
|Noninterest expenses                                                      |  |                          | 5,814    
|Income tax expense                                                        |  |                          | 723      
|Net income                                                                |  |                          | 1,886    
|                                                                         
|Per Share Data:                                                           |  |                          |          
|Basic net income                                                          |  | $                        | 1.30     
|Diluted net income                                                        |  |                          | 1.29     
|Cash dividends                                                            |  |                          | 0.41     
|Book value                                                                |  |                          | 14.02    
|                                                                         
|Weighted-Average Shares Outstanding:                                      |  |                          |          
|Basic                                                                     |  |                          | 1,453,013
|Diluted                                                                   |  |                          | 1,461,300
|                                                                         
|Balance Sheet Data:                                                       |  |                          |          
|Assets                                                                    |  | $                        | 199,899  
|Loans, net                                                                |  |                          | 129,999  
|Securities                                                                |  |                          | 42,731   
|Cash and cash equivalents                                                 |  |                          | 19,963   
|Deposits                                                                  |  |                          | 178,243  
|Stockholders equity                                                      |  |                          | 20,372   
|                                                                         
|Performance Ratios:                                                       |  |                          |          
|Return on average assets                                                  |  |                          | 0.94     
|Return on average equity                                                  |  |                          | 9.79     
|Dividend payout                                                           |  |                          | 31.54    
|                                                                         
|Asset Quality Ratios:                                                     |  |                          |          
|Allowance for loan losses to total loans, net of unearned income and
fees |  |                          | 0.99     
|Net charge-offs to average loans, net of unearned income and fees         |  |                          | 0.24     
|                                                                         
|Capital Ratios:                                                           |  |                          |          
|Leverage                                                                  |  |                          | 9.44     
|Risk-based:                                                               |  |                          |          
|Tier 1 capital                                                            |  |                          | 12.37    
|Total capital                                                             |  |                          | 13.21    
|Average equity to average assets                                          |  |                          | 9.62     



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TO OUR SHAREHOLDERS, CUSTOMERS AND FRIENDS:



The
financial performance of Pinnacle Bankshares, the parent company for The First National Bank of Altavista, showed marked improvement for 2002 when compared with 2001. Net income increased 28.91% in 2002 to $1,886,000, an all-time high for the
Company. On the other hand, returns on assets and equity in 2002 fell short of levels achieved in 2000. Return on average assets was 0.94% for 2002, while return on average equity was 9.79%.



As reported to you previously, in the course of the dramatic decline in
interest rates in 2001 our loans and investments repriced more rapidly than did our deposits. The repricing of a large portion of our liabilities in 2002 resulted in a reduction in our cost of funds and was primarily responsible for the improvement
in earnings for the year. Whereby our net interest income declined from 2000 to 2001, 2002 saw an increase in net interest income of 16.33%.



With lower deposit pricing occurring in 2002, it was difficult to attract new deposits and even maintaining existing deposit levels was a challenge. Total
deposits fell 0.89% for 2002 and ended the year at $178,243,000. In spite of the stagnant economy, net loans outstanding grew by 6.12% and amounted to $129,999,000 at the end of 2002. Expansion of our market area and the addition of an experienced
commercial lender to our staff helped enable us to expand our loan portfolio. Total assets remained virtually unchanged at just under $200,000,000.



Stockholders equity as of December 31, 2002 was $20,372,000, an increase of 10.36% for the year. Book value per share was $14.02 as of the end of
2002. Average equity to average assets for the year was 9.62% and the Company continues to be well capitalized by all standard measurements. The cash dividend rate increased to $0.41 per share in 2002 from $0.40 per share in 2001 and the
dividend payout ratio for 2002 was 31.54%.



The Bank evaluated
its personal checking account offerings in 2002 and as a result revamped and streamlined these offerings to make them more easily understood by the consumer and more easily sold by the Banks staff. A new no service charge account
coupled with Overdraft Privilege was introduced in December. Overdraft Privilege provides for the payment of insufficient funds items, within limits and at a fee, rather than automatically returning such items. This service,
which has been well received, is offered as a convenience to our customers and serves as a source of additional income for the Bank.



The Board of Directors and senior management collectively spent a great deal of time and effort in 2002 toward the development of a strategic plan. This
plan will serve as a guide in the management of the future direction of your Company. The first obvious result of the plan is the pursuit of a site for a new retail branch operation within the greater Lynchburg market. Acquisition and development of
a site is anticipated in 2003.



4



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William F. Overacre, President
and owner of Overacre, Inc. doing business as RE/MAX lst Olympic, was newly elected to the boards of Pinnacle and First National in 2002. 2002 also saw the end of service on our boards for Alvah Bohannon who has moved out of the area. Mr. Bohannon
provided diligent and faithful service to this Company over a span of seventeen years. His lasting contributions are appreciated and his participation in the affairs of our Company is missed.



Your board and management are dedicated to enhancing the value of your
investment in this Company. Thank you for your ongoing support of our efforts and for the business you share with First National Bank.



We look forward to the pleasure of your participation in our annual meeting which is scheduled to take place at 11:30 a.m., Tuesday, April 8, 2003 in the
Fellowship Hall of Altavista Presbyterian Church, 707 Broad Street, Altavista, Virginia.







/s/   Robert H. Gilliam, Jr. Robert H. Gilliam, Jr. President and Chief Executive Officer






February 26, 2003





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PINNACLE
BANKSHARES CORPORATION

AND SUBSIDIARY



Managements Discussion and Analysis of

Financial Condition and Results of Operations

Years
ended December 31, 2002 and 2001

(In thousands, except ratios, share and per share data)



Managements Discussion and Analysis



The following discussion is qualified in its entirety by the more detailed
information and the consolidated financial statements and accompanying notes appearing elsewhere in this Annual Report. In addition to the historical information contained herein, this Annual Report contains forward-looking statements within the
meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements, which are based on certain assumptions and describe future plans, strategies, and expectations of management, are generally identifiable by use of the words
believe, expect, intend, anticipate, estimate, project, may, will or similar expressions. Although we believe our plans, intentions and expectations
reflected in these forward-looking statements are reasonable, we can give no assurance that these plans, intentions, or expectations will be achieved. Our ability to predict results or the actual effect of future plans or strategies is inherently
uncertain, and actual results, performance or achievements could differ materially from those contemplated. Factors that could have a material adverse effect on our operations and future prospects include, but are not limited to, changes in:
interest rates; general economic conditions; the legislative/regulatory climate; monetary and fiscal policies of the U.S. Government, including policies of the U.S. Treasury and the Board of Governors of the Federal Reserve System; the quality or
composition of the loan or investment portfolios; demand for loan products; deposit flows; competition; demand for financial services in our market area; and accounting principles, policies and guidelines. These risks and uncertainties should be
considered in evaluating forward-looking statements contained herein, and you should not place undue reliance on such statements, which reflect our position as of the date of this report.



Pinnacle Bankshares Corporation, a Virginia corporation (Bankshares), was organized in 1997 and is registered as a bank
holding company under the Bank Holding Company Act of 1956, as amended. Bankshares is headquartered in Altavista, Virginia. Bankshares conducts all of its business activities through the branch offices of its wholly owned subsidiary bank, The First
National Bank of Altavista (the Bank). Bankshares exists primarily for the purpose of holding the stock of its subsidiary, the Bank, and of such other subsidiaries as it may acquire or establish.



The following discussion supplements and provides information about the major
components of the results of operations and financial condition, liquidity and capital resources of Bankshares and its subsidiary (collectively the Company). This discussion and analysis should be read in conjunction with the Companys
consolidated financial statements and accompanying notes.



Overview



Total assets at December 31,
2002 were $199,899, down 0.03% from $199,966 at December 31, 2001. The principal components of the Companys assets at the end of the year were $19,963 in cash and cash equivalents, $42,731 in securities and $129,999 in net loans. During the
year ended December 31, 2002, gross loans increased 6.14% or $7,599. The Companys lending activities are a principal source of income.



Total liabilities at December 31, 2002 were $179,527, down 1.09% from $181,506 at December 31, 2001, with the decrease reflective of a slight decrease in
total deposits of $1,598 or 0.89%. Noninterest-bearing demand deposits decreased $94 or 0.65% and represented 8.12% of total deposits at December 31, 2002, compared to 8.10% at December 31, 2001. Time deposits represented the largest portion of the
decrease in deposits with a decrease of $1,916 or 1.81% at December 31, 2002. The Companys deposits are provided by individuals and businesses located within the communities served.



6



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Total stockholders
equity at December 31, 2002 was $20,372 compared to $18,460 at December 31, 2001.



The Company had net income of $1,886 for the year ended December 31, 2002, compared to net income of $1,463 for the year ended December 31, 2001, an increase of 28.91%.



Profitability as measured by the Companys return on average assets (ROA)
was 0.94% in 2002, up from 0.77% in 2001. Another key indicator of performance, the return on average equity (ROE), was 9.79% for 2002, compared to 8.18% for 2001.



Results of Operations



Net Interest Income. Net interest income represents the principal source of earnings for the Company. Net interest income is the
amount by which interest and fees generated from loans, securities and other interest-earning assets exceed the interest expense associated with funding those assets. Changes in the amounts and mix of interest-earning assets and interest-bearing
liabilities, as well as their respective yields and rates, have a significant impact on the level of net interest income. Changes in the interest rate environment and the Companys cost of funds also affect net interest income.



The net interest spread increased to 3.51% for the year ended December 31,
2002 from 3.00% for the year ended December 31, 2001. Net interest income was $7,096 ($7,354 on a tax-equivalent basis) for the year ended December 31, 2002, compared to $6,100 ($6,416 on a tax-equivalent basis) for the year ended December 31, 2001,
and is attributable to interest income from loans, federal funds sold and securities exceeding the cost associated with interest paid on deposits and other borrowings. In the course of the dramatic decline in interest rates in 2001, our loans and
investments repriced at lower rates more rapidly than did our deposits during 2001. The increase in the interest rate spread in 2002 is due primarily to the repricing of a large portion of our interest-bearing liabilities resulting in a reduction in
our cost of funds. The Banks yield on interest-earning assets for the year ended December 31, 2002 was 1.08% lower than the year ended December 31, 2001 due to the lower interest rate environment in 2002; however, the Banks cost of funds
rate on interest-bearing liabilities in 2002 was 1.59% lower compared to the same period in 2001.



The following table presents the major categories of interest-earning assets, interest-earning liabilities and stockholders equity with corresponding average balances, related interest income or
interest expense and resulting yield and rates for the periods indicated.



ANALYSIS OF NET INTEREST INCOME



|                              |  | Years ended December 31, |        
|----------------------------- |  | ------------------------ | -------
|                              |  | 2002                     |        
|                              |  | Average balance(1)       |        
|Assets                        |  |                          |        
|Interest-earning assets:      |  |                          |        
|Loans (2)(3)                  |  | $                        | 130,233
|Investment securities:        |  |                          |        
|Taxable                       |  |                          | 33,302 
|Tax-exempt (4)                |  |                          | 11,912 
|Interest-earning deposits     |  |                          | 73     
|Federal funds sold            |  |                          | 13,452 
|                              |  |                          |        
|Total interest-earning assets |  |                          | 188,972
|Other assets:                 |  |                          |        
|Allowance for loan losses     |  |                          | (1,219 
|Cash and due from banks       |  |                          | 4,419  
|Other assets, net             |  |                          | 7,949  
|                              |  |                          |        
|Total assets                  |  | $                        | 200,121
|                              |  |                          |        



7



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ANALYSIS OF
NET INTEREST INCOME, Continued



|                                           |  | Years ended December 31, |        
|------------------------------------------ |  | ------------------------ | -------
|                                           |  | 2002                     |        
|                                           |  | Average balance(1)       |        
|Liabilities and Stockholders
Equity       |  |                          |        
|Interest-bearing liabilities:              |  |                          |        
|Savings and NOW                            |  | $                        | 59,905 
|Time                                       |  |                          | 104,240
|Other borrowings                           |  |                          | 560    
|                                           |  |                          |        
|Total interest-bearing liabilities         |  |                          | 164,705
|Noninterest-bearing liabilities:           |  |                          |        
|Demand deposits                            |  |                          | 15,087 
|Other liabilities                          |  |                          | 1,071  
|                                           |  |                          |        
|Total liabilities                          |  |                          | 180,863
|Stockholders equity                       |  |                          | 19,258 
|                                           |  |                          |        
|Total liabilities and stockholders equity |  | $                        | 200,121
|                                           |  |                          |        
|                                           |  |                          |        
|Net interest income                        |  |                          |        
|                                           |  |                          |        
|Net interest margin (5)                    |  |                          |        
|                                           |  |                          |        
|Net interest spread (6)                    |  |                          |        
|                                           |  |                          |        

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|(1) |  | Averages are daily averages.
|--- |  | ----------------------------

|(2) |  | Loan interest income includes accretion of loan fees of $40 and $156 for 2002 and 2001, respectively.
|--- |  | -----------------------------------------------------------------------------------------------------

|(3) |  | For the purpose of these computations, nonaccrual loans are included in average loans.
|--- |  | --------------------------------------------------------------------------------------

|(4) |  | Tax-exempt income from investment securities is presented on a tax-equivalent basis assuming a 34% U.S. Federal tax rate for 2002 and 2001.
|--- |  | -------------------------------------------------------------------------------------------------------------------------------------------

|(5) |  | The net interest margin is calculated by dividing net interest income by average total interest-earning assets.
|--- |  | ---------------------------------------------------------------------------------------------------------------

|(6) |  | The net interest spread is calculated by subtracting the interest rate paid on interest-bearing liabilities from the interest rate earned on interest-earning assets.
|--- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------



As discussed above, the Companys net
interest income is affected by the change in the amounts and mix of interest-earning assets and interest-bearing liabilities, referred to as volume change, as well as by changes in yields earned on interest-earning assets and rates paid
on deposits and other borrowed funds, referred to as rate change. The following table presents, for the periods indicated, a summary of changes in interest income and interest expense for the major categories of interest-earning assets
and interest-bearing liabilities and the amounts of change attributable to variations in volumes and rates.



8



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RATE/VOLUME
ANALYSIS



|                                                    |  | Years ended December 31,                  |     
|--------------------------------------------------- |  | ----------------------------------------- | ----
|                                                    |  | 2002 compared to 2001 Increase (decrease) |     
|                                                    |  | Volume                                    |     
|Interest earned on interest-earning assets:         |  |                                           |     
|Loans (1)                                           |  | $                                         | 449 
|Investment securities:                              |  |                                           |     
|Taxable                                             |  |                                           | 342 
|Tax-exempt (2)                                      |  |                                           | (66 
|Interest-earning deposits                           |  |                                           |    
|Federal funds sold                                  |  |                                           | (163
|                                                    |  |                                           |     
|Total interest earned on interest-earning assets    |  |                                           | 562 
|                                                    |  |                                           |     
|Interest paid on interest-bearing liabilities:      |  |                                           |     
|Savings and NOW                                     |  |                                           | 129 
|Time                                                |  |                                           | 128 
|Other borrowings                                    |  |                                           | (6  
|                                                    |  |                                           |     
|Total interest paid on interest-bearing liabilities |  |                                           | 251 
|                                                    |  |                                           |     
|Change in net interest income                       |  | $                                         | 311 
|                                                    |  |                                           |     

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|(1) |  | Nonaccrual loans are included in the average loan totals used in the calculation of this table.
|--- |  | -----------------------------------------------------------------------------------------------

|(2) |  | Tax-exempt income from investment securities is presented on a tax equivalent basis assuming a 34% U.S. Federal tax rate for 2002 and 2001.
|--- |  | -------------------------------------------------------------------------------------------------------------------------------------------



Provision for Loan Losses.
The provision for loan losses is based upon the Companys evaluation of the quality of the loan portfolio, total outstanding and committed loans, previous loan losses and current and anticipated economic conditions. The amount of the provision
for loan losses is a charge against earnings. Actual loan losses are charges against the allowance for loan losses.



The Companys allowance for loan losses is typically maintained at a level deemed adequate to provide for known and inherent losses in the loan
portfolio. No assurance can be given that unforeseen adverse economic conditions or other circumstances will not result in increased provisions in the future. Additionally, regulatory examiners may require the Company to recognize additions to the
allowance based upon their judgment about information available to them at the time of their examinations.



The provisions for loan losses for the years ended December 31, 2002 and 2001 were $429 and $380, respectively. See Allowance for Loan Losses for further discussion.



Noninterest Income. Total noninterest income for the year
ended December 31, 2001 increased $124, or 7.60% to $1,756 from $1,632 in 2001. The Companys principal source of noninterest income is service charges and fees on deposit accounts, particularly transaction accounts, fees on sales of mortgage
loans, and fees from other bank products. The increase in 2002 is attributed to fees on the sales of mortgage loans. Fees from these sales increased $62 for the year ended December 31, 2002, compared to 2001.



Noninterest Expense. Total noninterest expense for the
year ended December 31, 2002 increased $413 or 7.65% to $5,814 from $5,401 in 2001. The increase in noninterest expense is attributed to the effect of overall growth of the Company on personnel expenses, fixed asset costs associated with bank
premises additions and other operating expenses. The Company has added three new branches to its operations since June 1999.



Income Tax Expense. Applicable income taxes on 2002 earnings amounted to $723, resulting in an effective tax rate of 27.71% compared
to $488, or 25.01%, in 2001. The effective tax rate for 2002 is higher primarily because the level of pretax income for 2002 was higher than 2001; however, the level of tax-exempt interest income for 2002 was lower compared to 2001.



9



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Liquidity and
Asset/Liability Management



Effective asset/liability
management includes maintaining adequate liquidity and minimizing the impact of future interest rate changes on net interest income. The responsibility for monitoring the Companys liquidity and the sensitivity of its interest-earning assets
and interest-bearing liabilities lies with the Asset Liability Committee of the Bank which meets at least quarterly to review liquidity and the adequacy of funding sources.



Cash Flows. The Company derives cash flows from its operating, investing and financing activities. Cash
flows of the Company are primarily used to fund loans and securities and are provided by the deposits and borrowings of the Company.



The Companys operating activities for the year ended December 31, 2002 resulted in net cash provided of $3,054 primarily due to net income of $1,886
adjusted for depreciation of $400, a provision for loan losses of $429, a decrease in accrued income receivable of $118, and a decrease in other assets of $481, and partially offset by amortization of unearned fees, net of $40, a decrease in accrued
interest payable of $200, a decrease in other liabilities of $81 and a deferred income tax benefit of $11. The Companys operating activities for the year ended December 31, 2001 resulted in net cash provided of $2,630 primarily due to net
income of $1,463 adjusted for depreciation of $394, a provision for loan losses of $380, a decrease in accrued income receivable of $293, and a decrease in other assets of $251, and partially offset by amortization of unearned fees, net of $156, a
decrease in accrued interest payable of $30, a decrease in other liabilities of $48 and a deferred income tax benefit of $21.



The Companys cash flows from investing activities used net cash of $5,011 for the year ended December 31, 2002 compared to net cash used of $9,445
for 2001. In 2002, cash was used primarily to fund the net increase in loans to customers in the aggregate amount of $10,269, partially offset by collections on loan participations of $2,216, and for purchases of bank premises and equipment of $116.
In 2001, cash was used primarily to fund loan participation purchases and the net increase in loans to customers in the aggregate amount of $5,902, partially offset by collections on loan participations of $1,899, and for purchases of bank premises
and equipment of $217. Investing activities representing net proceeds from investment securities purchases, maturities, paydowns and calls generated cash inflows of $3,173 in 2002 compared to cash outflows of $5,379 in 2001.



Net cash used in financing activities for the year ended December 31, 2002
totaled $2,263 compared to net cash provided by financing activities of $18,646 for the year ended December 31, 2001. The net decrease in deposits totaled $1,598 in 2002 compared to an increase of $19,248 in 2001. The Company borrowed $1,000 during
1997 under a note payable to the Federal Home Loan Bank and made principal repayments of $100 during each of 2002 and 2001. Cash dividends paid to stockholders were $596 and $579 in 2002 and 2001, respectively. During 2002 and 2001, the Company sold
2,237 and 5,813 shares of common stock to the Companys dividend reinvestment plan, respectively.



Liquidity. Liquidity measures the ability of the Company to meet its maturing obligations and existing commitments, to withstand fluctuations in deposit levels, to fund its
operations, and to provide for customers credit needs. Liquidity represents an institutions ability to meet present and future financial obligations through either the sale or maturity of existing assets or the acquisition of additional
funds from alternative funding sources.



The Companys
liquidity is provided by cash and due from banks, federal funds sold, investments available-for-sale, managing investment maturities, interest-earning deposits in other financial institutions and loan repayments. The Companys ratio of liquid
assets to deposits and short-term borrowings was 29.24% as of December 31, 2002 as compared to 31.41% as of December 31, 2001. The Company sells excess funds as overnight federal funds sold to provide an immediate source of liquidity. Federal funds
sold as of December 31, 2002 was $15,447 compared to $19,094 as of December 31, 2001. The decrease in federal funds sold in 2002 was primarily related to the net increase in loans made to customers and the net decrease in deposits in 2002.



10



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Cash and due from banks of $4,516 as of December 31, 2002 was $573 lower when compared to the December 31, 2001 balance of $5,089.



The level of deposits may fluctuate significantly due to
seasonal business cycles of depository customers. Similarly, the level of demand for loans may vary significantly and at any given time may increase or decrease substantially. However, unlike the level of deposits, management has more direct control
over lending activities and maintains the level of those activities according to the amounts of available funds.



As a result of the Companys management of liquid assets and the ability to generate liquidity through alternative funding sources, management believes that the Company maintains overall liquidity
which is sufficient to satisfy its depositors requirements and to meet customers credit needs. Additional sources of liquidity available to the Company include its capacity to borrow funds through correspondent banks and the Federal Home
Loan Bank.



Interest Rates



While no single measure can completely identify the impact of changes in
interest rates on net interest income, one gauge of interest rate sensitivity is to measure, over a variety of time periods, the differences in the amounts of the Companys rate-sensitive assets and rate-sensitive liabilities. These differences
or gaps provide an indication of the extent to which net interest income may be affected by future changes in interest rates. A positive gap exists when rate-sensitive assets exceed rate-sensitive liabilities and indicates
that a greater volume of assets than liabilities will reprice during a given period. This mismatch may enhance earnings in a rising interest rate environment and may inhibit earnings in a declining interest rate environment Conversely, when
rate-sensitive liabilities exceed rate-sensitive assets, referred to as a negative gap, it indicates that a greater volume of liabilities than assets will reprice during the period. In this case, a rising interest rate environment may
inhibit earnings and a declining interest rate environment may enhance earnings. The cumulative one-year gap as of December 31, 2002 was $38,264, representing 19.14% of total assets. This negative gap falls within the parameters set by the Company.



The following table illustrates the Companys interest rate
sensitivity gap position at December 31, 2002.



REPRICING GAP POSITION



|                                         |  | Repricing period at December 31, 2002
|---------------------------------------- |  | -------------------------------------
|                                         |  | 1 year                               
|ASSET/(LIABILITY):                       |  |                                      
|Cumulative interest rate sensitivity gap |  | $                                    



As of December 31, 2002,
the Company was liability-sensitive in periods up to five years and asset-sensitive beyond five years. The foregoing table does not necessarily indicate the impact of general interest rate movements on the Companys net interest yield, because
the repricing of various categories of assets and liabilities is discretionary and is subject to competition and other pressures. As a result, various assets and liabilities indicated as repricing within the same period may in fact price at
different times and at different rate levels. Management attempts to mitigate the impact of changing interest rates in several ways, one of which is to manage its interest rate-sensitivity gap. At December 31, 2002, all fluctuations fell within
Company policy limitations. In addition to managing its asset/liability position, the Company has taken steps to mitigate the impact of changing interest rates by generating noninterest income through service charges, and offering products which are
not interest rate-sensitive.



Effects of Inflation



The effect of changing prices on financial institutions is
typically different from other industries as the Companys assets and liabilities are monetary in nature. Interest rates are significantly impacted by inflation, but neither the timing nor the magnitude of the changes are directly related to
price level indices. Impacts of inflation on interest rates, loan demand and deposits are reflected in the consolidated financial statements.



11



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Investment Portfolio



The Companys investment portfolio is used primarily
for investment income and secondarily for liquidity purposes. The Company invests funds not used for capital expenditures or lending purposes in securities of the U.S. Government and its agencies, mortgage-backed securities, and taxable and
tax-exempt municipal bonds, corporate securities or certificates of deposit. Obligations of the U.S. Government and its agencies include treasury notes and callable or noncallable agency bonds. Mortgage-backed securities include collateralized
mortgage obligations and mortgage-backed security pools. The collateralized mortgage obligations in the Companys investment securities portfolio are low risk as defined by applicable bank regulations and are diverse as to
collateral and interest rates of the underlying mortgages. The mortgage-backed securities are diverse as to interest rates and guarantors. The Company does not invest in derivatives or other high-risk type securities.



Investment securities available-for-sale as of December 31, 2002 were $32,158,
a decrease of $153 or 0.47% from $32,311 as of December 31, 2001. Investment securities held-to-maturity decreased to $10,573 as of December 31, 2002 from $12,759 as of December 31, 2001, a decrease of $2,186 or 17.13%.



The following table presents the composition of the Companys investment
portfolios as of the dates indicated.



|                                                                                      |  | December 31,   
|------------------------------------------------------------------------------------- |  | ---------------
|                                                                                      |  | 2002           
|Available-for-Sale                                                                    |  | Amortized costs
|U.S. Treasury securities and obligations of U.S. Government corporations and
agencies |  | $              
|Obligations of states and political subdivisions                                      |  |                
|Corporate securities                                                                  |  |                
|Mortgage-backed securitiesgovernment                                                 |  |                
|Other securities                                                                      |  |                
|                                                                                      |  |                
|Total available-for-sale                                                              |  | $              
|                                                                                      |  |                



|                                                                                      |  | December 31,   
|------------------------------------------------------------------------------------- |  | ---------------
|                                                                                      |  | 2002           
|Held-to-Maturity                                                                      |  | Amortized costs
|U.S. Treasury securities and obligations of U.S. Government corporations and
agencies |  | $              
|Obligations of states and political subdivisions                                      |  |                
|                                                                                      |  |                
|Total held-to-maturity                                                                |  | $              
|                                                                                      |  |                



The following table
presents the maturity distribution based on fair values and amortized costs of the investment portfolios as of the dates indicated.



12



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INVESTMENT
PORTFOLIO  MATURITY DISTRIBUTION



|                                                 |  | December 31, 2002 |       
|------------------------------------------------ |  | ----------------- | ------
|Available-for-Sale                               |  | Amortized Costs   |       
|U.S. Treasury securities and obligations of U.S. |  |                   |       
|Government corporations:                         |  |                   |       
|Within one year                                  |  | $                 | 1,996 
|After one but within five years                  |  |                   | 1,994 
|After five years through ten years               |  |                   | 494   
|Obligations of states and subdivisions:          |  |                   |       
|Within one year                                  |  |                   | 885   
|After one but within five years                  |  |                   | 3,678 
|After five years through ten years               |  |                   | 1,854 
|After ten years                                  |  |                   | 315   
|Corporate securities:                            |  |                   |       
|Within one year                                  |  |                   | 500   
|After one but within five years                  |  |                   | 8,090 
|Mortgage-backed securitiesgovernment            |  |                   | 11,038
|Other securities (1)                             |  |                   | 50    
|                                                 |  |                   |       
|Total available-for-sale                         |  | $                 | 30,894
|                                                 |  |                   |       
|                                                
|Held-to-Maturity                                 |  |                   |       
|U.S. Treasury securities and obligations of U.S. |  |                   |       
|Government corporations:                         |  |                   |       
|After one but within five years                  |  | $                 | 56    
|Obligations of states and subdivisions:          |  |                   |       
|Within one year                                  |  |                   | 937   
|After one but within five years                  |  |                   | 7,453 
|After five years through ten years               |  |                   | 2,127 
|                                                 |  |                   |       
|Total held-to-maturity                           |  | $                 | 10,573
|                                                 |  |                   |       

---

|(1) |  | Equity securities assume a life greater than ten years.
|--- |  | -------------------------------------------------------



Loan Portfolio



The Companys net loans were $129,999 as of December 31, 2002, an increase of $7,497 or 6.12% from $122,502 as of December 31, 2001. This increase
resulted primarily from increased volume of loan originations during 2002 due to the lower interest rate environment.



The Companys ratio of net loans to total deposits was 72.93% as of December 31, 2002 compared to 68.12% as of December 31, 2001. Typically, the
Company maintains a ratio of loans to deposits of between 65% and 80%. The loan portfolio primarily consists of commercial, real estate (including real estate term loans, construction loans and other loans secured by real estate), and loans to
individuals for household, family and other consumer expenditures. However, the Company adjusts its mix of lending and the terms of its loan programs according to market conditions and other factors. The Companys loans are typically made to
businesses and individuals located within the Companys market area, most of whom have account relationships with the Bank. There is no concentration of loans exceeding 10% of total loans which is not disclosed in the categories presented
below. The Company has not made any loans to any foreign entities including governments, banks, businesses or individuals. Commercial and construction loans in the Companys portfolio are primarily variable rate loans and have little interest
rate risk.



13



---



The following table presents
the composition of the Companys loan portfolio as of the dates indicated.



LOAN PORTFOLIO



|                                                                           |  | December 31, |        
|-------------------------------------------------------------------------- |  | ------------ | -------
|                                                                           |  | 2002         |        
|Real estate loans:                                                         |  |              |        
|Residential                                                                |  | $            | 51,134 
|Other                                                                      |  |              | 18,542 
|Loans to individuals for household, family and other consumer
expenditures |  |              | 44,948 
|Commercial and industrial loans                                            |  |              | 16,672 
|All other loans                                                            |  |              | 146    
|                                                                           |  |              |        
|Total loans, gross                                                         |  |              | 131,442
|Less unearned income and fees                                              |  |              | (145   
|                                                                           |  |              |        
|Loans, net of unearned income and fees                                     |  |              | 131,297
|Less allowance for loan losses                                             |  |              | (1,298 
|                                                                           |  |              |        
|Loans, net                                                                 |  | $            | 129,999
|                                                                           |  |              |        



Commercial
Loans. Commercial and industrial loans accounted for 12.68% of the Companys loan portfolio as of December 31, 2002 compared to 14.22% as of December 31, 2001. Such loans are generally made to provide operating lines of credit,
to finance the purchase of inventory or equipment, and for other business purposes. Commercial loans are primarily made at rates that adjust with changes in the prevailing prime interest rate, are generally made for a maximum term of five years
(unless they are term loans), and generally require interest payments to be made monthly. The creditworthiness of these borrowers is reviewed, analyzed and evaluated on a periodic basis. Most commercial loans are collateralized with business assets
such as accounts receivable, inventory and equipment. Even with substantial collateralization such as all of the assets of the business and personal guarantees, commercial lending involves considerable risk of loss in the event of a business
downturn or failure of the business.



Real Estate
Loans. Real estate loans accounted for 53.01% of the Companys loan portfolio as of December 31, 2002 compared to 49.61% as of December 31, 2001. The Company makes commercial and industrial real estate term loans that are
typically secured by a first deed of trust. As of December 31, 2002, 73.39% of the real estate loans were secured by 1-4 family residential properties compared to 78.40% at December 31, 2001, and 3.98% of total real estate loans were construction
loans at December 31, 2002 compared to 7.73% at December 31, 2001. Real estate lending involves risk elements when there is lack of timely payment and/or a decline in the value of the collateral.



Installment Loans. Installment loans are represented by
loans to individuals for household, family and other consumer expenditures. Installment loans accounted for 34.20% of the Companys loan portfolio as of December 31, 2002 compared to 35.95% as of December 31, 2001.



Loan Maturity and Interest Rate Sensitivity. The
following table presents loan portfolio information related to maturity distribution of commercial and industrial loans and real estate construction loans based on scheduled repayments at December 31, 2002.



LOAN MATURITY



|                                |  | Due within one year |       | Due one to five years |       | Due after five years |       | Total
|------------------------------- |  | ------------------- | ----- | --------------------- | ----- | -------------------- | ----- | -----
|Commercial and industrial loans |  | $                   | 9,776 |                       | 5,816 |                      | 1,080 |      
|Real estate  construction      |  |                     | 2,773 |                       |      |                      |      |      



14



---



The following table presents
the interest rate sensitivity of commercial and industrial loans and real estate construction loans maturing after one year as of December 31, 2002.



INTEREST RATE SENSITIVITY





|Fixed interest rates          |  | $ | 2,602
|----------------------------- |  | - | -----
|Variable interest rates       |  |   | 4,294
|                              |  |   |      
|Total maturing after one year |  | $ | 6,896
|                              |  |   |      



Nonperforming
Assets. Interest on loans is normally accrued from the date a disbursement is made and recognized as income as it is accrued. Generally, the Company reviews any loan on which payment has not been made for 90 days for potential
nonaccrual. The loan is examined and the collateral is reviewed to determine loss potential. If the loan is placed on nonaccrual, any prior accrued interest which remains unpaid is reversed. Loans on nonaccrual amounted to $347 and $302 as of
December 31, 2002 and 2001, respectively. Interest income that would have been earned on nonaccrual loans if they had been current in accordance with their original terms and the recorded interest that was included in income on these loans was not
significant for 2002 and 2001. There were no commitments to lend additional funds to customers whose loans were on nonaccrual status at December 31, 2002.



The following tables present information with respect to the Companys nonperforming assets and accruing loans 90 days or more past due by type as of
the dates indicated.



NONPERFORMING ASSETS



|                           |  | December 31,
|-------------------------- |  | ------------
|                           |  | 2002        
|Nonperforming loans        |  | $           
|Foreclosed properties      |  |             
|                           |  |             
|Total nonperforming assets |  | $           
|                           |  |             



Nonperforming assets
totaled $347 or 0.26% of total gross loans as of December 31, 2002, compared to $302 or 0.24% as of December 31, 2001. The following table presents the balance of accruing loans 90 days or more past due by type as of the dates indicated.



ACCRUING LOANS 90 DAYS OR MORE

PAST DUE BY TYPE





|                                              |  | December 31,
|--------------------------------------------- |  | ------------
|                                              |  | 2002        
|Loans 90 days or more past due by type:       |  |             
|Real estate loans                             |  | $           
|Loans to individuals                          |  |             
|Commercial loans                              |  |             
|                                              |  |             
|Total accruing loans 90 days or more past due |  | $           
|                                              |  |             



Allowance for Loan
Losses. The Company maintains an allowance for loan losses which it considers adequate to cover the risk of losses in the loan portfolio. The allowance is based upon managements ongoing evaluation of the quality of the loan
portfolio, total outstanding and committed loans, previous charges against the allowance and current and anticipated economic conditions. The allowance is also subject to regulatory examinations and determinations as to adequacy, which may take into
account such factors as the methodology used to calculate the allowance. The Companys management believes that as of December 31, 2002 and 2001, the allowance is adequate. The amount of the provision for loan losses is a charge against
earnings. Actual loan losses are charged against the allowance for loan losses.



As of December 31, 2002, the allowance for loan losses totaled $1,298 or 0.99% of total loans, net of unearned income and fees, compared to $1,176 or 0.95% as of December 31, 2001. The provision for loan losses for the years ended
December 31, 2002 and 2001 was $429 and $380, respectively. Net charge-offs for the Company were $307 and $273 for the years ended December 31, 2002 and 2001, respectively. The ratio of net loan charge-



15



---

offs during the period to average loans outstanding for the period was 0.24% and 0.22% for the years ended
December 31, 2002 and 2001, respectively. Management evaluates the reasonableness of the allowance for loan losses on a quarterly basis and adjusts the provision as deemed necessary.



The following table presents charged off loans, provisions for loan losses, recoveries on loans previously charged off,
allowance adjustments and the amount of the allowance for the dates indicated.



ANALYSIS OF ALLOWANCE FOR LOAN LOSSES



|                                                                           |  | Years ended December 31, |      
|-------------------------------------------------------------------------- |  | ------------------------ | -----
|                                                                           |  | 2002                     |      
|Balance at beginning of year                                               |  | $                        | 1,176
|Loan charge-offs:                                                          |  |                          |      
|Real estate loans  residential                                            |  |                          |     
|Real estate loans  commercial                                             |  |                          | (37  
|Commercial and industrial loans                                            |  |                          | (20  
|Loans to individuals for household, family and other consumer
expenditures |  |                          | (360 
|                                                                           |  |                          |      
|Total loan charge-offs                                                     |  |                          | (417 
|                                                                           |  |                          |      
|Loan recoveries:                                                           |  |                          |      
|Loans to individuals for household, family and other consumer
expenditures |  |                          | 110  
|                                                                           |  |                          |      
|Net loan charge-offs                                                       |  |                          | (307 
|Provisions for loan losses                                                 |  |                          | 429  
|                                                                           |  |                          |      
|Balance at end of year                                                     |  | $                        | 1,298
|                                                                           |  |                          |      



The primary risk element
considered by management with respect to each installment and conventional real estate loan is lack of timely payment and the value of the collateral. The primary risk elements with respect to real estate construction loans are fluctuations in real
estate values in the Companys market areas, inaccurate estimates of construction costs, fluctuations in interest rates, the availability of conventional financing, the demand for housing in the Companys market area and general economic
conditions. The primary risk elements with respect to commercial loans are the financial condition of the borrower, general economic conditions in the Companys market area, the sufficiency of collateral, the timeliness of payment and, with
respect to adjustable rate loans, interest rate fluctuations. Management has a policy of requesting and reviewing annual financial statements from its commercial loan customers and periodically reviews the existence of collateral and its value.
Management also has a reporting system that monitors all past due loans and has adopted policies to pursue its creditors rights in order to preserve the Companys position.



Loans are charged against the allowance when, in managements opinion, they are deemed uncollectible, although the Bank
continues to aggressively pursue collection. Although management believes that the allowance for loan losses is adequate to absorb losses as they arise, there can be no assurance that (i) the Company will not sustain losses in any given period which
could be substantial in relation to the size of the allowance for loan losses, (ii), the Companys level of nonperforming loans will not increase, (iii) the Company will not be required to make significant additional provisions to its allowance
for loan losses, or (iv) the level of net charge-offs will not increase and possibly exceed applicable reserves.



16



---



The following table presents
the allocation of the allowance for loan losses as of the dates indicated. Notwithstanding these allocations, the entire allowance for loan losses is available to absorb charge-offs in any category of loans.



|                                                                           |  | December 31, 2002         |       |                                                  | December 31, 2001 |  
|-------------------------------------------------------------------------- |  | ------------------------- | ----- | ------------------------------------------------ | ----------------- | -
|                                                                           |  | Allowance for loan losses |       | Percent of loans in each category to total loans |                   |  
|Real estate loans:                                                         |  |                           |       |                                                  |                   |  
|Residential                                                                |  | $                         | 137   |                                                  | 38.90             | %
|Other                                                                      |  |                           | 133   |                                                  | 14.11             | %
|Loans to individuals for household, family and other consumer
expenditures |  |                           | 210   |                                                  | 34.20             | %
|Commercial and industrial loans                                            |  |                           | 721   |                                                  | 12.68             | %
|All other loans                                                            |  |                           |      |                                                  | 0.11              | %
|Unallocated                                                                |  |                           | 97    |                                                  |                  |  
|                                                                           |  |                           |       |                                                  |                   |  
|Totals                                                                     |  | $                         | 1,298 |                                                  | 100.00            | %
|                                                                           |  |                           |       |                                                  |                   |  



Credit Risk
Management. The risk of nonpayment of loans is an inherent aspect of commercial banking. The degree of perceived risk is taken into account in establishing the structure of, and interest rates and security for, specific loans and
various types of loans. The Company strives to minimize its credit risk exposure by its credit underwriting standards and loan policies and procedures. Management continually evaluates the credit risks of such loans and believes it has provided
adequately for the credit risks associated with these loans. The Company has implemented and expects to continue to implement and update new policies and procedures to maintain its credit risk management systems.



Bank Premises and Equipment



Bank premises and equipment decreased 6.78% in 2002 compared to a decrease of
4.05% in 2001 due to depreciation charges, partially offset by purchases of bank premises and equipment.



Deposits



Average deposits were $179,232 for the year ended December 31, 2002, an increase of $8,277 or 4.84% from $170,955 of average deposits for the year ended December 31, 2001. As of December 31, 2002, total deposits were $178,243
representing a decrease of $1,598 or 0.89% from $179,841 in total deposits as of December 31, 2001. The change in deposits during 2002 was primarily due to changes in previously existing accounts, as well as new accounts opened as a result of
relationship changes, new products offered and more favorable pricing of certificates of deposit during 2002.



For the year ended December 31, 2002, average noninterest-bearing demand deposits were $15,087 or 8.42% of average deposits. For the year ended December 31, 2001, average noninterest-bearing demand
deposits were $13,689 or 8.00% of average deposits. Average interest-bearing deposits were $164,145 for the year ended December 31, 2002, representing an increase of $6,879 or 4.37% over the $157,266 in average interest-bearing deposits for the year
ended December 31, 2001.



The levels of noninterest-bearing
demand deposits (including retail accounts) are influenced by such factors as customer service, service charges and the availability of banking services. No assurance can be given that the Company will be able to maintain its current level of
noninterest-bearing deposits. Competition from other banks and thrift institutions as well as money market funds, some of which offer interest rates substantially higher than the Company, makes it difficult for the Company to maintain the current
level of noninterest-bearing deposits. Management continually works to implement pricing and marketing strategies designed to control the cost of interest-bearing deposits and to maintain a stable deposit mix.



The following table presents the Companys average deposits and the
average rate paid for each category of deposits for the periods indicated.



17



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AVERAGE
DEPOSIT INFORMATION



|                                    |  | Year ended December 31, 2002  |         |                   | Year ended December 31, 2001 |  
|----------------------------------- |  | ----------------------------- | ------- | ----------------- | ---------------------------- | -
|                                    |  | Average amount of deposits(1) |         | Average rate paid |                              |  
|Noninterest-bearing demand deposits |  | $                             | 15,087  |                   | N/A                          |  
|Interest-bearing demand deposits    |  |                               | 24,910  |                   | 1.00                         | %
|Savings deposits                    |  |                               | 34,995  |                   | 1.21                         | %
|Time deposits:                      |  |                               |         |                   |                              |  
|Under $100,000                      |  |                               | 81,204  |                   | 4.99                         | %
|$100,000 and over                   |  |                               | 23,036  |                   | 3.80                         | %
|                                    |  |                               |         |                   |                              |  
|Total average time deposits         |  |                               | 104,240 |                   |                              |  
|                                    |  |                               |         |                   |                              |  
|Total average deposits              |  | $                             | 179,232 |                   |                              |  
|                                    |  |                               |         |                   |                              |  

---

|(1) |  | Averages are daily averages.
|--- |  | ----------------------------



The following table presents the maturity schedule of time certificates of deposit of $100,000 and over and other time deposits of $100,000 and over as of
December 31, 2002.



TIME DEPOSITS OF $100,000
AND OVER



|                                         |  | Certificates of deposit |        | Other time deposits |       | Total
|---------------------------------------- |  | ----------------------- | ------ | ------------------- | ----- | -----
|Three months or less                     |  | $                       | 5,006  |                     | 161   |      
|Over three through six months            |  |                         | 2,147  |                     | 1,525 |      
|Over six through 12 months               |  |                         | 6,200  |                     | 363   |      
|Over 12 months                           |  |                         | 5,438  |                     | 2,919 |      
|                                         |  |                         |        |                     |       |      
|Total time deposits of $100,000 and over |  | $                       | 18,791 |                     | 4,968 |      
|                                         |  |                         |        |                     |       |      



Financial Ratios



The following table presents certain financial ratios for
the periods indicated.



RETURN ON EQUITY AND
ASSETS



|                                 |  | Years ended December 31, |  
|-------------------------------- |  | ------------------------ | -
|                                 |  | 2002                     |  
|Return on average assets         |  | 0.94                     | %
|Return on average equity         |  | 9.79                     | %
|Dividend payout ratio            |  | 31.54                    | %
|Average equity to average assets |  | 9.62                     | %



Capital Resources



The Companys financial position at December 31, 2002
reflects liquidity and capital levels currently adequate to fund anticipated future business expansion. Capital ratios are well in excess of required regulatory minimums for a well-capitalized institution. The assessment of capital
adequacy depends on a number of factors such as asset quality, liquidity, earnings performance, and changing competitive conditions and economic forces. The adequacy of the Companys capital is reviewed by management on an ongoing basis.
Management seeks to maintain a capital structure that will assure an adequate level of capital to support anticipated asset growth and to absorb potential losses.



The Companys capital position continues to exceed regulatory requirements. The primary indicators relied on by bank
regulators in measuring the capital position are the Tier I capital, total risk-based capital and leverage ratios. Tier I capital consists of common and qualifying preferred stockholders equity less goodwill. Total capital consists of Tier I
capital, qualifying subordinated debt and a portion of the allowance for loan losses. Risk-based capital ratios are calculated with reference to risk weighted assets. The Companys Tier I capital ratio was



18



---

12.37% at December 31, 2002, compared to 12.28% at December 31, 2001. The total capital ratio was 13.21% at December 31, 2002, compared to
13.10% at December 31, 2001.



These ratios are in excess of the
mandated minimum requirements of 4% and 8%, respectively. As of December 31, 2002 and 2001, the Company met all regulatory capital ratio requirements and was considered well capitalized in accordance with FDICIA.



Stockholders equity reached $20,372 at December 31, 2002 compared to
$18,460 at December 31, 2001. The leverage ratio consists of Tier I capital divided by quarterly average assets. At December 31, 2002, the Companys leverage ratio was 9.44% compared to 8.92% at December 31, 2001. Each of these exceeds the
required minimum leverage ratio of 4%. The dividend payout ratio was 31.54% and 39.60% in 2002 and 2001, respectively. During 2002, the Company paid dividends of $0.41 per share, up 2.50% from $0.40 per share paid in 2001.



Critical Accounting Policies



Certain critical accounting policies affect the more significant judgments
and estimates used in the preparation of the consolidated financial statements. The Companys single most critical accounting policy relates to the Companys allowance for loan losses, which reflects the estimated losses resulting from the
inability of the Companys borrowers to make required loan payments. If the financial condition of the Companys borrowers were to deteriorate, resulting in an impairment of their ability to make payments, the Companys estimates
would be updated, and additional provisions for loan losses may be required. Further discussion of the estimates used in determining the allowance for loan losses is contained in the discussion on Allowance for Loan Losses on page 15 and
Loans and Allowance for Loan Losses on page 27 of this Annual Report.



New Accounting Standards



In
August 2001, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 143, Accounting for Asset Retirement Obligations, which addresses financial accounting and reporting for obligations
associated with the retirement of tangible long-lived assets and the associated asset retirement costs. The standard applies to legal obligations associated with the retirement of long-lived assets that result from the acquisition, construction,
development and (or) normal use of the asset.



SFAS No. 143
requires that the fair value of a liability for an asset retirement obligation be recognized in the period in which it is incurred if a reasonable estimate of fair value can be made. The fair value of the liability is added to the carrying amount of
the associated asset and this additional carrying amount is depreciated over the life of the asset. The liability is accreted at the end of each period through charges to operating expense. If the obligation is settled for other than the carrying
amount of the liability, an entity would recognize a gain or loss on settlement.



SFAS No. 143 is effective for fiscal years beginning after June 15, 2002. The adoption of SFAS No. 143 is not expected to have a material effect on the financial position, results of operations or liquidity of the Company.



In April 2002, the FASB issued SFAS No. 145, Rescission of
FASB Statements No. 4, 44 and 64, Amendment of FASB Statement No. 13, and Technical Corrections,which rescinds both SFAS No. 4, Reporting Gains and Losses from Extinguishment of Debt,and an amendment of that Statement, SFAS No. 64,
Extinguishments of Debt Made to Satisfy Sinking-Fund Requirements. SFAS No. 145 amends SFAS No. 13, Accounting for Leases, to eliminate an inconsistency between the required accounting for sale-leaseback transactions and the required
accounting for certain lease modifications that have economic effects that are similar to sale-leaseback transactions. SFAS No. 145 also amends other existing authoritative pronouncements to make various technical corrections, clarify meanings, or
describe their applicability under changed conditions.



The
provisions of SFAS No. 145 related to the rescission of SFAS No. 4 must be applied in fiscal years beginning after May 15, 2002. The provisions of SFAS No. 145 related to SFAS No. 13 are effective for



19



---



transactions occurring after
May 15, 2002. All other provisions of SFAS No. 145 will be effective for financial statements issued on or after May 15, 2002. The adoption of SFAS No. 145 is not expected to have a material effect on the financial position, results of operations or
liquidity of the Company.



In July 2002, the FASB issued SFAS No.
146, Accounting for Costs Associated with Exit or Disposal Activities, which nullifies Emerging Issues Task Force (EITF) Issue No. 94-3, Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity
(including Certain Costs Incurred in a Restructuring).The principal difference between SFAS No. 146 and Issue No. 94-3 relates to the recognition of a liability for a cost associated with an exit or disposal activity. SFAS No. 146 requires that
a liability be recognized for those costs only when the liability is incurred, that is, when it meets the definition of a liability in the FASBs conceptual framework. In contrast, under Issue 94-3, a company recognized a liability for an exit
cost when it committed to an exit plan. SFAS No. 146 also establishes fair value as the objective for initial measurement of liabilities related to exit or disposal activities.



The provisions of SFAS No. 146 are effective for exit or disposal activities that are initiated after December 31, 2002. The
adoption of SFAS No. 146 is not expected to have a material effect on the financial position, results of operations or liquidity of the Company.



In December 2002, the FASB issued SFAS No. 148, Accounting for Stock-Based Compensation  Transition and Disclosure  an amendment of FASB
Statement No. 123. This Statement amends SFAS No. 123, Accounting forStock-Based Compensation, to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based
employee compensation. In addition, this Statement amends the disclosure requirements of SFAS No. 123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee
compensation and the effect of the method used on reported results.



The application of the transition provisions of SFAS No. 148 is effective for fiscal years ending after December 15, 2002. The application of the disclosure requirements is effective for financial reports for interim periods
beginning after December 15, 2002.



In November 2002, the FASB
issued FASB Interpretation No. 45, Guarantors Accounting and Disclosure requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others. This Interpretation elaborates on the disclosures to be made by a guarantor in
its interim and annual financial statements about its obligations under certain guarantees that it has issued. It also clarifies that a guarantor is required to recognize, at the inception of a guarantee, a liability for the fair value of the
obligation undertaken in issuing the guarantee. This Interpretation does not prescribe a specific approach for subsequently measuring the guarantors recognized liability over the term of the related guarantee. This Interpretation also
incorporates, without change, the guidance in FASB Interpretation No. 34, Disclosure of Indirect Guarantees of Indebtedness of Others, which is being superseded.



The initial recognition and initial measurement provisions of this Interpretation are applicable on a prospective basis to
guarantees issued or modified after December 31, 2002, irrespective of the guarantors fiscal year end. Management is currently evaluating the impact of this Interpretation on the financial position, results of operations and liquidity of the
Company.



As of December 31, 2002, there are no other new
accounting standards issued, but not yet adopted by the Company, which are expected to be applicable to the Companys financial position, operating results or financial statement disclosures.



20



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PINNACLE
BANKSHARES CORPORATION

AND SUBSIDIARY



Consolidated Balance Sheets

December 31, 2002 and 2001

(In thousands, except share data)







|                                                                                                                        |  | 2002 |         | 2001
|----------------------------------------------------------------------------------------------------------------------- |  | ---- | ------- | ----
|Assets                                                                                                                  |  |      |         |     
|Cash and cash equivalents:                                                                                              |  |      |         |     
|Cash and due from banks (note 2)                                                                                        |  | $    | 4,516   |     
|Federal funds sold                                                                                                      |  |      | 15,447  |     
|                                                                                                                        |  |      |         |     
|Total cash and cash equivalents                                                                                         |  |      | 19,963  |     
|Securities (note 3):                                                                                                    |  |      |         |     
|Available-for-sale, at fair value                                                                                       |  |      | 32,158  |     
|Held-to-maturity, at amortized cost (fair value of $11,239 in 2002 and $13,032 in
2001)                                 |  |      | 10,573  |     
|Federal Reserve Bank stock, at cost (note 1(c))                                                                         |  |      | 75      |     
|Federal Home Loan Bank stock, at cost (note 1(c))                                                                       |  |      | 565     |     
|Loans, net (notes 4, 9 and 10)                                                                                          |  |      | 129,999 |     
|Bank premises and equipment, net (note 5)                                                                               |  |      | 3,906   |     
|Accrued income receivable                                                                                               |  |      | 1,019   |     
|Other assets (notes 5, 8 and 15)                                                                                        |  |      | 1,641   |     
|                                                                                                                        |  |      |         |     
|Total assets                                                                                                            |  | $    | 199,899 |     
|                                                                                                                        |  |      |         |     
|Liabilities and Stockholders
Equity                                                                                    |  |      |         |     
|Liabilities:                                                                                                            |  |      |         |     
|Deposits (note 6):                                                                                                      |  |      |         |     
|Demand                                                                                                                  |  | $    | 14,468  |     
|Savings and NOW accounts                                                                                                |  |      | 59,684  |     
|Time                                                                                                                    |  |      | 104,091 |     
|                                                                                                                        |  |      |         |     
|Total deposits                                                                                                          |  |      | 178,243 |     
|Note payable to Federal Home Loan Bank (note 1(c))                                                                      |  |      | 500     |     
|Accrued interest payable                                                                                                |  |      | 496     |     
|Other liabilities (note 7)                                                                                              |  |      | 288     |     
|                                                                                                                        |  |      |         |     
|Total liabilities                                                                                                       |  |      | 179,527 |     
|                                                                                                                        |  |      |         |     
|Stockholders equity (notes 11 and 14):                                                                                 |  |      |         |     
|Common stock, $3 par value. Authorized 3,000,000 shares; issued and outstanding
1,453,203 in 2002 and 1,450,966 in 2001 |  |      | 4,360   |     
|Capital surplus                                                                                                         |  |      | 503     |     
|Retained earnings                                                                                                       |  |      | 14,675  |     
|Accumulated other comprehensive income, net                                                                             |  |      | 834     |     
|                                                                                                                        |  |      |         |     
|Total stockholders equity                                                                                              |  |      | 20,372  |     
|Commitments, contingencies and other matters (notes 9, 10 and 11)                                                       |  |      |         |     
|                                                                                                                        |  |      |         |     
|Total liabilities and stockholders equity                                                                              |  | $    | 199,899 |     
|                                                                                                                        |  |      |         |     



See
accompanying notes to consolidated financial statements.



21



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PINNACLE
BANKSHARES CORPORATION

AND SUBSIDIARY



Consolidated Statements of Income

Years ended December 31, 2002 and 2001

(In thousands, except per share data)



|                                                    |  | 2002 |        | 2001
|--------------------------------------------------- |  | ---- | ------ | ----
|Interest income:                                    |  |      |        |     
|Interest and fees on loans                          |  | $    | 9,315  |     
|Interest on securities:                             |  |      |        |     
|U.S. Treasury                                       |  |      | 64     |     
|U.S. Government agencies                            |  |      | 1,027  |     
|Corporate                                           |  |      | 446    |     
|States and political subdivisions (taxable)         |  |      | 402    |     
|States and political subdivisions (tax-exempt)      |  |      | 547    |     
|Other                                               |  |      | 34     |     
|Interest on federal funds sold                      |  |      | 221    |     
|                                                    |  |      |        |     
|Total interest income                               |  |      | 12,056 |     
|                                                    |  |      |        |     
|Interest expense:                                   |  |      |        |     
|Interest on deposits:                               |  |      |        |     
|Savings and NOW accounts                            |  |      | 676    |     
|Time  under $100,000                               |  |      | 3,373  |     
|Time  $100,000 and over                            |  |      | 876    |     
|Other interest expense                              |  |      | 35     |     
|                                                    |  |      |        |     
|Total interest expense                              |  |      | 4,960  |     
|                                                    |  |      |        |     
|Net interest income                                 |  |      | 7,096  |     
|Provision for loan losses (note 4)                  |  |      | 429    |     
|                                                    |  |      |        |     
|Net interest income after provision for loan losses |  |      | 6,667  |     
|                                                    |  |      |        |     
|Noninterest income:                                 |  |      |        |     
|Service charges on deposit accounts                 |  |      | 747    |     
|Net realized gain on securities (note 3)            |  |      | 2      |     
|Commissions and fees                                |  |      | 220    |     
|Fees on sales of mortgage loans                     |  |      | 416    |     
|Other operating income                              |  |      | 371    |     
|                                                    |  |      |        |     
|Total noninterest income                            |  |      | 1,756  |     
|                                                    |  |      |        |     
|Noninterest expense:                                |  |      |        |     
|Salaries and employee benefits (note 7)             |  |      | 3,303  |     
|Occupancy expense                                   |  |      | 312    |     
|Furniture and equipment                             |  |      | 547    |     
|Office supplies and printing                        |  |      | 142    |     
|Other operating expenses                            |  |      | 1,510  |     
|                                                    |  |      |        |     
|Total noninterest expense                           |  |      | 5,814  |     
|                                                    |  |      |        |     
|Income before income tax expense                    |  |      | 2,609  |     
|Income tax expense (note 8)                         |  |      | 723    |     
|                                                    |  |      |        |     
|Net income                                          |  | $    | 1,886  |     
|                                                    |  |      |        |     
|Basic net income per share (note 1(m))              |  | $    | 1.30   |     
|                                                    |  |      |        |     
|Diluted net income per share (note 1(m))            |  | $    | 1.29   |     
|                                                    |  |      |        |     



See
accompanying notes to consolidated financial statements.



22



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PINNACLE BANKSHARES CORPORATION

AND SUBSIDIARY



Consolidated Statements of Changes in Stockholders Equity

and Comprehensive Income

Years ended December 31, 2002 and 2001

(In thousands, except share and per share data)



|                                                                                                            |  | Common Stock |  | Capital Surplus |       | Retained Earnings |     |  | Accumulated Other Comprehensive Income |   | Total |    
|----------------------------------------------------------------------------------------------------------- |  | ------------ |  | --------------- | ----- | ----------------- | --- |  | -------------------------------------- | - | ----- | ---
|                                                                                                            |  | Shares       |  | Par Value       |       |                   |     | 
|Balances, December 31, 2000                                                                                 |  | 1,445,153    |  | $               | 4,335 |                   | 420 |  | 12,501                                 |   |       | 44 
|Net income                                                                                                  |  |             |  |                 |      |                   |    |  | 1,463                                  |   |       |   
|Change in net unrealized gains on available-for-sale securities, net of deferred income
tax expense of $103 |  |             |  |                 |      |                   |    |  |                                       |   |       | 199
|                                                                                                            |  |              |  |                 |       |                   |     |  |                                        |   |       |    
|Comprehensive income                                                                                        |  |              |  |                 |       |                   |     |  |                                        |   |       |    
|                                                                                                            |  |              |  |                 |       |                   |     |  |                                        |   |       |    
|Cash dividends declared by Bankshares ($0.40 per share)                                                     |  |             |  |                 |      |                   |    |  | (579                                   | ) |       |   
|Issuance of common stock  dividend reinvestment plan                                                       |  | 5,813        |  |                 | 18    |                   | 59  |  |                                       |   |       |   
|                                                                                                            |  |              |  |                 |       |                   |     |  |                                        |   |       |    
|Balances, December 31, 2001                                                                                 |  | 1,450,966    |  |                 | 4,353 |                   | 479 |  | 13,385                                 |   |       | 243
|Net income                                                                                                  |  |             |  |                 |      |                   |    |  | 1,886                                  |   |       |   
|Change in net unrealized gains on available-for-sale securities, net of deferred income
tax expense of $304 |  |             |  |                 |      |                   |    |  |                                       |   |       | 591
|                                                                                                            |  |              |  |                 |       |                   |     |  |                                        |   |       |    
|Comprehensive income                                                                                        |  |              |  |                 |       |                   |     |  |                                        |   |       |    
|                                                                                                            |  |              |  |                 |       |                   |     |  |                                        |   |       |    
|Cash dividends declared by Bankshares ($0.41 per share)                                                     |  |             |  |                 |      |                   |    |  | (596                                   | ) |       |   
|Issuance of common stock  dividend reinvestment plan                                                       |  | 2,237        |  |                 | 7     |                   | 24  |  |                                       |   |       |   
|                                                                                                            |  |              |  |                 |       |                   |     |  |                                        |   |       |    
|Balances, December 31, 2002                                                                                 |  | 1,453,203    |  | $               | 4,360 |                   | 503 |  | 14,675                                 |   |       | 834
|                                                                                                            |  |              |  |                 |       |                   |     |  |                                        |   |       |    



See
accompanying notes to consolidated financial statements.



23



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PINNACLE
BANKSHARES CORPORATION

AND SUBSIDIARY



Consolidated Statements of Cash Flows

Years ended December 31, 2002 and 2001

(In thousands)



|                                                                                       |  | 2002 |         |   | 2001 |        
|-------------------------------------------------------------------------------------- |  | ---- | ------- | - | ---- | -------
|Cash flows from operating activities:                                                  |  |      |         |   |      |        
|Net income                                                                             |  | $    | 1,886   |   |      | 1,463  
|Adjustments to reconcile net income to net cash provided by operating
activities:      |  |      |         |   |      |        
|Depreciation of bank premises and equipment                                            |  |      | 400     |   |      | 394    
|Amortization of intangible assets                                                      |  |      | 11      |   |      | 51     
|Amortization of unearned fees, net                                                     |  |      | (40     | ) |      | (156   
|Loss on sale of foreclosed properties                                                  |  |      |        |   |      | 16     
|Net amortization of premiums and discounts on securities                               |  |      | 63      |   |      | 40     
|Provision for loan losses                                                              |  |      | 429     |   |      | 380    
|Provision for deferred income taxes                                                    |  |      | (11     | ) |      | (21    
|Net realized gain on securities                                                        |  |      | (2      | ) |      | (3     
|Net decrease (increase) in:                                                            |  |      |         |   |      |        
|Accrued income receivable                                                              |  |      | 118     |   |      | 293    
|Other assets                                                                           |  |      | 481     |   |      | 251    
|Net increase (decrease) in:                                                            |  |      |         |   |      |        
|Accrued interest payable                                                               |  |      | (200    | ) |      | (30    
|Other liabilities                                                                      |  |      | (81     | ) |      | (48    
|                                                                                       |  |      |         |   |      |        
|                                                                                      
|Net cash provided by operating activities                                              |  |      | 3,054   |   |      | 2,630  
|                                                                                       |  |      |         |   |      |        
|                                                                                      
|Cash flows from investing activities:                                                  |  |      |         |   |      |        
|Purchases of available-for-sale securities                                             |  |      | (6,055  | ) |      | (8,602 
|Purchases of available-for-sale mortgaged-backed securities                            |  |      | (2,546  | ) |      | (13,856
|Proceeds from maturities and calls of held-to-maturity securities                      |  |      | 2,166   |   |      | 2,452  
|Proceeds from paydowns and maturities of held-to-maturity mortgage-backed
securities   |  |      |        |   |      | 1      
|Proceeds from maturities and calls of available-for-sale securities                    |  |      | 4,998   |   |      | 12,425 
|Proceeds from sale of available-for-sale mortgage-backed securities                    |  |      |        |   |      | 382    
|Proceeds from paydowns and maturities of available-for-sale mortgage-backed
securities |  |      | 4,610   |   |      | 1,819  
|Purchase of Federal Home Loan Bank stock                                               |  |      | (125    | ) |      | (13    
|Purchase of loan participations                                                        |  |      |        |   |      | (4,508 
|Collections on loan participations                                                     |  |      | 2,216   |   |      | 1,899  
|Net increase in loans made to customers                                                |  |      | (10,269 | ) |      | (1,394 
|Recoveries on loans charged off                                                        |  |      | 110     |   |      | 144    
|Purchases of bank premises and equipment                                               |  |      | (116    | ) |      | (217   
|Proceeds from sale and rental of foreclosed properties, net                            |  |      |        |   |      | 23     
|                                                                                       |  |      |         |   |      |        
|Net cash used in investing activities                                                  |  |      | (5,011  | ) |      | (9,445 
|                                                                                       |  |      |         |   |      |        



(Continued)



24



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PINNACLE
BANKSHARES CORPORATION

AND SUBSIDIARY



Consolidated Statements of Cash Flows

Years ended December 31, 2002 and 2001

(In thousands)



|                                                                     |  | 2002 |        |   | 2001 |       
|-------------------------------------------------------------------- |  | ---- | ------ | - | ---- | ------
|Cash flows from financing activities:                                |  |      |        |   |      |       
|Net increase in demand, savings and NOW deposits                     |  | $    | 318    |   |      | 7,359 
|Net increase (decrease) in time deposits                             |  |      | (1,916 | ) |      | 11,889
|Repayments of note payable to Federal Home Loan Bank                 |  |      | (100   | ) |      | (100  
|Proceeds from issuance of common stock to dividend reinvestment plan |  |      | 31     |   |      | 77    
|Cash dividends paid                                                  |  |      | (596   | ) |      | (579  
|                                                                     |  |      |        |   |      |       
|Net cash provided by (used in) financing activities                  |  |      | (2,263 | ) |      | 18,646
|                                                                     |  |      |        |   |      |       
|Net increase (decrease) in cash and cash equivalents                 |  |      | (4,220 | ) |      | 11,831
|Cash and cash equivalents, beginning of year                         |  |      | 24,183 |   |      | 12,352
|                                                                     |  |      |        |   |      |       
|Cash and cash equivalents, end of year                               |  | $    | 19,963 |   |      | 24,183
|                                                                     |  |      |        |   |      |       
|Supplemental disclosure of cash flows information:                   |  |      |        |   |      |       
|Cash paid during the year for:                                       |  |      |        |   |      |       
|Income taxes                                                         |  | $    | 670    |   |      | 570   
|Interest                                                             |  |      | 5,160  |   |      | 7,293 
|Supplemental schedule of noncash investing and financing activities: |  |      |        |   |      |       
|Transfer of loans to repossessed properties                          |  | $    | 57     |   |      | 95    
|Loans charged against the allowance for loan losses                  |  |      | 417    |   |      | 417   
|Unrealized gains on available-for-sale securities                    |  |      | 895    |   |      | 302   



See
accompanying notes to consolidated financial statements.



25



---



PINNACLE
BANKSHARES CORPORATION

AND SUBSIDIARY



Notes to Consolidated Financial Statements

December 31, 2002 and 2001

(In thousands, except share
and per share data)



|(1) |  | Summary of Significant Accounting Policies and Practices
|--- |  | --------------------------------------------------------



Pinnacle Bankshares Corporation, a Virginia corporation (Bankshares), was organized in 1997 and is registered
as a bank holding company under the Bank Holding Company Act of 1956, as amended. Bankshares is headquartered in Altavista, Virginia. Bankshares conducts all of its business activities through the branch offices of its wholly owned subsidiary bank,
The First National Bank of Altavista (the Bank). Bankshares exists primarily for the purpose of holding the stock of its subsidiary, the Bank, and of such other subsidiaries as it may acquire or establish. The Company has a single reportable segment
for purposes of segment reporting. Also see note 10.



The accounting and reporting policies of Bankshares and its wholly owned subsidiary (collectively, the Company), conform to accounting principles generally accepted in the United States of America and general practices within the
banking industry. The following is a summary of the more significant accounting policies and practices:



| | (a) |  | Consolidation
| | --- |  | -------------



The consolidated financial statements include the accounts of Pinnacle Bankshares Corporation and its wholly owned subsidiary. All
material intercompany balances and transactions have been eliminated.



| | (b) |  | Securities
| | --- |  | ----------



The Bank classifies its securities in three categories: (1) debt securities that the Bank has the positive intent and ability to hold to
maturity are classified as held-to-maturity securities and reported at amortized cost; (2) debt and equity securities that are bought and held principally for the purpose of selling them in the near term are classified as trading
securities and reported at fair value, with unrealized gains and losses included in net income; and (3) debt and equity securities not classified as either held-to-maturity securities or trading securities are classified as
available-for-sale securities and reported at fair value, with unrealized gains and losses excluded from net income and reported in accumulated other comprehensive income, a separate component of stockholders equity.
Held-to-maturity securities are stated at cost, adjusted for amortization of premiums and accretion of discounts on a basis which approximates the level yield method. The Bank does not maintain trading account securities. Gains or losses on
disposition are based on the net proceeds and adjusted carrying values of the securities called or sold, using the specific identification method. A decline in the market value of any available-for-sale or held-to-maturity security below cost that
is deemed other than temporary is charged to net income, resulting in the establishment of a new cost basis for the security.



| | (c) |  | Required Investments and Note Payable to FHLB
| | --- |  | ---------------------------------------------



As members of the Federal Reserve Bank (FRB) and the Federal Home Loan Bank (FHLB) of Atlanta, the Bank is required to maintain certain
minimum investments in the common stock of the FRB and FHLB, which are carried at cost. Required levels of investment are based upon the Banks capital and a percentage of qualifying assets.



In addition, the Bank is eligible to borrow from the FHLB
with borrowings collateralized by qualifying assets, primarily residential mortgage loans, and the Banks capital stock investment in the FHLB. At December 31, 2002, the Banks available borrowing limit was approximately $31,569.



26



---



The Bank had
$500 and $600 in borrowings outstanding at December 31, 2002 and 2001, respectively. The note payable, due in December 2007, is payable in annual installments of $100 and bears interest at a fixed rate of 6.13%. Maturities of the note payable for
each of the five years subsequent to December 31, 2002 are as follows: $100 in 2003; $100 in 2004; $100 in 2005; $100 in 2006; and $100 in 2007.



| | (d) |  | Loans and Allowance for Loan Losses
| | --- |  | -----------------------------------



Loans are stated at the amount of unpaid principal, reduced by unearned income and fees on loans, and an
allowance for loan losses. Income is recognized over the terms of the loans using methods which approximate the level yield method. The allowance for loan losses is a valuation allowance consisting of the cumulative effect of the provision for loan
losses, plus any amounts recovered on loans previously charged off, minus loans charged off. The provision for loan losses charged to operating expenses is the amount necessary in managements judgment to maintain the allowance for loan losses
at a level it believes sufficient to cover losses in the collection of the Banks loans. Management determines the adequacy of the allowance based upon reviews of individual credits, recent loss experience, delinquencies, current economic
conditions, the risk characteristics of the various categories of loans and other pertinent factors. Loans are charged against the allowance for loan losses when management believes the collectibility of the principal is unlikely. While management
uses available information to recognize losses on loans, future additions to the allowance for loan losses may be necessary based on changes in economic conditions. In addition, various regulatory agencies, as an integral part of their examination
process, periodically review the Banks allowance for loan losses. Such agencies may require the Bank to recognize additions to the allowance for loan losses based on their judgments about information available to them at the time of their
examinations.



Interest related to nonaccrual
loans is recognized on the cash basis. Loans are generally placed in nonaccrual status when the collection of principal and interest is 90 days or more past due, unless the obligation relates to a consumer or residential real estate loan or is both
well-secured and in the process of collection.



Impaired loans are required to be presented in the financial statements at the present value of the expected future cash flows or at the fair value of the loans collateral. Homogeneous loans such as real estate mortgage loans,
individual consumer loans, home equity loans and bankcard loans are evaluated collectively for impairment. Management, considering current information and events regarding the borrowers ability to repay their obligations, considers a loan to be
impaired when it is probable that the Bank will be unable to collect all amounts due according to the contractual terms of the loan agreement. Impairment losses are included in the allowance for loan losses through a charge to the provision for loan
losses. Cash receipts on impaired loans receivable are applied first to reduce interest on such loans to the extent of interest contractually due and any remaining amounts are applied to principal.



| | (e) |  | Loan Origination and Commitment Fees and Certain Related Direct Costs
| | --- |  | ---------------------------------------------------------------------



Loan origination and commitment fees and certain direct loan origination costs charged by the Bank are
deferred and the net amount amortized as an adjustment of the related loans yield. The Bank is amortizing these net amounts over the contractual life of the related loans or, in the case of demand loans, over the estimated life. Net fees
related to standby letters of credit are recognized over the commitment period.

| | 
| | 

| | (f) |  | Bank Premises and Equipment
| | --- |  | ---------------------------



Bank premises and equipment are stated at cost, net of accumulated depreciation. Depreciation is computed by the straight-line and
declining-balance methods over the estimated useful lives of the assets. Depreciable lives include 15 years for land improvements, 39 years for buildings, and 7 years for equipment, furniture and fixtures. The cost of assets retired and sold and the
related accumulated



27



---



depreciation
are eliminated from the accounts and the resulting gains or losses are included in determining net income. Expenditures for maintenance and repairs are charged to expense as incurred, and improvements and betterments are capitalized.



| | (g) |  | Foreclosed Properties
| | --- |  | ---------------------



Foreclosed properties consists of properties acquired through foreclosure or deed in lieu of foreclosure. These properties are carried at
the lower of cost or fair value less estimated costs to sell. Losses from the acquisition of property in full or partial satisfaction of loans are charged against the allowance for loan losses. Subsequent write-downs, if any, are charged to expense.
Gains and losses on the sales of foreclosed properties are included in determining net income in the year of the sale.



| | (h) |  | Impairment or Disposal of Long-Lived Assets
| | --- |  | -------------------------------------------



The Company accounts for long-lived assets in accordance with the provisions of SFAS No. 144, Accounting for the Impairment or Disposal
of Long-Lived Assets. This Statement requires that long-lived assets be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held
and used, such as bank premises and equipment, is measured by a comparison of the carrying amount of an asset to future net cash flows expected to be generated by the asset. If the carrying amount of an asset exceeds its estimated future cash flows,
an impairment charge is recognized by the amount by which the carrying amount of the asset exceeds the fair value of the asset. Assets to be disposed of, such as foreclosed properties, are reported at the lower of the carrying amount or fair value
less costs to sell.



The Company adopted SFAS
No. 144 on January 1, 2002. The adoption of SFAS No. 144 did not affect the Companys consolidated financial statements. Prior to the adoption of SFAS No. 144, the Company accounted for long-lived assets in accordance with SFAS No. 121,
Accounting for Impairment of Long-Lived and for Long-Lived Assets to be Disposed Of.



| | (i) |  | Reclassified Goodwill
| | --- |  | ---------------------



In October 2002, the FASB issued SFAS No. 147, Acquisitions of Certain Financial Institutions, an amendment of SFAS No. 72 and 144 and
FASB Interpretation No. 9. SFAS No. 72, Accounting for Certain Acquisitions of Banking or Thrift Institutions, and FASB Interpretation No. 9, Applying APB Opinions No. 16 and 17 When a Savings and Loan Association or a Similar
Institution Is Acquired in a Business Combination Accounted for by the Purchase Method, provided interpretive guidance on the application of the purchase method to acquisitions of financial institutions. Except for transactions between two or
more mutual enterprises, SFAS No. 147 removes acquisitions of financial institutions from the scope of both SFAS No. 72 and Interpretation No. 9 and requires that those transactions be accounted for in accordance with SFAS No. 141, Business
Combinations, and SFAS No. 142, Goodwill and Other Intangible Assets. Thus, the requirement in paragraph 5 of SFAS No. 72 to recognize (and subsequently amortize) any excess of the fair value of liabilities assumed over the fair value of
tangible and identifiable intangible assets acquired as an unidentifiable intangible asset no longer applies to acquisitions within the scope of SFAS No. 147. In addition, SFAS No. 147 amends SFAS No. 144, Accounting for the Impairment or
Disposal of Long-Lived Assets, to include in its scope long-term customer-relationship intangible assets of financial institutions such as depositor- and borrower-relationship intangible assets and credit cardholder intangible assets.
Consequently, those intangible assets are subject to the same undiscounted cash flow recoverability test and impairment loss recognition and measurement provisions that SFAS No. 144 requires for other long-lived assets that are held and used.



The provisions of SFAS No. 147 that relate to
the application of the purchase method of accounting apply to all acquisitions of financial institutions, except transactions between two or more mutual enterprises. The provisions of this Statement that relate to the application of SFAS No. 144
apply to certain long-term customer-relationship intangible assets recognized in an acquisition of a financial



28



---



institution,
including those acquired in transactions between mutual enterprises. This Statement clarifies that a branch acquisition that meets the definition of a business should be accounted for as a business combination, whereas a branch acquisition that does
not should be accounted for as an acquisition of net assets that does not result in the recognition of goodwill.



Paragraph 5 of SFAS No. 147, which relates to the application of the purchase method of accounting, is effective for acquisitions on or
after October 1, 2002. The provisions in paragraph 6 related to accounting for the impairment or disposal of certain long-term customer-relationship intangible assets are effective on October 1, 2002. Transition provisions for previously recognized
unidentifiable intangible assets in paragraph 8-14 are effective on October 1, 2002, with earlier application permitted.



The adoption of SFAS No. 147 as of October 1, 2002 had an impact on the Companys consolidated financial statements because certain
previous branch acquisitions met the definition of a business under criteria in Emerging Issues Task Force (EITF) Issue No. 98-3, Determining Whether a Nonmonetary Transaction Involves Receipt of Productive Assets or a Business. Accordingly,
the carrying amount of the intangible assets related to certain previous branch acquisitions were reclassified to goodwill and are no longer being amortized over the assets remaining useful lives after October 1, 2002. The Company also
retroactively restated its operating results for the first three quarters of 2002 to reverse amortization expense back to the beginning of 2002, and evaluated the reclassified goodwill for impairment as of October 1, 2002 in accordance with the
provisions of SFAS No. 142.



In connection with
SFAS No. 142s transitional goodwill impairment evaluation, the Company performed an assessment of whether there was an indication that reclassified goodwill was impaired as of the date of adoption. Based on the Companys assessment, it
was not required to recognize any transitional impairment loss as a cumulative effect of a change in accounting principle in the Companys 2002 consolidated statement of income.



Prior to January 1, 2002, intangible assets were amortized on a straight-line basis over 15 years (see also
note 15).



| | (j) |  | Pension Plan
| | --- |  | ------------



The Bank maintains a noncontributory defined benefit pension plan which covers substantially all of its employees. The net periodic
pension expense includes a service cost component, interest on the projected benefit obligation, a component reflecting the actual return on plan assets, the effect of deferring and amortizing certain actuarial gains and losses, and the amortization
of any unrecognized net transition obligation on a straight-line basis over the average remaining service period of employees expected to receive benefits under the plan. The Banks funding policy is to make annual contributions in amounts
necessary to satisfy the Internal Revenue Services funding standards and to the extent that they are tax deductible.



| | (k) |  | Income Taxes
| | --- |  | ------------



Income taxes are accounted for under the asset and liability method, whereby deferred tax assets and liabilities are recognized for the
future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. Deferred tax assets and
liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax
rates is recognized in net income in the period that includes the enactment date.



29



---



| | (l) |  | Stock Options
| | --- |  | -------------



The Company applies the intrinsic value-based method of accounting prescribed by Accounting Principles Board (APB) Opinion No. 25,
Accounting for Stock Issued to Employees, and related interpretations including FASB Interpretation No. 44, Accounting for Certain Transactions Involving Stock Compensation, an Interpretation of APB Opinion No. 25, to account for its
fixed plan stock options. Under this method, compensation expense is recorded on the date of grant only if the current market price of the underlying stock exceeded the exercise price. SFAS No. 123, Accounting for Stock-Based Compensation,
established accounting and disclosure requirements using a fair value-based method of accounting for stock-based employee compensation plans. As allowed by SFAS No. 123, the Company has elected to continue to apply the intrinsic value-based method
of accounting described above, and has adopted the disclosure requirements of SFAS No. 123, as amended by SFAS No. 148, Accounting for Stock-Based Compensation  Transition and Disclosure, an amendment of FASB Statement No. 123.



No compensation cost has been recognized for the
Companys stock options in the accompanying consolidated financial statements. Had the Company determined compensation cost based on the fair value of its stock options at the grant date under SFAS No. 123, the Companys net income, basic
net income per share and diluted net income per share would have decreased to the pro forma amounts for the years ended December 31, 2002 and 2001 indicated below:



|                                                                                                                  |  | 2002 |       |   | 2001 |      
|----------------------------------------------------------------------------------------------------------------- |  | ---- | ----- | - | ---- | -----
|Net income, as reported                                                                                           |  |      |       |   |      |      
|                                                                                                                  |  | $    | 1,886 |   |      | 1,463
|Deduct: Total stock-based employee compensation expense determined under SFAS No. 123,
net of related tax effects |  |      | (7    | ) |      | (13  
|                                                                                                                  |  |      |       |   |      |      
|Pro forma net income                                                                                              |  | $    | 1,879 |   |      | 1,450
|                                                                                                                  |  |      |       |   |      |      
|Basic net income per share:                                                                                       |  |      |       |   |      |      
|As reported                                                                                                       |  | $    | 1.30  |   |      | 1.01 
|Pro forma                                                                                                         |  |      | 1.29  |   |      | 1.00 
|Diluted net income per share:                                                                                     |  |      |       |   |      |      
|As reported                                                                                                       |  | $    | 1.29  |   |      | 1.00 
|Pro forma                                                                                                         |  |      | 1.29  |   |      | 1.00 



| | (m) |  | Net Income Per Share
| | --- |  | --------------------



Basic net income per share excludes dilution and is computed by dividing income available to common stockholders by the weighted-average
number of common shares outstanding for the period. Diluted net income per share reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the
issuance of common stock that then shared in the earnings of the Company.



The following is a reconciliation of the numerators and denominators of the basic and diluted net income per share computations for the periods indicated:



|Year ended December 31, 2002     |  | Net income (numerator) |       | Shares (denominator) |           | Per share amount
|-------------------------------- |  | ---------------------- | ----- | -------------------- | --------- | ----------------
|                                 |  |                       
|Basic net income per share       |  | $                      | 1,886 |                      | 1,453,013 |                 
|                                 |  |                        |       |                      |           |                 
|Effect of dilutive stock options |  |                        |      |                      | 8,287     |                 
|                                 |  |                        |       |                      |           |                 
|Diluted net income per share     |  | $                      | 1,886 |                      | 1,461,300 |                 
|                                 |  |                        |       |                      |           |                 



30



---



|Year ended December 31, 2001     |  | Net income (numerator) |       | Shares (denominator) |           | Per share amount
|-------------------------------- |  | ---------------------- | ----- | -------------------- | --------- | ----------------
|Basic net income per share       |  | $                      | 1,463 |                      | 1,449,681 |                 
|                                 |  |                        |       |                      |           |                 
|Effect of dilutive stock options |  |                        |      |                      | 7,224     |                 
|                                 |  |                        |       |                      |           |                 
|Diluted net income per share     |  | $                      | 1,463 |                      | 1,456,905 |                 
|                                 |  |                        |       |                      |           |                 



| | (n) |  | Consolidated Statements of Cash Flows
| | --- |  | -------------------------------------



For purposes of the consolidated statements of cash flows, cash and cash equivalents include cash on hand, amounts due from banks (with
original maturities of three months or less), and federal funds sold. Generally, federal funds are purchased and sold for one-day periods.



| | (o) |  | Comprehensive Income
| | --- |  | --------------------



SFAS No. 130, Reporting Comprehensive Income, requires the Company to classify items of Other Comprehensive Income
(such as net unrealized gains (losses) on available-for-sale securities) by their nature in a financial statement and present the accumulated balance of other comprehensive income separately from retained earnings and additional paid-in capital in
the equity section of a statement of financial position. The Companys comprehensive income consists of net income and net unrealized gains (losses) on securities available-for-sale, net of income taxes.



Effective in 2002, the Company changed its method of
presentation concerning comprehensive income. Prior to 2002, comprehensive income was reflected as part of the consolidated statement of income and comprehensive income. Comprehensive income is now presented as a separate component of the
Companys consolidated statement of changes in stockholders equity and comprehensive income. Reclassification of prior year amounts have been made to conform with the current year presentation.



| | (p) |  | Use of Estimates
| | --- |  | ----------------



In preparing the consolidated financial statements in accordance with accounting principles generally accepted in the United States of
America, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the dates of the consolidated balance sheets and revenues and expenses for the years ended December 31, 2002 and 2001.
Actual results could differ from those estimates.



|(2) |  | Restrictions on Cash
|--- |  | --------------------



To comply with Federal Reserve regulations, the Bank is required to maintain certain average reserve balances. The daily average reserve
requirements were approximately $1,033 and $950 for the weeks including December 31, 2002 and 2001, respectively.



31



---



|(3) |  | Securities
|--- |  | ----------



The amortized costs, gross unrealized gains, gross unrealized losses and fair values for securities at December 31, 2002 and 2001 are as
follows:



|                                                                                      |  | 2002           
|------------------------------------------------------------------------------------- |  | ---------------
|                                                                                      |  | Amortized costs
|Available-for-Sale                                                                    |  |                
|U.S. Treasury securities and obligations of U.S. Government corporations and
agencies |  | $              
|Obligations of states and political subdivisions                                      |  |                
|Corporate securities                                                                  |  |                
|Mortgage-backed securities  government                                               |  |                
|Other securities                                                                      |  |                
|                                                                                      |  |                
|Total available-for-sale                                                              |  | $              
|                                                                                      |  |                



|                                                                                      |  | Amortized costs |        | Gross unrealized gains |     | Gross unrealized losses |   | Fair values
|------------------------------------------------------------------------------------- |  | --------------- | ------ | ---------------------- | --- | ----------------------- | - | -----------
|Held-to-Maturity                                                                      |  |                 |        |                        |     |                         |   |            
|U.S. Treasury securities and obligations of U.S. Government corporations and
agencies |  | $               | 56     |                        | 1   |                         |  |            
|Obligations of states and political subdivisions                                      |  |                 | 10,517 |                        | 665 |                         |  |            
|                                                                                      |  |                 |        |                        |     |                         |   |            
|Total held-to-maturity                                                                |  | $               | 10,573 |                        | 666 |                         |  |            
|                                                                                      |  |                 |        |                        |     |                         |   |            



|                                                                                      |  | 2001           
|------------------------------------------------------------------------------------- |  | ---------------
|                                                                                      |  | Amortized costs
|Available-for-Sale                                                                    |  |                
|U.S. Treasury securities and obligations of U.S. Government corporations and
agencies |  | $              
|Obligations of states and political subdivisions                                      |  |                
|Corporate securities                                                                  |  |                
|Mortgage-backed securities  government                                               |  |                
|Other securities                                                                      |  |                
|                                                                                      |  |                
|Total available-for-sale                                                              |  | $              
|                                                                                      |  |                



|                                                                                      |  | 2001           
|------------------------------------------------------------------------------------- |  | ---------------
|                                                                                      |  | Amortized costs
|Held-to-Maturity                                                                      |  |                
|U.S. Treasury securities and obligations of U.S. Government corporations and
agencies |  | $              
|Obligations of states and political subdivisions                                      |  |                
|                                                                                      |  |                
|Total held-to-maturity                                                                |  | $              
|                                                                                      |  |                



32



---



The amortized
costs and fair values of available-for-sale and held-to-maturity securities at December 31, 2002, by contractual maturity, are shown below. Expected maturities may differ from contractual maturities because borrowers may have the right to call or
prepay obligations with or without call or prepayment penalties.



|                                       |  | 2002              
|-------------------------------------- |  | ------------------
|                                       |  | Available-for-Sale
|                                       |  | Amortized costs   
|Due in one year or less                |  | $                 
|Due after one year through five years  |  |                   
|Due after five years through ten years |  |                   
|Due after ten years                    |  |                   
|                                       |  |                   
|                                       |  |                   
|Mortgage-backed securities             |  |                   
|                                       |  |                   
|Totals                                 |  | $                 
|                                       |  |                   



Gross
gains of $2 and $3 were realized in 2002 and 2001, respectively, from sale of available-for-sale securities.



Securities with amortized costs of approximately $2,686 and $2,065 (fair values of $2,844 and $2,105, respectively) as of December 31,
2002 and 2001, respectively, were pledged as collateral for public deposits.



|(4) |  | Loans
|--- |  | -----



A summary of loans at December 31, 2002 and 2001 follows:



|                                                                           |  | 2002 |         |   | 2001 |        
|-------------------------------------------------------------------------- |  | ---- | ------- | - | ---- | -------
|Real estate loans:                                                         |  |      |         |   |      |        
|Residential                                                                |  | $    | 51,134  |   |      | 48,169 
|Other                                                                      |  |      | 18,542  |   |      | 13,273 
|Loans to individuals for household, family and other consumer
expenditures |  |      | 44,948  |   |      | 44,527 
|Commercial and industrial loans                                            |  |      | 11,734  |   |      | 17,614 
|All other loans                                                            |  |      | 5,084   |   |      | 260    
|                                                                           |  |      |         |   |      |        
|Total loans, gross                                                         |  |      | 131,442 |   |      | 123,843
|Less unearned income and fees                                              |  |      | (145    | ) |      | (165   
|                                                                           |  |      |         |   |      |        
|Loans, net of unearned income and fees                                     |  |      | 131,297 |   |      | 123,678
|Less allowance for loan losses                                             |  |      | (1,298  | ) |      | (1,176 
|                                                                           |  |      |         |   |      |        
|Loans, net                                                                 |  | $    | 129,999 |   |      | 122,502
|                                                                           |  |      |         |   |      |        



Nonaccrual loans amounted to approximately $347 and $302 at December 31, 2002 and 2001, respectively. Interest income that would have been earned on nonaccrual loans if they had been current in accordance with their original terms
and the recorded interest that was included in income on these loans was not significant for 2002 and 2001. There were no commitments to lend additional funds to customers whose loans were on nonaccrual status at December 31, 2002.



In the normal course of business, the Bank has made loans to
executive officers and directors. At December 31, 2002, loans to executive officers and directors were approximately $937 compared to $679 at December 31, 2001. During 2002, new loans to executive officers and directors amounted to approximately
$583 and repayments amounted to approximately $325. Loans to companies in which executive officers and directors have an interest amounted to approximately $1,542 and $1,626 at December 31, 2002 and 2001, respectively.



33



---



Activity in
the allowance for loan losses for the years ended December 31, 2002 and 2001 is summarized as follows:



|                              |  | 2002 |       |   | 2001 |      
|----------------------------- |  | ---- | ----- | - | ---- | -----
|Balances at beginning of year |  | $    | 1,176 |   |      | 1,069
|Provision for loan losses     |  |      | 429   |   |      | 380  
|Loans charged off             |  |      | (417  | ) |      | (417 
|Loan recoveries               |  |      | 110   |   |      | 144  
|                              |  |      |       |   |      |      
|Balances at end of year       |  | $    | 1,298 |   |      | 1,176
|                              |  |      |       |   |      |      



At
December 31, 2002 and 2001, the recorded investment in loans for which an impairment has been identified totaled approximately $347 and $302, respectively, with corresponding valuation allowances of approximately $49 and $44, respectively. The
average recorded investment in impaired loans receivable during 2002 and 2001 was approximately $258 and $265, respectively. Interest income recognized on a cash basis on impaired loans during 2002 and 2001 was approximately $17 and $12,
respectively.



|(5) |  | Bank Premises and Equipment
|--- |  | ---------------------------



Bank premises and equipment, net were comprised of the following as of December 31, 2002 and 2001:



|                                  |  | 2002 |        |   | 2001 |       
|--------------------------------- |  | ---- | ------ | - | ---- | ------
|Land improvements                 |  | $    | 376    |   |      | 364   
|Buildings                         |  |      | 3,347  |   |      | 3,339 
|Equipment, furniture and fixtures |  |      | 3,525  |   |      | 3,429 
|                                  |  |      |        |   |      |       
|                                  |  |      | 7,248  |   |      | 7,132 
|Less accumulated depreciation     |  |      | (4,069 | ) |      | (3,669
|                                  |  |      |        |   |      |       
|                                  |  |      | 3,179  |   |      | 3,463 
|Land                              |  |      | 727    |   |      | 727   
|                                  |  |      |        |   |      |       
|Bank premises and equipment, net  |  | $    | 3,906  |   |      | 4,190 
|                                  |  |      |        |   |      |       



Certain
land acquired in connection with the construction of the Companys Airport branch facility will not be used in operations and is currently listed for sale. Accordingly, the propertys carrying value of $329 is included in other assets on
the consolidated balance sheets.



|(6) |  | Deposits
|--- |  | --------



A summary of deposits at December 31, 2002 and 2001 follows:



|                                    |  | 2002 |         | 2001
|----------------------------------- |  | ---- | ------- | ----
|Noninterest-bearing demand deposits |  | $    | 14,468  |     
|Interest-bearing:                   |  |      |         |     
|Savings                             |  |      | 33,236  |     
|NOW accounts                        |  |      | 26,448  |     
|Time deposits  under $100,000      |  |      | 80,332  |     
|Time deposits  $100,000 and over   |  |      | 23,759  |     
|                                    |  |      |         |     
|Total interest-bearing deposits     |  |      | 163,775 |     
|                                    |  |      |         |     
|Total deposits                      |  | $    | 178,243 |     
|                                    |  |      |         |     



At
December 31, 2002, the scheduled maturity of time deposits are as follows: $27,397 in 2003; $42,691 in 2004; $13,835 in 2005; $9,295 in 2006; and $10,873 in 2007.



|(7) |  | Employee Benefit Plans
|--- |  | ----------------------



The Bank maintains a noncontributory defined benefit pension plan which covers substantially all of its employees. Benefits are computed
based on employees average final compensation and years of credited service. Pension expense amounted to approximately $183 and $130 in 2002 and 2001, respectively.



34



---



The change in
benefit obligation, change in plan assets and funded status of the pension plan at September 30, 2002 and 2001 (most recent information available) and pertinent assumptions are as follows:



|                                                            |  | Pension Benefits |      
|----------------------------------------------------------- |  | ---------------- | -----
|                                                            |  | 2002             |      
|Change in Benefit Obligation                                |  |                  |      
|Benefit obligation at beginning of year                     |  | $                | 2,641
|Service cost                                                |  |                  | 164  
|Interest cost                                               |  |                  | 198  
|Actuarial (gain) loss                                       |  |                  | 267  
|Benefits paid                                               |  |                  | (14  
|                                                            |  |                  |      
|Benefit obligation at end of year                           |  |                  | 3,256
|                                                            |  |                  |      
|Change in Plan Assets                                       |  |                  |      
|Fair value of plan assets at beginning of year              |  |                  | 2,190
|Actual return on plan assets                                |  |                  | (162 
|Employer contribution                                       |  |                  | 252  
|Benefit paid                                                |  |                  | (14  
|                                                            |  |                  |      
|Fair value of plan assets at end of year                    |  |                  | 2,266
|                                                            |  |                  |      
|Funded status                                               |  |                  | (990 
|Unrecognized net actuarial loss                             |  |                  | 786  
|Unrecognized prior service cost                             |  |                  | 71   
|                                                            |  |                  |      
|Accrued pension benefit cost, included in other liabilities |  | $                | (133 
|                                                            |  |                  |      
|                                                           
|                                                            |  | Pension Benefits |      
|                                                            |  | 2002             |      
|Weighted Average Assumptions as of December 31:             |  |                  |      
|Weighted average discount rate                              |  |                  | 6.75 
|Expected return on plan assets                              |  |                  | 9.00 
|Rate of compensation increase                               |  |                  | 5.00 



The
components of net pension benefit cost under the plan for the years ended December 31, 2002 and 2001 is summarized as follows:



|                               |  | Pension Benefits |     
|------------------------------ |  | ---------------- | ----
|                               |  | 2002             |     
|Service cost                   |  | $                | 164 
|Interest cost                  |  |                  | 198 
|Expected return on plan assets |  |                  | (188
|Net amortization               |  |                  | 9   
|Recognized net actuarial gain  |  |                  |    
|                               |  |                  |     
|Net pension benefit cost       |  | $                | 183 
|                               |  |                  |     



Plan
assets consisted of cash equivalents, U.S. Government securities, mortgage-backed securities, corporate bonds and equities securities in a pooled pension fund administered by the Virginia Bankers Association.



The Company also has a 401(k) plan for which the Company does
not currently match employee contributions to the plan.



35



---



|(8) |  | Income Taxes
|--- |  | ------------



Total income taxes for the years ended December 31, 2002 and 2001 are allocated as follows:



|                                                                                                                           |  | 2002 |       | 2001
|-------------------------------------------------------------------------------------------------------------------------- |  | ---- | ----- | ----
|Income                                                                                                                     |  | $    | 723   |     
|Stockholders equity for net unrealized gains on available-for-sale securities
recognized for financial reporting purposes |  |      | 304   |     
|                                                                                                                           |  |      |       |     
|Total income taxes                                                                                                         |  | $    | 1,027 |     
|                                                                                                                           |  |      |       |     



Income
tax expense (benefit) attributable to income before income tax expense for the years ended December 31, 2002 and 2001 is summarized as follows:



|                         |  | 2002 |     |   | 2001 |    
|------------------------ |  | ---- | --- | - | ---- | ---
|Current                  |  | $    | 734 |   |      | 509
|Deferred                 |  |      | (11 | ) |      | (21
|                         |  |      |     |   |      |    
|Total income tax expense |  | $    | 723 |   |      | 488
|                         |  |      |     |   |      |    



Included in income tax expense were tax expenses of approximately $1 for each of the years ended December 31, 2002 and 2001, related to net realized gains on securities.



Reported income tax expense for the years ended December 31, 2002 and 2001 differed from the amounts computed
by applying the U.S. Federal income tax rate of 34% to income before income tax expense as a result of the following:



|                                                           |  | 2002 |      |   | 2001 |     
|---------------------------------------------------------- |  | ---- | ---- | - | ---- | ----
|Computed expected income tax expense                     |  | $    | 887  |   |      | 663 
|Increase (reduction) in income tax expense resulting from: |  |      |      |   |      |     
|Tax-exempt interest                                        |  |      | (189 | ) |      | (213
|Disallowance of interest expense                           |  |      | 20   |   |      | 34  
|Other, net                                                 |  |      | 5    |   |      | 4   
|                                                           |  |      |      |   |      |     
|Reported income tax expense                                |  | $    | 723  |   |      | 488 
|                                                           |  |      |      |   |      |     



The tax
effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities at December 31, 2002 and 2001 are as follows



|                                                                                                           |  | 2002 |      |   | 2001 |     
|---------------------------------------------------------------------------------------------------------- |  | ---- | ---- | - | ---- | ----
|Deferred tax assets:                                                                                       |  |      |      |   |      |     
|Loans, principally due to allowance for loan losses                                                        |  | $    | 332  |   |      | 304 
|Accrued pension, due to accrual for financial reporting purposes in excess of actual
pension contributions |  |      | 131  |   |      | 138 
|Loans, due to unearned fees, net                                                                           |  |      | 55   |   |      | 58  
|Other                                                                                                      |  |      | 52   |   |      | 57  
|                                                                                                           |  |      |      |   |      |     
|Total gross deferred tax assets                                                                            |  |      | 570  |   |      | 557 
|                                                                                                           |  |      |      |   |      |     
|Deferred tax liabilities:                                                                                  |  |      |      |   |      |     
|Bank premises and equipment, due to differences in depreciation                                            |  |      | (97  | ) |      | (100
|Net unrealized gains on available-for-sale securities                                                      |  |      | (430 | ) |      | (126
|Other                                                                                                      |  |      | (5   | ) |      |    
|                                                                                                           |  |      |      |   |      |     
|Total gross deferred tax liabilities                                                                       |  |      | (532 | ) |      | (226
|                                                                                                           |  |      |      |   |      |     
|Net deferred tax asset, included in other assets                                                           |  | $    | 38   |   |      | 331 
|                                                                                                           |  |      |      |   |      |     



36



---



The Bank has
determined that a valuation allowance for the gross deferred tax assets is not necessary at December 31, 2002 and 2001, since realization of the entire gross deferred tax assets can be supported by the amounts of taxes paid during the carryback
periods available under current tax laws.



|(9) |  | Financial Instruments with Off-Balance-Sheet Risk
|--- |  | -------------------------------------------------



The Bank is a 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 commitments to extend credit and standby letters of credit. These instruments may involve, to varying degrees, credit risk in excess of the amount recognized in the balance sheets. The contract
amounts of these instruments reflect the extent of involvement the Bank has in particular classes of financial instruments.



Credit risk is defined as the possibility of sustaining a loss because the other parties to a financial instrument fail to perform in
accordance with the terms of the contract. The Banks maximum exposure to credit loss under commitments to extend credit and standby letters of credit is represented by the contractual amount of these instruments. The Bank uses the same credit
policies in making commitments and conditional obligations as it does for on-balance-sheet instruments.



The Bank requires collateral to support financial instruments when it is deemed necessary. The Bank evaluates such customers
creditworthiness on a case-by-case basis. The amount of collateral obtained upon extension of credit is based on managements credit evaluation of the counterparty. Collateral may include deposits held in financial institutions, U.S. Treasury
securities, other marketable securities, real estate, accounts receivable, inventory, and property, plant and equipment.



Financial instruments whose contract amounts represent credit risk:



|                             |  | Contract amounts at December 31,
|---------------------------- |  | --------------------------------
|                             |  | 2002                            
|Commitments to extend credit |  | $                               
|                             |  |                                 
|Standby letters of credit    |  | $                               
|                             |  |                                 



Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may
require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements.



Standby letters of credit are conditional commitments issued
by the Bank to guarantee the performance of a customer to a third party. These guarantees are primarily issued to support public and private borrowing arrangements, including bond financing and similar transactions. Unless renewed, substantially all
of the Banks credit commitments at December 31, 2002 will expire within one year. Management does not anticipate any material losses as a result of these transactions. The credit risk involved in issuing letters of credit is essentially the
same as that involved in extending loans to customers.



|(10) |  | Concentrations of Credit Risk
|---- |  | -----------------------------



The Bank grants commercial, residential, consumer and agribusiness loans to customers primarily in the central Virginia area. The Bank has
a diversified loan portfolio which is not dependent upon any particular economic sector. As a whole, the portfolio could be affected by general economic conditions in the central Virginia region.



The Banks commercial loan portfolio is diversified,
with no significant concentrations of credit. The real estate loan portfolio consists principally of 1-4 family residential property. The installment loan portfolio consists of consumer loans primarily for automobiles and other personal property.
Overall, the Banks loan portfolio is not concentrated within a single industry or group of industries, the loss of any one or more of which would generate a materially adverse impact on the business of the Bank.



37



---



The Bank has
established operating policies relating to the credit process and collateral in loan originations. Loans to purchase real and personal property are generally collateralized by the related property. Credit approval is principally a function of
collateral and the evaluation of the creditworthiness of the borrower based on available financial information.



|(11) |  | Dividend Restrictions and Capital Requirements
|---- |  | ----------------------------------------------



Bankshares principal source of funds for dividend payments is dividends received from its subsidiary Bank. For the years ended
December 31, 2002 and 2001, dividends from the subsidiary Bank totaled $580 and $535, respectively.



Substantially all of Bankshares retained earnings consists of undistributed earnings of its subsidiary Bank, which are restricted by
various regulations administered by federal banking regulatory agencies. Under applicable federal laws, the Comptroller of the Currency restricts, without prior approval, the total dividend payments of the Bank in any calendar year to the net
profits of that year, as defined, combined with the retained net profits for the two preceding years. At December 31, 2002, retained net profits of the Bank which were free of such restriction approximated $2,306.



Bankshares 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 Bankshares consolidated financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, Bankshares and the Bank must meet specific capital guidelines that involve
quantitative measures of their assets, liabilities and certain off-balance-sheet items as calculated under regulatory accounting practices. Bankshares and the Banks capital amounts and classification are also subject to qualitative judgments
by the regulators about components, risk weightings and other factors.



Quantitative measures established by regulation to ensure capital adequacy require Bankshares and the Bank to maintain minimum amounts and ratios (set forth in the table below) of total and Tier I capital (as defined in the
regulations) to risk-weighted assets (as defined), and of Tier I capital (as defined) to average assets (as defined). Management believes, as of December 31, 2002, that Bankshares and the Bank meets all capital adequacy requirements to which it is
subject.



As of December 31, 2002, the most
recent notification from Office of the Comptroller of the Currency categorized Bankshares and the Bank as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized,
Bankshares and the Bank must maintain minimum total risk-based, Tier I risk-based and Tier I leverage ratios as set forth in the table below. There are no conditions or events since that notification that management believes have changed Bankshares
and the Banks category.



Bankshares and
the Banks actual capital amounts and ratios are presented in the table below.



|                                               |  | Actual |        |       | For Capital Adequacy Purposes |   |        | To Be Well Capitalized Under Prompt
Corrective Action Provisions |       
|---------------------------------------------- |  | ------ | ------ | ----- | ----------------------------- | - | ------ | ------------------------------------------------------------------ | ------
|                                               |  | Amount |        | Ratio |                               |   | Amount |                                                                    | Ratio 
|As of December 31, 2002:                       |  |        |        |       |                               |   |        |                                                                    |       
|Total Capital (to Risk Weighted Assets):       |  |        |        |       |                               |   |        |                                                                    |       
|Bankshares consolidated                        |  | $      | 20,372 |       | 13.21                         | % |        | $                                                                  | 12,269
|Bank                                           |  |        | 20,175 |       | 13.16                         | % |        |                                                                    | 12,265
|Tier I Capital (to Risk Weighted Assets):      |  |        |        |       |                               |   |        |                                                                    |       
|Bankshares consolidated                        |  |        | 18,968 |       | 12.37                         | % |        |                                                                    | 6,135 
|Bank                                           |  |        | 18,877 |       | 12.31                         | % |        |                                                                    | 6,133 
|Tier I Capital (Leverage) (to Average Assets): |  |        |        |       |                               |   |        |                                                                    |       
|Bankshares consolidated                        |  |        | 18,968 |       | 9.44                          | % |        |                                                                    | 8,035 
|Bank                                           |  |        | 18,877 |       | 9.40                          | % |        |                                                                    | 8,035 



38



---



|                           |  |        |        |       |                   |   |             |                   |        |                   |     | To Be Well        | 
|-------------------------- |  | ------ | ------ | ----- | ----------------- | - | ----------- | ----------------- | ------ | ----------------- | --- | ------------------ | 
|                           |  |        |        |       |                   |   |             |                   |        |                   |     | Capitalized Under | 
|                           |  |        |        |       |                   |   | For Capital |                   |        | Prompt Corrective |    
|                           |  | Actual |        |       | Adequacy Purposes |   |             | Action Provisions |       
|                           |  | Amount |        | Ratio |                   |   | Amount      |                   | Ratio  |                   |     | Amount             | 
|As of December 31, 2001:   |  |        |        |       |                   |   |             |                   |        |                   |     |                    | 
|Total Capital              |  |        |        |       |                   |   |             |                   |        |                   |     |                    | 
|(to Risk Weighted Assets): |  |        |        |       |                   |   |             |                   |        |                   |     |                    | 
|Bankshares consolidated    |  | $      | 18,460 |       | 13.10             | % |             | $                 | 11,486 |                   | 8.0 | %                  | 
|Bank                       |  |        | 18,695 |       | 13.03             | % |             |                   | 11,478 |                   | 8.0 | %                  | 
|Tier I Capital             |  |        |        |       |                   |   |             |                   |        |                   |     |                    | 
|(to Risk Weighted Assets): |  |        |        |       |                   |   |             |                   |        |                   |     |                    | 
|Bankshares consolidated    |  |        | 17,632 |       | 12.28             | % |             |                   | 5,743  |                   | 4.0 | %                  | 
|Bank                       |  |        | 17,519 |       | 12.21             | % |             |                   | 5,739  |                   | 4.0 | %                  | 
|Tier I Capital (Leverage)  |  |        |        |       |                   |   |             |                   |        |                   |     |                    | 
|(to Average Assets):       |  |        |        |       |                   |   |             |                   |        |                   |     |                    | 
|Bankshares consolidated    |  |        | 17,632 |       | 8.92              | % |             |                   | 7,909  |                   | 4.0 | %                  | 
|Bank                       |  |        | 17,519 |       | 8.86              | % |             |                   | 7,909  |                   | 4.0 | %                  | 



|(12) |  | Disclosures About Fair Value of Financial Instruments
|---- |  | -----------------------------------------------------



SFAS No. 107, Disclosures about Fair Value of Financial Instruments, requires the Company to disclose estimated fair values of its
financial instruments.



The following methods
and assumptions were used to estimate the approximate fair value of each class of financial instrument for which it is practicable to estimate that value.



| | (a) |  | Cash and Due from Banks and Federal Funds Sold
| | --- |  | ----------------------------------------------



The carrying amounts are a reasonable estimate of fair value.



| | (b) |  | Securities
| | --- |  | ----------



The fair value of securities, except state and municipal securities, is estimated based on bid prices published in financial newspapers or
bid quotations received from securities dealers. The fair value of certain state and municipal securities is not readily available through market sources other than dealer quotations, so fair value estimates are based on quoted market prices of
similar instruments, adjusted for differences between the quoted instruments and the instruments being valued.



| | (c) |  | Loans
| | --- |  | -----



Fair values are estimated for portfolios of loans with similar financial characteristics. Loans are segregated by type such as commercial,
real estate  residential, real estate  other, loans to individuals and other loans. Each loan category is further segmented into fixed and adjustable rate interest terms.



The fair value of loans is calculated by discounting scheduled cash flows through the estimated maturity
using estimated market discount rates that reflect the credit and interest rate risk inherent in the loan as well as estimates for prepayments. The estimate of maturity is based on the Companys historical experience with repayments for each
loan classification, modified, as required, by an estimate of the effect of current economic and lending conditions.



| | (d) |  | Deposits and Note Payable to Federal Home Loan Bank
| | --- |  | ---------------------------------------------------



The fair value of demand deposits, NOW accounts, and savings deposits is the amount payable on demand. The
fair value of fixed maturity time deposits, certificates of deposit and the note payable to the Federal Home Loan Bank is estimated using the rates currently offered for deposits or borrowings of similar remaining maturities.



| | (e) |  | Commitments to Extend Credit and Standby Letters of Credit
| | --- |  | ----------------------------------------------------------



The only amounts recorded for commitments to extend credit and standby letters of credit are the deferred
fees arising from these unrecognized financial instruments. These deferred fees are not deemed significant at December 31, 2002 and 2001, and as such, the related fair values have not been estimated.



39



---



The carrying
amounts and approximate fair values of the Companys financial instruments are as follows at December 31, 2002 and 2001:



|                                       |  | 2002     |         | 2001       
|-------------------------------------- |  | -------- | ------- | -----------
|                                       |  | Carrying |         | Approximate
|                                       |  | amounts  |         | fair values
|Financial assets:                      |  |          |         |            
|Cash and due from banks                |  | $        | 4,516   |            
|Federal funds sold                     |  |          | 15,447  |            
|Securities:                            |  |          |         |            
|Available-for-sale                     |  |          | 32,158  |            
|Held-to-maturity                       |  |          | 10,573  |            
|Federal Reserve Bank Stock             |  |          | 75      |            
|Federal Home Loan Bank Stock           |  |          | 565     |            
|Loans, net of unearned income and fees |  |          | 131,297 |            
|                                       |  |          |         |            
|Total financial assets                 |  | $        | 194,631 |            
|                                       |  |          |         |            
|Financial liabilities:                 |  |          |         |            
|Deposits                               |  | $        | 178,243 |            
|Note payable to Federal Home Loan Bank |  |          | 500     |            
|                                       |  |          |         |            
|Total financial liabilities            |  | $        | 178,743 |            
|                                       |  |          |         |            



Fair
value estimates are made at a specific point in time, based on relevant market information and information about the financial instrument. These estimates do not reflect any premium or discount that could result from offering for sale at one time
the Companys entire holdings of a particular financial instrument. Because no market exists for a significant portion of the Companys financial instruments, fair value estimates are based on judgments regarding future expected loss
experience, current economic conditions, risk characteristics of various financial instruments and other factors. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and therefore cannot be
determined with precision. Changes in assumptions could significantly affect the estimates.



Fair value estimates are based on existing on and off-balance sheet financial instruments without attempting to estimate the value of anticipated future business and the value of assets and liabilities
that are not considered financial instruments. Significant assets that are not considered financial assets include deferred tax assets and premises and equipment and other real estate owned. In addition, the tax ramifications related to the
realization of the unrealized gains and losses can have a significant effect on fair value estimates and have not been considered in the estimates.



|(13) |  | Parent Company Financial Information
|---- |  | ------------------------------------



Condensed financial information of Bankshares (Parent) is presented below:



Condensed Balance Sheets

|                                    |  | December 31,
|----------------------------------- |  | ------------
|                                    |  | 2002        
|Assets                              |  |             
|Cash due from subsidiary            |  | $           
|Investment in subsidiary, at equity |  |             
|Other assets                        |  |             
|                                    |  |             
|Total assets                        |  | $           
|                                    |  |             



40



---



Condensed
Balance Sheets, Continued



|                                                                                                                                        |  | December 31,
|--------------------------------------------------------------------------------------------------------------------------------------- |  | ------------
|                                                                                                                                        |  | 2002        
|Liabilities and Stockholders Equity                                                                                                    |  |             
|Other liabilities                                                                                                                       |  | $           
|                                                                                                                                        |  |             
|Stockholders equity (notes 11 and 14):                                                                                                 |  |             
|Common stock of $3 par value. Authorized 3,000,000 shares; issued and outstanding
1,453,203 shares in 2002 and 1,450,966 shares in 2001 |  |             
|Capital surplus                                                                                                                         |  |             
|Retained earnings                                                                                                                       |  |             
|Accumulated other comprehensive income, net                                                                                             |  |             
|                                                                                                                                        |  |             
|Total stockholders equity                                                                                                              |  |             
|Commitments, contingencies and other matters (notes 9, 10 and 11)                                                                       |  |             
|                                                                                                                                        |  |             
|Total liabilities and stockholders equity                                                                                              |  | $           
|                                                                                                                                        |  |             



Condensed Statements of Income



|                                                                                      |  | Years ended December 31,
|------------------------------------------------------------------------------------- |  | ------------------------
|                                                                                      |  | 2002                    
|Income:                                                                               |  |                         
|Dividends from subsidiary (note 11)                                                   |  | $                       
|Expenses:                                                                             |  |                         
|Other expenses                                                                        |  |                         
|                                                                                      |  |                         
|Income before income tax benefit and equity in undistributed net income of
subsidiary |  |                         
|Applicable income tax benefit                                                         |  |                         
|                                                                                      |  |                         
|Income before equity in undistributed net income of subsidiary                        |  |                         
|Equity in undistributed net income of subsidiary                                      |  |                         
|                                                                                      |  |                         
|Net income                                                                            |  | $                       
|                                                                                      |  |                         



Condensed Statements of Cash Flows



|                                                                                  |  | Years ended December 31, |       
|--------------------------------------------------------------------------------- |  | ------------------------ | ------
|                                                                                  |  | 2002                     |       
|Cash flows from operating activities:                                             |  |                          |       
|Net income                                                                        |  | $                        | 1,886 
|Adjustments to reconcile net income to net cash provided by operating
activities: |  |                          |       
|Equity in undistributed net income of subsidiary                                  |  |                          | (1,342
|Increase in other assets                                                          |  |                          | (20   
|Increase in other liabilities                                                     |  |                          |      
|                                                                                  |  |                          |       
|Net cash provided by operating activities                                         |  |                          | 524   
|                                                                                  |  |                          |       
|Cash flows from financing activities:                                             |  |                          |       
|Proceeds from issuance of common stock                                            |  |                          | 31    
|Cash dividends paid                                                               |  |                          | (596  
|                                                                                  |  |                          |       
|Net cash used in financing activities                                             |  |                          | (565  
|                                                                                  |  |                          |       
|Net decrease in cash due from subsidiary                                          |  |                          | (41   
|Cash due from subsidiary, beginning of year                                       |  |                          | 49    
|                                                                                  |  |                          |       
|Cash due from subsidiary, end of year                                             |  | $                        | 8     
|                                                                                  |  |                          |       



41



---



|(14) |  | Stock Options
|---- |  | -------------



The Company has an Incentive Stock Option Plan (the Plan) instituted on the effective date of May 1, 1997, pursuant to which the
Companys Board of Directors may grant stock options to officers and key employees. The Plan authorizes grants of options to purchase up to 50,000 shares of the Companys authorized, but unissued common stock. Accordingly, 50,000 shares of
authorized, but unissued common stock are reserved for use in the Plan. All stock options are granted with an exercise price equal to the stocks fair market value at the date of grant. At December 31, 2002, there were 5,000 additional shares
available for grant under the Plan.



Stock
options generally have 10-year terms, vest at the rate of 20% per year, and become fully exercisable five years from the date of grant.



During 2002, options for 8,500 shares were granted to employees with an exercise price of $14.75 per share. During 2001, options for
11,500 shares were granted to employees with an exercise price of $14 per share. The per share weighted average fair value of stock options granted during 2002 and 2001 was $2.57 and $3.60, respectively, on the date of grant utilizing the
Black-Scholes option-pricing model with the following weighted-average assumptions:



|                                   |  | Granted in 2002 |   |  | Granted in 2001 |  
|---------------------------------- |  | --------------- | - |  | --------------- | -
|Expected dividend yield            |  | 4               | % |  | 4               | %
|Risk-free interest rate            |  | 4.12            | % |  | 5.0             | %
|Expected life of options           |  | 10 years        |   |  | 9.5 years       |  
|Expected volatility of stock price |  | 25              | % |  | 29              | %



Stock
option activity during the years ended December 31, 2002 and 2001 is as follows:



|                             |  | Number of shares |  | Weighted average exercise price
|---------------------------- |  | ---------------- |  | -------------------------------
|                             | 
|                             | 
|Balance at December 31, 2000 |  | 25,000           |  | $                              
|Expired/forfeited/exercised  |  |                 |  |                                
|Granted                      |  | 11,500           |  | $                              
|                             |  |                  |  |                                
|Balance at December 31, 2001 |  | 36,500           |  | $                              
|Expired/forfeited/exercised  |  |                 |  |                                
|Granted                      |  | 8,500            |  | $                              
|                             |  |                  |  |                                
|Balance at December 31, 2002 |  | 45,000           |  | $                              
|                             |  |                  |  |                                



At
December 31, 2002, options for 25,000 shares were exercisable at an exercise price of $10.00 per share and options for 2,300 shares were exercisable at an exercise price of $14.00 per share.



|(15) |  | Reclassified Goodwill and Other Intangible Assets
|---- |  | -------------------------------------------------



Amortization expense related to reclassified goodwill and other intangible assets was $51 in 2001. The following table reconciles
previously reported net income as if the provisions of SFAS No. 142 were in effect for the year ended December 31, 2001:



|Reported net income                         |  | $ | 1,463 |  
|------------------------------------------- |  | - | ----- | -
|Add back reclassified goodwill amortization |  |   | 40    |  
|Deduct related income tax effects           |  |   | (14   | )
|                                            |  |   |       |  
|Adjusted net income                         |  | $ | 1,489 |  
|                                            |  |   |       |  



Included in other assets is reclassified goodwill of $539 as of December 31, 2002 and 2001, and other amortizing intangible assets of $35 and $46 as of December 31, 2002 and 2001, respectively. There was no change in the carrying
amount of reclassified goodwill of $539 for the year ended December 31, 2002.





42



---



|(16) |  | Quarterly Results of Operations (Unaudited)
|---- |  | -------------------------------------------



As discussed in note 1(i), the Company has retroactively restated its operating results for the first three quarters of 2002 to reverse
amortization expense related to reclassified goodwill back to the beginning of 2002, in accordance with SFAS No. 147. The following is a summary of the unaudited quarterly results of operations for the years ended December 31, 2002 (as restated) and
2001:



|                             |  | 2002         
|---------------------------- |  | -------------
|                             |  | First quarter
|                             |  |              
|Income statement data:       |  |              
|Interest income              |  | $            
|Interest expense             |  |              
|                             |  |              
|Net interest income          |  |              
|Provision for loan losses    |  |              
|Noninterest income           |  |              
|Noninterest expense          |  |              
|Income tax expense           |  |              
|                             |  |              
|Net income                   |  | $            
|                             |  |              
|Per share data:              |  |              
|Basic net income per share   |  | $            
|Diluted net income per share |  |              
|Cash dividends per share     |  |              
|Book value per share         |  |              



|                             |  | 2001         
|---------------------------- |  | -------------
|                             |  | First quarter
|                             |  |              
|Income statement data:       |  |              
|Interest income              |  | $            
|Interest expense             |  |              
|                             |  |              
|Net interest income          |  |              
|Provision for loan losses    |  |              
|Noninterest income           |  |              
|Noninterest expense          |  |              
|Income tax expense           |  |              
|                             |  |              
|Net income                   |  | $            
|                             |  |              
|Per share data:              |  |              
|Basic net income per share   |  | $            
|Diluted net income per share |  |              
|Cash dividends per share     |  |              
|Book value per share         |  |              



43



---



Independent
Auditors Report



The
Board of Directors and Stockholders

Pinnacle Bankshares Corporation:



We have audited the accompanying consolidated balance sheets of Pinnacle
Bankshares Corporation and subsidiary as of December 31, 2002 and 2001, and the related consolidated statements of income, changes in stockholders equity and comprehensive income, and cash flows for the years then ended. These consolidated
financial statements are the responsibility of the Companys management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.



We conducted our audits in accordance with auditing standards generally accepted in the United States 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 audits
provide a reasonable basis for our opinion.



In our opinion, the
consolidated financial statements referred to above present fairly, in all material respects, the financial position of Pinnacle Bankshares Corporation and subsidiary as of December 31, 2002 and 2001, and the 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.



As discussed in note 1(i) to the consolidated financial statements, the Company changed its method of accounting for reclassified goodwill in 2002.





/s/ KPMG LLP

Roanoke, Virginia

January 31, 2003



44



---



PINNACLE
BANKSHARES CORPORATION

AND SUBSIDIARY



Shareholder Information



Annual Meeting



The 2003 Annual Meeting of Shareholders will be held on April 8, 2003, at 11:30 a.m. at the Fellowship Hall of Altavista Presbyterian Church, located at
707 Broad Street, Altavista, Virginia.



Market for Common
Equity and Related Stockholder Matters



The
Companys Common Stock is quoted on the OTC Bulletin Board. The following table below presents the high and low bid prices per share of the Common Stock and dividend information of the Company for the quarters presented. The high and low bid
prices of the Common Stock do not include retail markups, markdowns or commissions and may not represent actual transactions.



|               |  | 2002 |       | 2001
|-------------- |  | ---- | ----- | ----
|               |  | High |       | Low 
|First Quarter  |  | $    | 14.25 |     
|Second Quarter |  | $    | 15.20 |     
|Third Quarter  |  | $    | 15.00 |     
|Fourth Quarter |  | $    | 16.00 |     



Each share of Common
Stock is entitled to participate equally in dividends, which are payable as and when determined by the Board of Directors after consideration of the earnings, general economic conditions, the financial condition of the business and other factors as
might be appropriate. The Companys ability to pay dividends is dependent upon its receipt of dividends from its subsidiary. National banks may use only capital surplus that represents retained earnings, not paid-in capital, when calculating
permissible dividends.



As of December 31, 2002, there were
approximately 408 Shareholders of record of the Common Stock.



Requests for Information



Requests
for information about the Company should be directed to Bryan M. Lemley, Secretary, Treasurer and Chief Financial Officer, P.O. Box 29, Altavista, Virginia 24517, telephone (434) 369-3000. A copy of the Companys Annual Report on Form 10-KSB
for the year ended December 31, 2002, will be furnished without charge to shareholders upon request after March 31, 2003.



Shareholders seeking information regarding lost certificates and dividends should contact Registrar and Transfer Company in Cranford, New Jersey,
telephone (800) 368-5948. Please submit address changes in writing to:



Registrar and Transfer Company

Investor Relations Department

10 Commerce Drive

Cranford, New Jersey 07016-9982



45



---

[LOGO OF PINNACLE BANKSHARES CORPORATION]

622 Broad Street Post Office Box 29
Altavista, Virginia 24517

(434) 369-3000