**SECURITIES
AND EXCHANGE COMMISSION**
 **Washington,
D.C. 20549**
 
 **FORM
10-K**
 
 
 **|** **X** **|
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)**
 **OF
THE SECURITIES EXCHANGE ACT OF 1934**
 **For
the fiscal year ended December 31, 2004**
 
 |_|
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
 OF THE
SECURITIES EXCHANGE ACT OF 1934
 For the
transition period from ______ to ______
   
 
 **Commission
      File No. 0-24532**
    ******FLAG
      FINANCIAL CORPORATION***(Exact
      name of Registrant as specified in its charter)***Georgia**
    
    
    
    **58-2094179***(State
      or other jurisdiction**of
      incorporation or organization)*
    
    
    *(I.R.S.
      Employer Identification No.)***3475
      Piedmont Road, N.E., Suite 550, Atlanta, Georgia
      30305***(Address
      of principal executive offices)***(404)
      760-7700***(Registrant’s
      telephone number)*
 
 Securities
registered pursuant to Section 12(b) of the Act: None
 Securities
registered pursuant to Section 12(g) of the Act: **Common
Stock, $1.00 par value**
 _______________
 
 Indicate
by check mark whether the Registrant (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months and (2) has been subject to such filing requirements for the
past 90 days. Yes x No o
 
 Indicate
by check mark if disclosure of delinquent filers pursuant to Item 405 of
Regulation S-K is not contained herein, and will not be contained, to the best
of the Registrant’s knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. x
 
 Indicate
by check mark whether the registrant is an accelerated filer (as defined in
Exchange Act Rule 12b-2): Yes x No o
 
 The
aggregate market value of the Registrant’s outstanding Common Stock held by
non-affiliates of the Registrant on December 31, 2004, computed by reference to
the closing price of the Common Stock on June 30, 2004, was approximately
$93,080,541.  There
were 8,519,261 shares of Common Stock outstanding as of February 8,
2005 .
 
 DOCUMENTS
INCORPORATED BY REFERENCE
 
 Portions
of the Registrant’s Proxy Statement for the Annual Meeting of Shareholders to be
held on May 17, 2005, are incorporated by reference in Part III
hereof.
 
 
 **FLAG
FINANCIAL CORPORATION**
 **Annual
Report on Form 10-K**
 **For
the Fiscal Year Ended December 31, 2004**
 
 Table of
Contents
 
  Item
    
    
    PageNumber
    
    
    NumberPART
      IITEM 1.
    BUSINESS
    1ITEM 2.
    PROPERTIES
    10ITEM 3.
    LEGAL PROCEEDINGS
    10ITEM 4.
    SUBMISSION OF MATTERS TO A VOTE OF SECURITY
      HOLDERS
    10PART
      IIITEM 5.
    MARKET FOR REGISTRANT’S COMMON EQUITY AND
      RELATEDSHAREHOLDER MATTERS
    11ITEM 6.
    SELECTED FINANCIAL DATA
    12ITEM 7.
    MANAGEMENT’S DISCUSSION AND ANALYSIS OF
      FINANCIALCONDITION AND RESULTS OF OPERATIONS
    13ITEM 7A.
    QUANTITATIVE AND QUALITATIVE DISCLOSURES
      ABOUTMARKET RISK
    29ITEM 8.
    FINANCIAL STATEMENTS AND SUPPLEMENTARY
    DATA
    30ITEM 9.
    CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS
      ONACCOUNTING AND FINANCIAL DISCLOSURE
    66ITEM 9A.
    CONTROLS AND PROCEDURES
    66ITEM 9B.
    OTHER INFORMATION
    66PART
      IIIITEM 10.
    DIRECTORS AND EXECUTIVE OFFICERS OF THE
      REGISTRANT
    67ITEM 11.
    EXECUTIVE COMPENSATION
    67ITEM 12.
    SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS ANDMANAGEMENT AND RELATED SHAREHOLDER
    MATTERS
    68ITEM 13.
    CERTAIN RELATIONSHIPS AND RELATED
      TRANSACTIONS
    68ITEM 14.
    PRINCIPAL ACCOUNTANT FEES AND SERVICES
    68PART
      IVITEM 15.
    EXHIBITS AND FINANCIAL STATEMENT
      SCHEDULES
    68SIGNATURES
    
    72EXHIBIT INDEX
    
    75


**SPECIAL
CAUTIONARY NOTICE REGARDING FORWARD-LOOKING STATEMENTS**





Certain
of the matters discussed in this document and in documents incorporated by
reference herein, including matters discussed under the caption “Management’s
Discussion and Analysis of Financial Condition and Results of Operations,” may
constitute forward-looking statements for purposes of the Securities Act of
1933, as amended, and the Securities Exchange Act of 1934, as amended. These
forward-looking statements may involve known and unknown risks, uncertainties
and other factors which may cause the actual results, performance or
achievements of the Company to be materially different from future results,
performance or achievements expressed or implied by the forward-looking
statements. The words “expect,” “anticipate,” “intend,” “plan,” “believe,”
“seek,” “estimate,” and similar expressions are intended to identify the
forward-looking statements. The Company’s actual results may differ materially
from the results anticipated in these forward-looking statements due to a
variety of factors, including, without limitation:





(1)
    The
      effects of future economic conditions;(2)
    Governmental
      monetary and fiscal policies, as well as legislative and regulatory
      changes;(3)
    The
      risks of unexpected changes in interest rates on the level and composition
      of deposits, loan demand, and the values of loan collateral, securities
      and interest rate protection agreements, as well as interest rate
      risks;(4)
    The
      effects of competition from other financial institutions and companies in
      the financial services industry;(5)
    The
      failure of assumptions underlying the establishment of reserves for
      possible loan losses and estimations of values of collateral and various
      financial assets and liabilities; and(6)
    Potential
      difficulties in integrating acquired
businesses.


All written
or oral forward-looking statements attributable to the Company are expressly
qualified in their entirety by these cautionary statements.
 ****
 **PART
I**
 **ITEM
1.****BUSINESS**
 
 **The
Company**
 
 Flag
Financial Corporation (“Flag” or the “Company”) is a bank holding company
headquartered in Atlanta, Georgia and is registered under the Bank Holding
Company Act of 1956, as amended. The Company is the sole shareholder of Flag
Bank (the “Bank”) and was incorporated under the laws of the State of Georgia on
February 9, 1993.
 
 As a bank
holding company, the Company facilitates the Bank’s abilities to serve its
customers’ requirements for financial services. The holding company structure
provides greater financial and operating flexibility than is available to the
Bank. For example, the Company may assist the Bank in maintaining its required
capital ratios by borrowing money and contributing the proceeds of the debt to
the Bank as primary capital. Additionally, the Articles of Incorporation and
Bylaws of the Company contain terms that provide a degree of anti-takeover
protection to the Company that is currently unavailable to the Bank and its
shareholders under regulations of the Federal Deposit Insurance Corporation (the
“FDIC”), but is permissible for the Company under Georgia law.
 
 Flag
provides several services through divisions of Flag Bank including mortgage
services through Flag Mortgage, investment and insurance services through Flag
Financial Services and payroll processing through Payroll
Solutions.
 
 Flag’s
web site address
is www.flagbank.com .
You may
obtain free electronic copies of our annual reports on Form 10-K, quarterly
reports on Form 10-Q, current reports on Form 8-K and all amendments
to those reports at the investor relations section of our web site. These
reports are available on our web site as soon as reasonably practicable after we
electronically file them with the SEC.
 
 **The
Bank**
 
 Flag Bank
is a state bank organized under the laws of the State of Georgia with banking
offices in the following cities and counties: Atlanta (Fulton County, DeKalb
County and Cobb County), Unadilla (Dooly County), Vienna (Dooly County),
Montezuma (Macon County), Buena Vista (Marion County), LaGrange (Troup County),
Hogansville (Troup County), Jonesboro (Clayton County) and Suwanee (Forsyth
County), Georgia. Flag Bank was originally chartered in 1931 as Citizens Bank
and became a wholly-owned subsidiary of the Company through a series of
acquisitions commencing in 1998.
 
 Flag
Mortgage operates as a division of Flag Bank and operates mortgage loan
production offices in Atlanta (Fulton County), LaGrange (Troup County), Columbus
(Muscogee County), Macon (Bibb County), Newnan (Coweta County), and Warner
Robins (Houston County) Georgia.
 
 Payroll
Solutions operates as a division of Flag Bank and operates a payroll, human
resources and benefits services office in Macon (Bibb County),
Georgia.
 
 ***Business
of the Bank*** *.* The
Bank’s business consists primarily of attracting deposits from the general
public and, with these and other funds, making residential mortgage loans,
consumer loans, commercial loans, commercial real estate loans, residential
construction loans and securities investments. In addition to deposits, sources
of funds for the Bank’s loans and other investments include amortization and
prepayment of loans, loan origination and commitment fees, sales of loans or
participations in loans, fees received for servicing loans sold to others and
advances from the Federal Home Loan Bank of Atlanta (“FHLB”). The Bank’s
principal sources of income are interest and fees collected on loans, including
fees received for originating and selling loans and for servicing loans sold to
others, and, to a lesser extent, interest and dividends collected on other
investments and service charges on deposit accounts. The Bank’s principal
expenses are interest paid on deposits, interest paid on FHLB advances, employee
compensation, federal deposit insurance premiums, office expenses and other
overhead expenses.
 
 While the
Bank attempts to avoid concentrations of loans to a single industry or based on
a single type of collateral, the various types of loans the Bank makes have
certain risks associated with them. Consumer and commercial loans present risks
which, among other things, include fraud, bankruptcy, economic downturn,
deteriorated or non-existing collateral, changes in interest rates and customer
financial problems. Real estate construction loans present risks related to,
among other things, whether the builder is able to sell the property, whether
the buyer is able to obtain permanent financing and the nature of changing
economic conditions. Real estate mortgage loans present risks involving, among
other things, economic and demographic changes, deterioration of collateral and
customer financial problems.
 
 The
Company’s primary asset is its stock in the Bank. Accordingly, its financial
performance is determined primarily by the results of operations of the Bank.
For information regarding the consolidated financial condition and results of
operations of the Company as of December 31, 2004 and 2003 and for the three
years in the period ended December 31, 2004, see “Management’s Discussion and
Analysis of Financial Condition and Results of Operations,” and the Consolidated
Financial Statements of the Company and related notes presented in Part II
hereof. All average balances presented in this report were derived based on
daily averages.
 
 **Employees**
 
 As of
December 31, 2004, the Company (including the Bank) had 255 full-time and
14 part-time employees. The employees are not represented by any collective
bargaining unit, and the Company considers its relationship with its employees
to be good.
 
 **Competition**
 
 The
banking business in Georgia is highly competitive. The Bank competes not only
with other banks and thrifts that are located in the same counties as the Bank
and in surrounding counties, but with other financial service organizations
including credit unions, finance companies, and certain governmental agencies.
To the extent that the Bank must maintain non-interest earning reserves against
deposits, it may be at a competitive disadvantage when compared with other
financial service organizations that are not required to maintain reserves
against substantially equivalent sources of funds. Also, other financial
institutions with which the Bank competes may have substantially greater
resources and lending capabilities due to the size of the
organization.
 **Supervision
and Regulation**
 Both the
Company **** and the
Bank are subject to extensive state and federal banking regulations that impose
restrictions on and provide for general regulatory oversight of their
operations. These laws generally are intended to protect depositors and not
shareholders. The following discussion describes the material elements of the
regulatory framework that applies to us.
 
 ***The
Company***
 
 Because
the Company owns all of the capital stock of the Bank, it is a bank holding
company under the federal Bank Holding Company Act of 1956. As a result, the
Company is primarily subject to the supervision, examination, and reporting
requirements of the Bank Holding Company Act and the regulations of the Board of
Governors of the Federal Reserve System (the “Federal Reserve”). As a bank
holding company located in Georgia, the Georgia Department of Banking and
Finance also regulates and monitors all significant aspects of the Company’s
operations.
 
 ***Acquisitions
of Banks*** *.* The Bank
Holding Company Act requires every bank holding company to obtain the Federal
Reserve’s prior approval before:
 
 ·
    Acquiring
      direct or indirect ownership or control of any voting shares of any bank
      if, after the acquisition, the bank holding company will directly or
      indirectly own or control more than 5% of the bank’s voting
      shares;
 
 ·
    Acquiring
      all or substantially all of the assets of any bank;
or
 
 ·
    Merging
      or consolidating with any other bank holding
company.
 Additionally,
the Bank Holding Company Act provides that the Federal Reserve may not approve
any of these transactions if it would result in or tend to create a monopoly or,
substantially lessen competition or otherwise function as a restraint of trade,
unless the anti-competitive effects of the proposed transaction are clearly
outweighed by the public interest in meeting the convenience and needs of the
community to be served. The Federal Reserve is also required to consider the
financial and managerial resources and future prospects of the bank holding
companies and banks concerned and the convenience and needs of the community to
be served. The Federal Reserve’s consideration of financial resources generally
focuses on capital adequacy, which is discussed below.
 Under
the Bank Holding Company Act, if adequately capitalized and adequately managed,
the Company or any other bank holding company located in Georgia may purchase a
bank located outside of Georgia. Conversely, an adequately capitalized and
adequately managed bank holding company located outside of Georgia may purchase
a bank located inside Georgia. In each case, however, restrictions may be placed
on the acquisition of a bank that has only been in existence for a limited
amount of time or will result in specified concentrations of deposits.
Currently, Georgia law prohibits acquisitions of banks that have been chartered
for less than three years. Because the Bank has been incorporated for more than
three years, this limitation does not apply to the Bank or to the
Company.
 
 ***Change
in Bank Control*** *.* ****** Subject
to various exceptions, the Bank Holding Company Act and the Change in Bank
Control Act, together with related regulations, require Federal Reserve approval
prior to any person or company acquiring “control” of a bank holding company.
Control is conclusively presumed to exist if an individual or company acquires
25% or more of any class of voting securities of the bank holding company.
Control is refutably presumed to exist if a person or company acquires 10% or
more, but less than 25%, of any class of voting securities and either:
 
 ·
    The
      bank holding company has registered securities under Section 12 of
      the Securities Act of 1934; or
 
 ·
    No
      other person owns a greater percentage of that class of voting securities
      immediately after the transaction.
 
 Our
common is registered under Section 12 of the Securities Exchange Act of 1934.
The regulations also provide a procedure for challenging the rebuttable
presumption of control.
 ***Permitted Activities*** . A bank
holding company is generally permitted under the Bank Holding Company Act to
engage in or acquire direct or indirect control of more than 5% of the voting
shares of any company engaged in the following activities:
 ·
    Banking
      or managing or controlling banks; and
 
 ·
    Any
      activity that the Federal Reserve determines to be so closely related to
      banking as to be a proper incident to the business of
    banking.
 
 Activities
that the Federal Reserve has found to be so closely related to banking as to be
a proper incident to the business of banking include:
 
 ·
    Factoring
      accounts receivable;
 
 ·
    Making,
      acquiring, brokering or servicing loans and usual related
      activities;
 
 ·
    Leasing
      personal or real property;
 
 ·
    Operating
      a non-bank depository institution, such as a savings
      association;
 
 ·
    Trust
      company functions;
 
 ·
    Financial
      and investment advisory activities;
 
 ·
    Conducting
      discount securities brokerage activities;
 
 ·
    Underwriting
      and dealing in government obligations and money market
      instruments;
 
 ·
    Providing
      specified management consulting and counseling
  activities;
 
 ·
    Performing
      selected data processing services and support
services;
 
 ·
    Acting
      as agent or broker in selling credit life insurance and other types of
      insurance in connection with credit transactions;
and
 
 ·
    Performing
      selected insurance underwriting activities.
 
 Despite
prior approval, the Federal Reserve may order a bank holding company or its
subsidiaries to terminate any of these activities or to terminate its ownership
or control of any subsidiary when it has reasonable cause to believe that the
bank holding company’s continued ownership, activity or control constitutes a
serious risk to the financial safety, soundness, or stability of it or any of
its bank subsidiaries.
 
 In
addition to the permissible bank holding company activities listed above, a bank
holding company may qualify and elect to become a financial holding company,
permitting the bank holding company to engage in activities that are financial
in nature or incidental or complementary to financial activity. The Bank Holding
Company Act expressly lists the following activities as financial in nature:
 
 ·
    Lending,
      trust and other banking activities;
  ·
    Insuring,
      guaranteeing, or indemnifying against loss or harm, or providing and
      issuing annuities, and acting as principal, agent, or broker for these
      purposes, in any state;
  ·
    Providing
      financial, investment, or advisory
services;
  ·
    Issuing
      or selling instruments representing interests in pools of assets
      permissible for a bank to hold directly;
  ·
    Underwriting,
      dealing in or making a market in
securities;
  ·
    Other
      activities that the Federal Reserve may determine to be so closely related
      to banking or managing or controlling banks as to be a proper incident to
      managing or controlling banks;
  ·
    Foreign
      activities permitted outside of the United States if the Federal Reserve
      has determined them to be usual in connection with banking operations
      abroad;
  ·
    Merchant
      banking through securities or insurance affiliates;
and
  ·
    Insurance
      company portfolio investments.
 
 To
qualify to become a financial holding company, the Bank and any other depository
institution subsidiary of the Company must be well capitalized and well managed
and must have a Community Reinvestment Act rating of at least “satisfactory.”
Additionally, the Company must file an election with the Federal Reserve to
become a financial holding company and must provide the Federal Reserve with 30
days’ written notice prior to engaging in a permitted financial activity. While
the Company meets the qualification standards applicable to financial holding
companies, the Company has not elected to become a financial holding company at
this time.
 ******
 ***Support
of Subsidiary Institutions.*** **** Under
Federal Reserve policy, the Company is expected to act as a source of financial
strength for the Bank and to commit resources to support the Bank. This support
may be required at times when, without this Federal Reserve policy, the Company
might not be inclined to provide it. In addition, any capital loans made by the
Company to the Bank will be repaid only after the Bank’s deposits and various
other obligations are repaid in full. In the unlikely event of the Company’s
bankruptcy, any commitment by it to a federal bank regulatory agency to maintain
the capital of the Bank will be assumed by the bankruptcy trustee and entitled
to a priority of payment. ******
 
 **The
Bank**
 
 The Bank
is subject to extensive state and federal banking regulations that impose
restrictions on and provide for general regulatory oversight of our operations.
These laws are generally intended to protect depositors and not shareholders.
The following discussion describes the material elements of the regulatory
framework that applies to us.
 
 Because
the Bank is a commercial bank chartered under the laws of the State of Georgia,
it is primarily subject to the supervision, examination and reporting
requirements of the FDIC and the Georgia Department of Banking and Finance. The
FDIC and Georgia Department of Banking and Finance regularly examine the Bank’s
operations and have the authority to approve or disapprove mergers, the
establishment of branches and similar corporate actions. Both regulatory
agencies have the power to prevent the continuance or development of unsafe or
unsound banking practices or other violations of law. Additionally, the Bank’s
deposits are insured by the FDIC to the maximum extent provided by law. The Bank
is also subject to numerous state and federal statutes and regulations that
affect its business, activities and operations.
 
 ***Branching*** *.* Under
current Georgia law, the Bank may open branch offices throughout Georgia with
the prior approval of the Georgia Department of Banking and Finance. In
addition, with prior regulatory approval, the Bank may acquire branches of
existing banks located in Georgia. The Bank and any other national or
state-chartered bank generally may branch across state lines by merging with
banks in other states if allowed by the laws of the applicable state (the
foreign state). Georgia law, with limited exceptions, currently permits
branching across state lines through interstate mergers.
 
 Under the
Federal Deposit Insurance Act, states may “opt-in” and allow out-of-state banks
to branch into their state by establishing a new start-up branch in the state.
Currently, Georgia has not opted-in to this provision. Therefore, interstate
merger is the only method through which a bank located outside of Georgia may
branch into Georgia. This provides a limited barrier of entry into the Georgia
banking market, which protects us from an important segment of potential
competition. However, because Georgia has elected not to opt-in, our ability to
establish a new start-up branch in another state may be limited. Many states
that have elected to opt-in have done so on a reciprocal basis, meaning that an
out-of-state bank may establish a new start-up branch only if their home state
has also elected to opt-in. Consequently, until Georgia changes its election,
the only way we will be able to branch into states that have elected to opt-in
on a reciprocal basis will be through interstate merger.
 
 ***Prompt
Corrective Action*** *.* The
Federal Deposit Insurance Corporation Improvement Act of 1991 establishes a
system of prompt corrective action to resolve the problems of undercapitalized
financial institutions. Under this system, the federal banking regulators have
established five capital categories (well capitalized, adequately capitalized,
undercapitalized, significantly undercapitalized and critically
undercapitalized) in which all institutions are placed. The federal banking
agencies have also specified by regulation the relevant capital levels for each
of the other categories. At December 31, 2004, the Bank qualified for the
well-capitalized category.
 
 Federal
banking regulators are required to take various mandatory supervisory actions
and are authorized to take other discretionary actions with respect to
institutions in the three undercapitalized categories. The severity of the
action depends upon the capital category in which the institution is placed.
Generally, subject to a narrow exception, the banking regulator must appoint a
receiver or conservator for an institution that is critically undercapitalized.
  An
institution that is categorized as undercapitalized, significantly
undercapitalized, or critically undercapitalized is required to submit an
acceptable capital restoration plan to its appropriate federal banking agency. A
bank holding company must guarantee that a subsidiary depository institution
meets its capital restoration plan, subject to various limitations. The
controlling holding company’s obligation to fund a capital restoration plan is
limited to the lesser of 5% of an undercapitalized subsidiary’s assets at the
time it became undercapitalized or the amount required to meet regulatory
capital requirements. An undercapitalized institution is also generally
prohibited from increasing its average total assets, making acquisitions,
establishing any branches or engaging in any new line of business, except under
an accepted capital restoration plan or with FDIC approval. The regulations also
establish procedures for downgrading an institution to a lower capital category
based on supervisory factors other than capital.
 
 ***FDIC
Insurance Assessments*** *.* The FDIC
has adopted a risk-based assessment system for insured depository institutions
that takes into account the risks attributable to different categories and
concentrations of assets and liabilities. The system assigns an institution to
one of three capital categories: (1) well capitalized; (2) adequately
capitalized; and (3) undercapitalized. These three categories are substantially
similar to the prompt corrective action categories described above, with the
“undercapitalized” category including institutions that are undercapitalized,
significantly undercapitalized, and critically undercapitalized for prompt
corrective action purposes. The FDIC also assigns an institution to one of three
supervisory subgroups based on a supervisory evaluation that the institution’s
primary federal regulator provides to the FDIC and information that the FDIC
determines to be relevant to the institution’s financial condition and the risk
posed to the deposit insurance funds. Assessments range from 0 to 27 cents per
$100 of deposits, depending on the institution’s capital group and supervisory
subgroup. In addition, the FDIC imposes assessments to help pay off the $780
million in annual interest payments on the $8 billion Financing Corporation
bonds issued in the late 1980s as part of the government rescue of the thrift
industry. This assessment rate is adjusted quarterly and is set at 1.44 per $100
of deposits for the first quarter of 2005.
 
 The FDIC
may terminate its insurance of deposits if it finds that the institution has
engaged in unsafe and unsound practices, is in an unsafe or unsound condition to
continue operations, or has violated any applicable law, regulation, rule, order
or condition imposed by the FDIC.
 
 ***Community
Reinvestment Act*** *.* The
Community Reinvestment Act requires that, in connection with examinations of
financial institutions within their respective jurisdictions, the Federal
Reserve or the FDIC shall evaluate the record of each financial institution in
meeting the credit needs of its local community, including low and
moderate-income neighborhoods. These facts are also considered in evaluating
mergers, acquisitions, and applications to open a branch or facility. Failure to
adequately meet these criteria could impose additional requirements and
limitations on the Bank. Additionally, we must publicly disclose the terms of
various Community Reinvestment Act-related agreements.
 
 ***Other
Regulations*** *.* Interest
and other charges collected or contracted for by the Bank are subject to state
usury laws and federal laws concerning interest rates. For example, under the
Soldiers’ and Sailors’ Civil Relief Act of 1940, a lender is generally
prohibited from charging an annual interest rate in excess of 6% on any
obligation for which the borrower is a person on active duty with the United
States military.
 
 The
Bank’s loan operations are also subject to federal laws applicable to credit
transactions, such as the:
 
 ·
    Federal
      Truth-In-Lending Act, governing disclosures of credit terms to consumer
      borrowers;
 
 ·
    Home
      Mortgage Disclosure Act of 1975, requiring financial institutions to
      provide information to enable the public and public officials to determine
      whether a financial institution is fulfilling its obligation to help meet
      the housing needs of the community it serves;
 
 ·
    Equal
      Credit Opportunity Act, prohibiting discrimination on the basis of race,
      creed or other prohibited factors in extending
credit;
 
 ·
    Fair
      Credit Reporting Act of 1978, governing the use and provision of
      information to credit reporting agencies;
 
 ·
    Fair
      Debt Collection Act, governing the manner in which consumer debts may be
      collected by collection agencies;
 
 ·
    Soldiers’
      and Sailors’ Civil Relief Act of 1940, governing the repayment terms of,
      and property rights underlying, secured obligations of persons in military
      service; and
 
 ·
    Rules
      and regulations of the various federal agencies charged with the
      responsibility of implementing these federal
laws.
 
 In
addition to the federal and state laws noted above, the Georgia Fair Lending Act
(“GAFLA”) imposes restrictions and procedural requirements on most mortgage
loans made in Georgia, including home equity loans and lines of credit. On
August 5, 2003, the Office of the Comptroller of the Currency issued a formal
opinion stating that the entirety of GAFLA is preempted by federal law for
national banks and their operating subsidiaries. GAFLA contains a provision that
preempts GAFLA as to state banks in the event that the Office of the Comptroller
of the Currency preempts GAFLA as to national banks. Therefore, the Bank is
exempt from the requirements of GAFLA.
 
 The
deposit operations of the Bank are subject to:
 
 ·
    The
      Right to Financial Privacy Act, which imposes a duty to maintain
      confidentiality of consumer financial records and prescribes procedures
      for complying with administrative subpoenas of financial records;
      and
 
 ·
    The
      Electronic Funds Transfer Act and Regulation E issued by the Federal
      Reserve to implement that act, which govern automatic deposits to and
      withdrawals from deposit accounts and customers’ rights and liabilities
      arising from the use of automated teller machines and other electronic
      banking services.
 
 **Capital
Adequacy**
 
 
 The Company and the Bank are required to comply with the capital adequacy
standards established by the Federal Reserve, in the case of the Company, and
the FDIC, in the case of the Bank. The Federal Reserve has established a
risk-based and a leverage measure of capital adequacy for bank holding
companies. The Bank is also subject to risk-based and leverage capital
requirements adopted by the FDIC, which are substantially similar to those
adopted by the Federal Reserve for bank holding companies.
 
 The
risk-based capital standards are designed to make regulatory capital
requirements more sensitive to differences in risk profiles among banks and bank
holding companies, to account for off-balance-sheet exposure, and to minimize
disincentives for holding liquid assets. Assets and off-balance-sheet items,
such as letters of credit and unfunded loan commitments, are assigned to broad
risk categories, each with appropriate risk weights. The resulting capital
ratios represent capital as a percentage of total risk-weighted assets and
off-balance-sheet items.
 
 The
minimum guideline for the ratio of total capital to risk-weighted assets is 8%.
Total capital consists of two components, Tier 1 Capital and Tier 2 Capital.
Tier 1 Capital generally consists of common stock, minority interests in the
equity accounts of consolidated subsidiaries, noncumulative perpetual preferred
stock, and a limited amount of qualifying cumulative perpetual preferred stock,
less goodwill and other specified intangible assets. Tier 1 Capital must equal
at least 4% of risk-weighted assets. Tier 2 Capital generally consists of
subordinated debt, other preferred stock, and a limited amount of loan loss
reserves. The total amount of Tier 2 Capital is limited to 100% of Tier 1
Capital. At December 31, 2004 the Bank’s ratio of total capital to risk-weighted
assets was 11.23% and our ratio of Tier 1 Capital to risk-weighted assets was
9.98%.
 
 In
addition, the Federal Reserve has established minimum leverage ratio guidelines
for bank holding companies. These guidelines provide for a minimum ratio of Tier
1 Capital to average assets, less goodwill and other specified intangible
assets, of 3% for bank holding companies that meet specified criteria, including
having the highest regulatory rating and implementing the Federal Reserve’s
risk-based capital measure for market risk. All other bank holding companies
generally are required to maintain a leverage ratio of at least 4%. At December
31, 2004, our leverage ratio was 8.12%. The guidelines also provide that bank
holding companies experiencing internal growth or making acquisitions will be
expected to maintain strong capital positions substantially above the minimum
supervisory levels without reliance on intangible assets. The Federal Reserve
considers the leverage ratio and other indicators of capital strength in
evaluating proposals for expansion or new activities.
 
 Failure
to meet capital guidelines could subject a bank or bank holding company to a
variety of enforcement remedies, including issuance of a capital directive, the
termination of deposit insurance by the FDIC, a prohibition on accepting
brokered deposits, and certain other restrictions on its business. As described
above, significant additional restrictions can be imposed on FDIC-insured
depository institutions that fail to meet applicable capital
requirements.
 
 **Payment
of Dividends**
 
 The
Company is a legal entity separate and distinct from the Bank. The principal
sources of the Company’s cash flow, including cash flow to pay dividends to its
shareholders, are dividends that the Bank pays to its sole shareholder, the
Company. Statutory and regulatory limitations apply to the Bank’s payment of
dividends. If, in the opinion of the federal banking regulator, the Bank were
engaged in or about to engage in an unsafe or unsound practice, the federal
banking regulator could require, after notice and a hearing, that it stop or
refrain from engaging in the questioned practice. The federal banking agencies
have indicated that paying dividends that deplete a depository institution’s
capital base to an inadequate level would be an unsafe and unsound banking
practice. Under the Federal Deposit Insurance Corporation Improvement Act of
1991, a depository institution may not pay any dividend if payment would cause
it to become undercapitalized or if it already is undercapitalized. Moreover,
the federal agencies have issued policy statements that provide that bank
holding companies and insured banks should generally only pay dividends out of
current operating earnings. See “The Bank—Prompt Corrective
Action.”
 
 The
Georgia Department of Banking and Finance also regulates the Bank’s dividend
payments and must approve dividend payments that would exceed 50% of the Bank’s
net income for the prior year. Our payment of dividends may also be affected or
limited by other factors, such as the requirement to maintain adequate capital
above regulatory guidelines.
 
 At
December 31, 2004, the Bank could pay cash dividends of up to $3.68 million
without prior regulatory approval.
 
 **Restrictions
on Transactions with Affiliates**
 
 The
Company and the Bank are subject to the provisions of Section 23A of the Federal
Reserve Act. Section 23A places limits on the amount of:
 
 ·
    A
      bank’s loans or extensions of credit to
affiliates;
 
 ·
    A
      bank’s investment in affiliates;
 
 ·
    Assets
      a bank may purchase from affiliates, except for real and personal property
      exempted by the Federal Reserve;
 
 ·
    Loans
      or extensions of credit made by a bank to third parties collateralized by
      the securities or obligations of affiliates;
and
 
 ·
    A
      bank’s guarantee, acceptance or letter of credit issued on behalf of an
      affiliate.
 
 The total
amount of the above transactions is limited in amount, as to any one affiliate,
to 10% of a bank’s capital and surplus and, as to all affiliates combined, to
20% of a bank’s capital and surplus. In addition to the limitation on the amount
of these transactions, each of the above transactions must also meet specified
collateral requirements. The Bank must also comply with other provisions
designed to avoid the taking of low-quality assets.
 
 The
Company and the Bank are also subject to the provisions of Section 23B of the
Federal Reserve Act which, among other things, prohibit an institution from
engaging in the above transactions with affiliates unless the transactions are
on terms substantially the same, or at least as favorable to the institution or
its subsidiaries, as those prevailing at the time for comparable transactions
with nonaffiliated companies.
 
 The Bank
is also subject to restrictions on extensions of credit to its executive
officers, directors, principal shareholders and their related interests. These
extensions of credit (1) must be made on substantially the same terms, including
interest rates and collateral, as those prevailing at the time for comparable
transactions with third parties, and (2) must not involve more than the
normal risk of repayment or present other unfavorable features.
 
 **Privacy**
 
 Financial
institutions are required to disclose their policies for collecting and
protecting confidential information. Customers generally may prevent financial
institutions from sharing nonpublic personal financial information with
nonaffiliated third parties except under narrow circumstances, such as the
processing of transactions requested by the consumer or when the financial
institution is jointly sponsoring a product or service with a nonaffiliated
third party. Additionally, financial institutions generally may not disclose
consumer account numbers to any nonaffiliated third party for use in
telemarketing, direct mail marketing or other marketing to
consumers. ****
 ******Consumer
Credit Reporting**
 
 On
December 4, 2003, President Bush signed the Fair and Accurate Credit
Transactions Act (the “FAIR Act”), amending the federal Fair Credit Reporting
Act (the “FCRA”). These amendments to the FCRA (the “FCRA Amendments”) became
effective in 2004.
 
 The FCRA
Amendments include, among other things:
 
  ·
    Requirements
      for financial institutions to develop policies and procedures to identify
      potentialidentity
      theft and, upon the request of a consumer, place a fraud alert in the
      consumer’s creditfile
      stating that the consumer may be the victim of identity theft or other
      fraud;
 
 ·
    For
      entities that furnish information to consumer reporting agencies (which
      would include the Bank), new requirements to implement procedures and
      policies regarding the accuracy and integrity of the furnished information
      and regarding the correction of previously furnished information that is
      later determined to be inaccurate; and
 
 ·
    A
      requirement for mortgage lenders to disclose credit scores to
      consumers.
 
 The FCRA
Amendments also prohibit a business that receives consumer information from an
affiliate from using that information for marketing purposes unless the consumer
is first provided a notice and an opportunity to direct the business not to use
the information for such marketing purposes (the “opt-out”), subject to certain
exceptions. **** We do not
share consumer information among our affiliated companies for marketing
purposes, except as allowed under exceptions to the notice and opt-out
requirements. This will limit the Company’s cross-marketing possibilities as
compared to the years preceding adoption of the FCRA
Amendments.
  
  **Anti-Terrorism
and Money Laundering Legislation**
  
 The Bank **** is **** subject
to the Uniting and Strengthening America by Providing Appropriate Tools Required
to Intercept and Obstruct Terrorism ( the
“ USA
PATRIOT  Act”),
the Bank Secrecy Act, and rules and regulations of the Office of Foreign Assets
Control (the “OFAC”). These statutes and related rules and regulations
impose requirements and limitations on specified financial transactions and account
relationships, intended to guard against money laundering and terrorism
financing. The
Bank has  established a
customer identification program pursuant to Section
326 of the USA PATRIOT Act and the Bank Secrecy Act, and otherwise has
implemented policies and procedures to comply with the foregoing
rules.
 ****
 **Proposed
Legislation and Regulatory Action**
  New
regulations and statutes are regularly proposed that contain wide-ranging
proposals for altering the structures, regulations and competitive relationships
of financial institutions operating or doing business in the United States. We
cannot predict whether or in what form any proposed regulation or statute will
be adopted or the extent to which our business may be affected by any new
regulation or statute.
 
 **Effect
of Governmental Monetary Polices**
 
 Our earnings are affected by domestic economic conditions and the monetary and
fiscal policies of the United States government and its agencies. The Federal
Reserve Bank’s monetary policies have had, and are likely to continue to have,
an important impact on the operating results of commercial banks through its
power to implement national monetary policy in order, among other things, to
curb inflation or combat a recession. The monetary policies of the Federal
Reserve affect the levels of bank loans, investments and deposits through its
control over the issuance of United States government securities, its regulation
of the discount rate applicable to member banks and its influence over reserve
requirements to which member banks are subject. We cannot predict the nature or
impact of future changes in monetary and fiscal policies.


**ITEM
2.****PROPERTIES**





The
executive offices of the Company are located at 3475 Piedmont Road, N.E., Suite
550, Atlanta, Georgia 30305. The Company leases this property. The Company and
the Bank conduct business from facilities primarily owned by the Bank, all of
which are in good condition and are adequate for the Bank’s current and
foreseeable needs. The Company and Flag Bank provide services or perform
operational functions at 24 locations, of which 14 locations are owned and 10
are leased. See “Item 1 — Business” for a list of the locations in
which the Company and the Bank have offices.





**ITEM
3.****LEGAL
PROCEEDINGS**





The
Company and the Bank are periodically involved as plaintiff or defendant in
various other legal actions in the ordinary course of their business. We do not
believe that such litigation presents a material risk to the Company’s business,
financial condition or results of operations.





**ITEM
4.****SUBMISSION
OF MATTERS TO A VOTE OF SECURITY HOLDERS**





No matter
was submitted by the Company to a vote of its shareholders during the fourth
quarter of 2004.







**PART
II**


****


**ITEM
5.****MARKET
FOR REGISTRANT’S COMMON EQUITY AND RELATED SHAREHOLDER
MATTERS**





The
following table sets forth the high and low sales prices for the Flag common
stock, as reported by the NASDAQ Stock Market, and the cash dividends paid per
share of common stock for the periods indicated.





Quarter
    
    High
    
    Low
    
    Dividend*2004*Fourth
    
    $
    15.44
    
    $
    13.33
    
    $
    0.06Third
    
    
    14.10
    
    
    12.84
    
    
    0.06Second
    
    
    13.15
    
    
    12.25
    
    
    0.06First
    
    
    13.40
    
    
    12.45
    
    
    0.06*2003*Fourth
    
    $
    14.00
    
    $
    12.75
    
    $
    0.06Third
    
    
    14.20
    
    
    13.29
    
    
    0.06Second
    
    
    14.96
    
    
    12.65
    
    
    0.06First
    
    
    13.39
    
    
    11.00
    
    
    0.06





Subject
to board approval, the Company pays quarterly dividends on the first business
day of January, April, July and October. See “Item 1 — Business
— Supervision and Regulation — Payment of Dividends” for information
regarding regulatory restrictions on the Company’s ability to pay
dividends.








**ITEM
6.****SELECTED
FINANCIAL DATA**





The
following selected financial data is derived from and should be read in
conjunction with our consolidated financial statements, which are included
elsewhere in this report.





(In
      thousands except per share data)
    
    2004
    
    2003
    
    2002
    
    2001
    
    2000FOR
      THE YEARNet
      interest income
    
    $
    30,564
    
    
    25,987
    
    
    24,302
    
    
    23,980
    
    
    24,961Provision
      for loan losses
    
    
    1,845
    
    
    1,321
    
    
    4,549
    
    
    2,488
    
    
    3,597Non-interest
      income
    
    
    11,468
    
    
    10,365
    
    
    7,395
    
    
    10,668
    
    
    11,962Non-interest
      expense
    
    
    29,509
    
    
    26,202
    
    
    31,005
    
    
    25,701
    
    
    27,633Income
      taxes
    
    
    3,310
    
    
    2,724
    
    
    (2,028
    )
    
    1,753
    
    
    1,409Extraordinary
      item
    
    
    -
    
    
    -
    
    
    165
    
    
    696
    
    
    -Net
      earnings (loss)
    
    
    7,368
    
    
    6,105
    
    
    (1,994
    )
    
    4,010
    
    
    4,284PER
      COMMON SHAREBasic
      earnings (loss) per share
    
    $
    0.88
    
    
    0.72
    
    
    (0.24
    )
    
    0.51
    
    
    0.52Diluted
      earnings (loss) per share
    
    
    0.82
    
    
    0.67
    
    
    (0.24
    )
    
    0.51
    
    
    0.52Cash
      dividends declared
    
    
    0.24
    
    
    0.24
    
    
    0.24
    
    
    0.24
    
    
    0.24Book
      value
    
    
    8.14
    
    
    7.65
    
    
    7.24
    
    
    7.33
    
    
    6.83AT
      YEAR ENDLoans,
      net
    
    $
    596,101
    
    
    477,095
    
    
    374,784
    
    
    368,967
    
    
    384,661Earning
      assets
    
    
    772,387
    
    
    647,481
    
    
    569,755
    
    
    512,942
    
    
    501,046Assets
    
    
    828,337
    
    
    703,857
    
    
    636,131
    
    
    570,202
    
    
    559,037Deposits
    
    
    706,847
    
    
    570,570
    
    
    509,731
    
    
    440,582
    
    
    461,438Stockholders’
      equity
    
    
    69,202
    
    
    65,260
    
    
    60,749
    
    
    54,023
    
    
    55,498Common
      shares outstanding
    
    
    8,503
    
    
    8,528
    
    
    8,394
    
    
    7,370
    
    
    8,123AVERAGE
      BALANCESLoans
    
    $
    541,502
    
    
    417,395
    
    
    366,571
    
    
    378,867
    
    
    405,101Earning
      assets
    
    
    690,187
    
    
    587,484
    
    
    511,737
    
    
    508,752
    
    
    510,898Assets
    
    
    743,082
    
    
    645,430
    
    
    560,984
    
    
    560,816
    
    
    566,355Deposits
    
    
    612,712
    
    
    516,067
    
    
    442,645
    
    
    449,985
    
    
    455,338Stockholders’
      equity
    
    
    65,854
    
    
    63,299
    
    
    58,865
    
    
    56,294
    
    
    53,853Weighted
      average shares outstanding
    
    
    8,396
    
    
    8,471
    
    
    8,201
    
    
    7,808
    
    
    8,210KEY
      PERFORMANCE RATIOSReturn
      on average assets
    
    
    0.99
    %
    
    0.95
    %
    
    (0.36
    )%
    
    0.72
    %
    
    0.77
    %Return
      on average stockholders’ equity
    
    
    11.19
    %
    
    9.64
    %
    
    (3.39
    )%
    
    7.12
    %
    
    7.95
    %Net
      interest margin, tax equivalent basis
    
    
    4.48
    %
    
    4.50
    %
    
    4.86
    %
    
    4.83
    %
    
    4.99
    %Dividend
      payout ratio
    
    
    27.38
    %
    
    33.35
    %
    
    N/A
    
    
    46.27
    %
    
    45.98
    %Average
      equity to average assets
    
    
    8.86
    %
    
    9.81
    %
    
    10.49
    %
    
    10.04
    %
    
    9.51
    %









**ITEM 7.****MANAGEMENT’S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS**





**General**


Flag
Financial Corporation (“Flag” or the “Company”) is a bank holding company that
owns 100 percent of the common stock of Flag Bank (the “Bank”). The Bank is a
full-service, retail oriented bank primarily engaged in retail banking, small
business, residential and commercial real estate lending and mortgage banking.
Flag also owns Flag Financial Corporation Statutory Trust, a subsidiary whose
sole purpose was to issue $14.4 million of Trust Preferred Securities through a
pool sponsored by a super-regional bank in Atlanta, Georgia.
 
 The
following discussion focuses on significant changes in the financial condition
and results of operations of Flag during the three years ended December 31,
2004. This discussion and the financial information contained herein are
presented to assist the reader in understanding and evaluating the financial
condition, results of operations and future prospects of Flag and should be read
as a supplement to and in conjunction with the Consolidated Financial Statements
and Related Notes.
 
 **Executive
Summary**
 
 Changes
in Flag's operating performance and balance sheet continued during 2004, leading
to improvement in three primary areas: earnings, balance sheet growth and credit
quality.
 
 Earnings
- Flag recorded record earnings in 2004 of $7.4 million compared to $6.1 million
in 2003. This improvement in earnings of 20.7% has numerous contributing
factors, the most notable being loan growth and increases in non-interest
income.  Net interest income improved from $26.0 million in 2003 to $30.6
million in 2004. Flag’s net interest margin remained very strong, decreasing
only 2 basis points from 4.50% to 4.48%. Flag’s ability to maintain strong
margins while building its Metro Atlanta franchise with growth rates of over 20%
speaks to the Company’s expertise in building a banking franchise that leverages
customer relationships as the primary driver of its growth. In addition, Flag
continues to expand lending business such that the Company recorded record loan
fees in 2004 of $6.0 million, an increase of 42.9% over 2003 levels.
 
 Non-interest
income improved during 2004 to $11.5 million over $10.4 million for 2003. The
increase was due mostly to the $3.0 million gain on the sale of the Thomaston,
Georgia branch during the first quarter of 2004. Flag’s non-interest income
during 2003 was unusually high due to the refinancing opportunities that the
record low interest rate environment provided for homeowners and the Bank's
ability to attract these mortgage loan opportunities through its mortgage
division, Flag Mortgage.  Revenues from our mortgage division decreased
43.2% to $2.4 million during 2004, as refinancing activity subsided in
2004.
 
 Balance
Sheet Growth - Flag's total assets grew by approximately $124.5 million in 2004
or 17.7%.  Gross loans outstanding increased by approximately $120.9
million as the Company continued to develop its correspondent lending line of
business and further accelerated its commercial lending activities in
metropolitan Atlanta.  Demand deposits (interest bearing and non-interest
bearing) improved by $63.4 million or 19.0% during 2004 while total deposits
grew by $136.3 million or 23.9% during 2004.  This increase is due
principally to Flag's aggressive sales efforts at attracting new customer
relationships in metropolitan Atlanta.
 
 Credit
Quality - Improvement in credit quality was significant as well. Non-performing
assets to total assets improved to 0.64% at the end of 2004 compared to 1.06% at
the end of 2003.  Past due and classified loan trends also improved in
2004.  The improving credit quality at Flag is due largely to a
comprehensive loan review program as well as efforts that focus loan production
efforts in areas management believes provide higher quality credits. Net
charge-offs for 2004 were $328,000 compared to $1.5 million for 2003. Flag’s
provision for loan losses was $1.8 million in 2004 compared to $1.3 million in
2003. These levels represented 0.34% and 0.32% of average loans outstanding
during 2004 and 2003, respectively.
 ****
 **Acquisition
and Disposition Activity**
 
 In
December 2004, Flag purchased substantially all of the assets of Payroll
Solutions, Inc., (“Payroll Solutions”) a leading provider of payroll, human
resources and benefits services to small and medium-sized businesses primarily
in Georgia for approximately $4,685,000, including 236,723 shares of Flag common
stock valued at $3,314,000 and the assumption of debt of approximately
$1,371,000. The purchase of Payroll Solutions expands the suite of services that
the Bank offers it business customers.
 
 During
the third quarter of 2004, Flag acquired a mortgage and construction lending
practice from another Atlanta based bank. Flag purchased approximately $35
million in mortgage and construction loans and assumed several property leases
with market based rents and terms. Total consideration for the purchase will be
paid over the course of 60 months and totals approximately $930,000 in cash. The
acquisition of this mortgage and construction lending practice is in accordance
with Flag’s strategy to continue to grow its non-interest income.
 
 During
the first quarter of 2004, Flag sold its Thomaston, Georgia branch to another
Georgia based bank and recorded an after tax gain of approximately $1.47
million. Included in the sale was approximately $1,689,000 of premises and
equipment, $16,690,000 in loans and $35,801,000 million in deposits. Flag’s
decision to sell this branch was due to its continued focus on developing its
banking presence where Flag maintains high market share and in developing its
metro Atlanta presence.
 
 **Critical
Accounting Policies**
 
 The
accounting principles we follow and our methods of applying these principles
conform with accounting principles generally accepted in the United States and
with general practices within the banking industry. In connection with the
application of those principles, we have made judgments, estimates and
assumptions which, in the case of the determining our allowance for loan losses
(ALL), have been critical to the determination of our financial position and
results of operations. Management assesses the adequacy of the ALL regularly
during the year, and formally prior to the end of each calendar quarter. This
assessment includes procedures to estimate the allowance and test the adequacy
and appropriateness of the resulting balance.
 
 This
estimation process can affect our estimated loan loss expense for a given
period. Generally, the allowance for loan losses increases as the outstanding
balance of loans or the level of classified or impaired loans increases. Loans
or portions of loans that are deemed uncollectible are charged against and
reduce the allowance. The allowance is replenished by means of a provision for
loan losses that is charged as an expense. As a result, our estimate of the
allowance for loan losses affects our earnings directly.
 
 The ALL
consists of two portions (1) allocated amounts representing the potential
exposures on specifically identified credits and other exposures readily
predictable by historical or comparative experience; and (2) an unallocated
amount representative of inherent loss which is not readily identifiable. Even
though the ALL is composed of two components, the entire ALL is available to
absorb any credit losses. Allocated amounts are used on loans where management
has determined that there is an increased probability or severity of loss than
on the loan portfolio as a whole. We base the allocation for these unique loans
primarily on risk rating grades assigned to each of these loans as a result of
our loan management and review processes. We then assign each risk-rating grade
a loss ratio, which is determined based on the experience of management,
discussions with banking regulators and our independent loan review process. We
estimate losses on impaired loans based on estimated cash flows discounted at
the loan's original effective interest rate or based on the underlying
collateral value. To the extent that management does not believe that a certain
loan's risk is appropriately represented by the risk rating grades,
a  specific
review of the credit is performed which would result in a specific allocation
for that particular loan.
 
 Unallocated
amounts are particularly subjective and do not lend themselves to exact
mathematical calculation. The unallocated amount represents estimated inherent
credit losses which may exist, but have not yet been identified, as of the
balance sheet date. In estimating the unallocated amount, we consider such
matters as changes in the local or national economy, the depth or experience in
the lending staff, any concentrations of credit in any particular industry
group, and new banking laws or regulations. After we assess applicable factors,
we evaluate the aggregate unallocated amount based on our management's
experience. We then test the resulting ALL balance by comparing the balance in
the ALL to historical trends and peer information. Our management then evaluates
the result of the procedures performed, including the result of our testing, and
concludes on the appropriateness of the balance of the ALL in its
entirety.
 
 The audit
committee of our board of directors reviews the assessment prior to the filing
of quarterly and annual financial information. In assessing the adequacy of the
ALL, we also rely on an ongoing independent loan review process. We undertake
this process both to ascertain whether there are loans in the portfolio whose
credit quality has weakened over time and to assist in our overall evaluation of
the risk characteristics of the entire loan portfolio. Our loan review process
includes the judgment of management, input from our independent loan reviewer,
and reviews that may have been conducted by bank regulatory agencies as part of
their usual examination process.
 
 See
"Provision and Allowance for Loan Losses" for additional
information.
 
 **Results
of Operations**
 
 Flag
recorded record earnings in 2004 of $7,368,000 or $0.82 per diluted share,
compared to net earnings in 2003 of $6,105,000 or $0.67 per diluted share and a
net loss in 2002 of $1,994,000 or $0.24 per diluted share. Flag’s net loss in
2002 resulted primarily from the $6,044,000 after tax charge taken in the first
quarter to effect its management restructuring, a loss on the early repayment of
Federal Home Loan Bank (FHLB) advances, and a larger-than-normal addition to the
provision for loan losses. Flag recorded after-tax extraordinary items related
to the early repayment of FHLB advances totaling $165,000 in 2002.
 ****
 **Net
Interest Income**
 
 Net
interest income (the difference or spread between interest income on earning
assets and interest expense on borrowed funds) is the largest component of
Flag’s operating income. Flag manages net interest income in a manner that
realizes the largest spread while accepting certain levels of credit, liquidity
and interest rate risks. Managing these risks requires systems and processes to
identify and evaluate these risks at various levels in the organization. Net
interest income was $30.6 million in 2004, compared to $26.0 million and $24.3
million in 2003 and 2002, respectively. Flag’s change in net interest income
during 2004 and 2003 was primarily the result of annual increases in average
earning assets of 17.5% and 14.8%, respectively, coupled with successful efforts
on holding costs on deposit growth and incremental borrowing.
 
 Flag’s
net interest margin (net interest income divided by average earning assets)
decreased in 2004 to 4.48% from 4.50% in 2003 and 4.86% in 2002. The negative
impact on the net interest margin of strong competition in Metro Atlanta where
Flag expects growth rates in excess of 20% were offset by growth in loan fees of
$1.8 million to $6.0 million in 2004. Flag has employed an aggressive growth
strategy in earning assets for the last two years, attempting to leverage its
existing branch network, operations structure and management team. This strategy
has resulted in double digit growth rates in earning assets in 2003 and 2004.
The lower interest rate environment coupled with a very competitive market
resulted in lower incremental margins than what Flag has historically managed.
Management is satisfied with the incremental margins on the growth in earning
assets.
 
 
 Total
interest income in 2004 was $42.6 million, compared to $36.5 million and $36.7
million in 2003 and 2002, respectively. Yields on average earning assets in 2004
decreased to 6.23% compared to 6.29% and 7.28% in 2003 and 2002, respectively.
The lower interest rate environment was the primary reason for the lower yields
on earning assets. Allocation of earning assets improved during 2004 as Flag was
able to maintain lower relative levels of short-term investments (federal funds
sold, interest-bearing deposits in other banks and investments with maturities
under 90 days) than in the past. Short-term investments averaged approximately
4.2% of earning assets compared to 6.0% of earning assets in 2003 and 2.8% in
2002.
 
 Investment
securities averaged approximately $119.8 million during 2004. This compares to
averages of $135.1 million and $130.6 million for 2003 and 2002, respectively.
As a percentage of average earning assets, investment securities decreased to
17.4% from 23.0% in 2003 and from 25.5% in 2002. This trend is due to Flag’s
reliable lending lines of business and the rapid growth in the Company’s loan
portfolio since early 2002. Taxable equivalent yields on investment securities
for 2004 were 4.41%, compared to 4.51% and 5.57% for 2003 and 2002,
respectively. The decrease in yields is due to the low rate environment
experienced over the last few years and Flag’s recent investment philosophy to
invest excess funds in the market in shorter maturity ranges, anticipating
higher rates and better investment opportunities.
 
 Average
loans outstanding (including mortgage loans held-for-sale) increased 29.7% in
2004 to $541.5 million, compared to average balances of $417.4 million and
$366.6 million for 2003 and 2002, respectively. As a percentage of earning
assets, loans outstanding averaged approximately 78.5% during 2004. This
continued a trend of loans comprising an increasing portion of earning assets.
Loans averaged 71.0% of earning assets during 2003 and 71.6% during 2002. At
December 31, 2004, Flag’s loans outstanding (including mortgage loans
held-for-sale) totaled $615.4 million, representing 79.7% of earning
assets.
 
 Total
interest expense in 2004 increased 14.3% to $12.1 million, compared to $10.6
million in 2003 and $12.4 million in 2002. Increases in 2004 related mostly to
growth in average total funding of 16.5% or $95.3 million. Flag’s efforts to
improve profitability on funding through aggressive repricing continued for the
first part of the year and offset the increases caused by aggressive sales
efforts in Metro Atlanta and a rising interest rate environment in the second
half of the year. Decreases in interest expense during 2003 were the results of
aggressive repricing of deposit accounts in a record low interest rate
environment. Flag’s overall cost of funds decreased slightly during 2004 to
1.79% compared to overall cost of funds of 1.83% and 2.50% in 2003 and 2002,
respectively.
 
 Interest
expense on demand deposits (money market and interest-bearing checking accounts)
increased 52.7% to $5.1 million during 2004 compared to $3.3 million in 2003 and
$2.2 million in 2002. Increases in both years are the result of growth in
average interest-bearing demand deposit balances which have increased 39.4% in
2004 and 69.8% in 2003. Interest expense on time deposits continued to improve
during 2004 from repricing efforts that started several years ago. Yields on
time deposits decreased in 2004 to 2.39% compared to 2.75% and 3.65% in 2003 and
2002, respectively.
 
 Table 1
presents for the three years ended December 31, 2004, average balances of
interest-earning assets and interest-bearing liabilities, and the weighted
average interest rates earned and paid on those balances. In addition, interest
rate spreads, net interest margins and the ratio of interest-earning assets
versus interest-bearing liabilities for those years are presented.
  
  **Table
1 - Consolidated Average Balances, Interest, and Rates - Taxable Equivalent
Basis**
 (dollars
in thousands)
 **Years
      Ended December 31,******
    
    **2004**
    
    
    
    
    
    **2003**
    
    
    
    
    
    **2002****Interest**
    
    **Weighted**
    
    
    
    **Interest**
    
    **Weighted**
    
    
    
    **Interest**
    
    **Weighted****Average**
    
    **Income/**
    
    **Average**
    
    **Average**
    
    **Income/**
    
    **Average**
    
    **Average**
    
    **Income/**
    
    **Average****Balance**
    
    **Expense**
    
    **Rate**
    
    **Balance**
    
    **Expense**
    
    **Rate**
    
    **Balance**
    
    **Expense**
    
    **Rate****ASSETS**Interest-earning
      assets:Loans
    
    $
    541,502
    
    
    37,239
    
    
    6.88
    %
    $
    417,395
    
    
    30,268
    
    
    7.25
    %
    $
    366,571
    
    
    29,702
    
    
    8.10
    %Taxable investment securities
    
    
    111,994
    
    
    4,707
    
    
    4.20
    %
    
    125,754
    
    
    5,413
    
    
    4.30
    %
    
    120,364
    
    
    6,513
    
    
    5.41
    %Tax-free investment securities
    
    
    7,815
    
    
    571
    
    
    7.31
    %
    
    9,359
    
    
    676
    
    
    7.22
    %
    
    10,294
    
    
    768
    
    
    7.46
    %Interest-bearing deposits in other banks
    
    
    16,607
    
    
    349
    
    
    2.10
    %
    
    18,034
    
    
    432
    
    
    2.40
    %
    
    1,748
    
    
    74
    
    
    4.23
    %Federal funds sold
    
    
    12,269
    
    
    145
    
    
    1.18
    %
    
    16,942
    
    
    187
    
    
    1.10
    %
    
    12,760
    
    
    186
    
    
    1.46
    %Total interest-earning assets
    
    
    690,187
    
    
    43,011
    
    
    6.23
    %
    
    587,484
    
    
    36,976
    
    
    6.29
    %
    
    511,737
    
    
    37,243
    
    
    7.28
    %Other assets
    
    
    52,895
    
    
    
    
    
    
    
    
    57,946
    
    
    
    
    
    
    
    
    49,247Total assets
    
    $
    743,082
    
    
    
    
    
    
    
    $
    645,430
    
    
    
    
    
    
    
    $
    560,984**LIABILITIES
      AND STOCKHOLDERS’ EQUITY**Interest-bearing
      liabilities:Interest-bearing demand deposits
    
    $
    312,374
    
    
    5,108
    
    
    1.64
    %
    $
    224,103
    
    
    3,346
    
    
    1.49
    %
    $
    131,967
    
    
    2,151
    
    
    1.63
    %Savings deposits
    
    
    22,647
    
    
    130
    
    
    0.57
    %
    
    25,182
    
    
    148
    
    
    0.59
    %
    
    25,322
    
    
    214
    
    
    0.85
    %Time deposits
    
    
    233,846
    
    
    5,590
    
    
    2.39
    %
    
    224,988
    
    
    6,180
    
    
    2.75
    %
    
    244,113
    
    
    8,900
    
    
    3.65
    %Federal funds purchased
    
    
    4,721
    
    
    70
    
    
    1.48
    %
    
    4,287
    
    
    58
    
    
    1.35
    %
    
    3,406
    
    
    54
    
    
    1.59
    %FHLB advances andother borrowings
    
    
    43,992
    
    
    706
    
    
    1.60
    %
    
    56,033
    
    
    815
    
    
    1.45
    %
    
    48,715
    
    
    1,053
    
    
    2.16
    %Junior subordinated debentures
    
    
    10,292
    
    
    453
    
    
    4.40
    %
    
    -
    
    
    -
    
    
    -
    
    
    -
    
    
    -
    
    
    -Total interest-bearing liabilities
    
    
    627,872
    
    
    12,057
    
    
    1.92
    %
    
    534,593
    
    
    10,547
    
    
    1.97
    %
    
    453,523
    
    
    12,372
    
    
    2.73
    %Non-interest
      bearing demand deposits
    
    
    43,845
    
    
    
    
    
    
    
    
    41,794
    
    
    
    
    
    
    
    
    41,243Other liabilities
    
    
    5,511
    
    
    
    
    
    
    
    
    5,744
    
    
    
    
    
    
    
    
    7,353Stockholders’ equity
    
    
    65,854
    
    
    
    
    
    
    
    
    63,299
    
    
    
    
    
    
    
    
    58,865Total
      liabilities andStockholders’ equity
    
    $
    743,082
    
    
    
    
    
    
    
    $
    645,430
    
    
    
    
    
    
    
    $
    560,98Tax-equivalent
      adjustment
    
    
    
    
    
    390
    
    
    
    
    
    
    
    
    442
    
    
    
    
    
    
    
    
    570Net
      interest income
    
    
    
    
    
    30,564
    
    
    
    
    
    
    
    
    25,987
    
    
    
    
    
    
    
    
    24,302Interest
      rate spread
    
    
    
    
    
    
    
    
    4.31
    %
    
    
    
    
    
    
    
    4.32
    %
    
    
    
    
    
    
    
    4.55
    %Net
      interest margin
    
    
    
    
    
    
    
    
    4.48
    %
    
    
    
    
    
    
    
    4.50
    %
    
    
    
    
    
    
    
    4.86
    %Interest-earning
      assets/interest-bearing liabilities
    
    
    
    
    
    
    
    
    110
    %
    
    
    
    
    
    
    
    110
    %
    
    
    
    
    
    
    
    113
    %
 
 Table 2
shows the change in net interest income from 2004 to 2003 and from 2003 to 2002
due to changes in volumes and rates.
  **Table
2 - Rate/Volume Variance Analysis - Taxable Equivalent
Basis**
 (dollars
in thousands)
 
 **Years Ended December 31,****2004
      Compared to 2003**
    
    **2003
      Compared to 2002****Rate/**
    
    **Net**
    
    
    
    **Rate/**
    
    **Net****Volume**
    
    **Yield**
    
    **Change**
    
    **Volume**
    
    **Yield**
    
    **Change**Interest
      income:Loans
    
    $
    8,542
    
    
    (1,571
    )
    
    6,971
    
    $
    3,699
    
    
    (3,133
    )
    
    566Taxable investment securities
    
    
    (578
    )
    
    (128
    )
    
    (706
    )
    
    (303
    )
    
    (797
    )
    
    (1,100
    )Tax-free investment securities
    
    
    (113
    )
    
    8
    
    
    (105
    )
    
    (68
    )
    
    (24
    )
    
    (92
    )Interest-bearing deposits in banks
    
    
    (30
    )
    
    (53
    )
    
    (83
    )
    
    376
    
    
    (18
    )
    
    358Federal funds sold
    
    
    (55
    )
    
    13
    
    
    (42
    )
    
    46
    
    
    (45
    )
    
    1Total interest income
    
    
    7,766
    
    
    (1,731
    )
    
    6,035
    
    
    3,750
    
    
    (4,017
    )
    
    (267
    )Interest
      expense:Interest bearing demand deposits
    
    
    1,444
    
    
    318
    
    
    1,762
    
    
    1,376
    
    
    (181
    )
    
    1,195Savings deposits
    
    
    (15
    )
    
    (3
    )
    
    (18
    )
    
    (1
    )
    
    (65
    )
    
    (66
    )Other time deposits
    
    
    212
    
    
    (802
    )
    
    (590
    )
    
    (525
    )
    
    (2,195
    )
    
    (2,720
    )Federal funds purchased
    
    
    6
    
    
    6
    
    
    12
    
    
    12
    
    
    (8
    )
    
    4FHLB advances and other borrowings
    
    
    (193
    )
    
    84
    
    
    (109
    )
    
    106
    
    
    (344
    )
    
    (238
    )Junior subordinated debentures
    
    
    453
    
    
    -
    
    
    453Total interest expense
    
    
    1,907
    
    
    (397
    )
    
    1,510
    
    
    968
    
    
    (2,793
    )
    
    (1,825
    )Net
      interest income
    
    $
    5,859
    
    
    (1,334
    )
    
    4,525
    
    $
    2,782
    
    
    (1,224
    )
    
    1,558
   
 ****
 **Non-interest
Income**
 
 Total
non-interest income for 2004 was $11.5 million, an increase from $10.4 million
in 2003 and from $7.4 million in 2002. The majority of Flag’s non-interest
income has traditionally come from several sources including service charges on
deposit accounts and revenue from mortgage banking activities. Major sources of
non-interest income considered to be non-recurring are the sales of branches and
bank locations.
 
 Service
charges on deposit accounts increased slightly in 2004 to $3.7 million from $3.4
million in 2003 and from $3.5 million in 2002. While Flag maintained strong
growth in deposits during 2004 and 2003, most of the growth came from
higher-balance money market and interest-checking balances where customers carry
balances sufficient to qualify for reduced or eliminated fees. Management
believes that growth in service charges will continue at a slower pace than
deposits as a whole given this dynamic.
 
 Mortgage
banking activities include origination fees, service release premiums and the
gain on the sale of mortgage loans originated solely for the purpose of being
sold. During 2004, Flag recorded much lower revenues from its mortgage division
than in 2003. The lower interest rate environment during 2003 provided borrowers
with record low rate opportunities and pushed mortgage revenues to record levels
for Flag and the mortgage industry. Income from mortgage banking operations was
$2.4 million in 2004 compared to $4.2 million in 2003 and $2.9 million in 2002.
During the third quarter of 2004, Flag acquired a mortgage and construction
lending practice from another Atlanta based bank. Flag purchased approximately
$35 million in mortgage and construction loans.
 
 Flag
continued to search for ways to improve the efficiency of its banking locations
during 2004. This effort resulted in the sale of its Thomaston, Georgia branch
during the first quarter of 2004 that resulted in a pre-tax gain of
approximately $3.0 million. During 2003, this effort resulted in the closure of
its Sandy Springs office that was under lease, the relocation of the Company’s
primary operations facility to a smaller and better-designed location in
Jonesboro, Georgia, and the sale and leaseback of its Dunwoody location. These
decisions resulted in combined efficiencies of approximately $814,000.
 
  **Non-interest
Expenses**
 
 Salaries
and employee benefits for 2004 were $17.7 million compared to $15.8 million in
2003 and $18.6 million in 2002. Salaries and benefits increased in 2004 as Flag
was able to accelerate the hiring of key relationship lenders for its growing
Metro Atlanta franchise. In addition, Flag’s acquisition of the mortgage and
construction practice early in the third quarter added approximately twenty
employees, most of which were lending officers. Flag also added several
positions in its operations group in order to continue the high level of service
to internal and external customers. The decrease in 2003 over 2002 levels
relates largely to the management restructuring undertaken in the first quarter
of 2002, in which Flag took a charge related to buyouts of employment contracts
and severance pay of approximately $3.1 million. Excluding these charges taken
in the first quarter of 2002, Flag’s salary and benefits increased only $239,000
or 1.54% in 2003 over the 2002 amount. This relatively small increase in total
salary and benefits during 2003 came despite an increase in total assets of
10.6% in 2003. Total full-time equivalent employees were 262, 238 and 243 at
December 31, 2004, 2003, and 2002, respectively. Assets per full time equivalent
were $3.2 million, $3.0 million and $2.6 million at December 31, 2004, 2003, and
2002, respectively.
 
 Occupancy
expense for 2004 was $3.7 million, increasing slightly from $3.5 million during
2003. Decreases in occupancy expense related to the divestiture of the
Thomaston, Georgia branch were offset by increases in rent expense related to
the purchase of the mortgage and construction practice during the third quarter
of 2004. The decrease in 2003 over 2002 levels relates to Flag’s continued
strategy to consolidate branches and operating locations during the past four
years. This effort has resulted in 19 offices being closed or sold since the
beginning of 2000.
 
 Professional
fees increased substantially in 2004 to $1.3 million, an increase of $466,000
over $811,000 recorded in 2003. Compliance with the new regulations relating to
Sarbanes-Oxley and the increased scrutiny on regulatory reporting cost the
Company approximately $200,000 during the last half of 2004. Professional fees
relating to business acquisitions and the divestiture of the Thomaston, Georgia
branch amounted to approximately $280,000 for 2004. Decreases in professional
fees in 2003 from the 2002 level relates mostly to costs incurred in 2002
related to the management restructuring and the private placement effected in
the first quarter of 2002.
 
 Communications
and data expense remained mostly flat during 2004 increasing only 2.3% to $2.2
million. This compares to the $2.1 million recorded in 2003 and the $1.8 million
recorded in 2002. The increase in 2003 over 2002 levels relates mostly to the
Company’s decision to outsource both its data processing and the warehousing of
most networking equipment during 2003.
 
 Other
operating expenses increased in 2004 to $3.8 million compared to $3.1 million in
2003 and $4.1 million in 2002. Larger amounts of other operating expenses in
2004 and 2002 relate to the divestiture and/or closing of branches not included
in occupancy expense. Also, for 2004 Flag recorded approximately $400,000 of
write-downs in other real estate and incurred certain non-recurring expenses
relating the business acquisitions affected during the year. For 2002, Flag
incurred certain non-recurring expenses relating to the management restructuring
and private placement that are not reported in salary and benefits or
professional fees.
 
  **Investment
Securities**
 
 The
composition of the investment securities portfolio reflects management’s
strategy of maintaining an appropriate combination of liquidity, interest-rate
risk and yield. Flag seeks to maintain an investment portfolio with minimal
credit risk, investing mostly in obligations of the United States Treasury or
other state and federal governmental agencies.
 
 Investment
securities decreased during 2004 to $111.4 million from $122.6 million at
December 31, 2003. At December 31, 2004, all investment securities outstanding
were classified as available-for-sale. Refinancing opportunities available to
homeowners in 2004 continued to cause faster than usual prepayments in
mortgage-backed securities. Instead of reinvesting in securities, Flag chose to
invest more heavily in loans as the Company’s Metro Atlanta franchise and other
lending lines of business started to produce loan opportunities for the Company.
Flag anticipates that as rates continue to rise, better investment opportunities
will present themselves and Flag will be able to complement its loan growth with
a growing investment portfolio. At December 31, 2004, gross unrealized gains in
the total portfolio amounted to $1.0 million and gross unrealized losses
amounted to $951,000.
  Investment
securities available-for-sale at December 31, 2004 are summarized as follows (in
thousands):
 
 
 December
      31, 2004Gross
    
    Gross
    
    EstimatedAmortized
    
    Unrealized
    
    Unrealized
    
    FairCost
    
    Gains
    
    Losses
    
    ValueU.S.
      Treasuries and agencies
    
    $
    55,407
    
    
    83
    
    
    238
    
    
    55,252State,
      county and municipals
    
    
    6,839
    
    
    321
    
    
    -
    
    
    7,160Equity
      securities
    
    
    309
    
    
    -
    
    
    26
    
    
    283Mortgage-backed
      securities
    
    
    28,201
    
    
    322
    
    
    59
    
    
    28,464Corporate
      debt securities
    
    
    1,503
    
    
    31
    
    
    -
    
    
    1,534Trust
      preferred securities
    
    
    19,041
    
    
    284
    
    
    628
    
    
    18,697$
    111,300
    
    
    1,041
    
    
    951
    
    
    111,390
 
 At
December 31, 2004, unrealized losses in the investment portfolio related to
debt, equity and trust preferred securities. The unrealized losses on the debt
and equity securities arose due to changing interest rates and market conditions
and are considered to be temporary because of acceptable investment grades where
the repayment sources of principal and interest are largely backed by the U.S.
Government . At
December 31, 2004, none of the 29 securities issued by state and political
subdivisions contained unrealized losses while 21 out of 97 securities issued by
U.S. Government agencies and Government sponsored corporations, including
mortgage-backed securities, contained unrealized losses .  The
unrealized losses on the trust preferred securities arose due to changing
interest rates and market conditions and are considered to be temporary. At
December 31, 2004, two of 11 trust preferred securities contained unrealized
losses.
 Table 3
reflects the carrying amount of the investment securities portfolio for the past
three years.
 
 **Table
3 - Carrying Value of Investments**
 (dollars
in thousands)
 **2004**
    
    **2003**
    
    **2002**Securities
      available-for-sale:U.S.
      Treasuries and agencies
    
    $
    55,252
    
    
    60,361
    
    
    23,577Corporate
      debt securities
    
    
    1,534
    
    
    2,143
    
    
    ****2,201State,
      county and municipal
    
    
    7,160
    
    
    9,028
    
    
    9,972Mortgage-backed
      securities
    
    
    28,464
    
    
    28,054
    
    
    86,784Trust
      Preferred Securities
    
    
    18,697
    
    
    22,741
    
    
    15,886Equity
      securities
    
    
    283
    
    
    238
    
    
    ****434Total
    
    $
    111,390
    
    
    122,565
    
    
    138,854
  **Loans**
  Gross loans
(loans outstanding excluding mortgage loans held-for-sale and the allowance for
loan losses) increased 24.9% to $604.7 million from $483.8 million in 2003. In
2004, the Company continued to increase the pace of commercial lending in
Atlanta, Georgia, while maintaining reliable loan growth in its traditional
markets in Central and West Georgia. Flag concentrates its lending activities in
several areas that management believes provides adequate diversification with
acceptable yield and risk levels. These areas include, but are not limited to
construction, commercial real estate, agricultural and correspondent lending
(lending services to other community banks).
 
 Table
4 **** shows the
changes in the composition of Flag’s loan portfolio from December 31, 2000
through 2004.
 ****
 **Table
4 - Loan Portfolio**
 (dollars
in thousands)
 
 **2004**
    
    **2003**
    
    **2002**
    
    **2001**
    
    **2000**Commercial/financial/agricultural
    
    $
    57,231
    
    
    50,435
    
    
    56,052
    
    
    74,569
    
    
    92,757Real
      estate construction
    
    
    176,111
    
    
    100,108
    
    
    68,169
    
    
    65,052
    
    
    37,501Real
      estate mortgage
    
    
    355,575
    
    
    315,610
    
    
    240,182
    
    
    213,748
    
    
    228,508Installment
      loans to individuals
    
    
    15,644
    
    
    17,287
    
    
    15,848
    
    
    17,793
    
    
    28,767Lease
      financings
    
    
    142
    
    
    340
    
    
    1,421
    
    
    5,153
    
    
    3,711Total
      loans
    
    
    604,703
    
    
    483,780
    
    
    381,672
    
    
    376,315
    
    
    391,244Less:
      Allowance for loan losses
    
    
    8,602
    
    
    6,685
    
    
    6,888
    
    
    7,348
    
    
    6,583Total
      net loans
    
    $
    596,101
    
    
    477,095
    
    
    374,784
    
    
    368,967
    
    
    384,661
 
 As
      a percent of total loans:
    
    **2004**
    
    **2003**
    
    **2002**
    
    **2001**
    
    **2000**Commercial/financial/agricultural
    
    
    9.5
    %
    
    10.4
    %
    
    14.7
    %
    
    19.8
    %
    
    23.7
    %Real
      estate construction
    
    
    29.1
    %
    
    20.7
    %
    
    17.7
    %
    
    17.3
    %
    
    9.6
    %Real
      estate mortgage
    
    
    58.8
    %
    
    65.2
    %
    
    62.9
    %
    
    56.8
    %
    
    58.4
    %Installment
      loans to individuals
    
    
    2.6
    %
    
    3.6
    %
    
    4.2
    %
    
    4.7
    %
    
    7.4
    %Lease
      financings
    
    
    -
    
    
    0.1
    %
    
    0.5
    %
    
    1.4
    %
    
    0.9
    %Total loans
    
    
    100.0
    %
    
    100.0
    %
    
    100.0
    %
    
    100.0
    %
    
    100.0
    %
  
 Table 5
represents the expected maturities for commercial, financial, and agricultural
loans and real estate construction loans at December 31, 2004. The table also
presents the rate structure for these loans that mature after one
year.
 
 **Table
5 - Loan Portfolio Maturity**
 (dollars
in thousands)
 
 **Rate
      Structure for Loans with****Maturity
      in Months**
    
    **Maturities
      Over**
      **One
      Year****Less
      than 12**
    
    **13-60**
    
    **Over
      60**
    
    **Total**
    
    **Variable
      Rates**
    
    **Fixed**
      **Rates**Commercial,
      financial, and agricultural
    
    $
    25,137
    
    
    20,601
    
    
    11,493
    
    
    57,231
    
    
    20,528
    
    
    11,566Real
      estate - construction
    
    
    140,158
    
    
    35,953
    
    
    -
    
    
    176,111
    
    
    31,592
    
    
    4,361$
    165,295
    
    
    56,554
    
    
    11,493
    
    
    233,342
    
    
    52,120
    
    
    15,927
  **Provision
and Allowance for Loan Losses**
 
 
 Table 6 **** presents
an analysis of activities in the allowance for loan losses for the past five
years. An allowance for possible losses is provided through charges to Flag’s
earnings in the form of a provision for loan losses. The provision for loan
losses was $1.8 million in 2004, $1.3 million in 2003, and $4.5 million in 2002.
Flag’s increase in the provision for loan losses was due to the growth in 2004
in loan balances. Flag’s provision for loan losses as a percentage of average
loans was 0.34%, 0.32% and 1.23% in 2004, 2003 and 2002 respectively. The larger
provision in 2002 was needed to replenish the allowance for loan losses due to
the higher than normal amount of net charge-offs experienced.
 
 Management
determines the level of the provision for loan losses based on outstanding loan
balances, the levels of non-performing assets, and reviews of assets classified
as substandard, doubtful, or loss and larger credits, together with an analysis
of historical loss experience and current economic conditions.
 
 As shown
in Table 6, the year-end allowance for loan losses increased to $8.6 million
from $6.7 million at December 31, 2003. Flag evidenced its improving credit
quality by a lower level of net charge-offs for 2004 and a lower level of
non-performing assets. Net charge-offs reached a five-year low of $328,000 or
0.06% of average loans outstanding for the year. These amounts compared to net
charge-offs of $1.5 million or 0.37% for 2003 and $5.0 million or 1.37% for
2002. The allowance for loan losses was 1.42% of gross loans at December 31,
2004 compared to 1.38% and 1.80% at December 31, 2003 and 2002,
respectively.
 
 
 Management
believes that the allowance for loan losses is both adequate and appropriate.
However, the future level of the allowance for loan losses is highly dependent
upon loan growth, loan loss experience, and other factors, which cannot be
anticipated with a high degree of certainty.
 ****
 **Table
6 - Analysis of the Allowance for Loan Losses**
 (dollars
in thousands)
 Years
      Ended December 31,2004
    
    2003
    
    2002
    
    2001
    
    2000Average
      loans
    
    $541,502
    
    417,395
    
    366,571
    
    378,867
    
    405,101Allowance
      for loan losses, beginningof period
    
    $
    6,685
    
    
    6,888
    
    
    7,348
    
    
    6,583
    
    
    7,017Charge-offs
      for the period:Commercial/financial/agricultural
    
    
    107
    
    
    410
    
    
    1,009
    
    
    400
    
    
    1,246Real estate construction loans
    
    
    -
    
    
    -
    
    
    284
    
    
    24
    
    
    -Real estate mortgage loans
    
    
    506
    
    
    1,289
    
    
    3,737
    
    
    980
    
    
    2,308Installment loans to individuals
    
    
    188
    
    
    189
    
    
    462
    
    
    453
    
    
    894Lease financings
    
    
    77
    
    
    18
    
    
    77
    
    
    206
    
    
    6Total
      charge-offs
    
    
    878
    
    
    1,906
    
    
    5,569
    
    
    2,063
    
    
    4,454Recoveries
      for the period:Commercial/financial/agricultural
    
    
    269
    
    
    86
    
    
    107
    
    
    102
    
    
    86Real estate construction loans
    
    
    -
    
    
    -
    
    
    2
    
    
    -
    
    
    -Real estate mortgage loans
    
    
    173
    
    
    148
    
    
    316
    
    
    134
    
    
    964Installment loans to individuals
    
    
    108
    
    
    136
    
    
    100
    
    
    34
    
    
    93Lease financings
    
    
    -
    
    
    12
    
    
    35
    
    
    70
    
    
    109Total recoveries
    
    
    550
    
    
    382
    
    
    560
    
    
    340
    
    
    1,252Net charge-offs for the period
    
    
    328
    
    
    1,524
    
    
    5,009
    
    
    1,723
    
    
    3,202Provision
      for loan losses
    
    
    1,845
    
    
    1,321
    
    
    4,549
    
    
    2,488
    
    
    3,597Allowance
      related to assets acquired purchased/sold
    
    
    400
    
    
    -
    
    
    -
    
    
    -
    
    
    (829
    )Allowance
      for loan losses, end of period
    
    $
    8,602
    
    
    6,685
    
    
    6,888
    
    
    7,348
    
    
    6,583Ratio
      of allowance to total loans
    
    
    1.42
    %
    
    1.38
    %
    
    1.80
    %
    
    1.95
    %
    
    1.68
    %Ratio
      of net charge-offs during the period to totalto
      average loans during the period
    
    
    0.06
    %
    
    0.37
    %
    
    1.37
    %
    
    0.45
    %
    
    0.79
    %
  **Asset
Quality**
 
 At
December 31, 2004, non-performing assets totaled $5.3 million, compared to $7.4
million at the end of 2003. The decrease in 2004 is attributed to a combination
of Flag’s comprehensive loan review program and its strict management of problem
assets. At December 31, 2004 and 2003, nonaccrual loans were $4.2 million and
$4.7 million, respectively. At December 31, 2004, there were no commitments to
advance additional funds on any loan classified as nonaccrual.
 
 Flag has
recognized impaired loans of approximately $4.8 million  and $5.4
million at December 31, 2004  and 2003,
respectively, with a total allowance for loan losses related to these loans of
approximately  $1.3
million and  $1.2
million, respectively . The
average balance of impaired loans was approximately  $5.1
million , $5.1
million, and $4.2 million during 2004, 2003 and 2002, respectively. Interest
income on  impaired
loans of approximately $196,000, $143,000, and $88,000 was recognized for cash
payments  received
in 2004, 2003 and 2002, respectively .
  
  Table 7
summarizes the non-performing assets for each of the last five
years.
 
 **Table
7 - Risk Elements**
 (dollars
in thousands)
 
 **December
      31,****2004**
    
    **2003**
    
    **2002**
    
    **2001**
    
    **2000**Loans
      on nonaccrual
    
    $
    4,224
    
    
    4,685
    
    
    9,243
    
    
    17,122
    
    
    7,144Loans
      past due 90 days and still accruing
    
    
    74
    
    
    309
    
    
    122
    
    
    594
    
    
    4,701Other
      real estate owned
    
    
    1,012
    
    
    2,432
    
    
    1,718
    
    
    2,831
    
    
    992Total
      non-performing assets
    
    $
    5,310
    
    $
    7,426
    
    
    11,083
    
    
    20,547
    
    
    12,837Total
      non-performing loans as apercentage of net loans
    
    
    0.89
    %
    
    1.56
    %
    
    2.96
    %
    
    5.57
    %
    
    3.34
    %
  **Risk
Elements**
 
 There may
be additional loans within Flag’s loan portfolio that may become classified as
conditions may dictate; however, management was not aware of any such loans that
are material in amount at December 31, 2004. At December 31, 2004, management
was unaware of any known trends, events, or uncertainties that will have, or
that are reasonably likely to have a material effect on the Bank’s or Flag’s
liquidity, capital resources or operations.
  **Deposits
and Borrowings**
 
 Total
deposits increased approximately $136.3 million during 2004, totaling $706.8
million at December 31, 2004. This compares to $570.6 million at December 31,
2003. The increase in Flag’s deposit base in 2004 is mostly attributable to the
aggressive sales effort on deposits in metro Atlanta. Demand deposits
(interest-bearing and non-interest bearing) increased $63.4 million in 2004 to
$396.8 million at December 31, 2004, while time deposits increased $75.8 million
to $289.2 million at December 31, 2004.
 
 The
maturities of time deposits of $100,000 or more issued by the Bank at December
31, 2004, are summarized in Table 8.
 
 **Table
8 - Maturities of Time Deposits Over $100,000**
 (dollars
in thousands)
 Three
      months or less
    
    $
    12,978Over
      three months through six months
    
    
    7,206Over
      six months through twelve months
    
    
    52,324Over
      twelve months
    
    
    102,793$
    175,301
 
 
 At December 31, 2004 and 2003,
the Bank held $133.1 million and $36.5 million, respectively, in certificates of
deposits obtained through the efforts of third party brokers.  The weighted
average cost at December 31, 2004 and 2003 was 3.38% and 1.42%, respectively.
The weighted average maturity at December 31, 2004 and 2003 was 17.6 months and
5.2 months, respectively.
 
 At December 31, 2004, the Bank was a shareholder in the FHLB. Through this
affiliation, advances totaling $25.0 million were outstanding at rates
competitive with other sources of funding with similar maturities. Management
anticipates continued utilization of this short and long-term source of funds to
minimize interest-rate risk and to fund growth in earning assets when profitable
to do so.
 During 2002, Flag repaid $8.4 million in fixed-rate advances from the FHLB prior
to their original maturity date, incurring a prepayment penalty totaling
approximately $266,000. These advances were repaid due to a falling
interest-rate environment in which Flag could obtain new borrowings at
significantly lower rates.
 Flag has
entered into a line-of-credit agreement with a commercial bank with a total
commitment amount of $11,000,000. The line of credit bears interest at 0.5%
below the prime rate and is secured by the common stock of the Bank. Borrowings
outstanding at December 31, 2004 were $4.3 million and the interest rate was
4.75%.
 
 Flag has
entered into securities sold under agreements to repurchase which represent
obligations to other parties. The obligations are secured by investment
securities, and such collateral is held by a safekeeping agent. The maximum
amount of outstanding agreements at any month-end during 2004 and 2003 totaled
$2,589,000 and $4,098,000, respectively, and the daily average of such
agreements totaled $2,415,000 and $1,975,000 respectively. The weighted average
cost was 1.45% and 1.37% at December 31, 2004 and 2003, respectively, while the
weighted average cost during 2004 and 2003 was approximately 1.38% and 1.35%,
respectively.
 
 Flag
maintains relationships with correspondent banks that can provide funds on short
notice. As of December 31, 2004, Flag has arrangements for short-term unsecured
advances up to $35,000,000.
 
 Flag has
entered into three line-of credit agreements to purchase federal funds with
total commitment amounts of $19,000,000 $10,000,000 and $6,000,000 respectively.
There were no federal funds purchased outstanding as of December 31, 2004 or
2003.
 
 During
2004, Flag entered into a line-of-credit agreement with the Federal Reserve Bank
of Atlanta (“FRB”) through which Flag would pledge a portion of its unencumbered
loan portfolio to secure a commitment totaling $149.5 million at December 31,
2004. The commitment level varies proportional to the collateral balances but
Flag anticipates the commitment to remain in excess of $125 million. Flag did
not use the line during 2004 and established the line in order to enhance the
Bank’s liquidity ratios and preparedness.
 
 During the first quarter of 2004, the Company formed a wholly-owned Connecticut
statutory business trust, Flag Financial Corporation Statutory Trust, a
subsidiary whose sole purpose was to issue $14.4 million of Trust Preferred
Securities through a pool sponsored by SunTrust Bank in Atlanta, Georgia. The
Trust Preferred Securities have a maturity of 30 years and are redeemable after
five years with certain exceptions. At December 31, 2004, the floating-rate
securities had a 5.31% interest rate, which will reset quarterly at the
three-month LIBOR rate plus 2.75%. The Trust Preferred Securities are recorded
as junior subordinated debentures on the balance sheets, but subject to certain
limitations qualify for Tier 1 capital for regulatory capital
purposes.
 
  **Asset-Liability
Management**
 
 The
primary objective of Flag’s asset and liability management program is to control
exposure to interest- rate risk (the exposure to changes in net interest income
due to changes in market interest rates) so as to enhance its earnings and
protect its net worth against potential loss resulting from interest rate
fluctuations.
 
 
 Historically,
the average term to maturity or repricing (rate changes) of assets (primarily
loans and investment securities) has exceeded the average repricing period of
liabilities (primarily deposits and borrowings). Table 9 provides information
about the amounts of interest-earning assets and interest-bearing liabilities
outstanding as of December 31, 2004, that are expected to mature, prepay or
reprice in each of the future time periods shown (i.e., the interest rate
sensitivity). As presented in this table, at December 31, 2004, the liabilities
subject to rate changes within one year exceeded Flag’s assets subject to rate
changes within one year. Flag’s primary source of funding has been demand
deposits (interest-bearing and non-interest bearing) instead of time deposits
and wholesale borrowings with longer maturities. This method of funding earning
assets has issues concerning interest rate risk, liquidity and profitability,
all of which were contemplated and measured by the Company. Flag concluded that
this strategy is the most profitable method of funding growth in earning assets
of the Company for the foreseeable future and has committed significant sales,
marketing and training resources at being successful in this effort. Where
interest rate risk is concerned, Flag considered factors such as account size,
relationship strength and historical rate levels needed to remain competitive.
Generally speaking, it is the opinion of management that these deposits are less
sensitive to rate movements than the earning assets they are funding. Flag uses
an interest rate simulation model that uses management assumptions and theories
regarding rate movements and the impact each movement will have on individual
components of the balance sheet. This approach, believed to produce more
accurate results than the approach summarized in the following table, indicates
that Flag’s balance sheet is, in fact, asset-sensitive, meaning a rising rate
environment would have a positive impact on Flag’s net interest
income.
 
 Management
carefully measures and monitors interest rate sensitivity and believes that its
operating strategies offer protection against interest rate risk. As required by
various regulatory authorities, Flag’s Board of Directors has established an
interest rate risk policy, which sets specific limits on interest rate risk
exposure. Adherence to this policy is reviewed by Flag’s executive committee and
presented at least annually to the Board of Directors.
 
 **Table
9 - Interest Rate Sensitivity Analysis**
 (dollars
in thousands)
 **December
      31, 2004****Interest
      Rate Sensitivity in Months****Less
      than 12**
    
    **13-36**
    
    **37-60**
    
    **Over
      60**
    
    **Total**Interest-earning
      assets:Loans
    
    $
    450,934
    
    
    66,452
    
    
    47,055
    
    
    40,262
    
    
    604,703Loans
      held-for-sale
    
    
    10,688
    
    
    -
    
    
    -
    
    
    -
    
    
    10,688Investment
      securities
    
    
    59,198
    
    
    32,178
    
    
    13,516
    
    
    19,659
    
    
    124,551Interest-bearing
      deposits in other banks
    
    
    18,870
    
    
    -
    
    
    -
    
    
    -
    
    
    18,870Federal
      funds sold
    
    
    13,574
    
    
    -
    
    
    -
    
    
    -
    
    
    13,574Total
      interest-earning assets
    
    
    553,264
    
    
    98,630
    
    
    60,571
    
    
    59,921
    
    
    772,386Interest-bearing
      liabilities:Time
      deposits
    
    
    153,988
    
    
    131,667
    
    
    3,011
    
    
    489
    
    
    289,155NOW
      and money market accounts
    
    
    347,940
    
    
    -
    
    
    -
    
    
    -
    
    
    347,940Savings
      accounts
    
    
    20,940
    
    
    -
    
    
    -
    
    
    -
    
    
    20,940Federal Funds purchased andrepurchase agreements
    
    
    2,295
    
    
    -
    
    
    -
    
    
    -
    
    
    2,295Junior
      subordinated debentures
    
    
    14,433
    
    
    -
    
    
    -
    
    
    -
    
    
    14,433Other
      borrowings
    
    
    4,300
    
    
    -
    
    
    -
    
    
    -
    
    
    4,300FHLB
      advances
    
    
    25,000
    
    
    -
    
    
    -
    
    
    -
    
    
    25,000Total
      interest-bearing liabilities
    
    
    568,896
    
    
    131,667
    
    
    3,011
    
    
    489
    
    
    704,063Interest
      rate sensitivity gap
    
    
    (15,632
    )
    
    (33,037
    )
    
    57,560
    
    
    59,432
    
    
    68,323Cumulative
      interest rate sensitivity gap
    
    $
    (15,632
    )
    
    (48,669
    )
    
    8,891
    
    
    68,323Cumulative
      interest rate sensitivity gapto
      total assets
    
    
    (1.9
    %)
    
    (5.9
    %)
    
    1.1
    %
    
    8.2
    %
 
 
 Table
10 **** represents
the expected maturity of investment securities by maturity date and average
yields based on amortized cost at December 31, 2004. It should be noted that the
composition and maturity/repricing distribution of the investment portfolio is
subject to change depending on rate sensitivity, capital needs, and liquidity
needs.
 
 **Table
10 - Expected Maturity of Investment Securities
Available-for-sale**
 (dollars
in thousands)
 
  **Expected
      Maturity in Years****Within
      1 Year**
    
    **After
      One But Within Five Years**
    
    **After
      Five But Within Ten Years**
    
    **After
      10 Years**
    
    **Totals****Amount**
    
    **Yield**
    
    **Amount**
    
    **Yield**
    
    **Amount**
    
    **Yield**
    
    **Amount**
    
    **Yield**U.S.
      Treasury and agencies
    
    **$**
    ****26,509
    
    
    2.08
    %
    $
    18,793
    
    
    2.98
    %
    $
    10,105
    
    
    2.33
    %
    $
    -
    
    
    -
    
    $
    55,407State,
      county and municipals
    
    
    ****396
    
    
    2.23
    %
    
    2,156
    
    
    7.01
    %
    
    2,163
    
    
    7.41
    %
    
    2,124
    
    
    7.61
    %
    
    6,839Corporate
      debt securities
    
    
    1,503
    
    
    7.57
    %
    
    -
    
    
    -
    
    
    -
    
    
    -
    
    
    -
    
    
    -
    
    
    1,503Equity
      securities
    
    
    ******-**
    
    
    -
    
    
    -
    
    
    -
    
    
    -
    
    
    -
    
    
    309
    
    
    -
    
    
    309Mortgage-backed
      securities
    
    
    14
    
    
    5.50
    %
    
    9,073
    
    
    3.64
    %
    
    2,434
    
    
    5.75
    %
    
    16,680
    
    
    4.40
    %
    
    28,201Trust
      preferred securities
    
    
    -
    
    
    -
    
    
    -
    
    
    -
    
    
    -
    
    
    -
    
    
    19,041
    
    
    6.60
    %
    
    19,041$
    28,422
    
    
    2.37
    %
    $
    30,022
    
    
    3.47
    %
    $
    14,702
    
    
    3.64
    %
    $
    38,154
    
    
    5.64
    %
    $
    111,300
   **Liquidity**
 
 The
objective of liquidity management is to ensure that sufficient funding is
available, at reasonable cost, to meet the ongoing operational cash needs of
Flag and to take advantage of income-producing opportunities as they arise.
While the desired level of liquidity will vary depending upon a variety of
factors, it is the primary goal of Flag to maintain a sufficient level of
liquidity in all expected economic environments. Liquidity is defined as the
ability of a bank to convert assets into cash or cash equivalents without
significant loss and to raise additional funds by increasing liabilities.
Liquidity management involves maintaining Flag’s ability to meet the daily cash
flow requirements of the Bank’s customers, both depositors and
borrowers .
 
 The
primary objectives of asset/liability management are to provide for adequate
liquidity in order to meet the needs of customers and to maintain an optimal
balance between interest-sensitive assets and interest-sensitive liabilities; so
that Flag can also meet the investment requirements of its shareholders as
market interest rates change. Daily monitoring of the sources and uses of funds
is necessary to maintain a position that meets both requirements.
 
 The asset
portion of the balance sheet provides liquidity primarily through loan principal
repayments and the maturities and sales of securities. Mortgage loans
held-for-sale totaled $10.7 million at December 31, 2004, and typically turns
over every 45 days as the closed loans are sold to investors in the secondary
market. Real estate-construction and commercial loans that mature in one year or
less amounted to $165.3 million, or 27 .3% of
the total loan portfolio at December 31, 2004. Other short-term investments such
as federal funds sold are additional sources of liquidity.
 
 The
liability section of the balance sheet provides liquidity through depositors’
interest-bearing and non-interest bearing deposit accounts. Federal funds
purchased, FHLB advances, other borrowings and securities sold under agreements
to repurchase are additional sources of liquidity and represent Flag’s
incremental borrowing capacity. These sources of liquidity are short-term in
nature and are used as necessary to fund asset growth and meet other short-term
liquidity needs. See “Off Balance Sheet Arrangements and Contractual
Obligations” for additional information.
 
 As
disclosed in Flag’s consolidated statements of cash flows included in the
consolidated financial statements, net cash used in operating activities was
$814,000 during 2004. The major source of cash by operating activities is net
earnings during 2004 of $7.4 million. Net cash used by investing activities was
$144.9 million and consisted primarily of an increase in net loans and the cash
paid in the branch sale during the first quarter of 2004. Net cash provided by
financing activities was $149.3 million, and consisted mostly of the growth in
deposits offset to some degree by repayments of FHLB advances during
2004.
 
 In the
opinion of management, Flag’s liquidity position at December 31, 2004 is
sufficient to meet its expected cash flow requirements. Reference should be made
to the consolidated statements of cash flows appearing in the consolidated
financial statements for the three-year analysis of the changes in cash and cash
equivalents resulting from operating, investing and financing
activities.
 
 **Off
Balance Sheet Arrangements and Contractual Obligations**
 
 Flag 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 consist of commitments to extend credit and 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. Standby
letters of credit are written conditional commitments issued by the Bank to
guarantee the performance of a customer to a third party. Commitments
generally have fixed expiration dates or other termination clauses and may
require payment of a  fee. A
commitment involves, to varying degrees, elements of credit and interest rate
risk in excess of the amount recognized in the balance sheets. Flag’s exposure
to credit loss in the event of non-performance by the other party to the
instrument is represented by the contractual notional amount of the instrument.
 
 
 Since
certain commitments are expected to expire without being drawn upon, the total
commitment amounts do not necessarily represent future cash requirements. Flag
uses the same credit policies in making commitments to extend credit as they do
for on-balance-sheet instruments. Collateral held for commitments to extend
credit varies but may include accounts receivable, inventory, property, plant,
equipment, and income-producing commercial properties.
 
 The
following table summarizes Flag’s off-balance-sheet financial instruments whose
contract amounts represent credit risk as of December 31, 2004 and 2003 (in
thousands):
 
 2004
    
    2003Commitments
      to extend credit
    
    $
    142,036
    
    
    124,342Standby
      letters of credit
    
    $
    3,650
    
    
    1,128
 
 The
following table presents additional information about Flag’s contractual
obligations as of December 31, 2004, which by their terms have maturity and
termination dates subsequent to December 31, 2004 (dollars in
thousands):
 
 Next
      12
      months
    
    12-36
      months
    
    37-60
      months
    
    More
      than
      60
      months
    
    TotalsCertificates
      of deposit
    
    $
    153,988
    
    
    131,666
    
    
    3,011
    
    
    490
    
    
    289,155Securities
      sold under agreements to repurchase
    
    
    2,295
    
    
    -
    
    
    -
    
    
    -
    
    
    2,295Federal
      Home Loan Bank advances
    
    
    -
    
    
    25,000
    
    
    -
    
    
    -
    
    
    25,000Minimum
      operating lease commitments
    
    
    866
    
    
    1,932
    
    
    1,338
    
    
    1,719
    
    
    5,855
  **Capital
Resources and Dividends**
 
 Stockholders’
equity at December 31, 2004 increased 6.0% to $69.2 million from $65.3 million
at December 31, 2003. This increase is the combination of several factors
including a stock repurchase program that repurchased approximately $3.9 million
of Company stock. Offsetting the impact of the stock repurchase program were net
earnings of $7.4 million and the issuance of $3.3 million of stock relating to
the purchase of Payroll Solutions in the fourth quarter of 2004.
 
 The
Federal Deposit Insurance Corporation Improvement Act (“FDICIA”) requires
federal banking agencies to take “prompt corrective action” with regard to
institutions that do not meet minimum capital requirements. As a result of
FDICIA, the federal banking agencies introduced an additional capital measure
called the “Tier 1 risk-based capital ratio.” The Tier 1 ratio is the ratio of
core capital to risk adjusted total assets. Note 13 to the Consolidated
Financial Statements presents a summary of FDICIA’s capital tiers compared to
Flag’s and the Bank’s actual capital levels. The Bank exceeded all requirements
of a “well-capitalized” institution at December 31, 2004. See
“Business-Supervision and Regulation-Capital Adequacy.”
 
 **Table
11 - Equity Ratios**
 ****
 **Years
      Ended December 31,******
    
    **2004**
    
    **2003**
    
    **2002**Return
      on average assets
    
    
    0.99
    %
    
    0.95
    %
    
    (0.36
    %)Return
      on average equity
    
    
    11.19
    %
    
    9.64
    %
    
    (3.39
    %)Dividend
      payout ratio
    
    
    27.38
    %
    
    33.35
    %
    
    N/AAverage
      equity to average assets
    
    
    8.86
    %
    
    9.81
    %
    
    10.49
    %
  
 **Provision
for Income Taxes**
  The
provision for income taxes in 2004 was $3.3 million, compared to $2.7 million in
2003 and a benefit for income taxes in 2002 of $2.0 million. Flag’s effective
tax rates were 31.0%, 30.9% and 52.6% in 2004, 2003 and 2002, respectively. The
tax rates for 2004 and 2003 are lower than the statutory federal rate of 34%
primarily due to interest income on tax-exempt securities and general business
credits. The effective benefit rate in 2002 was higher than the federal
statutory rate of 34% due to interest income on tax- exempt securities and
general business credits. Also, during 2002 the amount of loss before income
taxes was lower than the earnings before income taxes in prior years. The effect
of tax-exempt interest income and general business credits is greater in years
that income (loss) before taxes is lower. See Flag’s consolidated financial
statements for an analysis of income taxes.
 
 **Impact
of Inflation and Changing Prices**
  The
consolidated financial statements and related financial data presented herein
have been prepared in accordance with generally accepted accounting principles
which require the measurement of financial position and operating results in
terms of historical dollars without considering changes in relative purchasing
power over time due to inflation.
 
 Unlike
most industrial companies, virtually all of the assets and liabilities of a
financial institution are monetary in nature. As a result, interest rates
generally have a more significant impact on a financial institution’s
performance than does the effect of inflation. The liquidity and maturity
structures of Flag’s assets and liabilities are critical to the maintenance of
acceptable performance levels.
  **Recent
Accounting Pronouncements**
 
 As
permitted by SFAS No. 123 *Accounting
for Stock-Based Compensation* , Flag
currently accounts for share-based payments to employees using APB opinion No.
25’s intrinsic value method and, as such, generally recognizes no compensation
expense for employee stock options. Accordingly, the adoption of SFAS No. 123’s
fair value method will not have a significant impact on our result of
operations, and it will not have a material impact on our overall financial
position. The impact of adoption of SFAS No. 123(R) cannot be predicted at this
time because it will depend on levels of share-based payments granted in the
future. However, had we adopted SFAS No.123(R) in prior periods, the impact of
that standard would have approximated the impact of SFAS No. 123 as described in
the disclosure of pro forma net income earnings per share in Note 1 to our
consolidated financial statements. SFAS No. 123(R) also requires the benefits of
tax deductions in excess of recognized compensation cost to be reported as a
financing cash flow, rather than as an operating cash flow as required under
current literature. This requirement will reduce net operating cash flows and
increase net financing cash flows in the periods after adoption. While the
company cannot estimate what those amounts will be in the future (because they
depend on, among other things, when employees exercise stock options), the
amount of operating cash flows recognized in prior periods for such excess tax
deductions were insignificant.
 
 During
March 2004, the SEC issued Staff Accounting Bulletin 105, *Application
of Accounting Principles*  *to
Loan Commitments* (SAB
105). SAB 105 addresses the accounting for loan commitments and provides that
the required fair value measurement include only differences between the
guaranteed interest rate in the loan commitment and a market interest rate
excluding any expected future cash flows related to the customer relationship of
loan servicing. SAB 105 applies to mortgage loan commitments accounted for as
derivatives and entered into after March 31, 2004. Substantially all of our
mortgage loan commitments are based on rates provided by third party
correspondents, who have agreed to purchase resulting loans at those rates. As a
result, we are protected from interest rate risk, and the adoption of SAB 105
did not have a material impact on our consolidated financial
statements.
 
 In March
2004, the Emerging Issues Task Force (“EITF”) released EITF Issue 03-01, *The
Meaning of Other-Than-Temporary Impairment and its Application to Certain
Investments* . The
Issue provides guidance for determining whether an investment is
other-than-temporarily impaired and requires certain disclosures with respect to
these investments. The recognition and measurement guidance for
other-than-temporary impairment has been delayed by the issuance of FASB Staff
Position EITF 03-1-1 on September 30, 2004. The adoption of Issue 03-1 did not
result in any other-than-temporary impairment.
 
 In
December 2003, the American Institute of Certified Public Accountants (AICPA)
issued Statement of Position (SOP) 03-3, *Accounting
for Loans or Certain Debt Securities Acquired in a Transfer.* The SOP
addresses accounting for differences between contractual cash flows and cash
flows expected to be collected from an investor’s initial investment in loans or
debt securities acquired in a transfer if those differences relate to a
deterioration of credit quality. The SOP also prohibits companies from “carrying
over” or creating a valuation allowance in the initial accounting for loans
acquired that meet the scope criteria of the SOP. The SOP is effective for loans
acquired in fiscal years beginning after December 15, 2004. The adoption of this
SOP is not expected to have a material impact on the Company’s financial
position or results of operations. In May 2003, the FASB issued SFAS No. 150, *“Accounting
for Certain Financial Instruments with Characteristics of Both Liabilities and
Equity”* (“SFAS
150”), which changes the accounting for certain financial instruments that have
characteristics of liabilities and equity. SFAS 150, which is effective for
interim periods beginning after June 15, 2003, requires that those instruments
be classified as liabilities in statements of financial position. The adoption
of SFAS 150 did not have a material impact on the Company’s financial position
or results of operations.
 
 In
January 2003, the Financial Accounting Standards Board (“FASB”) issued FIN No.
46, “ *Consolidation
of Variable Interest Entities”* (“FIN
46”). This interpretation of Accounting Research Bulletin No. 51, “Consolidated
Financial Statements,” addresses consolidation by business enterprises of
variable interest entities. The provisions of FIN 46 are effective immediately
for all variable interest entities created after January 31, 2003 and, for the
first fiscal year or interim period beginning after June 15, 2003, for variable
interest entities in which an enterprise holds variable interest that it
acquired before February 1, 2003. Flag implemented fully the provisions and
requirements of FIN 46 during 2004 without material impact on its financial
position or results of operations.
 **ITEM
7A.****QUANTITATIVE
AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK**
 The Company’s net interest income and the fair value of its financial
instruments (interest-earning assets and interest-bearing liabilities) are
influenced by changes in market interest rates. The Company actively manages its
exposure to interest rate fluctuations through policies established by its
senior management and Board of Directors. The Company’s senior management
implements asset/liability management policies, develops and implements
strategies to improve balance sheet positioning and net interest income and
regularly assesses the interest rate sensitivity of the Bank.
 The
Company’s asset/liability management committee (“ALCO”) utilizes an interest
rate simulation model to monitor and evaluate the impact of changing interest
rates on net interest income and the market value of its investment portfolio.
The ALCO policy limits the maximum percentage changes in net interest income and
investment portfolio equity, assuming a simultaneous, instantaneous change in
interest rate. These percentage changes are as follows:
 
 
 Changes
      in
    
    Percentage
    
    Percent
      Change inInterest
      Rates
    
    Change
      in Net
    
    Market
      Value of(In
      Basis Points)
    
    Interest
      Income
    
    Portfolio
      Equity300
    
    20%
    
    20%200
    
    20%
    
    20%100
    
    20%
    
    20%
 
 As of
December 31, 2004, the Company was in compliance with its ALCO policy. See also
“Management’s Discussion and Analysis of Financial Condition and Results of
Operations - Asset-Liability Management.”
  
  **ITEM
8.****FINANCIAL
STATEMENTS AND SUPPLEMENTARY DATA**
 
 The
following financial statements are included herein:
 Report of Independent Certified Public AccountantsConsolidated Balance Sheets as of December 31, 2004 and
    2003Consolidated Statements of Operations for the years ended December 31,
      2004, 2003 and 2002Consolidated Statements of Comprehensive Income (Loss) for the years ended
      December 31, 2004, 2003 and 2002Consolidated Statements of Changes in Stockholders’ Equity for the years
      ended December 31, 2004, 2003 and 2002Consolidated Statements of Cash Flows for the years ended December 31,
      2004, 2003 and 2002Notes to Consolidated Financial
Statements
   
   **REPORT
OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**
  
 To the
Board of Directors
 Flag
Financial Corporation
 Atlanta,
Georgia
 
 We have
audited management's assessment, included in the accompanying management's
report on internal controls, that Flag
Financial Corporation maintained effective internal control over financial reporting as of December
31, 2004, based on criteria established in Internal Control-Integrated Framework
issued by the Committee of Sponsoring Organizations of the Treadway Commission. Flag
Financial Corporation ’s
management is responsible for maintaining effective internal control over
financial reporting and for its assessment of the effectiveness of internal
control over financial reporting. Our responsibility is to express an opinion on
management's assessment and an opinion on the effectiveness of the Company's
internal control over financial reporting based on our audit.
 
 We
conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether effective
internal control over financial reporting was maintained in all material
respects. Our audit included obtaining an understanding of internal control over
financial reporting, evaluating management's assessment, testing and evaluating
the design and operating effectiveness of internal control, and performing such
other procedures as we considered necessary in the circumstances. We believe
that our audit provides a reasonable basis for our opinion.
 
 A
company's internal control over financial reporting is a process designed to
provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance
with generally accepted accounting principles. A company's internal control over
financial reporting includes those policies and procedures that (1) pertain to
the maintenance of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the Company; (2)
provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted
accounting principles, and that receipts and expenditures of the Company are
being made only in accordance with authorizations of management and directors of
the Company; and (3) provide reasonable assurance regarding prevention or timely
detection of unauthorized acquisition, use, or disposition of the Company's
assets that could have a material effect on the financial
statements.
 
 Because
of its inherent limitations, internal control over financial reporting may not
prevent or detect misstatements. Also, projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree of compliance
with the policies or procedures may deteriorate.
 
 In our
opinion, management's assessment that Flag
Financial Corporation maintained effective internal control over financial reporting as of December
31, 2004, is fairly stated, in all material respects, based on criteria
established in Internal Control-Integrated Framework issued by the Committee of
Sponsoring Organizations of the Treadway Commission. Also in our opinion, Flag
Financial Corporation maintained, in all material respects, effective internal control over financial
reporting as of December 31, 2004, based on criteria established in Internal
Control-Integrated Framework issued by the Committee of Sponsoring Organizations
of the Treadway Commission.
 
 We have
also audited, in accordance with the standards of the Public Company Accounting
Oversight Board (United States), the consolidated financial statements of Flag
Financial Corporation and our
report dated February 24, 2005, expressed an unqualified opinion.
 
 
 
 
 /s/ PORTER KEADLE MOORE, LLP
 
 Atlanta, Georgia
 February
24, 2005
  
  
 **REPORT
OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**
 
 
 
 
 To the
Board of Directors
 Flag
Financial Corporation
 Atlanta,
Georgia
 
 
 We have
audited the accompanying consolidated balance sheets of Flag Financial
Corporation and subsidiary as of December 31, 2004 and 2003, and the related
statements of operations, comprehensive income (loss), changes in stockholders’
equity and cash flows for each of the three years in the period ended December
31, 2004. These financial statements are the responsibility of Flag’s
management. Our responsibility is to express an opinion on these financial
statements based on our audits.
 
 We
conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). 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 Flag Financial Corporation
and subsidiary as of December 31, 2004 and 2003, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 2004, in conformity with accounting principles generally accepted
in the United States of America.
 
 We also
have audited, in accordance with the standards of the Public Company Accounting
Oversight Board (United States), the effectiveness of Flag Financial Corporation
and subsidiary’s internal control over financial reporting as of December 31,
2004, based on *criteria
established in Internal Control—Integrated Framework issued by the Committee of
Sponsoring Organizations of the Treadway Commission (COSO)* and our
report dated February 24, 2005 expressed an unqualified opinion on management’s
assessment of the effectiveness of Flag Financial Corporation’s internal control
over financial reporting and an unqualified opinion on the effectiveness of Flag
Financial Corporation’s internal control over financial reporting.
 
 /S/
PORTER KEADLE MOORE, LLP
 
 
 Atlanta,
Georgia
 February
24, 2005
 
 
 
 **FLAG
FINANCIAL CORPORATION AND SUBSIDIARY**
 
 **Consolidated
Balance Sheets**
 
 **December
31, 2004 and 2003**
 
 **Assets**
 
 2004
    
    2003*(In
      Thousands)*Cash
      and due from banks
    
    $
    13,345
    
    
    17,454Other
      interest-bearing deposits in banks
    
    
    13,397
    
    
    12,183Federal
      funds sold
    
    
    13,574
    
    
    7,100Cash
      and cash equivalents
    
    
    40,316
    
    
    36,737Other
      interest-bearing deposits in banks
    
    
    5,473
    
    
    2,675Investment
      securities available-for-sale
    
    
    111,390
    
    
    122,565Other
      investments
    
    
    13,161
    
    
    14,944Mortgage
      loans held-for-sale
    
    
    10,688
    
    
    4,234Loans,
      net
    
    
    596,101
    
    
    477,095Premises
      and equipment, net
    
    
    14,458
    
    
    16,497Other
      assets
    
    
    36,750
    
    
    29,110Total
      assets
    
    $
    828,337
    
    
    703,857**Liabilities and Stockholders’ Equity**Deposits:Demand
    
    $
    48,812
    
    
    51,087Interest-bearing
      demand
    
    
    347,940
    
    
    282,261Savings
    
    
    20,940
    
    
    23,898Time
    
    
    113,854
    
    
    131,681Time,
      over $100,000
    
    
    175,301
    
    
    81,643Total
      deposits
    
    
    706,847
    
    
    570,570Federal
      funds purchased and repurchase agreements
    
    
    2,295
    
    
    4,097Advances
      from Federal Home Loan Bank
    
    
    25,000
    
    
    58,000Other
      borrowings
    
    
    4,300
    
    
    1,100Junior
      subordinated debentures
    
    
    14,433
    
    
    -Other
      liabilities
    
    
    6,260
    
    
    4,830Total
      liabilities
    
    
    759,135
    
    
    638,597CommitmentsStockholders’
      equity:Preferred
      stock (10,000 shares authorized; none issued and
    outstanding)
    
    
    -
    
    
    -Common
      stock ($1 par value, 20,000 shares authorized, 10,054 and
      9,775shares
      issued in 2004 and 2003, respectively)
    
    
    10,054
    
    
    9,775Additional
      paid-in capital
    
    
    27,954
    
    
    24,557Retained
      earnings
    
    
    44,642
    
    
    39,294Accumulated
      other comprehensive income
    
    
    56
    
    
    1,211Less:
      treasury stock, at cost; 1,551 and 1,247 shares in 2004 and 2003,
      respectively
    
    
    (13,504
    )
    
    (9,577
    )Total
      stockholders’ equity
    
    
    69,202
    
    
    65,260$
    828,337
    
    
    703,857
 See
accompanying notes to consolidated financial statements .
 
 
 
 **FLAG
FINANCIAL CORPORATION AND SUBSIDIARY**
 **Consolidated
Statements of Operations**
 
 **For
the Years Ended December 31, 2004, 2003 and 2002**
 
 2004
    
    2003
    
    2002*(In
      Thousands Except Per Share Data)*Interest
      income:Interest
      and fees on loans
    
    $
    37,066
    
    
    30,083
    
    
    29,424Interest
      on investment securities
    
    
    5,061
    
    
    5,832
    
    
    6,989Interest-bearing
      deposits and federal funds sold
    
    
    494
    
    
    619
    
    
    261Total
      interest income
    
    
    42,621
    
    
    36,534
    
    
    36,674Interest
      expense:Deposits
    
    
    10,829
    
    
    9,674
    
    
    11,264Borrowings
    
    
    1,228
    
    
    873
    
    
    1,108Total
      interest expense
    
    
    12,057
    
    
    10,547
    
    
    12,372Net
      interest income before provision for loan losses
    
    
    30,564
    
    
    25,987
    
    
    24,302Provision
      for loan losses
    
    
    1,845
    
    
    1,321
    
    
    4,549Net
      interest income after provision for loan losses
    
    
    28,719
    
    
    24,666
    
    
    19,753Other
      income:Service
      charges on deposit accounts
    
    
    3,660
    
    
    3,417
    
    
    3,508Gain
      (loss) on sales of investment securities
    
    
    700
    
    
    136
    
    
    (341
    )Mortgage
      banking activities
    
    
    2,410
    
    
    4,241
    
    
    2,902Gain
      on sale of branches
    
    
    3,000
    
    
    -
    
    
    -Other
    
    
    1,698
    
    
    2,571
    
    
    1,326Total
      other income
    
    
    11,468
    
    
    10,365
    
    
    7,395Other
      expenses:Salaries
      and employee benefits
    
    
    17,703
    
    
    15,750
    
    
    18,611Professional
      fees
    
    
    1,277
    
    
    811
    
    
    1,796Postage,
      printing and supplies
    
    
    914
    
    
    973
    
    
    1,019Communications
    
    
    2,152
    
    
    2,103
    
    
    1,840Occupancy
    
    
    3,679
    
    
    3,511
    
    
    3,589Other
      operating
    
    
    3,784
    
    
    3,054
    
    
    4,150Total
      other expenses
    
    
    29,509
    
    
    26,202
    
    
    31,005Earnings
      (loss) before income taxes and extraordinary item
    
    
    10,678
    
    
    8,829
    
    
    (3,857
    )Provision
      (benefit) for income taxes
    
    
    3,310
    
    
    2,724
    
    
    (2,028
    )Earnings
      (loss) before extraordinary item
    
    
    7,368
    
    
    6,105
    
    
    (1,829
    )Extraordinary
      item - loss on redemption of debt,net
      of income tax benefit of $101 in 2002
    
    
    -
    
    
    -
    
    
    165Net
      earnings (loss)
    
    $
    7,368
    
    
    6,105
    
    
    (1,994
    )Basic
      earnings (loss) per share:Basic
      earnings (loss) before extraordinary item
    
    $
    0.88
    
    
    0.72
    
    
    (0.22
    )Extraordinary
      item
    
    
    -
    
    
    -
    
    
    (0.02
    )Basic
      earnings (loss) per share
    
    $
    0.88
    
    
    0.72
    
    
    (0.24
    )Diluted
      earnings (loss) per share:Diluted
      earnings (loss) before extraordinary item
    
    $
    0.82
    
    
    0.67
    
    
    (0.22
    )Extraordinary
      item
    
    
    -
    
    
    -
    
    
    (0.02
    )Diluted
      earnings (loss) per share
    
    $
    0.82
    
    
    0.67
    
    
    (0.24
    )
 See
accompanying notes to consolidated financial statements.
 
 
 
 **FLAG
FINANCIAL CORPORATION AND SUBSIDIARY**
 
 **Consolidated
Statements of Comprehensive Income (Loss)**
 
 **For
the Years Ended December 31, 2004, 2003 and 2002**
 
 
 2004
    
    2003
    
    2002*(In
      Thousands)*Net
      earnings (loss)
    
    $
    7,368
    
    
    6,105
    
    
    (1,994
    )Other
      comprehensive (loss) income, net of tax:Unrealized
      gains (losses) on investment securitiesavailable-for-sale:Unrealized
      (losses) gains arising during the period,net
      of tax (benefit) of $(448), $(385) and $291, respectively
    
    
    (721
    )
    
    (629
    )
    
    475Reclassification
      adjustment for (gains) losses includedin
      net earnings (loss), net of tax of $266, $52 and $(130), respectively
    
    
    (434
    )
    
    (84
    )
    
    211Unrealized
      loss on cash flow hedges, net of tax of $0, $46 and $183,
      respectively
    
    
    -
    
    
    (75
    )
    
    (299
    )Other
      comprehensive (loss) income
    
    
    (1,155
    )
    
    (788
    )
    
    387Comprehensive
      income (loss)
    
    $
    6,213
    
    
    5,317
    
    
    (1,607
    )
 
 See
accompanying notes to consolidated financial statements .
 
 
 
 **FLAG
FINANCIAL CORPORATION AND SUBSIDIARY**
 
 **Consolidated
Statements of Changes in Stockholders’ Equity**
 
 **For
the Years Ended December 31, 2004, 2003 and 2002**
  AccumulatedAdditional
    
    
    
    OtherCommon
      Stock
    
    Paid-in
    
    Retained
    
    Comprehensive
    
    TreasuryShares
    
    Amount
    
    Capital
    
    Earnings
    
    Income
      (Loss)
    
    Stock
    
    Total*(In
      Thousands Except Share Data)*Balance,
      December 31, 2001
    
    
    8,277,995
    
    
    8,278
    
    
    11,355
    
    
    39,223
    
    
    1,612
    
    
    (6,445
    )
    
    54,023Sale
      of common stock
    
    
    1,272,000
    
    
    1,272
    
    
    10,435
    
    
    -
    
    
    -
    
    
    -
    
    
    11,707Sale
      of warrants
    
    
    -
    
    
    -
    
    
    1,236
    
    
    -
    
    
    -
    
    
    -
    
    
    1,236Purchase
      of treasury stock (338,960 shares)
    
    
    -
    
    
    -
    
    
    -
    
    
    -
    
    
    -
    
    
    (3,132
    )
    
    (3,132
    )Exercise
      of stock options
    
    
    88,506
    
    
    89
    
    
    437
    
    
    -
    
    
    -
    
    
    -
    
    
    526Change
      in accumulated othercomprehensive
      income
    
    
    -
    
    
    -
    
    
    -
    
    
    -
    
    
    387
    
    
    -
    
    
    387Net
      loss
    
    
    -
    
    
    -
    
    
    -
    
    
    (1,994
    )
    
    -
    
    
    -
    
    
    (1,994
    )Dividends
      declared ($0.24 per share)
    
    
    -
    
    
    -
    
    
    -
    
    
    (2,004
    )
    
    -
    
    
    -
    
    
    (2,004
    )Balance,
      December 31, 2002
    
    
    9,638,501
    
    
    9,639
    
    
    23,463
    
    
    35,225
    
    
    1,999
    
    
    (9,577
    )
    
    60,749Sale
      of common stock
    
    
    12,000
    
    
    12
    
    
    126
    
    
    -
    
    
    -
    
    
    -
    
    
    138Sale
      of warrants
    
    
    -
    
    
    -
    
    
    12
    
    
    -
    
    
    -
    
    
    -
    
    
    12Exercise
      of stock options
    
    
    124,598
    
    
    124
    
    
    956
    
    
    -
    
    
    -
    
    
    -
    
    
    1,080Change
      in accumulated othercomprehensive
      income
    
    
    -
    
    
    -
    
    
    -
    
    
    -
    
    
    (788
    )
    
    -
    
    
    (788
    )Net
      earnings
    
    
    -
    
    
    -
    
    
    -
    
    
    6,105
    
    
    -
    
    
    -
    
    
    6,105Dividends
      declared ($0.24 per share)
    
    
    -
    
    
    -
    
    
    -
    
    
    (2,036
    )
    
    -
    
    
    -
    
    
    (2,036
    )Balance,
      December 31, 2003
    
    
    9,775,099
    
    
    9,775
    
    
    24,557
    
    
    39,294
    
    
    1,211
    
    
    (9,577
    )
    
    65,260Sale
      of common stock
    
    
    6,000
    
    
    6
    
    
    72
    
    
    -
    
    
    -
    
    
    -
    
    
    78Common
      stock issued in businesspurchase
    
    
    236,723
    
    
    237
    
    
    3,077
    
    
    -
    
    
    -
    
    
    
    
    
    3,314Sale
      of warrants
    
    
    -
    
    
    -
    
    
    6
    
    
    -
    
    
    -
    
    
    -
    
    
    6Purchase
      of treasury stock (304,225 shares)
    
    
    -
    
    
    -
    
    
    -
    
    
    -
    
    
    -
    
    
    (3,927
    )
    
    (3,927
    )Exercise
      of stock options
    
    
    35,750
    
    
    36
    
    
    242
    
    
    -
    
    
    -
    
    
    -
    
    
    278Change
      in accumulated othercomprehensive
      income
    
    
    -
    
    
    -
    
    
    -
    
    
    -
    
    
    (1,155
    )
    
    -
    
    
    (1,155
    )Net
      earnings
    
    
    -
    
    
    -
    
    
    -
    
    
    7,368
    
    
    -
    
    
    -
    
    
    7,368Dividends
      declared ($0.24 per share)
    
    
    -
    
    
    -
    
    
    -
    
    
    (2,020
    )
    
    -
    
    
    -
    
    
    (2,020
    )Balance,
      December 31, 2004
    
    
    10,053,572
    
    
    10,054
    
    
    27,954
    
    
    44,642
    
    
    56
    
    
    (13,504
    )
    
    69,202
   See
accompanying notes to consolidated financial statements.
 
 
 
 **FLAG
FINANCIAL CORPORATION AND SUBSIDIARY**
 
 **Consolidated
Statements of Cash Flows**
 
 **For
the Years Ended December 31, 2004, 2003 and 2002**
 
 2004
    
    2003
    
    2002*(In
      Thousands)*Cash
      flows from operating activities:Net
      earnings (loss)
    
    $
    7,368
    
    
    6,105
    
    
    (1,994
    )Adjustments
      to reconcile net earnings to net cash provided (used) by operatingactivities:Depreciation,
      amortization and accretion
    
    
    2,947
    
    
    3,000
    
    
    2,265Provision
      for loan losses
    
    
    1,845
    
    
    1,321
    
    
    4,549Deferred
      tax (benefit) expense
    
    
    128
    
    
    3,168
    
    
    (1,947
    )Gain
      on sale of branches
    
    
    (3,000
    )
    
    -
    
    
    -(Gain)loss
      on sales of securities
    
    
    (700
    )
    
    (136
    )
    
    341Gain
      on sale of other real estate
    
    
    (150
    )
    
    (118
    )
    
    (128
    )Loss
      (gain) on disposal of premises and equipment
    
    
    78
    
    
    (936
    )
    
    912Change
      in:Mortgage
      loans held-for-sale
    
    
    (6,454
    )
    
    8,372
    
    
    (6,152
    )Other
      assets and liabilities
    
    
    (2,876
    )
    
    (3,276
    )
    
    (4,634
    )Net cash (used)
      provided by operating activities
    
    
    (814
    )
    
    17,500
    
    
    (6,788
    )Cash
      flows from investing activities (net of effect of branch sales and
      acquisitions):Net
      change in interest-bearing deposits
    
    
    (2,798
    )
    
    9,737
    
    
    (12,252
    )Proceeds
      from sales, calls and maturities of securities
      available-for-sale
    
    
    75,640
    
    
    105,263
    
    
    74,196Proceeds
      from sale of other investments
    
    
    3,804
    
    
    1,021
    
    
    154Purchases
      of other investments
    
    
    (2,021
    )
    
    (9,170
    )
    
    (1,114
    )Purchases
      of securities available-for-sale
    
    
    (66,608
    )
    
    (90,858
    )
    
    (80,471
    )Net
      change in loans
    
    
    (137,541
    )
    
    (103,633
    )
    
    (12,738
    )Proceeds
      from sales of real estate
    
    
    2,033
    
    
    1,938
    
    
    -Purchases
      of premises and equipment
    
    
    (1,788
    )
    
    (898
    )
    
    (2,061
    )Proceeds
      from sale of premises and equipment
    
    
    183
    
    
    4,359
    
    
    -Cash
      acquired in branch acquisition, net of premium paid
    
    
    -
    
    
    -
    
    
    84,167Cash
      paid in branch sale
    
    
    (14,141
    )
    
    -
    
    
    -Cash
      paid in business acquisitions
    
    
    (1,647
    )
    
    (735
    )
    
    (1,405
    )Net
      cash (used) provided by investing activities
    
    
    (144,884
    )
    
    (82,976
    )
    
    48,476Cash
      flows from financing activities (net of effect of branch sales and
      acquisitions):Net
      change in deposits
    
    
    172,031
    
    
    60,838
    
    
    (27,400
    )Proceeds
      from issuance of junior subordinated debentures
    
    
    14,433
    
    
    -
    
    
    -Change
      in federal funds purchased and repurchase agreements
    
    
    (1,802
    )
    
    2,763
    
    
    (18,001
    )Change
      in other borrowings
    
    
    3,200
    
    
    1,100
    
    
    (5,000
    )Proceeds
      from FHLB advances
    
    
    15,000
    
    
    5,000
    
    
    53,000Payments
      of FHLB advances
    
    
    (48,000
    )
    
    (5,000
    )
    
    (34,448
    )Proceeds
      from exercise of stock options
    
    
    278
    
    
    1,080
    
    
    526Purchase
      of treasury stock
    
    
    (3,927
    )
    
    -
    
    
    (3,132
    )Proceeds
      from sale of common stock and warrants
    
    
    84
    
    
    150
    
    
    12,943Cash
      dividends paid
    
    
    (2,020
    )
    
    (2,028
    )
    
    (1,944
    )Net
      cash provided (used) by financing activities
    
    
    149,277
    
    
    63,903
    
    
    (23,456
    )Net
      change in cash and cash equivalents
    
    
    3,579
    
    
    (1,573
    )
    
    18,232Cash
      and cash equivalents at beginning of year
    
    
    36,737
    
    
    38,310
    
    
    20,078Cash
      and cash equivalents at end of year
    
    $
    40,316
    
    
    36,737
    
    
    38,310
 
 See
accompanying notes to consolidated financial statements.
 
 
 
 FLAG FINANCIAL CORPORATION AND
SUBSIDIARY
 **Consolidated
Statements of Cash Flows, continued**
 
 **For
the Years Ended December 31, 2004, 2003 and 2002**
 
 2004
    
    2003
    
    2002*(In
      Thousands)*Supplemental
      disclosures of cash flow information:Cash
      paid during the year for:Interest
    
    $
    11,872
    
    
    11,005
    
    
    12,814Income
      taxes
    
    $
    4,119
    
    
    1,251
    
    
    -Supplemental
      schedule of noncash investing and financing activities:Real
      estate acquired through foreclosure
    
    $
    901
    
    
    2,624
    
    
    2,372Change
      in unrealized gain/loss on securities available-for-sale, net of
      tax
    
    $
    (721
    )
    
    (629
    )
    
    480Increase
      in dividends payable
    
    $
    6
    
    
    8
    
    
    60Deposit
      liabilities assumed in branch acquisition
    
    $
    -
    
    
    -
    
    
    96,549Assets
      acquired in acquisition, other than cashand cash equivalents
    
    $
    34,197
    
    
    -
    
    
    8,221Assets
      disposed of in branch sale
    
    $
    18,432
    
    
    -
    
    
    -
 
 See
accompanying notes to consolidated financial statements.
  
 **FLAG
FINANCIAL CORPORATION AND SUBSIDIARY**
 
 **Notes
to Consolidated Financial Statements**
 
 **(1)**
    **Summary
      of Significant Accounting Policies**
 Basis
of Presentation
 The
      consolidated financial statements include the accounts of Flag Financial
      Corporation (“Flag”) and its wholly-owned subsidiary, Flag Bank (the
      “Bank”). All significant intercompany accounts and transactions have been
      eliminated in consolidation. Flag is a bank holding company formed in 1994
      whose business is conducted by the Bank. Flag is subject to regulation
      under the Bank Holding Company Act of 1956. The Bank is primarily
      regulated by the Georgia Department of Banking and Finance (“DBF”) and the
      Federal Deposit Insurance Corporation (“FDIC”). The Bank provides a full
      range of commercial, mortgage and consumer banking services in
      West-Central and Middle Georgia and metropolitan Atlanta, Georgia.
 
 The
      accounting principles followed by Flag and its subsidiary, and the methods
      of applying these principles, conform with accounting principles generally
      accepted in the United States of America ("GAAP") and with general
      practices within the banking industry. In preparing financial statements
      in conformity with GAAP, management is required to make estimates and
      assumptions that affect the reported amounts in the financial statements.
      Actual results could differ significantly from those estimates. Material
      estimates common to the banking industry that are particularly susceptible
      to significant change in the near term include, but are not limited to,
      the determination of the allowance for loan losses, the valuation of real
      estate acquired in connection with or in lieu of foreclosure on loans, and
      valuation allowances associated with the realization of deferred tax
      assets which are based on future taxable
income.
 
 Cash
and Cash Equivalents
 Cash
      equivalents include amounts due from banks, interest-bearing demand
      deposits with banks with maturities less than 90 days and federal funds
      sold. Generally, federal funds are sold for one-day periods. As of
      December 31, 2004 and 2003, the Company maintained cash balances with well
      capitalized financial institutions totaling $17,398,000 and $11,200,000,
      respectively, which exceeded federal deposit insurance limits. Reserve
      requirements maintained with the Federal Reserve Bank totaled $895,000 and
      $680,000 at December 31, 2004 and 2003, respectively.
 
 Investment
Securities
 Flag
      classifies its securities in one of three categories: trading,
      available-for-sale, or held-to-maturity. Trading securities are securities
      held for the purpose of generating profits on short-term differences in
      price. Securities held-to-maturity are those securities for which Flag has
      the ability and intent to hold to maturity. All other securities are
      classified as available-for-sale. As of December 31, 2004 and 2003, all of
      Flag’s investment securities were classified as
      available-for-sale.
 
 Trading
      and available-for-sale securities are recorded at fair value.
      Held-to-maturity securities are recorded at cost, adjusted for the
      amortization or accretion of premiums or discounts. Unrealized holding
      gains and losses on trading securities are included in earnings in the
      period in which the gain or loss occurs. Unrealized holding gains and
      losses, net of the related tax effect, on securities available-for-sale
      are excluded from earnings and are reported as a separate component of
      stockholders' equity until realized. Transfers of securities between
      categories are recorded at fair value at the date of transfer.
 
 A
      decline in the market value of any available-for-sale or held-to-maturity
      investment below cost that is deemed other than temporary is charged to
      earnings and establishes a new cost basis for the security. Premiums and
      discounts are amortized or accreted over the life of the related security
      as an adjustment to the yield. Realized gains and losses are included in
      earnings and the cost of securities sold is derived using the
      specific identification method.
  
  **FLAG
FINANCIAL CORPORATION AND SUBSIDIARY**
 
 **Notes
to Consolidated Financial Statements, continued**
 
 **(1)** **Summary
of Significant Accounting Policies, continued**
 Other
Investments
 Other
      investments include Federal Home Loan Bank ("FHLB") stock, other equity
      securities with no readily determinable fair value, an investment in a
      limited partnership and a note receivable. Flag owns a 43% interest in a
      limited partnership, which invests in multi-family real estate and passes
      low-income housing credits to the investors. Flag recognizes these tax
      credits in the year received. The note receivable, purchased in 2003, is
      from a joint venture among two super-regional banks and a large investment
      bank. The joint venture specializes in underwriting and pooling
      trust-preferred securities and offering for investment traunches that are
      differentiated by their claim on the cash flow from the pool of
      securities. Each traunch's interest rate is relative to its position in
      the pool. Flag's note is subordinate to several traunches that have
      obtained credit ratings, but senior to the material interest of the joint
      venture. These investments are carried at cost, which approximates fair
      value.
 
 Mortgage
Loans Held-for-Sale
 Mortgage
      loans originated and intended for sale in the secondary market are carried
      at the lower of aggregate cost or market value. The amount by which cost
      exceeds market value is accounted for as a valuation allowance. Changes,
      if any, in the valuation allowance are included in the determination of
      net earnings in the period in which the change occurs. Flag has recorded
      no valuation allowance as of December 31, 2004 related to its mortgage
      loans held-for-sale as their cost approximates market value. Gains and
      losses from the sale of loans are determined using the specific
      identification method.
 
 Loans
and Interest Income
 Loans
      that management has the intent and ability to hold for the foreseeable
      future or until maturity are reported at their outstanding unpaid
      principal balances, net of the allowance for loan losses, and unamortized
      premiums or discounts on purchased loans. Interest income on loans is
      calculated by using the simple interest method on daily balances of the
      principal amount outstanding.
 
 Flag
      considers a loan impaired when, based on current information and events,
      it is probable that all amounts due according to the contractual terms of
      the loan agreement will not be collected. Impaired loans are measured
      based on the present value of expected future cash flows, discounted at
      the loan's effective interest rate or at the loan's observable market
      price, or the fair value of the collateral of the loan if the loan is
      collateral dependent. Interest income from impaired loans is recognized
      using a cash basis method of accounting during the time within that period
      in which the loans were impaired. Accrual of interest is discontinued on a
      loan when management believes, after considering economic and business
      conditions and collection efforts that the borrower’s financial condition
      is such that collection of interest is
doubtful.
 
 Allowance
      for Loan Losses
 The
      allowance for loan losses is established through provisions for loan
      losses charged to expense. Loans are charged against the allowance for
      loan losses when management believes that the collection of the principal
      is unlikely. The allowance is an amount which, in management's judgment,
      will be adequate to absorb losses on existing loans that may become
      uncollectible. The allowance is established through consideration of such
      factors, including, but not limited to, historical loss experience,
      changes in the nature and volume of the portfolio, adequacy of collateral,
      delinquency trends, loan concentrations, specific problem loans, and
      economic conditions that may affect the borrower's ability to
      pay.
  
  **FLAG
FINANCIAL CORPORATION AND SUBSIDIARY**
 
 **Notes
to Consolidated Financial Statements, continued**
 
 **(1)** **Summary
of Significant Accounting Policies, continued**
 Allowance
      for Loan Losses, continued
 Management
      believes that the allowance for loan losses is adequate. While management
      uses available information to recognize losses on loans, future additions
      to the allowance may be necessary based on changes in economic conditions.
      In addition, various regulatory agencies, as an integral part of their
      examination process, periodically review Flag's allowance for loan losses.
      Such agencies may require Flag to recognize additions to the allowance
      based on their judgments about information available to them at the time
      of their examination.
 
 Other
      Real Estate Owned
 Real
estate acquired through foreclosure is carried at the lower of cost (defined as
carrying value at foreclosure) or fair value less estimated costs to dispose.
Fair value is defined as the amount that is expected to be received in a current
sale between a willing buyer and seller other than in a forced or liquidation
sale. Fair values at foreclosure are based on appraisals. Losses arising from
the acquisition of foreclosed properties are charged against the allowance for
loan losses. Subsequent writedowns are provided by a charge to operations
through the allowance for losses on other real estate in the period in which the
subsequent decline occurs.
 
 Premises
      and Equipment
 Premises
      and equipment are stated at cost less accumulated depreciation. Major
      additions and improvements are charged to the asset accounts while
      maintenance and repairs that do not improve or extend the useful lives of
      the assets are expensed currently. When assets are retired or otherwise
      disposed of, the cost and related accumulated depreciation are removed
      from the accounts, and any gain or loss is reflected in earnings for the
      period.
 
 
 Depreciation
expense is computed using the straight-line method over the following estimated
useful lives:
  Buildings
      and improvements
    15-40
      yearsFurniture
      and equipment
    3-10
      years
 
 Income
Taxes
 Deferred
      tax assets and liabilities are recorded for the future tax consequences
      attributable to differences between the financial statement carrying
      amounts of existing assets and liabilities and their respective tax bases.
      Future tax benefits, such as net operating loss carryforwards, are
      recognized to the extent that realization of such benefits is more likely
      than not. Deferred tax assets and liabilities are measured using enacted
      tax rates expected to apply to taxable income in the years in which the
      assets and liabilities are expected to be recovered or settled. The effect
      on deferred tax assets and liabilities of a change in tax rates is
      recognized in income tax expense in the period that includes the enactment
      date.
 
 In
      the event the future tax consequences of differences between the financial
      reporting bases and the tax bases of Flag’s assets and liabilities results
      in deferred tax assets, an evaluation of the probability of being able to
      realize the future benefits indicated by such assets is required. A
      valuation allowance is provided when it is more likely than not that some
      portion or all of the deferred tax asset will not be realized. In
      assessing the ability to realize the deferred tax assets, management
      considers the scheduled reversals of deferred tax liabilities, projected
      future taxable income, and tax planning
strategies.
  
  **FLAG
FINANCIAL CORPORATION AND SUBSIDIARY**
 
 **Notes
to Consolidated Financial Statements, continued**
 
 **(1)** **Summary
of Significant Accounting Policies, continued**
 Income
Taxes, continued
 A
      deferred tax liability is not recognized for portions of the allowance for
      loan losses for income tax purposes in excess of the financial statement
      balance, as described in Note 9. Such a deferred tax liability will only
      be recognized when it becomes apparent that those temporary differences
      will reverse in the foreseeable future.
 
 Stock-Based
      Compensation
 At
      December 31, 2004, Flag sponsors stock-based compensation plans, which are
      described more fully in Note 12. Flag accounts for these plans under the
      recognition and measurement principles of APB Opinion No. 25,*“Accounting
      for Stock Issued to Employees”,*and related Interpretations. The fair values of the stock awards are
      determined using a single estimated expected life. The compensation
      expense is recognized on a straight-line basis over the vesting period. No
      stock-based employee compensation cost is reflected in net earnings, as
      all options granted under those plans had an exercise price equal to the
      market value of the underlying common stock on the date of grant. The
      following table illustrates the effect on net earnings (loss) and earnings
      (loss) per share if Flag had applied the fair value recognition provisions
      of Statement of Financing Accounting Standards (“SFAS”) No. 123,*“Accounting
      for Stock-Based Compensation”,*to
      stock-based employee compensation (in thousands, except per share
      amounts).
  
 Year
      Ended December 31,2004
    
    2003
    
    2002Net
      earnings (loss) as reported
    
    $
    7,368
    
    
    6,105
    
    
    (1,994
    )Deduct:
      Total stock-based employeecompensation
      expense determined underfair-value
      based method for all awards,net of
      tax
    
    
    (174
    )
    
    (347
    )
    
    (1,839
    )Pro
      forma net earnings (loss)
    
    $
    7,194
    
    
    5,758
    
    
    (3,833
    )Basic
      earnings (loss) per share:As
      reported
    
    $
    0.88
    
    
    0.72
    
    
    (0.24
    )Pro
      forma
    
    $
    0.86
    
    
    0.68
    
    
    (.047
    )Diluted
      earnings (loss) per share:As
      reported
    
    $
    0.82
    
    
    0.67
    
    
    (0.24
    )Pro
      forma
    
    $
    0.80
    
    
    0.64
    
    
    (0.47
    )
 
 
  
  **FLAG
FINANCIAL CORPORATION AND SUBSIDIARY**
 
 **Notes
to Consolidated Financial Statements, continued**
 **(1)** **Summary
of Significant Accounting Policies, continued**
 Net
Earnings Per Common Share
 Flag is
required to report earnings per common share with and without the dilutive
effects of potential common stock issuances from instruments such as options,
convertible securities and warrants on the face of the statements of operations.
Basic earnings per common share are based on the weighted average number of
common shares outstanding during the period while the effects of potential
common shares outstanding during the period are included in diluted earnings per
share. Additionally, Flag must reconcile the amounts used in the computation of
both “basic earnings per share” and “diluted earnings per share .”
Antidilutive stock options and warrants have not been included in the diluted
earnings per share calculations . No
options were antidilutive as of December 31, 2004 . Antidilutive
shares at  December
31, 2003 and 2002 were 127,625, and 2,152,427, respectively. For 2002, the
potential effect of outstanding options and warrants would be antidilutive, and
therefore is not presented. The weighted average number of common shares
outstanding at December 31, 2002 was 8,200,983. Earnings per common share
amounts for the years ended December 31, 2004 and 2003 are as follows (in
thousands, except share and per share amounts):
 
 
 **For
      the Year Ended December 31, 2004**Net
      Earnings
    
    Common
      Share
    
    Per
      Share(Numerator)
    
    (Denominator)
    
    AmountBasic
      earnings per share
    
    $
    7,368
    
    
    8,396,047
    
    $
    0.88Effect
      of dilutive securities - stock optionsand
      warrants
    
    
    -
    
    
    585,573
    
    
    (0.06
    )Diluted
      earnings per share
    
    $
    7,368
    
    
    8,981,620
    
    $
    0.82**For
      the Year Ended December 31, 2003**
    
    
    Net
      Earnings
    
    
    Common
      Share
    
    
    Per
      Share(Numerator)
    
    
    (Denominator)
    
    
    AmountBasic
      earnings per share
    
    $
    6,105
    
    
    8,471,009
    
    $
    0.72Effect
      of dilutive securities - stock options
    
    
    -
    
    
    592,314
    
    
    (0.05
    )Diluted
      earnings per share
    
    $
    6,105
    
    
    9,063,323
    
    $
    0.67
 
  
  **FLAG
FINANCIAL CORPORATION AND SUBSIDIARY**
 
 **Notes
to Consolidated Financial Statements, continued**
 **(1)** **Summary
of Significant Accounting Policies, continued**
 Derivative
Instruments and Hedging Activities
 Flag
recognizes the fair value of derivatives as assets or liabilities in the
financial statements. The accounting for the changes in the fair value of a
derivative depends on the intended use of the derivative instrument at
inception. The change in fair value of instruments used as fair value hedges is
accounted for in the income of the period simultaneous with accounting for the
fair value change of the item being hedged. The change in fair value of the
effective portion of cash flow hedges is accounted for in comprehensive income
rather than income, and the change in fair value of foreign currency hedges is
accounted for in comprehensive income as part of the translation adjustment. The
change in fair value of derivative instruments that are not intended as a hedge
and any hedge ineffectiveness is accounted for in the income of the period of
the change.
 
 Goodwill
and Intangible Assets
 Effective
January 1, 2002, Flag adopted SFAS No. 141, *“Business
Combinations”* , SFAS
No. 142, *“Goodwill
and Other Intangible Assets”* and SFAS
No. 147, *“Acquisitions
of Certain Financial Institutions”* . SFAS
No. 141 requires all business combinations completed after its adoption to be
accounted for under the purchase method of accounting and establishes specific
criteria for the recognition of intangible assets separately from goodwill. SFAS
No. 142 addresses the accounting for goodwill and intangible assets subsequent
to their initial recognition. Upon adoption of SFAS No. 142, goodwill and some
intangible assets will no longer be amortized and will be tested for impairment
at least annually. SFAS No. 147 requires that the acquisition of all or a part
of a financial institution that meets the definition of a business combination
shall be accounted for in accordance with SFAS No. 141.
  Recent
Accounting Pronouncements
 As
permitted by SFAS No. 123 *Accounting
for Stock-Based Compensation* , Flag
currently accounts for share-based payments to employees using APB opinion No.
25’s intrinsic value method and, as such, generally recognizes no compensation
expense for employee stock options. Accordingly, the adoption of SFAS No. 123’s
fair value method will not have a significant impact on our result of
operations, and it will not have material impact on our overall financial
position. The impact of adoption of SFAS No. 123(R) cannot be predicted at this
time because it will depend on levels of share-based payments granted in the
future. However, had we adopted SFAS No.123(R) in prior periods, the impact of
that standard would have approximated the impact of SFAS No. 123 as described in
the disclosure of pro forma net income earnings per share in Note 1 to our
consolidated financial statements. SFAS No. 123(R) also requires the benefits of
tax deductions in excess of recognized compensation cost to be reported as a
financing cash flow, rather than as an operating cash flow as required under
current literature. This requirement will reduce net operating cash flows and
increase net financing cash flows in the periods after adoption. While the
company cannot estimate what those amounts will be in the future (because they
depend on, among other things, when employees exercise stock options), the
amount of operating cash flows recognized in prior periods for such excess tax
deductions were insignificant.
 
 During
March 2004, the SEC issued Staff Accounting Bulletin 105, *Application
of Accounting Principles to Loan Commitments* (SAB
105). SAB 105 addresses the accounting for loan commitments and provides that
the required fair value measurement include only differences between the
guaranteed interest rate in the loan commitment and a market interest rate
excluding any expected future cash flows related to the customer relationship of
loan servicing. SAB 105 applies to mortgage loan commitments accounted for as
derivatives and entered into after March 31, 2004. Substantially all of our
mortgage loan commitments are based on rates provided by third party
correspondents, who have agreed to purchase resulting loans at those rates. As a
result, we are protected from interest rate risk, and the adoption of SAB 105
did not have a material impact on our consolidated financial
statements.
  
  **FLAG
FINANCIAL CORPORATION AND SUBSIDIARY**
 
 **Notes
to Consolidated Financial Statements, continued**
 
 **(1)** **Summary
of Significant Accounting Policies, continued**
 Recent
Accounting Pronouncements, continued
 In March
2004, the Emerging Issues Task Force (“EITF”) released EITF Issue 03-01, *The
Meaning of Other-Than-Temporary Impairment and its Application to Certain
Investments* . The
Issue provides guidance for determining whether an investment is
other-than-temporarily impaired and requires certain disclosures with respect to
these investments. The recognition and measurement guidance for
other-than-temporary impairment has been delayed by the issuance of FASB Staff
Position EITF 03-1-1 on September 30, 2004. The adoption of Issue 03-1 did not
result in any other-than-temporary impairment.
 
 In
December 2003, the American Institute of Certified Public Accountants (AICPA)
issued Statement of Position (SOP) 03-3, *Accounting
for Loans or Certain Debt Securities Acquired in a Transfer.* The SOP
addresses accounting for differences between contractual cash flows and cash
flows expected to be collected from an investor’s initial investment in loans or
debt securities acquired in a transfer if those differences relate to a
deterioration of credit quality. The SOP also prohibits companies from “carrying
over” or creating a valuation allowance in the initial accounting for loans
acquired that meet the scope criteria of the SOP. The SOP is effective for loans
acquired in fiscal years beginning after December 15, 2004. The adoption of this
SOP is not expected to have a material impact on the Company’s financial
position or results of operations.
 In May
2003, the FASB issued SFAS No. 150, *“Accounting
for Certain Financial Instruments with Characteristics of Both Liabilities and
Equity”* (“SFAS
150”), which changes the accounting for certain financial instruments that have
characteristics of liabilities and equity. SFAS 150, which is effective for
interim periods beginning after June 15, 2003, requires that those instruments
be classified as liabilities in statements of financial position. The adoption
of SFAS 150 did not have a material impact on the Company’s financial position
or results of operations.
 
 In
January 2003, the Financial Accounting Standards Board (“FASB”) issued FIN No.
46, “ *Consolidation
of Variable Interest Entities”* (“FIN
46”). This interpretation of Accounting Research Bulletin No. 51, “Consolidated
Financial Statements,” addresses consolidation by business enterprises of
variable interest entities. The provisions of FIN 46 are effective immediately
for all variable interest entities created after January 31, 2003 and, for the
first fiscal year or interim period beginning after June 15, 2003, for variable
interest entities in which an enterprise holds variable interest that it
acquired before February 1, 2003. Flag implemented fully the provisions and
requirements of FIN 46 during 2004 without material impact on its financial
position or results of operations.
  
 Reclassifications
 Certain
reclassifications have been made to the 2003 and 2002 financial statements to
conform with classifications for 2004.
 ****
 **FLAG
FINANCIAL CORPORATION AND SUBSIDIARY**
 
 **Notes
to Consolidated Financial Statements, continued**
 
 **(2)** **Business
Combinations**
 Other
Acquisitions and Dispositions
 On
December 2, 2004, Flag purchased substantially all of the assets of Payroll
Solutions, Inc., a leading provider of payroll, human resources and benefits
services to small and medium-sized businesses primarily in Georgia. Total
consideration for the purchase was $4,685,000, including 236,723 shares of Flag
common stock or $3,314,000 and the assumption of debt of approximately
$1,371,000. Of the total number of shares of the Common Stock issued under the
Asset Purchase Agreement, 47,143 shares were held in escrow at year end and will
likely be released during 2005 upon accomplishment of certain business
objectives. The purchase of Payroll Solutions expands the suite of services that
the Bank offers it business customers.
 
 The
following table summarizes the estimated fair values of the assets acquired at
the date of acquisition of Payroll Solutions (in thousands):
 
 Premises
      and equipment
    
    $
    72Goodwill
    
    
    4,613Total
      assets acquired
    
    $
    4,685
 
 The
following table summarizes the pro forma impact of the contribution of Payroll
Solutions, Inc. for the year ended December 31, 2004 (in
thousands):
 
 Flag
      Financial
    
    Payroll
      Solutions
    
    CombinedNet
      interest income
    
    $
    30,564
    
    
    (42
    )
    
    30,522Provision
      for loan losses
    
    
    1,845
    
    
    -
    
    
    1,845Net
      interest income after provision for loan losses
    
    
    28,719
    
    
    (42
    )
    
    28,677Other
      income
    
    
    11,468
    
    
    1,634
    
    
    13,102Other
      expenses
    
    
    29,509
    
    
    1,096
    
    
    30,605Income
      taxes
    
    
    3,310
    
    
    188
    
    
    3,498Net
      earnings
    
    
    7,368
    
    
    308
    
    
    7,676Basic
      earnings per share
    
    
    0.88
    
    
    0.01
    
    
    0.89Diluted
      earnings per share
    
    
    0.82
    
    
    0.01
    
    
    0.83Basic
      shares outstanding
    
    
    8,396
    
    
    237
    
    
    8,633Diluted
      shares outstanding
    
    
    8,981
    
    
    237
    
    
    9,218
 
 
 During
the third quarter of 2004, Flag acquired a mortgage and construction lending
practice of another Atlanta based bank. Flag purchased approximately $35 million
in mortgage and construction loans and assumed several property leases with
market based rents and terms. Total consideration for the purchase will be paid
over the course of 60 months and totals approximately $930,000 in cash. The
acquisition of this mortgage and construction lending practice is in accordance
with Flag’s strategy to continue to grow its non-interest income.
 
 During
the first quarter of 2004, Flag sold its Thomaston, Georgia branch to another
Georgia based bank. After $635,000 in expenses related directly to the sale of
the branch, Flag recorded an after tax gain of approximately $1.47 million.
Included in the sale was approximately $1,689,000 of premises and equipment,
$16,690,000 in loans and $35,801,000 million in deposits. Flag’s decision to
sell this
 
 
 
 ****
 **FLAG
FINANCIAL CORPORATION AND SUBSIDIARY**
 
 **Notes
to Consolidated Financial Statements, continued**
 
 **(2)** **Business
Combinations, continued**
 Other
Acquisitions and Dispositions, continued
 branch
was due to its continued focus on developing its banking presence where Flag
maintains high market share and in developing its metro Atlanta
presence.
 
 On
November 8, 2002, Flag acquired the Atlanta banking facilities of Encore Bank
(“Encore Branches”) for a total purchase price of $12,905,000, which was all
paid in cash. The results of the Encore Branches have been included in the
consolidated financial statements since that date.
 
 The
following table summarizes the estimated fair values of the assets acquired and
the liabilities assumed at the date of acquisition of the Encore branches (in
thousands):
 
 Cash
    
    $
    96,767Premises
      and equipment
    
    
    8,059Deposit
      intangible
    
    
    900Goodwill
    
    
    5,214Total
      assets acquired
    
    
    110,940Deposits
    
    
    97,817Accrued
      interest payable
    
    
    218Total
      liabilities assumed
    
    
    98,035Net
      assets acquired
    
    $
    12,905
 
 The
deposit intangible is subject to amortization and has a weighted-average useful
life of approximately ten years. The goodwill recorded is expected to be fully
deductible for tax purposes.
 
 On
November 12, 2002, Flag acquired the assets and the lending line of business of
Bankers Capital Group, LLC (“BCG”). BCG is a company owned by certain members of
management of Flag who purchased common stock and warrants during 2002. The
results of this line of business have been included in the consolidated
financial statements since the date of acquisition. BCG is a commercial loan
origination company, specializing in higher-yielding, non-traditional financing.
As a result of the acquisition, this line of business has become a source of
high-yielding assets.
 
 The
aggregate purchase price paid for BCG was $1,405,000 in cash paid at closing and
an additional $1,500,000 of contingent consideration, payable based on the
future performance of BCG. During 2004 and 2003, the performance of BCG was
sufficient to cause all contingent consideration to be paid. During 2004 and
2003, payments of the contingent consideration were made in the amount of
$765,000 and $735,000, respectively.
 
 The
following table summarizes the estimated fair values of the assets acquired at
the date of acquisition and through 2004 when all contingent payments were made
(in thousands):
 
 Premises
      and equipment
    
    $
    130Goodwill
    
    
    2,775Total
      assets acquired
    
    $
    2,905
 
 The
goodwill recorded is expected to be fully deductible for tax
purposes.
  
  **FLAG
FINANCIAL CORPORATION AND SUBSIDIARY**
 
 **Notes
to Consolidated Financial Statements, continued**
 
 **(2)** **Business
Combinations, continued**
 Intangible
Assets and Goodwill
 As a
result of these business combinations, Flag has recorded intangible assets. As
of December 31, 2004 and 2003, Flag had recorded deposit intangible assets that
are subject to amortization totaling $900,000 with accumulated
amortization  of
$195,000 and $105,000, respectively. Flag recognized amortization expense on
this intangible of $90,000 for each of the years ended December 31, 2004 and
2003, and $15,000 in 2002.
 
 The
changes in the carrying amount of goodwill for the years ended December 31, 2004
and 2003 are as follows (in thousands):
 
 2004
    
    2003Balance
      as of January 1, 2004
    
    $
    15,037
    
    
    14,302Goodwill
      acquired during the year
    
    
    6,054
    
    
    735Balance
      as of December 31, 2004
    
    $
    21,091
    
    
    15,037
 
 Flag
tests its goodwill for impairment on an annual basis using the expected present
value of future cash flows. Management estimates there is no impairment of
goodwill as of December 31, 2004 and 2003.
 ****
 **(3)** **Investment
Securities**
 Investment
securities available-for-sale at December 31, 2004 and 2003 are summarized as
follows (in thousands):
 
 
 December
      31, 2004Gross
    
    Gross
    
    EstimatedAmortized
    
    Unrealized
    
    Unrealized
    
    FairCost
    
    Gains
    
    Losses
    
    ValueU.S.
      Treasuries and agencies
    
    $
    55,407
    
    
    83
    
    
    238
    
    
    55,252State,
      county and municipals
    
    
    6,839
    
    
    321
    
    
    -
    
    
    7,160Equity
      securities
    
    
    309
    
    
    -
    
    
    26
    
    
    283Mortgage-backed
      securities
    
    
    28,201
    
    
    322
    
    
    59
    
    
    28,464Corporate
      debt securities
    
    
    1,503
    
    
    31
    
    
    -
    
    
    1,534Trust
      preferred securities
    
    
    19,041
    
    
    284
    
    
    628
    
    
    18,697$
    111,300
    
    
    1,041
    
    
    951
    
    
    111,390
 
 December
      31, 2003Gross
    
    Gross
    
    EstimatedAmortized
    
    Unrealized
    
    Unrealized
    
    FairCost
    
    Gains
    
    Losses
    
    ValueU.S.
      Treasuries and agencies
    
    $
    59,930
    
    
    432
    
    
    1
    
    
    60,361State,
      county and municipals
    
    
    8,617
    
    
    411
    
    
    -
    
    
    9,028Equity
      securities
    
    
    309
    
    
    3
    
    
    74
    
    
    238Mortgage-backed
      securities
    
    
    27,564
    
    
    531
    
    
    41
    
    
    28,054Collateralized
      mortgage obligations
    
    
    2,012
    
    
    131
    
    
    -
    
    
    2,143Trust
      preferred securities
    
    
    22,179
    
    
    562
    
    
    -
    
    
    22,741$
    120,611
    
    
    2,070
    
    
    116
    
    
    122,565
  
 
 
 **FLAG
FINANCIAL CORPORATION AND SUBSIDIARY**
 
 **Notes
to Consolidated Financial Statements, continued**
 ****
 **(3)** **Investment
Securities, continued**
 Unrealized
      losses and fair value, aggregated by investment category and length of
      time that individual securities have been in a continuous unrealized loss
      position, as of December 31, 2004 are summarized as follows (in
      thousands):
 
 December
31, 2004
 Less
      than 12 Months
    
    12
      Months or More
    
    TotalFair
    
    Unrealized
    
    Fair
    
    Unrealized
    
    Fair
    
    UnrealizedValue
    
    Losses
    
    Value
    
    Losses
    
    Value
    
    LossesU.S.
      Treasuries and agencies
    
    $
    52,521
    
    
    238
    
    
    -
    
    
    -
    
    
    52,521
    
    
    238Equity
      securities
    
    
    -
    
    
    -
    
    
    283
    
    
    26
    
    
    283
    
    
    26Mortgage-backed
      securities
    
    
    5,824
    
    
    33
    
    
    1,441
    
    
    26
    
    
    7,265
    
    
    59Trust
      Preferred securities
    
    
    3,185
    
    
    628
    
    
    -
    
    
    -
    
    
    3,185
    
    
    628$
    61,530
    
    
    899
    
    
    1,724
    
    
    52
    
    
    63,254
    
    
    951
 
 December
31, 2003
 Less
      than 12 Months
    
    12
      Months or More
    
    TotalFair
    
    Unrealized
    
    Fair
    
    Unrealized
    
    Fair
    
    UnrealizedValue
    
    Losses
    
    Value
    
    Losses
    
    Value
    
    LossesU.S.
      Treasuries and agencies
    
    $
    10,168
    
    
    1
    
    
    -
    
    
    -
    
    
    10,168
    
    
    1Equity
      securities
    
    
    1
    
    
    3
    
    
    234
    
    
    71
    
    
    235
    
    
    74Mortgage-backed
      securities
    
    
    6,786
    
    
    41
    
    
    -
    
    
    -
    
    
    6,786
    
    
    41$
    16,955
    
    
    45
    
    
    234
    
    
    71
    
    
    17,189
    
    
    116
  At
December 31, 2004, unrealized losses in the investment portfolio related to
debt, equity and trust preferred securities. The unrealized losses on the debt
and equity securities arose due to changing interest rates and market conditions
and are considered to be temporary because of acceptable investment grades where
the repayment sources of principal and interest are largely backed by the U.S.
Government . At
December 31, 2004, none of the 29 securities issued by state and political
subdivisions contained unrealized losses while 21 out of 97 securities issued by
U.S. Government agencies and Government sponsored corporations, including
mortgage-backed securities, contained unrealized losses and 3 of the 3 equity
securities contained unrealized losses . The
unrealized losses on the trust preferred securities arose due to changing
interest rates and market conditions and are considered to be temporary. At
December 31, 2004, two of 11 trust preferred securities contained unrealized
losses.
  
  **FLAG
FINANCIAL CORPORATION AND SUBSIDIARY**
 ****
 **Notes
to Consolidated Financial Statements, continued**
 **(3)** **Investment
Securities, continued**
 The
amortized cost and estimated fair value of investment securities
available-for-sale at December 31, 2004, by contractual maturity, are shown
below (in thousands). 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.
 
 
 Amortized
    
    EstimatedCost
    
    Fair
      ValueU.S.
      Treasuries and agencies, state, countyand
      municipals and corporate debt:Within
      1 year
    
    $
    28,408
    
    
    28,4361
      to 5 years
    
    
    20,949
    
    
    20,9235
      to 10 years
    
    
    12,268
    
    
    12,359More
      than 10 years
    
    
    2,124
    
    
    2,228Equity
      securities
    
    
    309
    
    
    283Mortgage-backed
      securities
    
    
    28,201
    
    
    28,464Trust
      preferred securities
    
    
    19,041
    
    
    18,697$
    111,300
    
    
    111,390
 
 Proceeds
from sales of securities available-for-sale during 2004, 2003 and 2002 totaled
approximately $12,072,000, $24,266,000 and $17,723,000,
respectively.  Gross
gains of  approximately $700,000, $209,000 and $72,000 and gross losses of
approximately $0, $73,000 and $413,000 were realized on those sales during 2004,
2003 and 2002, respectively.
 Securities
with a carrying value of approximately $74,675,000 at December 31, 2004 were
pledged to secure other public deposits. Securities with a carrying value of
approximately $84,207,000 at December 31, 2003 were pledged to secure advances
from the FHLB and other public deposits.
  **(4)** **Loans**
 Major
      classifications of loans at December 31, 2004 and 2003 are summarized as
      follows (in thousands):
 
 2004
    
    2003Commercial,
      financial and agricultural
    
    $
    57,231
    
    
    50,435Real
      estate - construction
    
    
    176,111
    
    
    100,108Real
      estate - mortgage
    
    
    355,575
    
    
    315,610Installment
      loans to individuals
    
    
    15,644
    
    
    17,287Lease
      financings
    
    
    142
    
    
    340Gross
      loans
    
    
    604,703
    
    
    483,780Less
      allowance for loan losses
    
    
    8,602
    
    
    6,685$
    596,101
    
    
    477,095
 
 Flag
      concentrates its lending activities in the origination of permanent
      residential mortgage loans, permanent residential construction loans,
      commercial mortgage loans, commercial business loans, and consumer
      installment loans. The majority of Flag’s real estate loans are secured by
      real property located in West-Central and Middle Georgia and metropolitan
      Atlanta, Georgia.
 
  
  **FLAG
FINANCIAL CORPORATION AND SUBSIDIARY**
 
 **Notes
to Consolidated Financial Statements, continued**
 
 **(4)** **Loans,
continued**
 Flag has
recognized impaired loans of approximately $4,835,000  and
$5,393,000 at December 31, 2004  and 2003,
respectively, with a total allowance for loan losses related to these loans of
approximately  $1,288,000
and  $1,165,000,
respectively . The
average balance of impaired loans was approximately  $5,078,000 , $5,141,000,
and $4,236,000 during 2004, 2003 and 2002, respectively. Interest income
on  impaired
loans of approximately $196,000, $143,000, and $88,000 was recognized for cash
payments  received
in 2004, 2003 and 2002, respectively .
 Activity
in the allowance for loan losses is summarized as follows for the years ended
December 31, 2004, 2003 and 2002 (in thousands):
  
 2004
    
    2003
    
    2002Balance
      at beginning of year
    
    $
    6,685
    
    
    6,888
    
    
    7,348Provisions
      charged to operations
    
    
    1,845
    
    
    1,321
    
    
    4,549Loans
      charged off
    
    
    (878
    )
    
    (1,906
    )
    
    (5,569
    )Recoveries
      on loans previously charged off
    
    
    550
    
    
    382
    
    
    560Allowance
      related to purchase transaction
    
    
    400
    
    
    -
    
    
    -Balance
      at end of year
    
    $
    8,602
    
    
    6,685
    
    
    6,888
 
 Mortgage
      loans secured by 1-4 family residences totaling approximately $58,213,909
      and $47,461,000were
      pledged as collateral for outstanding FHLB advances as of December 31,
      2004 and 2003, respectively. In addition to these mortgage loans, Flag has
      pledged certain commercial and real estate loans to the Federal Reserve
      Bank of Atlanta totaling $204,952,000 to secure a line of credit
      established for liquidity purposes.
 
 **(5)** **Premises
and Equipment**
 Premises and equipment at December 31, 2004 and 2003 are summarized as follows
(in thousands):
  
 2004
    
    2003Land
      and land improvements
    
    $
    4,099
    
    
    4,617Buildings
      and improvements
    
    
    12,558
    
    
    14,161Furniture
      and equipment
    
    
    15,227
    
    
    14,78331,884
    
    
    33,561Less
      accumulated depreciation
    
    
    17,426
    
    
    17,064$
    14,458
    
    
    16,497
  Depreciation
expense approximated $1,877,000, $2,042,000 and $2,037,000 for the years ended
December 31, 2004, 2003 and 2002, respectively.
  During
the first quarter of 2004, Flag sold its Thomaston, Georgia branch to another
Georgia based bank and recorded an after tax gain of approximately $1.47
million. Included in the sale was premises and equipment with an approximate
cost basis of $1,689,000.
  During
the year ended December 31, 2003, Flag sold certain premises and equipment
resulting in a gain of approximately $936,000, which is included in other
income.
 
 ****
 **FLAG
FINANCIAL CORPORATION AND SUBSIDIARY**
 
 **Notes
to Consolidated Financial Statements, continued**
 
 
 **(6)**
    **Time
      Deposits**
 At
      December 31, 2004, contractual maturities of time deposits are summarized
      as follows (in thousands):
 
 Year
      ending December 31,2005
    
    $
    153,9872006
    
    
    121,4102007
    
    
    10,2582008
    
    
    1,7362009
    
    
    1,274Thereafter
    
    
    490$
    289,155
 
 At
      December 31, 2004 and 2003, the Bank held $133,111,000 and $36,489,000,
      respectively, in certificates of deposits obtained through the efforts of
      third party brokers.  The weighted average cost at December 31, 2004
      and 2003 was 3.38% and 1.42%, respectively. The weighted average maturity
      at December 31, 2004 and 2003 was 17.6 months and 5.2 months,
      respectively. During 2004, the brokered certificates of deposit held at
      December 31, 2003 matured and were replaced with brokered certificates of
      deposits at an increased weighted average
cost.
 
 ******(7)**
    **Advances
      from Federal Home Loan Bank**
 Advances
      from FHLB are collateralized by FHLB stock, certain investment securities
      and certain first mortgage loans. Advances from FHLB outstanding at
      December 31, 2004 consisted of one advance of $25 million that matures in
      2007 and has a variable rate of interest that adjusts quarterly indexed on
      three month LIBOR. At December 31, 2004, Flag’s interest rate on this
      advance was 2.5013%.
 
 In
      2002, Flag repaid $9,434,000 in advances from the FHLB prior to their
      original maturity date and incurred a prepayment penalty of approximately
      $266,000. These advances were repaid due to a falling interest rate
      environment in which Flag could obtain new borrowings at significantly
      lower rates. This redemption of debt has been recorded as an extraordinary
      item, net, of income taxes of approximately $101,000, in the 2002
      statement of operations.
 
 **** **(8)** **Other
Borrowings**
 Other
borrowings as of December 31, 2004 and 2003consisted of a line of credit with a
bank with a total commitment amount of $11,000,000. The line of credit bears
interest at 0.5% below the prime rate, is secured by the common stock of the
Bank and has various covenants and restrictions. Borrowings outstanding at
December 31, 2004 and 2003 were $4,300,000 and $1,100,000, with an interest rate
of 4.75% and 3.50%, respectively, and a maturity date of March 15, 2015.
Management believes that Flag and the Bank were in compliance with all covenants
and restrictions at December 31, 2004.
 
 Flag has
entered into securities sold under agreements to repurchase which represent
obligations to other parties. The obligations are secured by investment
securities, and such collateral is held by a safekeeping agent. The maximum
amount of outstanding agreements at any month-end during 2004  and 2003
totaled $2,589,000 and $4,098,000, respectively, and the daily average of such
agreements  totaled
$2,415,000 and $1,975,000, respectively. The weighted average cost was 1.45% and
1.37% at December 31, 2004 and 2003, respectively, while the weighted average
cost  during
2004 and 2003 was approximately 1.38% and 1.35%, respectively.
  
  **FLAG
FINANCIAL CORPORATION AND SUBSIDIARY**
 
 **Notes
to Consolidated Financial Statements, continued**
  **(8)** **Other
Borrowings, continued**
 Flag has
entered into three line-of credit agreements to purchase federal funds with
total commitment amounts of $19,000,000, $10,000,000 and $6,000,000
respectively. There were no federal funds purchased outstanding as of December
31, 2004 or 2003.
 
 **(9)** **Junior
Subordinated Debt**
 During
the first quarter of 2004, the Company formed a wholly-owned Connecticut
statutory business trust, Flag Financial Corporation Statutory Trust, a
subsidiary whose sole purpose was to issue $14.4 million of Trust Preferred
Securities through a pool sponsored by SunTrust Bank in Atlanta, Georgia. The
Trust Preferred Securities have a maturity of 30 years and are redeemable after
five years with certain exceptions. At December 31, 2004, the floating-rate
securities had a 5.31% interest rate, which will reset quarterly at the
three-month LIBOR rate plus 2.75%. The Trust Preferred Securities are recorded
as junior subordinated debentures on the balance sheets, but subject to certain
limitations qualify for Tier 1 capital for regulatory capital
purposes.
 
 In
accordance with FASB Interpretation No. 46, Flag Trust is not consolidated with
the Company. Accordingly, the Company does not report the securities issued by
Flag Trust as liabilities, and instead reports as liabilities the junior
subordinated debentures issued by the Company and held by Flag Trust, as these
are no longer eliminated in consolidation. The Trust Preferred Securities are
recorded as junior subordinated debentures on the balance sheets, but subject to
certain limitations qualify for Tier 1 capital for regulatory capital
purposes.
  **(10)** **Income
Taxes**
 The
      following is an analysis of the components of income tax expense (benefit)
      for the years ended December 31, 2004, 2003 and 2002 (in
      thousands):
 
 2004
    
    2003
    
    2002Current
    
    $
    3,182
    
    
    (444
    )
    
    (81
    )Deferred
    
    
    128
    
    
    3,168
    
    
    (1,947
    )$
    3,310
    
    
    2,724
    
    
    (2,028
    )
 
 The
differences between income tax expense (benefit) and the amount computed by
applying the statutory federal income tax rate to earnings (loss) before taxes
for the years ended December 31, 2004 , 2003 and
2002 are as follows (in thousands):
  
 2004
    
    2003
    
    2002Pretax
      income (loss) at statutory rate
    
    $
    3,631
    
    
    3,002
    
    
    (1,311
    )Add
      (deduct):Tax-exempt
      interest income
    
    
    (216
    )
    
    (245
    )
    
    (316
    )State
      income taxes, net of federal effect
    
    
    76
    
    
    130
    
    
    (343
    )Increase
      in cash surrender value of life insurance
    
    
    (53
    )
    
    (55
    )
    
    (63
    )General
      business credits
    
    
    (123
    )
    
    (120
    )
    
    (42
    )Other
    
    
    (5
    )
    
    12
    
    
    47$
    3,310
    
    
    2,724
    
    
    (2,028
    )
   
   **FLAG
FINANCIAL CORPORATION AND SUBSIDIARY**
 **Notes
to Consolidated Financial Statements, continued**
 
 **(10)** **Income
Taxes, continued**
 The
following summarizes the net deferred tax asset. The deferred tax asset is
included as a component of other assets at December 31, 2004 and 2003 (in
thousands).
 
 2004
    
    2003Deferred
      tax assets:Allowance
      for loan losses
    
    $
    3,113
    
    
    2,537Net
      operating loss carryforwards and credits
    
    
    479
    
    
    515Nondeductible
      interest on non-accrual loans
    
    
    90
    
    
    177Nondeductible
      expenses
    
    
    59
    
    
    257Nondeductible
      loss
    
    
    298
    
    
    128Other
    
    
    255
    
    
    214Total
      gross deferred tax assets
    
    
    4,294
    
    
    3,828Deferred
      tax liabilities:Premises
      and equipment
    
    
    495
    
    
    239Tax
      installment sale
    
    
    351
    
    
    356Goodwill
      and core deposit intangibles
    
    
    1,213
    
    
    877Unrealized
      gain on securities available-for-sale
    
    
    35
    
    
    742Other
    
    
    47
    
    
    40Total
      gross deferred tax liabilities
    
    
    2,141
    
    
    2,254Net
      deferred tax asset
    
    $
    2,153
    
    
    1,574
 
 As of
December 31, 2004, Flag had state net operating loss carryforwards totaling
approximately $533,000 that will begin to expire in 2017 unless previously
utilized.
 
 The
Internal Revenue Code (“IRC”) was amended during 1996 and the IRC section 593
reserve method for loan losses for thrift institutions was repealed. Effective
January 1, 1996, certain banks that have been merged into the Bank began to
compute their tax bad debt reserves under the rules of IRC section 585, which
apply to commercial banks. In years prior to 1996, these banks obtained tax bad
debt deductions approximating $2.9 million in excess of their financial
statement allowance for loan losses for which no provision for federal income
tax was made. These amounts were then subject to federal income tax in future
years pursuant to the prior IRC section 593 provisions if used for purposes
other than to absorb bad debt losses. Effective January 1, 1996, approximately
$2.9 million of the excess reserve is subject to recapture only if the Bank
ceases to appropriately qualify pursuant to the provisions of IRC section
585.
  **(11)        Stockholders’
Equity**
 In a
series of private placements of common stock and warrants under Rule 506 of the
Securities Act of 1933, the
Company sold 6,000 shares of common stock in 2004, 12,000 shares in 2003 and
1,272,000 shares in 2002 at prices ranging from $9.10 to $13.01 per share,
representing in each case the fair market value of the stock. See Note 12 for
information about the warrants. The proceeds were used for general corporate
purposes. In December 2004, the Company issued 236,723 shares of common stock in
a business purchase transaction under Rule 506.
  Shares of
preferred stock may be issued from time to time in one or more series as
established by resolution of the Board of Directors of Flag, up to a maximum of
10 , 000 , 000
shares. Each resolution shall include the number of shares issued, preferences,
special rights and limitations as determined by the
Board.
  
  **FLAG
FINANCIAL CORPORATION AND SUBSIDIARY**
 
 **Notes
to Consolidated Financial Statements, continued**
 
 **(12)** **Employee
and Director Benefit Plans**
 *Defined
      Contribution Plan*
 Flag
sponsors the Flag Financial Profit Sharing Thrift Plan that is qualified
pursuant to IRC section 401(k). The plan allows eligible employees to defer a
portion of their income by making contributions into the plan on a pretax basis.
The plan provides a matching contribution based on a percentage of the amount
contributed by the employee. The plan also provides that the Board of Directors
may make discretionary profit-sharing contributions up to 15% of eligible
compensation to the plan. The plan allows participants to direct up to 75% of
their account balance and/or contributions to be invested in the common stock of
Flag. The trustee of the plan is required to purchase the Flag stock at market
value and may not acquire more than 25% of the issued and outstanding
shares.   At December 31, 2004 and 2003, 227,230 shares with a market
value of $3,438,000 and 233,877 shares with a market value of $3,054,000,
respectively, of the Company's common stock were held by the plan.  During
the years ended December 31, 2004, 2003 and 2002, the Company contributed
approximately $413,000, $475,000 and $430,000, respectively, to this plan under
its matching provisions.
  *Nonqualified* *Directors’
Retirement Plans*
 The Bank sponsors postretirement benefit plans to provide retirement
benefits to certain of their Board of Directors and executives and to provide
death benefits for their designated beneficiaries. Under these plans, the Bank
purchased split-dollar universal life insurance contracts on the lives of each
participant. At December 31, 2004 and 2003, the cash surrender value of the
insurance contracts was approximately $6,470,000 and $4,603,000,respectively,
and the accrued liability was $786,000 and $337,000, respectively.During
the years ended December 31, 2004, 2003 and 2002, the Company expensed
approximately $460,000, $84,000 and $63,000, respectively, for retirement
benefits.Expenses
incurred for benefits were approximately $5,000 during 2004, $6,000 during 2003
and $6,000 during 2002.
 *Stock
Option Plan and Warrants*
 Flag
sponsors an employee stock incentive plan and a director stock incentive plan.
The plans were adopted for the benefit of directors and key officers and
employees in order that they may purchase Flag stock at a price equal to the
fair market value on the date of grant . A total
of 1,314,000 shares were reserved for possible issuance under the employee plan
and approximately 267,000 shares were reserved under the director plan. The
options generally vest over a four-year period and expire after ten years. The
plans expired in 2004 and a new plan was adopted. A total of 543,000 shares were
reserved for the benefit of directors and key officers and employees under the
new plan.
 
 In
connection with the Company’s private placement described in Note 11, warrants
for 6,000 shares, 12,000 shares and 1,236,000 shares were issued for the
purchases of common stock for $1 per warrant during 2004, 2003 and 2002,
respectively. The warrants allow each holder to purchase one additional share of
common stock for each share purchased in connection with the applicable private
placement and were issued as of the date of issuance of common stock sold in the
private placement. The warrants will be exercisable for a period of ten years
following issuance at prices ranging from $9.10 to $13.01 per
share.
  
  
 **FLAG
FINANCIAL CORPORATION AND SUBSIDIARY**
 
 **Notes
to Consolidated Financial Statements, continued**
 
 **(12)** **Employee
and Director Benefit Plans, continued**
 *Stock
      Option Plan and Warrants,
continued*
 A summary
of activity in the warrants and stock option plans is presented
below:
 
 2004
    
    2003
    
    2002Weighted
    
    
    Weighted
    
    
    WeightedAverage
    
    
    Average
    
    
    AveragePrice
    
    
    Price
    
    
    PriceShares
    Per
      Share
    
    Shares
    Per
      Share
    
    Shares
    Per
      ShareOutstanding,
      beginning of year
    2,030,415
    $
      9.30
    
    2,152,427
    $
      9.21
    
    998,095
    $
      9.22Granted
      during the year
    100,000
    12.88
    
    23,100
    12.91
    
    1,415,000
    9.12Cancelled
      during the year
    (76,600)
    10.74
    
    (28,014)
    11.37
    
    (172,162)
    10.25Exercised
      during the year
    (35,750)
    7.77
    
    (117,098)
    7.78
    
    (88,506)
    5.94Outstanding,
      end of year
    2,018,065
    $9.45
    
    2,030,415
    $9.30
    
    2,152,427
    $9.21
 
 A summary
of options and warrants outstanding as of December 31, 2004 is presented
below:
 
 Weighted
    
    
    
    Options
    
    WeightedOptions
    
    Range
      of
    
    Average
    
    
    
    and
      Warrants
    
    Averageand
      Warrants
    
    Price
      per
    
    Price
    
    Years
    
    Currently
    
    PriceOutstanding
    
    Share
    
    Per
      Share
    
    Remaining
    
    Exercisable
    
    Per
      Share213,398
    
    $
      4.50 - 7.75
    
    $
      6.82
    
    5
    
    149,096
    
    $
      6.811,447,961
    
    7.76
      - 10.00
    
    9.10
    
    7
    
    1,429,251
    
    9.11356,706
    
    10.01
      - 14.55
    
    12.46
    
    6
    
    266,331
    
    12.302,018,065
    
    $4.50-14.55
    
    $9.45
    
    7
    
    1,844,678
    
    $9.38
 
  The fair
value of each option is estimated on the date of grant using the Black-Scholes
options-pricing model with the following weighted average assumptions: dividend
yield of 1.80%, risk free interest rate ranging from 3.29% to 4.70% and
an  expected
life of 7 years. Volatility ranged from .2232 to .2941 in 2004, .2496 to .9803
in 2003 and from .2973 to .9803 in 2002. The  weighted
average grant-date fair value of options and warrants granted in 2004, 2003 and
2002 was  $3.44,  $3.60 and
$1.82, respectively.
 
 **(13)** **Regulatory
Matters**
 Flag 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, action by
regulators that, if undertaken, could have a direct material effect on the
Bank’s financial statements. Under capital adequacy guidelines and the
regulatory framework for prompt corrective action, the Bank must meet specific
capital guidelines that involve quantitative measures of the Bank’s assets,
liabilities, and certain off-balance sheet items as calculated under regulatory
accounting practices. 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 the Bank
to maintain minimum amounts and ratios of total and Tier 1 capital (as defined)
to risk-weighted assets (as defined), and of Tier 1 capital (as defined) to
average assets (as defined). Management believes, as of December 31, 2004 that
Flag and the Bank meet all capital adequacy requirements to which they are
subject.
  
  
 **FLAG
FINANCIAL CORPORATION AND SUBSIDIARY**
 
 **Notes
to Consolidated Financial Statements, continued**
 **(13)        
Regulatory Matters, continued**
 Minimum
ratios required by the Bank to ensure capital adequacy are 8% for total capital
to risk weighted assets and 4% each for Tier 1 capital to average assets.
Minimum ratios required by the Bank to be well capitalized under prompt
corrective action provisions are 10% for total capital to risk weighted assets,
6% for Tier 1 capital to risk weighted assets and 5% for Tier 1 capital to
average assets. Minimum amounts required for capital adequacy purposes and to be
well capitalized under prompt corrective action provisions are presented below
for Flag and the Bank. Prompt corrective action provisions do not apply to bank
holding companies .
 
 To
      Be WellCapitalized
      UnderFor
      Capital
    
    Prompt
      CorrectiveActual
    
    Adequacy
      Purposes
    
    Action
      ProvisionsAmount
    
    Ratio
    
    Amount
    
    Ratio
    
    Amount
    
    Ratio(000’s)
    
    
    
    (000’s)
    
    
    
    (000’s)**As
      of December 31, 2004:**Total
      Capital (to Risk Weighted Assets)Flag
      consolidated
    
    $
    70,013
    
    
    11.23
    %
    $
    49,869
    
    
    8.00
    %
    
    N/A
    
    
    N/AFlag
      Bank
    
    $
    67,035
    
    
    10.74
    %
    $
    49,917
    
    
    8.00
    %
    $
    62,397
    
    
    10.00
    %Tier
      1 Capital (to Risk Weighted Assets)Flag
      consolidated
    
    $
    62,203
    
    
    9.98
    %
    $
    24,915
    
    
    4.00
    %
    
    N/A
    
    
    N/AFlag
      Bank
    
    $
    59,225
    
    
    9.49
    %
    $
    24,959
    
    
    4.00
    %
    $
    37,438
    
    
    6.00
    %Tier
      1 Capital (to Average Assets)Flag
      consolidated
    
    $
    62,203
    
    
    8.12
    %
    $
    30,642
    
    
    4.00
    %
    
    N/A
    
    
    N/AFlag
      Bank
    
    $
    59,225
    
    
    7.79
    %
    $
    30,425
    
    
    4.00
    %
    $
    38,031
    
    
    5.00
    %**As
      of December 31, 2003:**Total
      Capital (to Risk Weighted Assets)Flag
      consolidated
    
    $
    57,871
    
    
    10.46
    %
    $
    44,260
    
    
    8.00
    %
    
    N/A
    
    
    N/AFlag
      Bank
    
    $
    53,109
    
    
    9.59
    %
    $
    44,304
    
    
    8.00
    %
    $
    55,379
    
    
    10.00
    %Tier
      1 Capital (to Risk Weighted Assets)Flag
      consolidated
    
    $
    51,186
    
    
    9.25
    %
    $
    22,134
    
    
    4.00
    %
    
    N/A
    
    
    N/AFlag
      Bank
    
    $
    46,424
    
    
    8.38
    %
    $
    22,159
    
    
    4.00
    %
    $
    33,239
    
    
    6.00
    %Tier
      1 Capital (to Average Assets)Flag
      consolidated
    
    $
    51,186
    
    
    7.46
    %
    $
    27,446
    
    
    4.00
    %
    
    N/A
    
    
    N/AFlag
      Bank
    
    $
    46,424
    
    
    6.81
    %
    $
    27,268
    
    
    4.00
    %
    $
    34,085
    
    
    5.00
    %
 
 Banking
regulations limit the amount of dividends the Bank can pay to Flag without prior
regulatory approval. These limitations are a function of excess regulatory
capital and net earnings in the year the dividend is declared. In 2005, the Bank
can pay dividends of approximately $3,684,000 without prior regulatory
approval.
 
 **(14)** **Commitments**
 Flag 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 and to manage its cost
of funds. These financial instruments include commitments to extend credit and
standby letters of credit. These instruments involve, to varying degrees,
elements of credit risk in excess of the amounts recognized in the consolidated
balance sheets. The contract amounts of these instruments reflect the extent of
involvement the Bank has in particular classes of financial
instruments.
 
 
 
 
 
 **FLAG
FINANCIAL CORPORATION AND SUBSIDIARY**
 
 **Notes
to Consolidated Financial Statements, continued**
 
 **(14)**
    **Commitments,
      continued**
 Commitments
      to originate first mortgage loans and 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. The Bank evaluates each customer's creditworthiness on a
      case-by-case basis. The amount of collateral obtained, if deemed necessary
      by the Bank upon extension of credit, is based on management's credit
      evaluation of the counterparty. The Bank’s loans are primarily
      collateralized by residential and commercial real properties, automobiles,
      savings deposits, accounts receivable, inventory and
      equipment.
 ****
 Standby
      letters of credit are written conditional commitments issued by the Bank
      to guarantee the performance of a customer to a third party. Those
      guarantees are primarily issued to support public and private borrowing
      arrangements. Most letters of credit extend for less than one year. The
      credit risk involved in issuing letters of credit is essentially the same
      as that involved in extending loan facilities to
  customers.
 
 Flag’s
exposure to credit loss in the event of nonperformance by the other party to the
financial instrument for commitments to extend credit and standby letters of
credit is represented by the contractual amount of those instruments. The Bank
uses the same credit policies in making commitments and conditional obligations
as it does for on-balance sheet instruments. All standby letters of credit are
secured at December 31, 2004 and 2003 .
  
 2004
    
    2003Financial
      instruments whose contract amountsrepresent
      credit risk (in thousands):Commitments
      to extend credit
    
    $
    142,036
    
    
    124,342Standby
      letters of credit
    
    $
    3,650
    
    
    1,128
 
 Flag
maintains an overall interest rate risk-management strategy that incorporates
the use of derivative instruments to minimize significant unplanned fluctuations
in earnings that are caused by interest rate volatility. The goal is to manage
interest rate sensitivity by modifying the repricing or maturity characteristics
of certain assets and liabilities so that the net interest margin is not, on a
material basis, adversely affected by certain movements in interest rates. Flag
views this strategy as a prudent management of interest rate sensitivity, such
that earnings are not exposed to undue risk presented by changes in interest
rates.
 
 Derivative
instruments that are used as part of Flag’s interest rate risk-management
strategy include interest rate contracts. As a matter of policy, Flag does not
use highly leveraged derivative instruments for interest rate risk management.
During 2001, Flag settled a previously outstanding interest rate contract. The
gain realized upon settlement was recognized over the original life of the
contract, which expired during 2003.
 
 
 
 **FLAG
FINANCIAL CORPORATION AND SUBSIDIARY**
 
 **Notes
to Consolidated Financial Statements, continued**
 ****
 **(14)**
    **Commitments,
      continued**
 By using
derivative instruments, Flag is exposed to credit and market risk. If the
counterparty fails to perform, credit risk is equal to the extent of the
fair-value gain in a derivative. When the fair value of a derivative contract is
positive, this generally indicates that the counterparty owes Flag, and,
therefore, creates a repayment risk for Flag. When the fair value of a
derivative contract is negative, Flag owes the counterparty and, therefore, it
has no repayment risk. Flag minimizes the credit (or repayment) risk in
derivative instruments by entering into transactions with high-quality
counterparties that are reviewed periodically.
 
 Flag’s
derivative activities are monitored by its asset/liability management committee
as part of that committee’s oversight of Flag’s asset/liability and treasury
functions. Flag’s asset/liability committee is responsible for implementing
various hedging strategies that are developed through its analysis of data from
financial simulation models and other internal and industry sources. The
resulting hedging strategies are then incorporated into the overall
interest-rate risk management.
 
 At
December 31, 2004, the Company had three derivative instruments designated as
cash flow hedges. No fair value hedges were outstanding. The following table
summarizes the outstanding derivative instruments.
 
 **Type**
    **Transaction**
      **Date**
    **Term**
      **Date**
    **Notional**
    **Receive**
      **Rate**
    **Pay**
      **Rate**
    **Current**
      **Spread**Receive
      Fixed, Pay LIBOR Swap
    June
      2004
    Dec
      2005
    5,000,000
    2.68%
    1.84%
    0.84%Receive
      Fixed, Pay LIBOR Swap
    June
      2004
    June
      2006
    15,000,000
    3.00%
    1.84%
    1.16%Receive
      Fixed, Pay LIBOR Swap
    June
      2004
    Dec
      2006
    5,000,000
    3.27%
    1.84%
    1.43%Total
      Received Fixed Swaps
    
    
    25,000,000
    2.99%
    1.84%
    1.15%
 
 For the
years ended December 31, 2004, 2003 and 2002, there were no material amounts
recognized which represented the ineffective portion of cash flow hedges. All
components of each derivative’s gain or loss are included in the assessment of
hedge effectiveness, unless otherwise noted.
  For
      the years ended December 31, 2004, 2003 and 2002, the Company had rent
      expense in the amount of $926,000, $544,000 and $479,000, respectively.At
      December 31, 2004,minimum
      operating lease commitmentsare summarized as follows (in thousands):
 
  Year
      ending December 31,2005
    
    $
    8662006
    
    
    1,0062007
    
    
    9262008
    
    
    7372009
    
    
    601Thereafter
    
    
    1,719$
    5,855
 
 
 
 
 
 **FLAG
FINANCIAL CORPORATION AND SUBSIDIARY**
 
 **Notes
to Consolidated Financial Statements, continued**
 
 **(15)** **Related
Party Transactions**
 Flag
conducts transactions with its directors and executive officers, including
companies in which they have beneficial interest, in the normal course of
business. It is the policy of Flag that loan transactions with directors and
executive officers are made on substantially the same terms as those prevailing
at the time for comparable loans to other persons. The following is a summary of
activity for related party loans for 2004 (in thousands).
 
 
 Balance
      at December 31, 2003
    
    $
    3,290New
      loans
    
    
    2,918Repayments
    
    
    (903
    )Changes
      in directors and executive officers, net
    
    
    (298
    )Balance
      at December 31, 2004
    
    $
    5,007
 
 At
December 31, 2004, deposits from directors, executive officers and their related
interests aggregated approximately $6,154,000. These deposits were taken in the
normal course of business at market interest rates.
 
 
 
 
 **FLAG
FINANCIAL CORPORATION AND SUBSIDIARY**
 
 **Notes
to Consolidated Financial Statements, continued**
 
 **(16)        
Flag Financial Corporation (Parent Company Only) Financial
Information**
 
 Balance
Sheets
 
 December
31, 2004 and 2003
 
 Assets
 
 2004
    
    2003*(In
      Thousands)*Cash
    
    $
    2,679
    
    
    771Investment
      securities
    
    
    7,523
    
    
    8,614Investment
      in subsidiary
    
    
    77,483
    
    
    60,444Other
      assets
    
    
    3,650
    
    
    2,700$
    91,335
    
    
    72,529Liabilities
      and Stockholders’ EquityAccounts
      payable and accrued expenses
    
    $
    686
    
    
    598Other
      borrowings
    
    
    7,014
    
    
    6,671Junior
      subordinated debentures
    
    
    14,433
    
    
    -Stockholders’
      equity
    
    
    69,202
    
    
    65,260$
    91,335
    
    
    72,529
   Statements
of Operations
 
 For the
Years Ended December 31, 2004, 2003 and 2002
 
 2004
    
    2003
    
    2002*(In
      Thousands)*Income:Dividend
      income from subsidiary
    
    
    -
    
    
    -
    
    
    5,021Interest
      income
    
    $
    735
    
    
    572
    
    
    5Other
    
    
    -
    
    
    -
    
    
    2Total
      income
    
    
    735
    
    
    572
    
    
    5,028Operating
      expenses:Interest
      expense
    
    
    688
    
    
    181
    
    
    42(Gain) loss on sale of investments
    
    
    -
    
    
    (125
    )
    
    380Other
    
    
    296
    
    
    209
    
    
    851Total
      operating expenses
    
    
    984
    
    
    265
    
    
    1,273(Loss)
      earnings before income tax benefit (expense) and dividendsreceived
      in excess of earnings of subsidiary and equity inundistributed
      earnings of subsidiary
    
    
    (249
    )
    
    307
    
    
    3,755Income
      tax benefit (expense)
    
    
    95
    
    
    (113
    )
    
    209(Loss)
      earnings before dividends received in excess of earnings
ofsubsidiary
      and equity in undistributed earnings ofsubsidiary
    
    
    (154
    )
    
    194
    
    
    3,964Dividends
      received in excess of earnings of subsidiary
    
    
    -
    
    
    ---
    
    
    (5,958
    )Equity
      in undistributed earnings of subsidiary
    
    
    7,522
    
    
    5,911
    
    
    -Net
      earnings (loss)
    
    $
    7,368
    
    
    6,105
    
    
    (1,994
    )
  
 
 
 **FLAG
FINANCIAL CORPORATION AND SUBSIDIARY**
 
 **Notes
to Consolidated Financial Statements, continued**
 
 ****
 **(16) 
       Flag Financial Corporation (Parent Company
Only) Financial Information, continued**
 
 Statements
of Cash Flows
 
 For the
Years Ended December 31, 2004, 2003 and 2002
 
 2004
    
    2003
    
    2002*(In
      Thousands)*Cash
      flows from operating activities:Net
      earnings (loss)
    
    $
    7,368
    
    
    6,105
    
    
    (1,994
    )Adjustments
      to reconcile net earnings (loss) to net cash (used) provided
      byoperating
      activities:Depreciation
      and amortization
    
    
    -
    
    
    -
    
    
    3(Gain)
      loss on investments
    
    
    -
    
    
    (125
    )
    
    380Write
      down of premises and equipment
    
    
    -
    
    
    -
    
    
    29Dividends
      received in excess of earnings of subsidiary
    
    
    -
    
    
    -
    
    
    5,958Equity
      in undistributed earnings of subsidiary
    
    
    (7,522
    )
    
    (5,911
    )
    
    -Change
      in other assets and liabilities
    
    
    (882
    )
    
    (754
    )
    
    (1,162
    )Net
      cash (used) provided by operating activities
    
    
    (1,036
    )
    
    (685
    )
    
    3,214Cash
      flows from investing activities:Purchase
      of investment securities
    
    
    1,143
    
    
    (8,100
    )
    
    (50
    )Proceeds
      from sale and maturity of investment securities
    
    
    -
    
    
    803
    
    
    117Investment
      in Statutory Trust
    
    
    (419
    )
    
    -
    
    
    -Investment in subsidiary
    
    
    (6,971
    )
    
    -
    
    
    (4,500
    )Net
      cash used in investing activities
    
    
    (6,247
    )
    
    (7,297
    )
    
    (4,433
    )Cash
      flows from financing activities:Proceeds
      from issuance of common stock
    
    
    78
    
    
    138
    
    
    11,707Proceeds
      from issuance of warrants
    
    
    6
    
    
    12
    
    
    1,236Change
      in other borrowings
    
    
    343
    
    
    6,671
    
    
    (5,000
    )Proceeds from issuance of junior subordinated debentures
    
    
    14,433
    
    
    -
    
    
    -Proceeds
      from exercise of stock options
    
    
    278
    
    
    1,080
    
    
    526Purchase
      of treasury stock
    
    
    (3,927
    )
    
    -
    
    
    (3,132
    )Cash
      dividends paid
    
    
    (2,020
    )
    
    (2,028
    )
    
    (1,944
    )Net
      cash provided by financing activities
    
    
    9,191
    
    
    5,873
    
    
    3,393Net
      change in cash
    
    
    1,908
    
    
    (2,109
    )
    
    2,174Cash
      at beginning of year
    
    
    771
    
    
    2,880
    
    
    706Cash
      at end of year
    
    $
    2,679
    
    
    771
    
    
    2,880
 
 
 
 
 
  
 **FLAG
FINANCIAL CORPORATION AND SUBSIDIARY**
 
 **Notes
to Consolidated Financial Statements, continued**
 
 **(17)** **Quarterly
Operating Results (Unaudited)**
 The
following is a summary of the unaudited condensed consolidated quarterly
operating results of Flag for the years ended December 31, 2004 and 2003 (in
thousands, except per share amounts):
 
 **2004****Quarter
      Ended****Dec.
      31**
    
    **Sept.
      30**
    
    **June
      30**
    
    **March
      31**Interest
      income
    
    $
    12,063
    
    
    10,813
    
    
    10,071
    
    
    9,674Interest
      expense
    
    
    3,639
    
    
    3,165
    
    
    2,712
    
    
    2,541Net interest income
    
    
    8,424
    
    
    7,648
    
    
    7,359
    
    
    7,133Provision
      for loan losses
    
    
    375
    
    
    375
    
    
    375
    
    
    720Net interest income after provision
    
    
    8,049
    
    
    7,273
    
    
    6,984
    
    
    6,413Non-interest
      income
    
    
    1,931
    
    
    2,254
    
    
    2,591
    
    
    4,692Non-interest
      expense
    
    
    7,490
    
    
    7,297
    
    
    6,734
    
    
    7,988Earnings
      before income taxes
    
    
    2,490
    
    
    2,230
    
    
    2,841
    
    
    3,117Provision
      for income taxes
    
    
    798
    
    
    571
    
    
    920
    
    
    1,021Net earnings
    
    $
    1,692
    
    
    1,659
    
    
    1,921
    
    
    2,096Basic
      earnings per share
    
    $
    0.20
    
    
    0.20
    
    
    0.23
    
    
    0.25Diluted
      earnings per share
    
    $
    0.19
    
    
    0.19
    
    
    .0.21
    
    
    0.23Weighted
      average shares outstanding
    
    
    8,993
    
    
    8,856
    
    
    8,991
    
    
    9,095
 
 **2003********Quarter
      Ended****Dec.
      31**
    
    **Sept.
      30**
    
    **June
      30**
    
    **March
      31**Interest
      income
    
    $
    9,461
    
    
    9,267
    
    
    8,725
    
    
    9,081Interest
      expense
    
    
    2,608
    
    
    2,490
    
    
    2,606
    
    
    2,843Net interest income
    
    
    6,853
    
    
    6,777
    
    
    6,119
    
    
    6,238Provision
      for loan losses
    
    
    375
    
    
    375
    
    
    315
    
    
    256Net interest income after provision
    
    
    6,478
    
    
    6,402
    
    
    5,804
    
    
    5,982Non-interest
      income
    
    
    2,042
    
    
    2,332
    
    
    3,538
    
    
    2,453Non-interest
      expense
    
    
    6,327
    
    
    6,503
    
    
    7,083
    
    
    6,289Earnings
      before income taxes
    
    
    2,193
    
    
    2,231
    
    
    2,259
    
    
    2,146Provision
      for income taxes
    
    
    664
    
    
    685
    
    
    736
    
    
    639Net earnings
    
    $
    1,529
    
    
    1,546
    
    
    1,523
    
    
    1,507Basic
      earnings per share
    
    $
    0.18
    
    
    0.18
    
    
    0.18
    
    
    0.18Diluted
      earnings per share
    
    $
    0.17
    
    
    0.17
    
    
    0.17
    
    
    0.17Weighted
      average shares outstanding
    
    
    9,121
    
    
    9,164
    
    
    9,130
    
    
    8,875
 
 
 
 
 
 **FLAG
FINANCIAL CORPORATION AND SUBSIDIARY**
 
 **Notes
to Consolidated Financial Statements, continued**
 
 **(18)** **Fair
Value of Financial Instruments**
Flag is
required to disclose fair value information about financial instruments, whether
or not recognized on the face of the balance sheet, for which it is practicable
to estimate that value. The assumptions used in the estimation of the fair value
of Flag’s financial instruments are detailed below. Where quoted prices are not
available, fair values are based on estimates using discounted cash flows and
other valuation techniques. The use of discounted cash flows can be
significantly affected by the assumptions used, including the discount rate and
estimates of future cash flows. The following disclosures should not be
considered a surrogate of the liquidation value of Flag or the Bank, but rather
a good-faith estimate of the increase or decrease in value of financial
instruments held by Flag since purchase, origination or issuance.

Cash and Cash Equivalents and Interest-Bearing
Deposits
 For cash,
due from banks, federal funds sold and interest-bearing deposits with other
banks the carrying  amount is
a reasonable estimate of fair value.
 
 Securities
Available-for-Sale
 Fair
values for securities available-for-sale are based on quoted market
prices.
 
 Other
Investments
 The
carrying value of other investments approximates fair value.
 
 Loans
and Mortgage Loans Held-for-Sale
 The fair
value of fixed rate loans is estimated by discounting the future cash flows
using the current  rates at  which
similar loans would be made to borrowers with similar credit ratings. For
variable rate  loans,
the carrying amount is a reasonable estimate of fair value.
 
 Cash
Surrender Value of Life Insurance
 The
carrying value of cash surrender value of life insurance approximates fair
value.
 
 Deposits
 The fair
value of demand deposits, savings accounts, NOW accounts, certain money market
deposits,  advances
from borrowers and advances payable to secondary market is the amount payable on
demand  at the
reporting date. The fair value of fixed maturity certificates of deposits is
estimated by discounting  the
future cash flows using the rates currently offered for deposits of similar
remaining maturities.
 
 Federal
Funds Purchased, Repurchase Agreements and Other Borrowings
 For
federal funds purchased, repurchase agreements and other borrowings, the
carrying amount is a  reasonable
estimate of fair value.
 
 Advances
from the Federal Home Loan Bank
 The
carrying amount of FHLB variable rate borrowings approximates fair value. The
fair value of the  FHLB
fixed rate borrowings is estimated using discounted cash flows, based on
the current  incremental
borrowing rates for similar types of borrowing arrangements.
 
 
 
 **FLAG
FINANCIAL CORPORATION AND SUBSIDIARY**
 
 **Notes
to Consolidated Financial Statements, continued**
 
 **(18)** **Fair
Value of Financial Instruments, continued**
 Commitments
to Originate First Mortgage Loans, Commitments to Extend Credit and Standby
Letters  of
Credit
 Because
commitments to originate first mortgage loans, commitments to extend credit and
standby letters  of credit
are generally short-term and at variable rates, the contract value and estimated
fair value  associated
with these instruments are immaterial.
 
 Junior
Subordinated Debentures
 Junior  debentures bear interest on a floating basis, and as such, the carrying amount
approximates fair value.
 
 Interest
Rate Contracts
 The fair
value of interest rate contracts is obtained from dealer quotes. These values
represent the amount the Company would receive to terminate the contracts or
agreements, taking into account current interest rates and, when appropriate,
the current creditworthiness of the counterparties.
 
 Limitations
 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 Flag’s entire holdings of a particular financial instrument. Because no
market exists for a significant portion of Flag’s financial instruments, fair
value estimates are based on many judgments. 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 and liabilities that are not
considered financial instruments include the mortgage banking operation,
deferred income taxes, premises and equipment and purchased core deposit
intangible. 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.
 
 
 
 **FLAG
FINANCIAL CORPORATION AND SUBSIDIARY**
 
 **Notes
to Consolidated Financial Statements, continued**
 
 **(18)** **Fair
Value of Financial Instruments, continued**
 The
carrying amount and estimated fair values of Flag’s financial instruments at
December 31, 2004 and 2003 are as follows (in thousands):
 
 **2004**
    
    **2003****Carrying**
    
    **Estimated**
    
    **Carrying**
    
    **Estimated****Amount**
    
    **Fair
      Value**
    
    **Amount**
    
    **Fair
      Value****Assets:**Cash
      and cash equivalents
    
    $
    40,316
    
    
    40,316
    
    
    36,737
    
    
    36,737Interest-bearing
      deposits
    
    
    5,473
    
    
    5,473
    
    
    2,675
    
    
    2,675Investment
      securities available-for-sale
    
    
    111,390
    
    
    111,390
    
    
    122,565
    
    
    122,565Other
      investments
    
    
    13,161
    
    
    13,161
    
    
    14,944
    
    
    14,944Mortgage
      loans held-for-sale
    
    
    10,688
    
    
    10,688
    
    
    4,234
    
    
    4,234Loans,
      net
    
    
    596,101
    
    
    596,097
    
    
    477,095
    
    
    478,084Cash
      surrender value of life insurance
    
    
    6,470
    
    
    6,470
    
    
    4,603
    
    
    4,603Interest
      rate contracts
    
    
    -
    
    
    (93
    )
    
    -
    
    
    -**Liabilities:**Deposits
    
    $
    706,847
    
    
    707,820
    
    
    570,570
    
    
    571,056Federal
      funds purchased and repurchase agreements
    
    
    2,295
    
    
    2,295
    
    
    4,097
    
    
    4,097Advances
      from Federal Home Loan Bank
    
    
    25,000
    
    
    25,000
    
    
    58,000
    
    
    58,544Other
      borrowings
    
    
    4,300
    
    
    4,300
    
    
    1,100
    
    
    1,100Junior subordinated debentures
    
    
    14,433
    
    
    14,433
    
    
    -
    
    
    -
 ****
 **(19)**  **Miscellaneous
Operating Expenses**
 Components
of other operating expenses which are greater than 1% of interest income and
other operating income for the years ended December 31, 2004 and 2003 are as
follows:
 2004
    2003
    2002Marketing
    $552
    235
    160
  **ITEM
9.****CHANGES
IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE**
 
 None
 
 
 **ITEM
9A.** **CONTROLS AND PROCEDURES**
 
 As of the
end of the period covered by this report, the Company carried out an evaluation,
under the supervision and with the participation of the Company’s management,
including the Company’s Chief Executive Officer and Chief Financial Officer, of
the effectiveness of the design and operation of the Company’s disclosure
controls and procedures pursuant to Exchange Act Rule 13a-15. Based upon that
evaluation, the Company’s Chief Executive Officer and Chief Financial Officer
concluded that the Company’s disclosure controls and procedures are effective in
timely alerting them to material information relating to the Company (including
its consolidated subsidiary) that is required to be included in the Company’s
periodic filings with the Securities and Exchange Commission. There have been no
significant changes in the Company’s internal controls or, to the Company’s
knowledge, in other factors that could significantly affect those internal
controls subsequent to the date the Company carried out its evaluation, and
there have been no corrective actions with respect to significant deficiencies
or material weaknesses.
 **MANAGEMENT’S
REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING**
   Flag’s
management is responsible for establishing and maintaining adequate internal
control over financial reporting. Flag’s internal control over financial
reporting is a process designed under the supervision of the Chief Executive
Officer and Chief Financial Officer to provide reasonable assurance regarding
the reliability of financial reporting and the preparation of Flag’s financial
statements for external purposes in accordance with generally accepted
accounting principles.
  Because
of its inherent limitations, internal control over financial reporting may not
prevent or detect misstatements. Therefore, even those systems determined to be
effective can provide only reasonable assurance with respect to financial
statement preparation and presentation.
  Flag’s
management assessed the effectiveness of Flag’s internal control over financial
reporting as of December 31, 2004 based on the criteria for effective
internal control over financial reporting established in “Internal Control —
Integrated Framework”, issued by the Committee of Sponsoring Organizations of
the Treadway Commission. Based on the assessment, management determined that
Flag maintained effective internal control over financial reporting as of
December 31, 2004.
 
 Porter Keadle Moore, LLP, the
independent registered public accounting firm that audited the consolidated
financial statements of Flag included in this Annual Report on Form 10-K, has
issued an attestation report on management’s assessment of the effectiveness of
Flag’s internal control over financial reporting as of December 31, 2004.
The report, which expresses unqualified opinions on management’s assessment and
on the effectiveness of Flag’s internal control over financial reporting as of
December 31, 2004, is included in Item 8 of this Report under the
heading “Report of Independent Registered Public Accounting Firm”.
 ITEM 9B. OTHER
INFORMATION  None
 **PART
III**
 
 **ITEM
10.****DIRECTORS
AND EXECUTIVE OFFICERS OF THE REGISTRANT**
 
 Information
relating to the directors and executive officers of the Company is set forth
under the captions “Proposal 1 - Election of Directors-Nominees, - Information
Regarding Nominees and Continuing Directors and - Executive Officers” in the
Company’s Proxy Statement for its 2005 Annual Meeting of Shareholders. Such
information is incorporated herein by reference.
 
 Information
regarding compliance with Section 16(a) of the Securities Exchange Act of 1934,
as amended, by directors and executive officers of the Company and the Bank is
set forth under the caption “Section 16(a) Beneficial Ownership Reporting
Compliance” in the Proxy Statement referred to above. Such information is
incorporated herein by reference. To the Company’s knowledge, no person was the
beneficial owner of more than 10% of the Company’s common stock during
2004.
 
 The
Company has adopted a Code of Conduct that applies to all of its directors,
officers and employees, including its principal executive, financial and
accounting officers. The Code is posted on the Company’s website at www.flagbank.com . Any
waivers from, or amendments to, the code will be posted on the website at that
address.
 
 **ITEM
11.****EXECUTIVE
COMPENSATION**
 
 Information
relating to executive compensation is set forth under the captions “Proposal 1-
Election of Directors- Director Compensation” and “Executive Compensation” in
the Proxy Statement referred to in Item 10 above. Such information is
incorporated herein by reference.
 
 ****
 **ITEM
12.****SECURITY
OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED SHAREHOLDER
MATTERS**
 Information
regarding ownership of the Company’s common stock by management and beneficial
owners of 5% of the Company’s common stock is set forth under the captions
“Proposal 1 - Election of Directors - Management Stock Ownership” in the Proxy
Statement referred to in Item 10 above and is incorporated herein by reference.
 
 Equity
      Compensation Plan Table(a)
    
    (b)
    
    (c)Plan
      category
    
    
    Number
      of securities to be issued upon exercise of outstanding options, warrants
      and rights
    
    
    Weighted-average
      exercise price of outstanding options, warrants and rights
    
    
    Number
      of securities remaining available for future issuance under equity
      compensations plans (excluding securities reflected in column
      (a))Equity
      compensation plans approved by security holders
    
    
    2,018,065
    
    
    $
      9.45
    
    
    531,500Equity
      compensation plans not approved by security holders
    
    
    -
    
    
    -
    
    
    -Total
    
    
    2,018,065
    
    
    $
      9.45
    
    
    531,500
 
 **ITEM
13.****CERTAIN
RELATIONSHIPS AND RELATED TRANSACTIONS**
 
 Information
regarding related party transactions is set forth under the caption “Related
Party Transactions” in the Proxy Statement referred to in Item 10 above and is
incorporated herein by reference.
 
 **ITEM
14.****PRINCIPAL
ACCOUNTANT FEES AND SERVICES**
 
 Information
relating to the fees billed by the Company’s independent accountants is set
forth under the caption “Ratification of Independent Accountants” in the Proxy
Statement referred to in Item 10 above and is incorporated herein by
reference.
 
 
 **PART
IV**
 ****
 **ITEM
15.****EXHIBITS
AND FINANCIAL STATEMENT SCHEDULES**
 
 (a)(1) The list
of financial statements is included at Item 8.
 
 (a)(2) The
financial statement schedules are either included in the financial statements or
are not applicable.
 
 (a)(3) Exhibit
List
 
   **Exhibit
      No****.**
    **Description**3.1
    Articles
      of Incorporation, as amended through October 15, 1993 (incorporated by
      reference from Exhibit 3.1(i) to the Company’s Annual Report on Form 10-K
      for the fiscal year ended December 31, 1993)3.2
    Bylaws,
      as amended through March 30, 1998 (incorporated by reference from
      Exhibit 3.1(ii) to the Company’s Annual Report on Form 10-K/A for the
      fiscal year ended December 31, 1997)3.3
    Amendment
      to Bylaws as adopted by resolution of Board of Directors on
      October 19, 1998 (incorporated by reference from Exhibit 3.3 to the
      Annual Report on Form 10-K for the fiscal year ended December 31,
      1998)3.4
    Amendment
      to Bylaws as adopted by resolution of the Board of Directors on
      December 20, 2000 (incorporated by reference from Exhibit 3.4 to the
      Annual Report on Form 10-K for the fiscal year ended December 31,
      2001)3.5
    Amendment
      to Bylaws as adopted by resolution of the Board of Directors on
      February 19, 2001 (incorporated by reference from Exhibit 3.5 to the
      Annual Report on Form 10-K for the fiscal year ended December 31,
      2001)3.6
    Amendment
      to Bylaws as adopted by resolution of the Board of Directors on January
      20, 2004 (incorporated by reference from Exhibit 3.6 to the Annual Report
      on Form 10-K for the fiscal year ended December 31,
  2003)4.1
    Instruments
      Defining the Rights of Security Holders (See Articles of Incorporation at
      Exhibit 3.1 hereto and Bylaws at Exhibits 3.2, 3.3, 3.4 and 3.5
      hereto)4.2
    Form
      of Warrant Agreement and Form of Warrant issued in connection with the
      issuance of common stock.10.1*
    Amended
      and Restated Employment Agreement between J. Daniel Speight, Jr. and the
      Company dated as of February 21, 2002 (incorporated by reference from
      exhibit of the same number to the Annual Report on Form 10-K for the
      fiscal year ended December 31, 2001)10.2*
    Employment
      Agreement between Stephen W. Doughty and the Company dated January 13,
      2003 (incorporated by reference from Exhibit 10.4 to the Annual Report on
      Form 10-K for the fiscal year ended December 31, 2002)10.3*
    Employment
      Agreement between J. Thomas Wiley, Jr. and the Company dated January 13,
      2003 (incorporated by reference from Exhibit 10.5 to the Annual Report on
      Form 10-K for the fiscal year ended December 31, 2002)10.5*
    Director
      Indexed Retirement Program for Citizens Bank dated January 13, 1995
      (incorporated by reference from Exhibit 10.8 to Amendment No. 1
      to the Company’s Annual Report on Form 10-K/A for the fiscal year ended
      December 31, 1997)10.6*
    Form
      of Executive Agreement (pursuant to Director Indexed Retirement Program
      for Citizens Bank) for individuals listed on exhibit cover page
      (incorporated by reference from Exhibit 10.9 to Amendment No. 1
      to the Company’s Annual Report on Form 10-K/A for the fiscal year ended
      December 31, 1997)10.7*
    Form
      of Flexible Premium Life Insurance Endorsement Method Split Dollar Plan
      Agreement (pursuant to Director Indexed Retirement Program for Citizens
      Bank) for individuals listed on exhibit cover page (incorporated by
      reference from Exhibit 10.10 to Amendment No. 1 to the Company’s
      Annual Report on Form 10-K/A for the fiscal year ended December 31,
      1997)10.8*
    Director
      Indexed Fee Continuation Program for First Federal Savings Bank of
      LaGrange effective February 3, 1995 (incorporated by reference from
      Exhibit 10.12 to Amendment No. 1 to the Company’s Annual Report
      on Form 10-K/A for the fiscal year ended December 31,
      1997)10.9*
    Form
      of Director Agreement (pursuant to Director Indexed Fee Continuation
      Program for First Federal Savings Bank of LaGrange) for individuals listed
      on exhibit cover page (incorporated by reference from Exhibit 10.13
      to Amendment No. 1 to the Company’s Annual Report on Form 10-K/A for
      the fiscal year ended December 31, 1997)10.10*
    Form
      of Flexible Premium Life Insurance Endorsement Method Split Dollar Plan
      Agreement (pursuant to Director Indexed Fee Continuation Program of First
      Federal Savings Bank of LaGrange) for individuals listed on exhibit cover
      page (incorporated by reference from Exhibit 10.14 to Amendment
      No. 1 to the Company’s Annual Report on Form 10-K/A for the fiscal
      year ended December 31, 1997)10.11*
    Form
      of Indexed Executive Salary Continuation Plan Agreement by and between
      First Federal Savings Bank of LaGrange and individuals listed on exhibit
      cover page (incorporated by reference from Exhibit 10.15 to Amendment
      No. 1 to the Company’s Annual Report on Form 10-K/A for the fiscal
      year ended December 31, 1997)10.12*
    Form
      of Flexible Premium Life Insurance Endorsement Method Split Dollar Plan
      Agreement (pursuant to Executive Salary Continuation Plan for First
      Federal Savings Bank of LaGrange) for individuals listed on exhibit cover
      page (incorporated by reference from Exhibit 10.16 to Amendment
      No. 1 to the Company’s Annual Report on Form 10-K/A for the fiscal
      year ended December 31, 1997)10.13*
    Form
      of Deferred Compensation Plan by and between The Citizens Bank and
      individuals listed on exhibit cover page (incorporated by reference from
      Exhibit 10.16 to the Annual Report on Form 10-K for the fiscal year ended
      December 31, 2000)10.14*
    Flag
      Financial Corporation 1994 Employees Stock Incentive Plan (as amended and
      restated through March 30, 1998) (incorporated by reference from Exhibit
      10.17 to the Annual Report on Form 10-K for the fiscal year ended
      December 31, 2000)10.15*
    Flag
      Financial Corporation 1994 Directors Stock Incentive Plan (as amended
      through September 18, 1997) (incorporated by reference from Exhibit 10.18
      to the Annual Report on Form 10-K for the fiscal year ended
      December 31, 2000)10.16*
    First
      Amendment to the Flag Financial Corporation 1994 Employees Stock Incentive
      Plan (as amended and restated as of March 30, 1998), dated as of March 15,
      1999 (incorporated by reference from Exhibit 10.19 to the Annual Report on
      Form 10-K for the fiscal year ended December 31,
  2000)10.17*
    Second
      Amendment to the Flag Financial Corporation 1994 Employees Stock Incentive
      Plan (as amended and restated as of March 30, 1998), dated as of
      January 16, 2001 (incorporated by reference from Exhibit 10.20 to the
      Annual Report on Form 10-K for the fiscal year ended December 31,
      2000)10.18*
    First
      Amendment to the Flag Financial Corporation 1994 Directors Stock Incentive
      Plan (as amended and restated as of September 18, 1997), dated as of
      December 21, 1998 (incorporated by reference from Exhibit 10.21 to the
      Annual Report on Form 10-K for the fiscal year ended December 31,
      2000)10.19*
    Second
      Amendment to the Flag Financial Corporation 1994 Directors Stock Incentive
      Plan (as amended and restated as of September 18, 1997), dated as of
      October 25, 1999 (incorporated by reference from Exhibit 10.22 to the
      Annual Report on Form 10-K for the fiscal year ended December 31,
      2000)10.20*
    Third
      Amendment to the Flag Financial Corporation 1994 Directors Stock Incentive
      Plan (as amended and restated as of September 18, 1997), dated
      January 16, 2001 (incorporated by reference from Exhibit 10.23 to the
      Annual Report on Form 10-K for the fiscal year ended December 31,
      2000)10.21*
    Third
      Amendment to Flag Financial Corporation 1994 Employees Stock Incentive
      Plan (as amended and restated as of March 30, 1998), dated as of
      February 19, 2002 (incorporated by reference from Exhibit 10.24 to
      the Annual Report on Form 10-K for the fiscal year ended December 31,
      2002)10.22*
    Fourth
      Amendment to Flag Financial Corporation 1994 Directors Stock Incentive
      Plan (as amended and restated as of September 18, 1997), dated as of
      February 19, 2002 (incorporated by reference to Exhibit 10.2 to the
      Quarterly Report on Form 10-Q for the quarter ended March 31,
      2001)10.23*
    Flag
      Financial Corporation 2004 Equity Incentive Plan (incorporated by
      reference to Appendix B to the Definitive Proxy Statement filed on March
      11, 2004 on Schedule 14A for the 2004 Annual Meeting of
      Shareholders)10.24
    Purchase
      and Assumption Agreement among Flag Financial Corporation, Bankers’
      Capital Group, LLC, and Gulfstream Financial Services, Inc., dated as of
      November 12, 2002 (incorporated by reference by Exhibit 10.24 to the
      Annual Report on Form 10-K for the fiscal year ended December 31,
      2003)10.25*
    Form
      of Employee Stock Option Agreement pursuant to the Flag Financial
      Corporation 1994 Stock Incentive Plan10.26*
    Form
      of Director Stock Option Agreement pursuant to the Flag Financial
      Corporation 1994 Directors Stock Incentive Plan10.27*
    Form
      of Employee/Director Stock Option Agreement pursuant to the Flag Financial
      Corporation 2004 Equity Incentive Plan10.28*
    Executive
      Salary Continuation Agreement between Flag Financial Corporation, Flag
      Bank and J. Daniel Speight10.29*
    Information
      regarding executive compensation21
    Subsidiaries
      (incorporated by reference from exhibit of the same number to the Annual
      Report on Form 10-K for the fiscal year ended December 31,
      2000)23
    Consent
      of Porter Keadle Moore, LLP31.1
    Certification
      by Chief Executive Officer under Section 302 of the Sarbanes-Oxley Act of
      200231.2
    Certification
      by Chief Financial Officer under Section 302 of the Sarbanes-Oxley Act of
      200232.1
    Certification
      by Chief Executive Officer and Chief Financial Officer under Section 906
      of the Sarbanes-Oxley Act of 2002
 ____________________
 
 *  The
indicated exhibit is a compensatory plan required to be filed as an exhibit to
this Form 10-K.
  (b)  The
Exhibits not incorporated herein by reference are submitted as a separate part
of this report.
  (c)
    Financial
      Statement Schedules: The financial statement schedules are either included
      in the financial statements or are not
applicable.
 
  
  **SIGNATURES**
 
 Pursuant
to the requirements of Section 13 or 15(d) of the Securities Exchange Act of
1934, the Registrant has duly caused this Annual Report on Form 10-K to be
signed on its behalf by the undersigned, thereunto duly authorized.
 
 **FLAG
FINANCIAL CORPORATION**
 
 
 
 **FLAG
      FINANCIAL CORPORATION**(Registrant)Date:
      March 16, 2005
    By:
    /s/
      Joseph W. EvansJoseph
      W. EvansChief Executive Officer
 
 
 Pursuant
to the requirements of the Securities Act of 1934, this Report has been signed
by the following persons in the capacities indicated on March 16,
2005:
 
 
 Signature
    
    Title/s/
      William H. Anderson, II
    
    DirectorWilliam
      H. Anderson, II/s/
      H. Speer Burdette, III
    
    DirectorH.
      Speer Burdette, III/s/
      Stephen W. Doughty
    
    Vice
      Chairman, Chief RiskStephen
      W. Doughty
    
    Management
      Officer and Director/s/
      Quill O. Healey
    
    DirectorQuill
      O. Healey/s/
      Joseph W. Evans
    
    Chairman,
      President and Chief Executive OfficerJoseph
      W. Evans
    
    (principal
      executive officer)/s/
      James W. Johnson
    
    DirectorJames
      W. Johnson/s/
      J. Daniel Speight
    
    Vice
      Chairman, Chief Financial Officer, SecretaryJ.
      Daniel Speight
    
    and
      Director (principal financial officer and principalaccounting
      officer)/s/
      J. Thomas Wiley, Jr.
    
    Vice
      Chairman, Chief Banking OfficerJ.
      Thomas Wiley, Jr.
    
    and
      Director/s/
      John D. Houser
    
    DirectorJohn
      D. Houser


**Exhibit Index**





The
following exhibits are filed as part of or incorporated by reference in this
report. Where such filing is made by incorporation by reference to a previously
filed registration statement or report, such registration statement or report is
identified in parentheses.





**Exhibit
      No****.**
    **Description**3.1
    Articles
      of Incorporation, as amended through October 15, 1993 (incorporated by
      reference from Exhibit 3.1(i) to the Company’s Annual Report on Form 10-K
      for the fiscal year ended December 31, 1993)3.2
    Bylaws,
      as amended through March 30, 1998 (incorporated by reference from
      Exhibit 3.1(ii) to the Company’s Annual Report on Form 10-K/A for the
      fiscal year ended December 31, 1997)3.3
    Amendment
      to Bylaws as adopted by resolution of Board of Directors on
      October 19, 1998 (incorporated by reference from Exhibit 3.3 to the
      Annual Report on Form 10-K for the fiscal year ended December 31,
      1998)3.4
    Amendment
      to Bylaws as adopted by resolution of the Board of Directors on
      December 20, 2000 (incorporated by reference from Exhibit 3.4 to the
      Annual Report on Form 10-K for the fiscal year ended December 31,
      2000)3.5
    Amendment
      to Bylaws as adopted by resolution of the Board of Directors on
      February 19, 2001 (incorporated by reference from Exhibit 3.5 to the
      Annual Report on Form 10-K for the fiscal year ended December 31,
      2001)3.6
    Amendment
      to Bylaws as adopted by resolution of the Board of Directors on January
      20, 2004 (incorporated by reference from Exhibit 3.6 to the Annual Report
      on Form 10-K for the fiscal year ended December 31,
  2003)4.1
    Instruments
      Defining the Rights of Security Holders (See Articles of Incorporation at
      Exhibit 3.1 hereto and Bylaws at Exhibits 3.2, 3.3, 3.4 and 3.5
      hereto)4.4
    Form
      of Warrant Agreement and Form of Warrant issued in connection with the
      issuance of common stock sold in a private placement
  dated10.1*
    Amended
      and Restated Employment Agreement between J. Daniel Speight, Jr. and the
      Company dated as of February 21, 2002 (incorporated by reference from
      exhibit of the same number to the Annual Report on Form 10-K for the
      fiscal year ended December 31, 2001)10.2*
    Employment
      Agreement between Stephen W. Doughty and the Company dated January 13,
      2003 (incorporated by reference from Exhibit 10.4 to the Annual Report on
      Form 10-K for the fiscal year ended December 31, 2002)10.3*
    Employment
      Agreement between J. Thomas Wiley, Jr. and the Company dated January 13,
      2003 (incorporated by reference from Exhibit 10.5 to the Annual Report on
      Form 10-K for the fiscal year ended December 31, 2002)10.5*
    Director
      Indexed Retirement Program for Citizens Bank dated January 13, 1995
      (incorporated by reference from Exhibit 10.8 to Amendment No. 1
      to the Company’s Annual Report on Form 10-K/A for the fiscal year ended
      December 31, 1997)10.6*
    Form
      of Executive Agreement (pursuant to Director Indexed Retirement Program
      for Citizens Bank) for individuals listed on exhibit cover page
      (incorporated by reference from Exhibit 10.9 to Amendment No. 1
      to the Company’s Annual Report on Form 10-K/A for the fiscal year ended
      December 31, 1997)10.7*
    Form
      of Flexible Premium Life Insurance Endorsement Method Split Dollar Plan
      Agreement (pursuant to Director Indexed Retirement Program for Citizens
      Bank) for individuals listed on exhibit cover page (incorporated by
      reference from Exhibit 10.10 to Amendment No. 1 to the Company’s
      Annual Report on Form 10-K/A for the fiscal year ended December 31,
      1997)10.8*
    Director
      Indexed Fee Continuation Program for First Federal Savings Bank of
      LaGrange effective February 3, 1995 (incorporated by reference from
      Exhibit 10.12 to Amendment No. 1 to the Company’s Annual Report
      on Form 10-K/A for the fiscal year ended December 31,
      1997)10.9*
    Form
      of Director Agreement (pursuant to Director Indexed Fee Continuation
      Program for First Federal Savings Bank of LaGrange) for individuals listed
      on exhibit cover page (incorporated by reference from Exhibit 10.13
      to Amendment No. 1 to the Company’s Annual Report on Form 10-K/A for
      the fiscal year ended December 31, 1997)10.10*
    Form
      of Flexible Premium Life Insurance Endorsement Method Split Dollar Plan
      Agreement (pursuant to Director Indexed Fee Continuation Program of First
      Federal Savings Bank of LaGrange) for individuals listed on exhibit cover
      page (incorporated by reference from Exhibit 10.14 to Amendment
      No. 1 to the Company’s Annual Report on Form 10-K/A for the fiscal
      year ended December 31, 1997)10.11*
    Form
      of Indexed Executive Salary Continuation Plan Agreement by and between
      First Federal Savings Bank of LaGrange and individuals listed on exhibit
      cover page (incorporated by reference from Exhibit 10.15 to Amendment
      No. 1 to the Company’s Annual Report on Form 10-K/A for the fiscal
      year ended December 31, 1997)10.12*
    Form
      of Flexible Premium Life Insurance Endorsement Method Split Dollar Plan
      Agreement (pursuant to Executive Salary Continuation Plan for First
      Federal Savings Bank of LaGrange) for individuals listed on exhibit cover
      page (incorporated by reference from Exhibit 10.16 to Amendment
      No. 1 to the Company’s Annual Report on Form 10-K/A for the fiscal
      year ended December 31, 1997)10.13*
    Form
      of Deferred Compensation Plan by and between The Citizens Bank and
      individuals listed on exhibit cover page (incorporated by reference from
      Exhibit 10.16 to the Annual Report on Form 10-K for the fiscal year ended
      December 31, 2000)10.14*
    Flag
      Financial Corporation 1994 Employees Stock Incentive Plan (as amended and
      restated through March 30, 1998) (incorporated by reference from Exhibit
      10.17 to the Annual Report on Form 10-K for the fiscal year ended
      December 31, 2000)10.15*
    Flag
      Financial Corporation 1994 Directors Stock Incentive Plan (as amended
      through September 18, 1997) (incorporated by reference from Exhibit 10.18
      to the Annual Report on Form 10-K for the fiscal year ended
      December 31, 2000)10.16*
    First
      Amendment to the Flag Financial Corporation 1994 Employees Stock Incentive
      Plan (as amended and restated as of March 30, 1998), dated as of March 15,
      1999 (incorporated by reference from Exhibit 10.19 to the Annual Report on
      Form 10-K for the fiscal year ended December 31,
  2000)10.17*
    Second
      Amendment to the Flag Financial Corporation 1994 Employees Stock Incentive
      Plan (as amended and restated as of March 30, 1998), dated as of
      January 16, 2001 (incorporated by reference from Exhibit 10.20 to the
      Annual Report on Form 10-K for the fiscal year ended December 31,
      2000)10.18*
    First
      Amendment to the Flag Financial Corporation 1994 Directors Stock Incentive
      Plan (as amended and restated as of September 18, 1997), dated as of
      December 21, 1998 (incorporated by reference from Exhibit 10.21 to the
      Annual Report on Form 10-K for the fiscal year ended December 31,
      2000)10.19*
    Second
      Amendment to the Flag Financial Corporation 1994 Directors Stock Incentive
      Plan (as amended and restated as of September 18, 1997), dated as of
      October 25, 1999 (incorporated by reference from Exhibit 10.22 to the
      Annual Report on Form 10-K for the fiscal year ended December 31,
      2000)10.20*
    Third
      Amendment to the Flag Financial Corporation 1994 Directors Stock Incentive
      Plan (as amended and restated as of September 18, 1997), dated
      January 16, 2001 (incorporated by reference from Exhibit 10.23 to the
      Annual Report on Form 10-K for the fiscal year ended December 31,
      2000)10.21*
    Third
      Amendment to Flag Financial Corporation 1994 Employees Stock Incentive
      Plan (as amended and restated as of March 30, 1998), dated as of
      February 19, 2002 (incorporated by reference from Exhibit 10.24 to
      the Annual Report on Form 10-K for the fiscal year ended December 31,
      2001)10.22*
    Fourth
      Amendment to Flag Financial Corporation 1994 Directors Stock Incentive
      Plan (as amended and restated as of September 18, 1997), dated as of
      February 19, 2002 (incorporated by reference to Exhibit 10.2 to the
      Quarterly Report on Form 10-Q for the quarter ended March 31,
      2002)10.23*
    Flag
      Financial Corporation 2004 Equity Incentive Plan (incorporated by
      reference to Appendix B to the Definitive Proxy Statement filed on March
      11, 2004 on Schedule 14A for the 2004 Annual Meeting of
      Shareholders)10.24
    Purchase
      and Assumption Agreement among Flag Financial Corporation, Bankers’
      Capital Group, LLC, and Gulfstream Financial Services, Inc., dated as of
      November 12, 2002.10.25*
    Form
      of Employee Stock Option Agreement pursuant to the Flag Financial
      Corporation 1994 Employees Stock Incentive Plan10.26*
    Form
      of Director Stock Option Agreement pursuant to the Flag Financial
      Corporation 1994 Directors Stock Incentive Plan10.27*
    Form
      of Employee/Director Option Agreement pursuant to the Flag Financial
      Corporation 2004 Equity Incentive Plan10.28*
    Executive
      Salary Continuation Agreement between Flag Financial Corporation, Flag
      Bank and J. Daniel Speight10.29*
    Information
      regarding executive compensation21
    Subsidiaries
      (incorporated by reference from exhibit of the same number to the Annual
      Report on Form 10-K for the fiscal year ended December 31,
      2000)23
    Consent
      of Porter Keadle Moore, LLP31.1
    Certification
      by Chief Executive Officer under Section 302 of the Sarbanes-Oxley Act of
      200231.2
    Certification
      by Chief Financial Officer under Section 302 of the Sarbanes-Oxley Act of
      200232.1
    Certification
      by Chief Executive Officer and Chief Financial Officer under Section 906
      of the Sarbanes-Oxley Act of 2002


____________________





*  The
indicated exhibit is a compensatory plan required to be filed as an exhibit to
this Form 10-K.