**Exhibit 13**

 
| **** |   | **MANAGEMENT’S DISCUSSION AND ANALYSIS** |   | COMMUNITY  FIRST BANKSHARES, INC. |
|------|--------|-----------------------------------------------|--------|-----------------------------------|

 

**BASIS OFPRESENTATION**

 

The followingrepresents management’s discussion and analysis of Community First Bankshares,Inc.’s (the “Company”) financial condition as of December 31, 2003 and 2002,and its results of operations for the years ended December 31, 2003, 2002 and2001. This discussion should be read in conjunction with the consolidatedfinancial statements and related footnotes and the five year summary of selectedfinancial data.  Certain amounts inprior periods have been reclassified to conform to the current presentation.

 

The Company isa bank holding company which at the end of 2003, conducted banking operationsin 136 communities located throughout the Midwest, Inter-mountain and Southwestregions.  The Company’s community banksprovide a full range of financial services through 92 Regional FinancialCenters and branches, and 44 Community Financial Centers.  In addition to its primary emphasis oncommercial and consumer banking services, the Company offers trust, mortgage,insurance and non-deposit investment products and services.  The Company’s principal source of income isinterest income from loans and investment securities.  Additional sources of income include fees on deposit accounts andother non-interest income including commissions from the sale of insurance andnon-deposit investment products and services. Among the key drivers of the Company’s profitability has been theinterest rate environment, from both a deposit pricing and a loan pricingperspective.  Profitability is alsoimpacted by the Company’s ability to find risk appropriate investment andlending opportunities; the Company’s ability to maintain and grow its depositbase in the face of historically low interest rates; increasing competitionfrom other providers of financial services and the Company’s ability to controlits non-interest expense, while at the same time keeping pace with necessarytechnological improvements.  Other keyfactors affecting the Company include national, regional and local economicconditions that affect demand for loans and impact the rate of loan defaults.

 

**OVERVIEW**

 

**GENERAL**

 

For the yearended December 31, 2003, the Company reported net income of $75.0 million, adecrease of $4.2 million, or 5.3%, from the $79.2 million earned during2002.  Diluted earnings per share were$1.95, compared to $1.97 in 2002. Return on average assets was 1.34% for 2003, compared with 1.40% for2002.  Return on average common shareholders’equity for 2003 and 2002 was 20.50% and 21.76%, respectively.  The decrease in return on assets and returnon equity is principally due to a 5.3% decline in net income, as average assetsdeclined 1.1% while average common equity increased 0.5% from 2002 to 2003.

 

For the yearended December 31, 2002, the Company reported net income of $79.2 million, anincrease of $14.1 million, or 21.7%, from the $65.1 million earned during2001.  Diluted earnings per share were$1.97, compared to $1.57 in 2001.  Returnon average assets was 1.40% for 2002, compared with 1.11% for 2001.  Return on average common shareholders’equity for 2002 and 2001 was 21.76% and 18.66%, respectively.  The increase in return on assets isprincipally due to the combination of an increase in net income and a $218million decrease in average assets, while the increase in return on equity isprincipally due to an increase in net income. Earnings per share for 2002 included a positive full-year cumulativeimpact of 12 cents per share, due to the accounting standards change ending theamortization of goodwill.

 

Total assetswere $5.5 billion at December 31, 2003 and $5.8 billion at December 31, 2002, areduction of $366 million or 6.3%. This reduction was principally due to theCompany’s balance sheet management strategy in the current economicenvironment. Management was reluctant to pursue asset growth at the risk ofcompromising asset quality, but rather focused on improving profitabilitythrough the pursuit of increased non-interest income, including commissions onthe sale of insurance and non-deposit investment products.

 

**STRATEGICINITIATIVES**

 

During 2002 and 2003, theCompany has continued to implement a series of strategic initiatives that aredesigned to improve customer service and strengthen its position as a providerof diversified financial services. These initiatives included a redefinition of the Company’s deliverymodel, the sale or closure of selected banking offices and a market extensionstrategy.

 

Under the redesigned deliverystructure, the Company is implementing a centralized credit process, which,when fully operational, will offer a complete range of decision, origination,documentation and collection services to all Company offices through a Fargo,North Dakota, location.  As of December31, 2003, all indirect consumer underwriting, administration, documentation andall consumer collection have been centralized. Centralization of the underwriting, administration, and documentation ofdirect consumer loans, as well as documentation of commercial and agriculturalloans, are expected to be completed by the second quarter of 2004, at whichtime the centralized delivery initiative will be completed.

 

During 2003 the Company alsoinitiated a strategy, which consists of a market extension model, wherein theCompany intends to open additional offices in selected areas of the Company’scurrent geographic footprint, that the Company believes are growth or emerginggrowth markets.  Additional offices areexpected to be within the 12-state area within which the Company currentlyoperates.  Services provided at the newlocations will be determined by the opportunities identified in that area, andmay include business, retail, investment sales, insurance products, mortgageproducts and wealth management.  During2003, the Company announced its initial five market extension locations in themetropolitan Minneapolis/St. Paul market. The Company expects to open the first office during the first quarter of2004 and the second office during the second quarter of 2004.  The additional offices, which the Companyexpects to open in late 2004, are pending regulatory approval.  The addition of these offices is notexpected to have a material impact on the Company’s financial condition or resultsof operations during 2004.  The Companyhas announced that it plans to open 30 new offices by 2007.

 

During 2003the Company announced the transition of 16 additional Regional FinancialCenters to Community Financial Centers. Regional Financial Centers offer a broad mix of business and retailactivity, while Community Financial Centers maintain a retail focus.  Transitioning branches into the CommunityFinancial Center model is consistent with the Company’s long-term strategicplan to specifically address the client needs of its individual markets throughhighly targeted service offerings.  TheCompany expects to complete these transitions in early 2004.

 

        The Company continues to focus on insuranceagency acquisitions and is committed to providing insurance in each of itsmarkets.  During 2003, through itsinsurance subsidiary, the Company completed the purchase of five insuranceagencies, which at the time of acquisition, had a combined annual commissionrevenue of approximately $1.3 million. Acquisitions included the November 4, 2003 purchase of a limitedservices agency in Englewood, Colorado; the October 1, 2003 purchase of aninsurance agency in Frisco, Colorado, with offices in Frisco, Leadville andVail, Colorado; the June 2, 2003 purchase of an agency located in Rock Springs,Wyoming; the May 1, 2003 purchase of an agency in Grand Junction, Colorado; andthe April 1, 2003 purchase of a Thornton, Colorado agency.  The Company recognized $1.7 million of intangibleassets, including $526, 000 of unamortized goodwill relative to thesetransactions.

 

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**MORTGAGELOAN JOINT VENTURE**

 

In June 2001,the Company, through its subsidiary bank, and Wells Fargo & Company formeda joint venture mortgage company named Community First Mortgage, LLC.  This joint venture mortgage company providesmortgage origination, documentation and support for substantially all of theresidential mortgage business of the Company. The joint venture provides the Company access to competitive technologyand the benefits of future technological developments, as well as expertise inthe processing and loan servicing of mortgage products.  The alliance allows the Company to expandits residential mortgage origination business through access to a broader rangeof mortgage products, while improving efficiency and reducing operating, creditand capital market risks. The Company has 50% ownership and 50% voting rightsover the affairs of the joint venture and records its investment and itscontinuing share of the income or loss of the joint venture under the equitymethod.  As a result of the formation ofthe joint venture, substantially all residential mortgage originations areeffected through the joint venture rather than through the Company.

** **

**STOCKREPURCHASE PLAN**

 

Since April2000, the Company has conducted common stock repurchase programs providing forthe systematic repurchase of the Company’s common stock.  Under these programs, the shares arepurchased primarily on the open market, with timing depending upon marketconditions.  The program provides theCompany with an alternative opportunity for capital utilization.  In addition, the shares acquired can be usedfor the issuance of common stock upon exercise of stock options, under theCompany’s compensation plans and for other purposes, including businesscombinations.  On April 24, 2003, theCompany approved an additional common stock repurchase authorization whereinthe Company may repurchase up to an additional 3 million shares of commonstock.  As of December 31, 2003, theCompany had repurchased 14.4 million shares of common stock under these plans,at prices ranging from $15.25 to $29.29. The Company repurchased 1.7 million and 1.9 million shares of commonstock during 2003 and 2002 at an average price of $26.93 and $25.62,respectively.  As of December 31, 2003,2.4 million shares remain available for repurchase.  The Company believes the program provides liquidity toinvestors.  The effect of the repurchaseprogram is to increase reported earnings per share and reduce tangible bookvalue through the reduction of common shares outstanding.

 

**CRITICALACCOUNTING ESTIMATES**

 

The Companyhas established various accounting policies which govern the application ofaccounting principles generally accepted in the United States in thepreparation of the Company’s financial statements.  The significant accounting policies of the Company are describedin the footnotes to the consolidated financial statements. Certain accountingpolicies involve significant judgments and assumptions by management that havea material impact on the carrying value of certain assets and liabilities;management considers such accounting policies to be critical accountingpolicies.  The judgments and assumptionsused by management are based on historical experience and other factors, whichare believed to be reasonable under the circumstances.  Because of the nature of the judgments andassumptions made by management, actual results could differ from thesejudgments and estimates which could have a material impact on the carryingvalues of assets and liabilities and the results of operations of theCompany.  The Company believes that itscritical accounting policies include the allowance for loan losses, goodwillimpairment and income taxes.

 

The Companybelieves the allowance for loan losses is a critical accounting policy thatrequires the most significant judgment and estimates used in preparation of itsconsolidated financial statements. Refer to the section entitled Allowance for Loan Losses, in thisManagement Discussion and Analysis of Financial Condition and Results ofOperations, and Note 1, Significant Accounting Polices and Note 9, FinancialInstruments with Off-Balance Sheet Risk and Concentrations of Credit Risk inthe audited financial statements for a detailed description of the Company’sestimation process and methodology related to the allowance for loan losses andfor the Company’s exposure to concentrations of credit.  The Company’s recorded allowance for loanlosses and related provisions for loan losses could be materially differentthan the amounts recorded under different conditions or using differentassumptions. Changes in the estimate related to the allowance for loan lossescan materially affect net income.  Theprocess of determining the allowance requires an estimate of losses on loanswhich can be highly uncertain and require a high degree of judgment; and isimpacted by regional, national and global economic trends, and differentassumptions regarding economic conditions could have been used and would havehad a material impact on the provision for loan losses and on the consolidatedresults of operations.

 

The Companybelieves the annual testing for impairment of goodwill is a critical accountingpolicy that requires significant judgment and estimates.  The Company performed its initial impairmenttest during the first quarter of 2002 and annual impairment tests during thefourth quarter of 2003 and 2002.  Alltests indicated no impairment existed, thus no adjustment to the carrying costof goodwill was recorded.  The Companyuses a multi-period discounted earnings model to determine if the equity fairvalue of the underlying reporting unit is equal to or greater than the currentbook value.  The model is based onmanagement’s estimate of the Company’s projected earnings stream over thefollowing five years.  The 2003 and 2002impairment tests indicated the equity fair value exceeded the current book value,thus eliminating the need to perform the second step, measuring impairment, asno impairment was noted.  The valuationmodel includes various management estimates and assumptions and thus, to theextent these estimates and assumptions vary from actual future results, aresubject to error and may not be indicative of future impairment tests.

 

The Companyaccounts for income tax expense by applying an estimated effective tax rate toits pre-tax income.  The effective taxrate is based on management’s judgments and estimates regarding permanent differencesin the treatment of specific items of income and expense for financialstatement and income tax purposes. The Company makes its estimates based on itsinterpretation of existing tax laws as they relate to the Company’s activity.  Such interpretation could differ from thoseof the taxing authorities. Periodically, the Company is examined by variousfederal and state tax authorities.  Inthe event management’s estimates and assumptions vary from the views of thetaxing authority, adjustments to the periodic tax accrual may benecessary.  In addition, the Companyrecognizes deferred tax assets and liabilities, recorded in the ConsolidatedStatements of Financial Condition, based on management’s judgments and estimatesregarding temporary differences in the recognition of income and expenses forfinancial statement and income tax purposes.

 

The Companymust also assess the likelihood that any deferred tax assets will be realizedthrough the reduction or refund of taxes in future periods and establish avaluation allowance for those assets for which recovery is unlikely.  In making this assessment, Management mustmake judgments and estimates regarding the ability to realize the asset throughcarryback to taxable income in prior years, the future reversal of existingtaxable temporary differences, future taxable income, and the possibleapplication of future tax planning strategies. Although the Company has determined a valuation allowance is notrequired for all deferred tax assets, there is no guarantee that these assetsare recognizable.  For additionaldiscussion of income taxes, see Notes 1 and 17 in the audited financialstatements.

 

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**RESULTS OF OPERATIONS**

 

**NET INTERESTINCOME**

 

The principal source of theCompany’s earnings is net interest income, the difference between totalinterest income on earning assets such as loans and investments and interestpaid on deposits and other interest-bearing liabilities.  The net interest margin is net interestincome, on a tax-equivalent basis, expressed as a percentage of average earningassets.  The margin is affected byvolume and mix of earning assets and interest-bearing liabilities, the level ofinterest-free funding sources, interest rate environment and income taxrates.  As discussed later, managementactively monitors its interest rate sensitivity and seeks an approximatelyequal amount of rate sensitive assets and rate sensitive liabilities tominimize the impact of changes in the interest rate environment.

 

The following table presentsthe Company’s average balance sheets, interest earned or paid and the relatedyields and rates on major categories of the Company’s earning assets andinterest-bearing liabilities on a tax-equivalent basis for the periodsindicated:

 

 
|                                                |   | **2003**             |      | **2002**     |    | **2001**         |   |
|-----------------------------------------------------|--------|----------------------|-----------|--------------|---------|------------------|--------|
| **Years Ended December 31  (Dollars in thousands)** |   | **Average  Balance** |      | **Interest** |    | **Yield/  Rate** |   | **Average  Balance** |   | **Interest** |   | **Yield/  Rate** |   | **Average  Balance** |   | **Interest** |   | **Yield/  Rate** |   |
| **ASSETS**                                          |   |                 |      |         |    |             |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Loans  *(1) (2)*                                    |   | $                    | 3,446,507 |         | $       | 245,693          |   | 7.13 | % | $ | 3,689,015 |   | $ | 281,768 |   | 7.64 | % | $ | 3,785,553 |   | $ | 341,287 |   | 9.02 | % |
| Investment  securities *(2)*                        |   | 1,584,564            |      | 68,770       |    | 4.34             | %      | 1,403,276 |   | 78,512 |   | 5.59 | % | 1,487,044 |   | 94,792 |   | 6.37 | % |
| Other  earning assets                               |   | 7,117                |      | 53           |    | 0.74             | %      | 12,424 |   | 201 |   | 1.62 | % | 11,923 |   | 391 |   | 3.28 | % |
| Total  earning assets                               |   | 5,038,188            |      | 314,516      |    | 6.24             | %      | 5,104,715 |   | 360,481 |   | 7.06 | % | 5,284,520 |   | 436,470 |   | 8.26 | % |
| Noninterest-earning  assets                         |   | 544,583              |      |         |    |             |   | 540,002 |   |   |   |   |   | 578,549 |   |   |   |   |   |
| Total  assets                                       |   | $                    | 5,582,771 |         |    |             |   |   | $ | 5,644,717 |   |   |   |   |   | $ | 5,863,069 |   |   |   |   |   |
|                                                |   |                 |      |         |    |             |   |   |   |   |   |   |   |   |   |   |   |   |   |
| **LIABILITIES AND SHAREHOLDERS’ EQUITY**       |   |                 |      |         |    |             |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest-bearing  checking                          |   | 973,038              |      | 3,653        |    | 0.38             | %      | 924,102 |   | 5,869 |   | 0.64 | % | 872,642 |   | 9,943 |   | 1.14 | % |
| Savings  deposits                                   |   | 948,020              |      | 4,436        |    | 0.47             | %      | 923,098 |   | 8,331 |   | 0.90 | % | 971,915 |   | 19,428 |   | 2.00 | % |
| Time  deposits                                      |   | 1,559,911            |      | 40,470       |    | 2.59             | %      | 1,818,771 |   | 61,372 |   | 3.37 | % | 2,053,548 |   | 109,171 |   | 5.32 | % |
| Short-term  borrowings                              |   | 441,823              |      | 4,940        |    | 1.12             | %      | 339,193 |   | 6,340 |   | 1.87 | % | 361,563 |   | 15,001 |   | 4.15 | % |
| Long-term  borrowings                               |   | 246,324              |      | 17,039       |    | 6.92             | %      | 264,663 |   | 18,743 |   | 7.08 | % | 256,745 |   | 19,268 |   | 7.50 | % |
| Total  interest-bearing liabilities                 |   | 4,169,116            |      | 70,538       |    | 1.69             | %      | 4,269,827 |   | 100,655 |   | 2.36 | % | 4,516,413 |   | 172,811 |   | 3.83 | % |
| Demand  deposits                                    |   | 986,584              |      |         |    |             |   | 948,353 |   |   |   |   |   | 921,855 |   |   |   |   |   |
| Noninterest-bearing  liabilities                    |   | 61,036               |      |         |    |             |   | 62,451 |   |   |   |   |   | 76,125 |   |   |   |   |   |
| Common  shareholders’ equity                   |   | 366,035              |      |         |    |             |   | 364,086 |   |   |   |   |   | 348,676 |   |   |   |   |   |
|                                                |   | 1,413,655            |      |         |    |             |   | 1,374,890 |   |   |   |   |   | 1,346,656 |   |   |   |   |   |
| Total  liabilities and shareholders’ equity    |   | $                    | 5,582,771 |         |    |             |   |   | $ | 5,644,717 |   |   |   |   |   | $ | 5,863,069 |   |   |   |   |   |
| Net  interest income                                |   |                 |      | $            | 243,978 |             |   |   |   |   | $ | 259,826 |   |   |   |   |   | $ | 263,659 |   |   |   |
| Net  interest spread                                |   |                 |      |         |    | 4.55             | %      |   |   |   |   | 4.70 | % |   |   |   |   | 4.43 | % |
| Net  interest margin                                |   |                 |      |         |    | 4.84             | %      |   |   |   |   | 5.09 | % |   |   |   |   | 4.99 | % |

 

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*(1)Includes nonaccrual loans and loan fees.*

*(2) Interest yields on loans and investments are presentedon a tax-equivalent basis to reflect the tax-exempt nature of certain assets.The incremental tax rate applied was 35%.*

 

The following table presentsthe components of changes in net interest income by volume and rate on atax-equivalent basis. The net change attributable to the combined impact ofvolume and rate has been allocated solely to the change in volume:

 
|                                            |   | **2003 COMPARED TO 2002** |    | **2002 COMPARED TO 2001** |   |
|-------------------------------------------------|--------|---------------------------|---------|---------------------------|--------|
| **(In thousands)**                              |   | **Volume**                |    | **Rate**                  |   | **Total** |   | **Volume** |   | **Rate** |   | **Total** |   |
| Interest  income:                               |   |                      |    |                      |   |   |   |   |   |   |   |   |   |
| Loans  *(1)*                                    |   | $                         | (18,523 | )                         | $      | (17,552 | ) | $ | (36,075 | ) | $ | (8,703 | ) | $ | (50,816 | ) | $ | (59,519 | ) |
| Investment  securities *(1)*                    |   | 10,143                    |    | (19,885                   | )      | (9,742 | ) | (5,340 | ) | (10,940 | ) | (16,280 | ) |
| Other  earning assets                           |   | (86                       | )       | (62                       | )      | (148 | ) | 16 |   | (206 | ) | (190 | ) |
| Total  interest income                          |   | $                         | (8,466  | )                         | $      | (37,499 | ) | $ | (45,965 | ) | $ | (14,027 | ) | $ | (61,962 | ) | $ | (75,989 | ) |
| Interest  expense:                              |   |                      |    |                      |   |   |   |   |   |   |   |   |   |
| Savings  deposits and interest-bearing checking |   | 536                       |    | (6,647                    | )      | (6,111 | ) | $ | (389 | ) | $ | (14,782 | ) | $ | (15,171 | ) |
| Time  deposits                                  |   | (8,735                    | )       | (12,167                   | )      | (20,902 | ) | (12,481 | ) | (35,318 | ) | (47,799 | ) |
| Short-term  borrowings                          |   | 1,918                     |    | (3,318                    | )      | (1,400 | ) | (928 | ) | (7,733 | ) | (8,661 | ) |
| Long-term  borrowings                           |   | (1,299                    | )       | (405                      | )      | (1,704 | ) | 594 |   | (1,119 | ) | (525 | ) |
| Total  interest expense                         |   | $                         | (7,580  | )                         | $      | (22,537 | ) | $ | (30,117 | ) | $ | (13,204 | ) | $ | (58,952 | ) | $ | (72,156 | ) |
| Decrease  in net interest income                |   | $                         | (886    | )                         | $      | (14,962 | ) | $ | (15,848 | ) | $ | (823 | ) | $ | (3,010 | ) | $ | (3,833 | ) |

 

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*(1) Fees on loans have been included in interest on loans.Interest income is reported on a tax-equivalent basis. The incremental tax rateapplied was 35%.*

 

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Net interest income on atax-equivalent basis in 2003 was $244.0 million, a $15.8 million decrease from2002.  The decrease was primarily due toa 1.3% decrease in earning assets which contributed to a 25 basis pointdecrease in the net interest margin. The decrease in earning assets reflectmanagement’s reluctance to compromise its loan quality standards in the currenteconomic environment which presents fewer quality loan growth opportunities.Due to the weak loan demand, the Company’s level of investment securitiesincreased $181 million or 12.9%.  TheCompany was able to acquire core deposits at lower rates due to the relativelyunattractive investment alternatives for depositors.

 

Net interest income on atax-equivalent basis in 2002 was $259.8 million, a $3.8 million decrease from2001.  The decrease was primarily due toa 3.4% reduction in earning assets partially offset by a 10 basis pointincrease in the net interest margin. Average investment securities in 2002 were $84 million less than in2001. Average loans in 2002 decreased $97 million from the 2001 average. 

 

The net interest margin was4.84%, 5.09%, and 4.99% in 2003, 2002 and 2001, respectively.  This decrease in margin was due to a changein the mix of earning assets, including a 82 basis point decrease in rates onearning assets and a 67 basis point decrease in interest bearingliabilities.  However, average earningassets decreased $67 million, from 2002 to 2003.  Average loans to average earning assets was 68.4% in 2003compared to 72.3% in 2002 and to 71.6% in 2001.  While management anticipates continued pressure on the Company’snet interest margin as a result of the current interest rate environment, theyexpect the net interest margin to remain stable during 2004.  The sluggish economy makes growth of the loanportfolio challenging, while maintaining credit quality. Record low interestrates, mortgage-backed security prepayments and fewer high-yieldingreinvestment opportunities will contribute to margin pressure.

 

**PROVISIONFOR LOAN LOSSES**

 

Annual fluctuations in theprovision for loan losses result from management’s regular assessment of theadequacy of the allowance for loan losses. The provision for loan losses for 2003 was $12.6 million, a decrease of$660,000, or 5.0% from the 2002 provision of $13.3 million.  The decrease was primarily due tomanagement’s assessment of the required loan loss reserve level and the impactof the $243 million, or 6.6% decline in average loans outstanding during 2003.  The allowance as a percentage of total loanswas 1.57% at December 31, 2003 and 2002. The amount of the loan loss provision to be recorded in future periodswill depend on management’s assessment of the adequacy of the allowance forloan losses in relation to the entire loan portfolio. The provision for loan lossesfor 2002 was $13.3 million, a decrease of $4.2 million or 24.3%, from $17.5million during 2001.  The decrease inthe loan loss provision was principally due to the Company’s credit experienceas reflected in a decrease in net charge-offs. Charge-offs in 2001 included a $2.4 million charge-off of the Company’slargest non-performing asset, an Arizona-based loan of which $1.2 million wasrecovered in 2002.

 

**NONINTERESTINCOME**

 

TheCompany continues to expand noninterest income associated with the Company’scommunity banking operations.  Theprimary sources of noninterest income consist of service charges on depositaccounts, insurance commissions, fees from the sale of investment products andfees for trust services.  Management isworking to increase the contribution of noninterest income to operating resultsby increasing the delivery of financial products and services, including trustservices, insurance policy sales and security sales through a third partyprovider of standardized securities products.

 

The following table presentsthe components of noninterest income for the periods indicated:

 
| **Years Ended December 31 (In thousands)** |   | **2003**   |       | **2002** |   | **2001** |   |
|--------------------------------------------|--------|------------|------------|----------|--------|----------|--------|
| Service  charges on deposit accounts       |   | **$**      | **40,239** |     | $      | 40,121   |   | $ | 41,850 |   |
| Insurance  commissions                     |   | **15,223** |       | 13,822   |   | 12,535   |   |
| Security  sales commissions                |   | **9,057**  |       | 9,526    |   | 6,644    |   |
| Fees  from fiduciary activities            |   | **5,264**  |       | 5,405    |   | 5,661    |   |
| Bank  owned life insurance income          |   | **4,433**  |       | 3,632    |   | 3,543    |   |
| Net  gains on sales of securities          |   | **4,334**  |       | 373      |   | 804      |   |
| Gain  on sales of loans                    |   | **4,104**  |       | 2,784    |   | 1,557    |   |
| Other                                      |   | **10,039** |       | 9,460    |   | 10,842   |   |
| Total  noninterest income                  |   | **$**      | **92,693** |     | $      | 85,123   |   | $ | 83,436 |   |

 

Noninterest income for 2003was $92.7 million, an increase of $7.6 million, or 8.9%, from the 85.1 millionearned in 2002.  The increase wasprincipally due to an increase of $1.4 million or 10.1% in insurancecommissions to $15.2 million, from $13.8 million in 2002, and an increase of$4.0 million in net gains on sales of investment securities, to $4.3 million in2003 from $373,000 in 2002.  Theincrease in insurance commissions is principally due to the acquisition of fourinsurance agencies in 2002 and five agencies in 2003.  The increase in net gains on investment securities is dueprincipally to the Company’s decision to sell selected security issues in aneffort to limit potential prepayment risk and in part as a result of realizinggains sufficient to offset approximately $1.3 million in prepayment penaltiesassociated with the Company’s decision to retire early, selected high rate longterm borrowings.  Bank owned lifeinsurance income increased $801,000, or 22.1% from $3.6 million in 2002 to $4.4million in 2003, due principally to an increase in the payout of specificindividual contracts.  Service chargeson deposit accounts increased only $118,000, or 0.3%, from $40.1 million in2002 to $40.2 million in 2003.  Lowerthan anticipated service charges are due principally to the decline in depositlevels.  Commissions from the sale ofinvestment securities decreased to $9.1 million in 2003 from $9.5 million in2002, a decrease of $469,000 or 4.9%, due principally to record levels recordedin 2002, driven by a second quarter 2002 sales campaign.  Gain on sales of loans increased $1.3million or 47.4% from $2.8 million in 2002 to $4.1 million in 2003, dueprincipally to the increased volume of Small Business Administration guaranteedloans originated and sold in 2003. Trust revenue decreased $141,000, or 2.6%,to $5.3 million in 2003 from $5.4 million in 2002.

 

Noninterest income for 2002was $85.1 million, an increase of $1.7 million, or 2.0%, from the $83.4 millionearned in 2001.  The increase wasprincipally due to an increase in commissions from the sale of investmentsecurities in 2002 to $9.5 million from $6.6 million in 2001, an increase of$2.9 million, or 43.9%, and resulted in part from the Company’s sales campaignsduring 2002, which focused on providing non-deposit investment alternatives tomeet customer needs.  Insurance commissionsincreased to $13.8 million in 2002, from $12.5 million in 2001, an increase of$1.3 million, or 10.4%.  Service chargeson deposit accounts decreased to $40.1 million in 2002, from $41.9 million in2001, a decrease of $1.8 million, or 4.3%. Trust revenue decreased to $5.4 million in 2002, from $5.7 million in2001, a decrease of $256,000 or 4.5%. Net gains on the sale of investment securities were $431,000 less in2002 than in 2001.

 

**NONINTERESTEXPENSE**

 

Noninterestexpenses consist of salaries and benefits, occupancy, equipment and otherexpenses such as legal and postage necessary for the operation of theCompany.  Management is committed toimproving the quality of service while controlling such costs through improvedefficiency and consolidation of certain activities to achieve economies ofscale.

 

Thefollowing table presents the components of noninterest

 

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expensefor the periods indicated:

 
| **Years Ended December 31 (In thousands)** |   | **2003**   |        | **2002**   |   | **2001** |   |
|--------------------------------------------|--------|------------|-------------|------------|--------|----------|--------|
| Salaries  and employee benefits            |   | **$**      | **112,886** | ** ** | $      | 113,994  |   | $ | 115,743 |   |
| Net  occupancy                             |   | **33,490** | ** **  | 32,832     |   | 31,593   |   |
| FDIC  insurance                            |   | **720**    | ** **  | 800        |   | 915      |   |
| Legal  and accounting                      |   | **2,691**  | ** **  | 3,138      |   | 3,764    |   |
| Other  professional services               |   | **4,503**  | ** **  | 4,340      |   | 4,634    |   |
| Advertising                                |   | **3,881**  | ** **  | 3,983      |   | 5,037    |   |
| Telephone                                  |   | **5,780**  | ** **  | 5,575      |   | 5,633    |   |
| Restructuring  charge                      |   | **—** | ** **  | —     |   | 7,656    |   |
| Data  processing                           |   | **7,036**  | ** **  | 7,210      |   | 6,940    |   |
| Amortization  of intangibles               |   | **3,374**  | ** **  | 3,318      |   | 9,928    |   |
| Other                                      |   | **32,498** | ** **  | 31,960     |   | 33,200   |   |
| Total  noninterest expense                 |   | **$**      | **206,859** | ** ** | $      | 207,150  |   | $ | 225,043 |   |

 

Noninterest expense decreased$291,000 to $206.9 million in 2003.  Thedecrease was principally due to a decrease in salary and employeebenefits.  Salaries and employee benefitsdecreased to $112.9 million in 2003, from $114.0 million in 2002, a decrease of$1.1 million, or 1.0%.  The decrease insalary and benefit expense from 2002 to 2003 is due principally to a reductionin staff levels during 2003 as a result of the efficiencies realized from the implementationof strategic initiatives, including the centralized credit process and thetransition of branches into the Community Financial Center delivery model.  The Company’s ability to maintain the 2003level of non-interest expense slightly less than the 2002 level is a reflectionof the continued success of the internal cost control initiatives which theCompany continues to implement.

 

Noninterest expense decreased$17.8 million to $207.2 million in 2002. The decrease was principally due to a $6.6 million, or 66.7% decrease inthe amortization of intangibles from $9.9 million in 2001 to $3.3 million in2002, due to the accounting standards change ending the amortization ofgoodwill.  During 2001, a $7.7 millionrestructuring charge was recorded as a result of strategic initiatives implementedin 2001.  Salary and employee benefitsdecreased to $114.0 million in 2002, from $115.7 million in 2001, a decrease of$1.7 million or 1.5%.  The decrease wasattributed to a reduction in the number of employees during 2002, in responsepartially to the strategic initiatives announced in 2001.

 

**PROVISIONFOR INCOME TAXES**

 

TheCompany records a provision for income taxes currently payable and for taxespayable in the future because of differences in the timing of recognition ofcertain items for financial statement and income tax purposes.  The effective income tax rate differs fromthe statutory rate primarily due to tax-exempt income from loans andinvestments and state income taxes.  The2003 effective tax rate is similar to the Company’s anticipated effective taxrates in future periods.  The effectivetax rate was 33.0%, 33.3%, and 34.0% for 2003, 2002 and 2001, respectively.

 

**FINANCIAL CONDITION**

 

**INVESTMENTOF FUNDS**

 

**Loans**

 

At December 31, 2003, totalloans were $3.3 billion as compared to $3.6 billion at December 31, 2002, adecrease of $254 million, or 7.1%.  Thedecrease is due principally to soft loan demand and the Company’s desire togenerate lending opportunities consistent with its credit quality standards.  In addition, residential real estate loansare originated through Community First Mortgage, LLC and primarily sold on thesecondary market.

 

***General****. *The Company’s loan mix remained relativelyconstant from 2002 to 2003.  Real estateloans continued to be the largest category of loans, representing 56.7% of thetotal loan portfolio.

 

***Real Estate and Real Estate Construction Loans.**** *A significantportion of the Company’s real estate loan portfolio consists of residentialreal estate first mortgages that have been underwritten and documented to meetsecondary mortgage requirements. Substantially all of the Company’s real estate loans are based in theCompany’s primary market area.  As ofDecember 31, 2003, $552 million, or 29.3%, of the Company’s real estate loanportfolio consisted of residential real estate loans, including home equityloans, $137 million, or 7.3%, were secured by farmland, $874 million, or 46.4%,represented commercial and other real estate loans and $321 million, or 17.0%,represented construction loans. Residential real estate loans decreased $128 million from 2002 to 2003,due partially to the impact of the Company’s strategic initiative whereinresidential mortgages are now originated principally through Community FirstMortgage, LLC.

 

***Commercial Loans.**** *Loans in this category include loans toretail, wholesale, manufacturing and service businesses, including agriculturalservice businesses.  Commercial loansare underwritten based on the financial strength and repayment ability of theborrower, as well as the collateral securing the loans.

 

***Consumer and Other Loans.**** *Loansclassified as consumer and other loans include automobile, personal loans,consumer lines of credit and overdrafts. The consumer loan portfolio also includes dealer-generated installmentcontracts for consumer goods, including automobiles and major homeappliances.  The majority of theseindirect loans are installment loans with fixed interest rates, which, as aresult of the Company’s strategic initiative to implement a centralizedconsumer credit process, were originated and processed through a centralizedprocess.

 

***Agricultural Loans.**** *Agricultural loans are made principally tofarmers and ranchers.  The Companyprovides short-term credit for operating loans and intermediate-term loans formachinery purchases and other improvements.

 

The following table presentsthe Company’s balance of each major category of loans at the dates indicated:

 
|                                           |   | **2003**    |          | **2002**                     |       | **2001**   |   | **2000**                     |   | **1999**   |   |
|------------------------------------------------|--------|-------------|---------------|------------------------------|------------|------------|--------|------------------------------|--------|------------|--------|
| **As of December 31,  (Dollars in thousands)** |   | **Amount**  |          | **Percent  of Total  Loans** |       | **Amount** |   | **Percent  of Total  Loans** |   | **Amount** |   | **Percent  of Total  Loans** |   | **Amount** |   | **Percent  of Total  Loans** |   | **Amount** |   | **Percent  of Total  Loans** |   |
| Loan category:                                 |   |        |          |                         |       |       |   |                         |   |       |   |   |   |   |   |   |   |   |   |   |   |
| Real estate                                    |   | **$**       | **1,562,443** | ** **                   | **47.0**   | **%**      | $      | 1,568,710                    |   | 43.8       | %      | $ | 1,515,118 |   | 40.5 | % | $ | 1,458,494 |   | 39.0 | % | $ | 1,319,678 |   | 35.8 | % |
| Real estate construction                       |   | **321,323** | ** **    | **9.7**                      | **%**      | 439,536    |   | 12.3                         | %      | 519,031    |   | 13.9 | % | 466,616 |   | 12.5 | % | 434,924 |   | 11.8 | % |
| Commercial                                     |   | **582,861** | ** **    | **17.5**                     | **%**      | 723,530    |   | 20.2                         | %      | 824,318    |   | 22.1 | % | 872,824 |   | 23.4 | % | 994,624 |   | 26.9 | % |
| Consumer and other                             |   | **678,457** | ** **    | **20.4**                     | **%**      | 625,429    |   | 17.5                         | %      | 627,034    |   | 16.8 | % | 686,064 |   | 18.3 | % | 681,423 |   | 18.5 | % |
| Agricultural                                   |   | **178,488** | ** **    | **5.4**                      | **%**      | 220,688    |   | 6.2                          | %      | 251,191    |   | 6.7 | % | 254,204 |   | 6.8 | % | 259,704 |   | 7.0 | % |
| Total loans                                    |   | **$**       | **3,323,572** |                         | **100.00** | **%**      | $      | 3,577,893                    |   | 100.0      | %      | $ | 3,736,692 |   | 100.0 | % | $ | 3,738,202 |   | 100.0 | % | $ | 3,690,353 |   | 100.0 | % |
| Less allowance for loan  losses                |   | **(52,231** | **)**         |                         |       | (56,156    | )      |                         |   | (54,991    | )      |   |   | (52,168 | ) |   |   | (48,878 | ) |   |   |
| Net loans                                      |   | **$**       | **3,271,341** | ** **                   |       |       | $      | 3,521,737                    |   |       |   | $ | 3,681,701 |   |   |   | $ | 3,686,034 |   |   |   | $ | 3,641,475 |   |   |   |

 

5

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**Investments**

 

The Company supplements thequality of its loan portfolio by maintaining what it considers to be a highquality investment portfolio oriented toward U.S. Treasury, U.S. Governmentagency debt and U.S. Government agency and government guaranteedmortgage-backed securities.  Theinvestment portfolio also provides the opportunity to structure maturities andrepricing timetables in a flexible manner and to meet applicable requirementsfor pledging securities. Mortgage-backed securities, which are fixed and adjustable rate pools,are used as tools in managing the Company’s interest rate exposure andenhancing its net interest margin.

 

Thefollowing table sets forth the composition of the Company’s available-for-salesecurities portfolio at estimated fair value as of the dates indicated:

 
|                                 |   | **Estimated Fair Value at December  31,** |          |
|--------------------------------------|--------|-------------------------------------------|---------------|
| **(In thousands)**                   |   | **2003**                                  |          | **2002** |   | **2001** |   |
| U.S.  Treasury                       |   | **$**                                     | **42,048**    | ** ** | $ | 53,468 |   | $ | 69,297 |   |
| U.S.  Government agencies            |   | **318,767**                               | ** **    | 293,227 |   | 231,380 |   |
| Mortgage-backed  securities          |   | **1,062,940**                             | ** **    | 1,038,044 |   | 887,148 |   |
| Collateralized  mortgage obligations |   | **1,864**                                 | ** **    | 3,512 |   | 4,377 |   |
| State  and political securities      |   | **61,584**                                | ** **    | 71,095 |   | 97,603 |   |
| Other  securities                    |   | **76,216**                                | ** **    | 213,099 |   | 147,261 |   |
| Total                                |   | **$**                                     | **1,563,419** | ** ** | $ | 1,672,445 |   | $ | 1,437,066 |   |

 

The Company did not have anyheld-to-maturity securities at December 31, 2003, 2002 or 2001.

 

The following tables setforth the composition by contractual maturity of the Company’savailable-for-sale securities portfolio:

 
|                                 |   | **At December 31, 2003, Maturing in** |   |
|--------------------------------------|--------|---------------------------------------|--------|
|                                 |   | **One Year or Less**                  |   | **Over One Year  Through 5 Years** |   | **Over 5 Years  Through 10 Years** |   | **Over 10 Years** |   | **Total** |   |
| **(Dollars in thousands)**           |   | **Amount**                            |   | **Weighted  Yield(1)** |   | **Amount** |   | **Weighted  Yield(1)** |   | **Amount** |   | **Weighted  Yield(1)** |   | **Amount** |   | **Weighted  Yield(1)** |   | **Amount** |   | **Weighted  Yield(1)** |   |
| U.S. Treasury                        |   | $                                     | 13,205 |   | 3.96 | % | $ | 28,843 |   | 2.10 | % | $ | — |   | — |   | $ | — |   | — |   | $ | 42,048 |   | 2.68 | % |
| U.S. Government agencies             |   | 20,780                                |   | 3.79 | % | 184,520 |   | 2.83 | % | 113,467 |   | 3.25 | % | — |   | — |   | 318,767 |   | 3.04 | % |
| Mortgage-backed  securities          |   | 57                                    |   | 6.56 | % | 6,663 |   | 5.43 | % | 40,635 |   | 5.43 | % | 1,015,585 |   | 4.20 | % | 1,062,940 |   | 4.26 | % |
| Collateralized mortgage  obligations |   | —                                |   | — |   | 1,282 |   | 2.27 | % | 504 |   | 2.26 | % | 78 |   | 4.26 | % | 1,864 |   | 2.35 | % |
| State and political  securities      |   | 656                                   |   | 8.03 | % | 7,489 |   | 7.28 | % | 21,206 |   | 7.53 | % | 32,233 |   | 7.81 | % | 61,584 |   | 7.65 | % |
| Other securities                     |   | —                                |   | — |   | 266 |   | 1.93 | % | 595 |   | 2.62 | % | 75,355 |   | 5.51 | % | 76,216 |   | 5.47 | % |
| Total                                |   | $                                     | 34,698 |   | 3.94 | % | $ | 229,063 |   | 2.96 | % | $ | 176,407 |   | 4.26 | % | $ | 1,123,251 |   | 4.39 | % | $ | 1,563,419 |   | 4.16 | % |

 

----

*(1) Interest yields on investments are presented on atax-equivalent basis to reflect the tax-exempt nature of certain assets. Yieldsare based on a 35%  incremental tax rateand a 0.88%  cost of funds.*

 

The Company’s investments,all of which are recorded as available-for-sale, decreased $109 million, or6.5%, to $1.6 billion at December 31, 2003, from $1.7 billion at December 31,2002, due primarily to a reduction in cash flows derived from depositgeneration, which as a result of the current sluggish economy, presents feweropportunities to attract deposits at favorable interest rates.  At December 31, 2003, the Company’sinvestments represented 28.6% of total assets, compared to 28.7% at December31, 2002.

 

The majority of theinvestment portfolio is comprised of government and government sponsoredenterprise securities (“GSE”).  Thecredit risk associated with these issuers is within tolerances set bymanagement.  A significant portion ofthe GSE debt includes mortgage-backed securities.  Because of their embedded prepayment options, these securitiesare subject to prepayment and extension risk in volatile rate environments.

 

**BANK OWNEDLIFE INSURANCE**

 

As part of the Company’sstrategy to manage employee health care and benefit costs, it has purchased aseries of insurance contracts with the intent of matching in part futureincreases in benefit costs with earnings from the insurance contracts.  The appreciation of cash value of thecontracts as well as periodic redemption of individual contracts is recorded asnon-interest income.

 

**CREDITPOLICY**

 

The Company’s lendingactivities are guided by the general loan policy established by the Board ofDirectors.  The Board of Directors ofthe bank subsidiary has established loan approval limits for each banking officeof the Company.  The limits establishedfor each office range from $5,000 to $500,000 per borrower, which is reduced tonot more than $25,000 for any criticized or classified borrower.  Amounts in excess of the individual banklending authority are presented to corporate credit officers.  The corporate credit officers have lendingauthority up to $1,000,000 for pass-rated borrower.  Loans above $1,000,000 for pass-rated borrowers, $500,000 forwatch-rated borrowers, $250,000 for classified borrowers, and $500,000 forSmall Business Administration government guaranteed borrowers are presented tothe Senior Credit Committee wherein approval must be unanimous.  The Senior Credit Committee is comprised ofthe Company’s chief operating officer, two executive vice president – divisionpresidents, the executive vice president – credit administrative officer andthe senior regional credit officer.

 

An integral part of theCompany’s initiative to redesign its delivery structure is the implementationof a centralized loan processing function. Begun in 2001, the Company continued its credit centralization processduring 2003, with the expectation that it will be fully implemented during thesecond quarter of 2004.  This processcentralizes the underwriting, documentation, administration and collection ofall consumer loans and document preparation for commercial and agriculturalcredit.  As of December 31, 2003,consumer loan collections and indirect consumer underwriting, administrationand documentation have been centralized. The centralization of direct consumer loans, as well as documentation ofcommercial and agricultural loans is progressing on schedule.  The Company has augmented its servicing andcollection of commercial and agricultural distressed credits through implementationof a special assets group, which was organized to provide greater support forthe Company’s larger, more complex credit facilities. The centralizationprocess and special assets group will afford the Company additional control andoversight of the entire credit process. The Company administers all aspects of its small business administrationcredit function through a centralized location.

 

                        Although the Company has a diversified loan portfolio, the economichealth of significant portions of the Company’s primary trade area and theability of many of the Company’s borrowers to repay their loans (including realestate and commercial loans, as well as agricultural loans) is dependent to alarge extent on the health of their local sector of the economy.  The Company has identified and implementedstrategies to deal with these factors, including an emphasis on quality localloan growth and the diversification and performance of its earning assetportfolios.

 

6

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**NONPERFORMINGASSETS**

 

The Company followsregulatory guidelines with respect to classifying loans on a nonaccrualbasis.  Loans are placed on nonaccrualwhen they become past due over 90 days, unless well secured and in the processof collection, or when the collection of interest or principal is consideredunlikely.  The Company does not return aloan to accrual status until the doubt of full collectibility is removed andthe borrower has re-established loan payments for a reasonable period.  When a loan is placed on nonaccrual status,any previously accrued and uncollected interest is reversed.  Interest income of $2,846,000, $3,615, 000,and $2,722,000, on nonaccrual loans would have been recorded during 2003, 2002,and 2001, respectively, if the loans had been current in accordance with theiroriginal terms. The Company recorded interest income of $540,000, $679,000, and$1,113,000 related to loans that were on nonaccrual status as of December 31,2003, 2002, and 2001, respectively.

 

The Company considersnonperforming assets to include all nonaccrual loans, restructured loansdefined as troubled debt restructurings under SFAS No.15 and other real estateowned (“OREO”).

 

Nonperforming assets of theCompany are summarized in the following table:

 
| **December 31 (Dollars in thousands)**                        |   | **2003**   |          | **2002**   |   | **2001**  |   | **2000** |      | **1999** |   |
|---------------------------------------------------------------|--------|------------|---------------|------------|--------|-----------|--------|----------|-----------|----------|--------|
|                                                          |   |       |          |       |   |      |   |     |      |     |   |
| Loans:                                                        |   |       | ** **    |       |   |      |   |     |      |     |   |
| Nonaccrual  loans                                             |   | **$**      | **20,630**    | ** ** | $      | 22,728    |   | $        | 20,818    |     | $      | 23,426 |   | $ | 25,764 |   |
| Restructured  loans                                           |   | **188**    | ** **    | 220        |   | 252       |   | 224      |      | 284      |   |
| Nonperforming  loans                                          |   | **20,818** | ** **    | 22,948     |   | 21,070    |   | 23,650   |      | 26,048   |   |
| OREO                                                          |   | **5,461**  | ** **    | 5,990      |   | 2,869     |   | 2,437    |      | 6,525    |   |
| Nonperforming  assets                                         |   | **$**      | **26,279**    | ** ** | $      | 28,938    |   | $        | 23,939    |     | $      | 26,087 |   | $ | 32,573 |   |
| Loans  90 days or more past due but still accruing            |   | **$**      | **3,220**     | ** ** | $      | 4,258     |   | $        | 6,270     |     | $      | 2,482 |   | $ | 1,949 |   |
| Nonperforming  loans as a percentage of total loans           |   | **0.63**   | **%**         | 0.64       | %      | 0.56      | %      | 0.63     | %         | 0.71     | %      |
| Nonperforming  assets as a percentage of total assets         |   | **0.48**   | **%**         | 0.50       | %      | 0.41      | %      | 0.43     | %         | 0.52     | %      |
| Nonperforming  assets as a percentage of total loans and OREO |   | **0.79**   | **%**         | 0.81       | %      | 0.64      | %      | 0.70     | %         | 0.88     | %      |
| Total  loans                                                  |   | **$**      | **3,323,572** | ** ** | $      | 3,577,893 |   | $        | 3,736,692 |     | $      | 3,738,202 |   | $ | 3,690,353 |   |
| Total  assets                                                 |   | **$**      | **5,465,107** | ** ** | $      | 5,830,850 |   | $        | 5,775,778 |     | $      | 6,093,219 |   | $ | 6,305,871 |   |

 

Nonperforming assets were$26.3 million at December 31, 2003, a decrease of $2.6 million, or 9.0%, from$28.9 million at December 31, 2002. Nonperforming loans decreased by $2.1 million during the sameperiod.  The reduction in nonperformingassets from 2002 to 2003 was due in part to the partial charge-off of twospecific credits, an agri-business loan and a construction contractor credit,both of which were included in nonperforming assets at December 31, 2002.  OREO decreased $529,000, or 8.8%, from $6.0million at December 31, 2002 to $5.5 million at December 31, 2003.  The ratio of nonperforming assets to totalassets at December 31, 2003, was .48%, compared to .50% at December 31, 2002.

 

Nonperforming assets were$28.9 million at December 31, 2002, an increase of $5.0 million, or 20.9%, from$23.9 million at December 31, 2001. Nonperforming loans increased by $1.9 million during the sameperiod.  OREO increased $3.1 million, or106.9%, from $2.9 million at December 31, 2001 to $6.0 million at December 31,2002.  The increase in OREO wasprincipally due to the addition of two properties, one in Colorado and one inArizona, which previously had been classified as nonaccrual loans. The ratio ofnonperforming assets to total assets at December 31, 2002, was .50%, comparedto .41% at December 31, 2001.

 

**ALLOWANCEFOR LOAN LOSSES**

 

The current level of theallowance for loan losses is a result of management’s assessment of the riskswithin the portfolio based on the information obtained through the creditevaluation processes.  The Company utilizesa risk-rating system on non-homogenous loans, including purchased loans, and amonthly credit review and reporting process that results in the calculation ofthe reserves based on the risk within the portfolio.  This assessment of risk takes into account the composition of theloan portfolio, previous loan experience, current economic conditions and otherfactors that, in management’s judgment, deserve recognition.

 

The allowance is allocated toindividual loan categories based upon the relative risk characteristics of theloan portfolios and actual loss experience. Additional reserves are provided to recognize the Company’s exposure toinherent, but undetected losses within the overall loan portfolio.  Risk is assessed and reserves are allocatedto the individual loan portfolios through the periodic application of riskassessment processes including migration analysis, specific credit analysis andanalysis of portfolio sectors possessing common traits.

 

For commercial andagricultural loans, including commercial and agricultural real estate, realestate construction and purchased assets, portfolio risk is determined usingmigration analysis wherein the actual loan loss experience is tracked, on aloan-by-loan basis, over the previous 36 months to determine a weighted-averageloss rate inherent in the respective portfolios.  In addition, individual loans, which have been identified in theperiodic portfolio review as problem loans, are allocated reserves based onmanagement’s assessment of loss probability. Also, on a quarterly basis, management identifies sectors of each loanportfolio, which, in their judgment, demonstrate more or less risk than thatrisk identified in the allocated reserve calculated in the portfolio migrationanalysis.  The basis of these allocationadjustments includes historical and expected delinquency and charge-offstatistics, changes in underwriting criteria, assessment of lender managementexpertise and changes in loan volume. Portfolio sectors are identified based on a combination of common characteristics,which may include collateral type, term, purpose, geographic concentration ofborrowers or other common characteristics encountered in management’sassessment of the portfolio.

 

Consumer and residential realestate loan portfolio risk is determined through the application of separatemigration analyses designed to identify estimated inherent losses, wherein theactual portfolio losses are aggregated to determine the loss ratio applicableto the respective period.  The resultingloss ratio calculated in the analysis is applied to the entire consumer andreal estate portfolios respectively, based on the average term of all portfolioloans.  Also, on a quarterly basis,management identifies sectors of the loan portfolio, which in their judgmentdemonstrate more or less risk than that risk identified in the portfoliomigration analysis.  The basis of theseallocation adjustments includes historical delinquency and

 

7

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charge-off statistics,changes in underwriting criteria, assessment of lender management expertise andchanges in loan volume.  Portfoliosectors are identified based on a combination of common characteristics, whichmay include collateral type, term, purpose, geographic concentration of borrowersor other common characteristics encountered in management’s assessment of theportfolio.

 

The Company also maintains anadditional allowance amount to recognize its exposure to inherent, butundetected losses.  This exposure iscaused by inherent delays in obtaining information regarding an individualborrower’s financial condition or change in their specific business condition;the judgmental nature of individual loan evaluations, collateral assessmentsand the interpretation of economic trends; the volatility of general economicor specific customer conditions affecting the identification and quantificationof losses for large individual credits; and the sensitivity of assumptions usedin establishing allocated allowances for general categories of loans.

 

The 2003, 2002, and 2001allocation reflects the Company’s methodology utilized to allocate theallowance within individual loan portfolios. The methodology was modified in 2001 due to the Company’s desire to morespecifically identify credit risk within each individual loan portfolio.  As a result, a greater portion of theallowance for loan losses was allocated to specific loan portfolios, whichresulted in a smaller percentage of additional allowance. While designed tomore specifically identify risk inherent in a specific loan portfolio, themethodology did not result in a need for additional allowance, but ratherpermitted the Company to better assign its allowance balance to the riskassociated with specific loan portfolios. The resulting increase in allocated allowance and decrease in additionalallowance in 2003, 2002, and 2001 is primarily a result of the modifiedmethodology.

 

The allocated portion of theallowance increased to $46.2 million at December 31, 2003, an increase of $3.4million, or 7.9% from $42.8 million at December 31, 2002.  The increase was principally due to changesin the Company’s assessment of the underlying loan portfolios.  The allocated allowance as a percentage ofloans outstanding was 1.39% at December 31, 2003 and 1.20% at December 31,2002.  While the allowance as apercentage of loans outstanding remained constant at 1.57% at December 31, 2003and 2002, the allocated reserve percentage increased and conversely, theunallocated reserve declined.  The shiftin allocated and unallocated is attributed to management’s application of itsreserve analysis methodology wherein management focuses primarily on specificloan categories and sub-categories within the various portfolios.  In this manner management believes it is ableto identify the majority of the risk elements at the category level, thusreducing the unallocated reserve that is necessary.  The additional allowance decreased to $6.0 million at December31, 2003, a decrease of $7.3 million, or 54.9% from $13.3 million at December31, 2002.  The additional allowance as apercentage of loans outstanding was .18% at December 31, 2003 and .37% atDecember 31, 2002.  The level of theadditional allowance reflects the Company’s assessment of inherent, butundetected losses. The accompanying table shows the allocated and additionalallowance for the various loan classifications.

 

The allocated portion of theallowance at December 31, 2003 increased to $18.7 million in the consumer andother portfolio, from $15.1 million at December 31, 2002, a $3.6 million, or23.8%, increase.  The increase isprincipally due to the increase in the level of delinquencies and charge-offsin the portfolio and reflects management’s expectation of portfolio performancein the current economic environment.  Asa percentage of the portfolio, the allowance allocated to consumer and otherloans increased from 2.41% of the 2002 portfolio to 2.76% of the 2003portfolio.  The December 31, 2003allowance allocated to the agricultural portfolio increased to $3.7 million, a23.3% increase from December 31, 2002. As a percentage of the portfolio, the allowance allocated toagricultural loans increased from 1.37% of the 2002 portfolio to 2.09% of the2003 portfolio.  The commercialportfolio allowance decreased $455,000, or 4.9% to $8.7 million at December 31,2003, from $9.2 million at December 31, 2002. As a percentage of the portfolio, the allowance allocated to commercialloans increased from 1.27% of the 2002 portfolio to 1.50% of the 2003portfolio.  The allowance allocated forthe real estate construction portfolio decreased to $2.5 million at December31, 2003, from $4.1 million at December 31, 2002.  As a percentage of the portfolio, the allowance allocated to realestate construction loans decreased from 0.94% of the 2002 portfolio to 0.79%of the 2003 portfolio. The real estate portfolio allowance allocation of $12.4million at December 31, 2003, increased $1.0 million or 8.8% from $11.4 millionat December 31, 2002.  As a percentageof the portfolio, the allowance allocated to real estate loans increased from0.73% of the portfolio in 2002 to 0.80% of the portfolio in 2003.  For all portfolios, the change in theallocated allowance was principally due to the Company’s delinquency andcharge-off experience within the respective portfolios and reflectsmanagement’s estimate of probable losses in the portfolio at period-end.

 

The allocated portion of theallowance at December 31, 2002 increased to $15.1 million in the consumer andother portfolio, from $11.3 million at December 31, 2001, a $3.8 million, or33.6%, increase.  The increase wasprincipally due to the increase in the level of delinquencies and charge-offsin the portfolio and reflected management’s expectation of portfolioperformance.  As a percentage of theportfolio, the allowance allocated to consumer and other loans increased from1.80% of the 2001 portfolio to 2.41% of the 2002 portfolio.  The December 31, 2002 allowance allocated tothe agricultural portfolio increased slightly to $3.0 million, a 1.1% increasefrom December 31, 2001.  As a percentageof the portfolio, the allowance allocated to agricultural loans increased from1.19% of the 2001 portfolio to 1.37% of the 2002 portfolio.  The commercial portfolio allowance decreased$1.1 million, or 10.7%, to $9.2 million at December 31, 2002, from $10.3million at December 31, 2001.  As apercentage of the portfolio, the allowance allocated to commercial loansincreased slightly from 1.25% of the 2001 portfolio to 1.27% of the 2002 portfolio.The allowance allocated for the real estate construction portfolio decreasedslightly to $4.1 million at December 31, 2002, from $4.3 million at December31, 2001.  As a percentage of theportfolio, the allowance allocated to real estate construction loans increasedfrom 0.82% of the 2001 portfolio to 0.94% of the 2002 portfolio.  The real estate portfolio allowanceallocation of $11.4 million at December 31, 2002, decreased $1.1 million or8.8% from $12.5 million at December 31, 2001. As a percentage of the portfolio, the allowance allocated to real estateloans decreased from 0.83% of the portfolio in 2001 to 0.73% of the portfolioin 2002.  For all portfolios, the changein the allocated allowance was principally due to the Company’s delinquency andcharge-off experience within the respective portfolios and reflectsmanagement’s estimate of probable losses in the portfolio at period-end.

 

8

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The following table setsforth the allocation of the allowance for loan losses to various loancategories, as well as the allocation as a percentage of loans outstanding ineach category, as of the dates indicated:

 
|                        |   | **Allowance for Loan Losses at December 31,** |       | **Allowance as a Percent of Loans Outstanding  by Category at December 31,** |   |
|-----------------------------|--------|-----------------------------------------------|------------|------------------------------------------------------------------------------|--------|
| **(Dollars in thousands)**  |   | **2003**                                      |       | **2002**                                                                     |   | **2001** |   | **2000** |   | **1999** |   | **2003** |   | **2002** |   | **2001** |   | **2000** |   | **1999** |   |
| Real estate                 |   | **$**                                         | **12,425** |                                                                         | $      | 11,413 |   | $ | 12,519 |   | $ | 12,234 |   | $ | 10,329 |   | **0.80** | **%** | 0.73 | % | 0.83 | % | 0.84 | % | 0.78 | % |
| Real estate construction    |   | **2,535**                                     |       | 4,116                                                                        |   | 4,256 |   | 515 |   | 218 |   | **0.79** | **%** | 0.94 | % | 0.82 | % | 0.11 | % | 0.05 | % |
| Commercial                  |   | **8,743**                                     |       | 9,198                                                                        |   | 10,293 |   | 7,117 |   | 8,673 |   | **1.50** | **%** | 1.27 | % | 1.25 | % | 0.82 | % | 0.87 | % |
| Consumer and other          |   | **18,744**                                    |       | 15,069                                                                       |   | 11,272 |   | 4,147 |   | 4,657 |   | **2.76** | **%** | 2.41 | % | 1.80 | % | 0.60 | % | 0.68 | % |
| Agricultural                |   | **3,738**                                     |       | 3,029                                                                        |   | 2,996 |   | 3,016 |   | 2,643 |   | **2.09** | **%** | 1.37 | % | 1.19 | % | 1.19 | % | 1.02 | % |
| Total allocated  allowance  |   | **46,185**                                    |       | 42,825                                                                       |   | 41,336 |   | 27,029 |   | 26,520 |   | **1.39** | **%** | 1.20 | % | 1.11 | % | 0.72 | % | 0.72 | % |
| Total additional  allowance |   | **6,046**                                     |       | 13,331                                                                       |   | 13,655 |   | 25,139 |   | 22,358 |   | **0.18** | **%** | 0.37 | % | 0.36 | % | 0.68 | % | 0.60 | % |
| Total allowance             |   | **$**                                         | **52,231** |                                                                         | $      | 56,156 |   | $ | 54,991 |   | $ | 52,168 |   | $ | 48,878 |   | **1.57** | **%** | 1.57 | % | 1.47 | % | 1.40 | % | 1.32 | % |

 

The actual amount of lossesincurred can vary significantly from the estimated amount.  To the extent that actual losses mightexceed the estimates, additional provision expense may be required in futureperiods.  Conversely, if actual lossesare substantially less than estimated, future periods may reflect a lowerprovision expense.  The Company’smethodology includes general factors intended to minimize the differences inestimated and actual losses.  Thesefactors allow the Company to adjust its estimates of losses based on the mostrecent information available.  Althoughthe Company determines the amount of each element of the allowance for loanlosses separately, and this process is an important credit management tool, theentire allowance for loan losses is available for the entire loan portfolio.

 

At December 31, 2003, theallowance for loan losses was $52.2 million, a decrease of $4.0 million fromthe December 31, 2002 level of $56.2 million. At December 31, 2003 and December 31, 2002, the allowance for loanlosses as a percentage of total loans was 1.57%.  The decrease in the allowance for loan losses is the result ofmanagement’s assessment of credit risk associated with the current loanportfolio and as a percentage of total loans, remains constant with the prioryears, due in part to a $254 million reduction in loans outstanding.

 

At December 31, 2002, the allowancefor loan losses was $56.2 million, an increase of $1.2 million from theDecember 31, 2001, level of $55.0 million. At December 31, 2002, the allowance for loan losses as a percentage oftotal loans was 1.57%, as compared to 1.47% at December 31, 2001.  This increase is due to the combined effectof the Company’s analysis of the loan portfolio credit quality at the Company’sbank subsidiary and a decrease in the volume of loans outstanding.

 

During 2003, net charge-offswere $16.5 million, an increase of $4.4 million from net charge-offs of the$12.1 million during 2002.  The increasein net charge-offs is principally due to the partial charge-off in 2003 of twospecific credits, an agri-business loan and a construction contractorcredit.  Management believes the twocredits are isolated transactions and not indicative of systemic asset qualitydeterioration.  The Company’s provisionfor loan losses decreased from $13.3 million in 2002 to $12.6 million in 2003.  The decrease is attributed in part to the$254 million reduction in the Company loan portfolio from December 31, 2002 toDecember 31, 2003.

 

During 2002, net charge-offswere $12.1 million, a decrease of $2.6 million from the $14.7 million during2001.  The decrease is principally dueto the 2001 charge-off of an Arizona-based loan and the $1.2 million recoveryrecorded on the loan in 2002.  TheCompany’s provision for loan losses decreased from $17.5 million in 2001 to$13.3 million in 2002.

 

The provision for loan lossesis recorded to bring the allowance for loan losses to the level deemedappropriate by management.  Theprovision is the result of estimates based on management’s analysis, and assuch, future earnings could be adversely affected if the provision is notsufficient to cover future losses.

 

The following table setsforth the Company’s allowance for loan losses as of the dates indicated:

 
| **December 31 (Dollars in thousands)**        |   | **2003**   |          | **2002** |   | **2001**  |   | **2000** |      | **1999** |   |
|-----------------------------------------------|--------|------------|---------------|----------|--------|-----------|--------|----------|-----------|----------|--------|
| Balance  at beginning of year                 |   | **$**      | **56,156**    |     | $      | 54,991    |   | $        | 52,168    |     | $      | 48,878 |   | $ | 51,860 |   |
| Allowance  of acquired companies and other    |   | **—** |          | —   |   | —    |   | —   |      | 270      |   |
| Charge-offs:                                  |   |       |          |     |   |      |   |     |      |     |   |
| Real  estate                                  |   | **2,083**  |          | 2,468    |   | 1,588     |   | 1,176    |      | 2,181    |   |
| Real  estate construction                     |   | **340**    |          | 50       |   | 2,538     |   | 408      |      | 2,965    |   |
| Commercial                                    |   | **6,538**  |          | 6,191    |   | 5,374     |   | 6,644    |      | 8,349    |   |
| Consumer  and other                           |   | **10,214** |          | 11,040   |   | 10,033    |   | 7,893    |      | 13,802   |   |
| Agricultural                                  |   | **3,435**  |          | 300      |   | 336       |   | 996      |      | 553      |   |
| Total  charge-offs                            |   | **22,610** |          | 20,049   |   | 19,869    |   | 17,117   |      | 27,850   |   |
| Recoveries:                                   |   |       |          |     |   |      |   |     |      |     |   |
| Real  estate                                  |   | **330**    |          | 243      |   | 498       |   | 155      |      | 928      |   |
| Real  estate construction                     |   | **21**     |          | 1,309    |   | 70        |   | 4        |      | —   |   |
| Commercial                                    |   | **1,142**  |          | 893      |   | 839       |   | 1,565    |      | 468      |   |
| Consumer  and other                           |   | **4,525**  |          | 5,332    |   | 3,438     |   | 2,648    |      | 2,537    |   |
| Agricultural                                  |   | **65**     |          | 175      |   | 327       |   | 254      |      | 481      |   |
| Total  recoveries                             |   | **6,083**  |          | 7,952    |   | 5,172     |   | 4,626    |      | 4,414    |   |
| Net  charge-offs                              |   | **16,527** |          | 12,097   |   | 14,697    |   | 12,491   |      | 23,436   |   |
| Provision  charged to operations              |   | **12,602** |          | 13,262   |   | 17,520    |   | 15,781   |      | 20,184   |   |
| Balance  at end of year                       |   | **$**      | **52,231**    |     | $      | 56,156    |   | $        | 54,991    |     | $      | 52,168 |   | $ | 48,878 |   |
| Allowance  as a percentage of total loans     |   | **1.57**   | **%**         | 1.57     | %      | 1.47      | %      | 1.40     | %         | 1.32     | %      |
| Net  charge-offs to average loans outstanding |   | **0.48**   | **%**         | 0.33     | %      | 0.39      | %      | 0.34     | %         | 0.66     | %      |
| Total  loans                                  |   | **$**      | **3,323,572** |     | $      | 3,577,893 |   | $        | 3,736,692 |     | $      | 3,738,202 |   | $ | 3,690,353 |   |
| Average  loans                                |   | **$**      | **3,446,507** |     | $      | 3,689,015 |   | $        | 3,785,553 |     | $      | 3,706,144 |   | $ | 3,573,060 |   |

 

9

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**SOURCE OF FUNDS**

 

**Deposits**

 

The Company’smajor source of funds is provided by core deposits from individuals, businessesand local government units. Core deposits consist of all in-marketnoninterest-bearing deposits, interest-bearing savings and checking accountsand time deposits of less than $100,000.

 

The following table sets forth a summary of the deposits of the Companyat the dates indicated, (in thousands):

 
| **December 31**                      |   | **2003**      |          | **2002**   |   | **2001**  |   |
|--------------------------------------|--------|---------------|---------------|------------|--------|-----------|--------|
| Noninterest-bearing                  |   | **$**         | **447,648**   | ** ** | $      | 470,900   |   | $ | 487,864 |   |
| Interest-bearing:                    |   |          | ** **    |       |   |      |   |
| Savings  and checking accounts       |   | **2,552,056** | ** **    | 2,424,943  |   | 2,367,255 |   |
| Time  accounts less than $100,000    |   | **888,066**   | ** **    | 1,103,716  |   | 1,203,379 |   |
| Time  accounts greater than $100,000 |   | **501,440**   | ** **    | 670,187    |   | 692,315   |   |
| Total  deposits                      |   | **$**         | **4,389,210** | ** ** | $      | 4,669,746 |   | $ | 4,750,813 |   |

 

Total depositsat December 31, 2003, were $4.4 billion, a decrease of $281 million, or 6.0%,from $4.7 billion at December 31, 2002. The decrease is principally the resultof the Company’s strategy to manage the rate of interest paid on depositaccounts in relationship to the availability of lending and investmentopportunities. To the extent attractive lending or investment opportunities areidentified, the Company may, at its discretion, adjust rates in an effort toattract additional deposits. The Company’s core deposits as a percentage oftotal deposits were 88.6% and 85.6% as of December 31, 2003 and December 31,2002, respectively.

 

At December31, 2003, $501 million, or 11.4% of total deposits were in time accountsgreater than $100,000, a decrease of $169 million, or 25.2%, from $670 millionat December 31, 2001. Management believes virtually all the deposits in excessof $100,000 are with persons or entities that hold other deposit relationshipswith the bank. Maturities of deposits in excess of $100,000 at December 31,2003 were (in thousands):

 
| Maturing  in less than three months   |   | $       | 172,506 |   |
|---------------------------------------|--------|---------|---------|--------|
| Maturing  in three to six months      |   | 98,072  |    |
| Maturing  in six to twelve months     |   | 114,310 |    |
| Maturing  in over twelve months       |   | 116,552 |    |
| Total  deposits in excess of $100,000 |   | $       | 501,440 |   |

 

At December31, 2003, the Company had $18 million in deposits obtained through a brokereddeposit relationship. In addition to the availability of core deposits,management has determined it may continue to employ a brokered deposit programin an effort to attract lower cost sources of funds.

 

**SHORT-TERMBORROWINGS**

 

Short-termborrowings include securities sold under agreements to repurchase, commercialpaper, Federal Home Loan Bank advances and federal funds purchased. These fundsare used to fund the growth in loans and securities and manage the Company’sinterest rate sensitivity risk. They are subject to short-term interest ratechanges as the Company’s needs change or the overall market rates forshort-term investment funds change.

 

TheCompany’s subsidiary bank has an arrangement with the Federal Home Loan Bankthat provides for borrowing up to $364 million. As of December 31, 2003, $30million in advances were outstanding of which $6 million are short-termborrowings. The Company also had $20 million outstanding on its $50 millionshort-term commercial paper arrangement at December 31, 2003. The $11 milliondecrease in short-term borrowings from December 31, 2002 is due to a reductionin the level of short-term borrowings necessary to fund lending opportunitiesthat meet the Company’s credit quality criteria. The Company has a $35 millionshort-term line of credit with a nonaffiliated commercial bank for purposes offunding operating expenses. As of December 31, 2003, there was no balanceoutstanding on this line.

 

Thefollowing table sets forth a summary of the short-term borrowings of theCompany during 2003, 2002 and 2001, and as of the end of each such period:

 
| **(Dollars in thousands)**                                                  |   | **Outstanding  at Year-End** |    | **Average  Daily  Amount  Outstanding** |   | **Maximum  Outstanding  at any  Month-End** |   | **Weighted  Average  Interest  Rate** |    | **Average  Interest  Rate at  Year-End** |   |
|-----------------------------------------------------------------------------|--------|------------------------------|---------|-----------------------------------------|--------|---------------------------------------------|--------|---------------------------------------|---------|------------------------------------------|--------|
| **2003**                                                                    |   |                         |    |                                    |   |                                        |   |                                  |    |                                     |   |
| Federal  funds purchased and securities sold under agreements to repurchase |   | $                            | 416,689 |                                    | $      | 394,297                                     |   | $                                     | 507,426 |                                     | 1.03   | % | 0.90 | % |
| Commercial  paper                                                           |   | 19,577                       |    | 28,978                                  |   | 47,329                                      |   | 1.51                                  | %       | 1.36                                     | %      |
| FHLB  advances                                                              |   | 6,000                        |    | 10,072                                  |   | 29,000                                      |   | 2.64                                  | %       | 3.84                                     | %      |
| Other                                                                       |   | —                       |    | 8,476                                   |   | 30,000                                      |   | 1.92                                  | %       | —                                   |   |
| Total                                                                       |   | $                            | 442,266 |                                    | $      | 441,823                                     |   | $                                     | 590,339 |                                     | 1.12   | % | 0.96 | % |
| **2002**                                                                    |   |                         |    |                                    |   |                                        |   |                                  |    |                                     |   |
| Federal  funds purchased and securities sold under agreements to repurchase |   | $                            | 377,230 |                                    | $      | 296,791                                     |   | $                                     | 387,810 |                                     | 1.76   | % | 1.34 | % |
| Commercial  paper                                                           |   | 32,260                       |    | 31,567                                  |   | 45,558                                      |   | 2.30                                  | %       | 1.93                                     | %      |
| FHLB  advances                                                              |   | 44,000                       |    | 10,835                                  |   | 58,000                                      |   | 3.69                                  | %       | 1.70                                     | %      |
| Other                                                                       |   | —                       |    | —                                  |   | —                                      |   | —                                |    | —                                   |   |
| Total                                                                       |   | $                            | 453,490 |                                    | $      | 339,193                                     |   | $                                     | 462,881 |                                     | 1.87   | % | 1.42 | % |
| **2001**                                                                    |   |                         |    |                                    |   |                                        |   |                                  |    |                                     |   |
| Federal  funds purchased and securities sold under agreements to repurchase |   | $                            | 318,859 |                                    | $      | 263,252                                     |   | $                                     | 363,638 |                                     | 3.47   | % | 2.46 | % |
| Commercial  paper                                                           |   | 19,780                       |    | 22,285                                  |   | 34,051                                      |   | 4.98                                  | %       | 2.78                                     | %      |
| FHLB  advances                                                              |   | 4,000                        |    | 72,513                                  |   | 210,000                                     |   | 6.27                                  | %       | 4.39                                     | %      |
| Other                                                                       |   | —                       |    | 3,513                                   |   | 5,000                                       |   | 6.40                                  | %       | —                                   |   |
| Total                                                                       |   | $                            | 342,639 |                                    | $      | 361,563                                     |   | $                                     | 496,856 |                                     | 4.15   | % | 2.51 | % |

 

10

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**LONG-TERMDEBT**

 

Long-term debtof the Company was $222 million as of December 31, 2003, and $251 million as ofDecember 31, 2002. The decrease is principally due to the repurchase of $10million of its 7.30% Subordinated Notes due June 30, 2004 and a $19 millionreduction in the level of subsidiary bank borrowings at the Federal Home LoanBank.

 

**JUNIORSUBORDINATED DEBENTURES**

 

Junior subordinateddebentures of the Company were $120 million as of December 31, 2003 and 2002.At December 31, 2003, the total consisted of $60 million of 8.125% juniorsubordinated debentures issued March 27, 2002 to CFB Capital III and $60million of 7.60% junior subordinated debentures issued March 4, 2003 to CFBCapital IV. CFB Capital III and CFB Capital IV, respectively, issued CumulativeCapital Securities to the public which bear interest at the same rate as thejunior subordinated debentures and mature not later than March 15,2033. TheCompany has unconditionally guaranteed the obligation of CFB Capital III underthe 8.125% junior subordinated debentures and the obligation of CFB Capital IVunder the 7.60% junior subordinated debentures. At December 31, 2002, theCompany had outstanding the 8.125% junior subordinated debentures issued March27, 2003 and $60 million of 8.20% junior subordinated debentures issuedDecember 10, 1997. The 8.20% junior subordinated debentures were redeemed onApril 4, 2003.

 

**SHAREHOLDERS**’ **EQUITY**

 

Total shareholders’ equitydecreased $16.6 million, or 4.4%, to $361.8 million at December 31, 2003, from$378.4 million at December 31, 2002. The decrease is due principally to a $16.8million decrease in unrealized gains on available-for-sale securities, net oftax and an increase of $39.9 million in treasury stock as a result of theCompany’s common stock repurchase program. These were offset in part by theretention of $40.7 million of 2003 earnings, net of $34.3 million in dividendspaid on common stock.

 

On June 16, 2003, the Company filed a shelf registration statement withthe Securities and Exchange Commission for the purpose of issuing up to $120million of debt securities, common stock, preferred stock, and othersecurities. The Company expects to use the proceeds from the shelf offering toredeem or repurchase outstanding securities, repay debt, acquisitions and forgeneral working capital.

 

On February 22, 2002, the Company filed a shelf registration statementwith the Securities and Exchange Commission for the purpose of issuing $180million of various debt and equity securities. At December 31, 2003, $60million remains available for issuance of debt and equity securities.

 

On April 10, 2000, the Company announced its intention to repurchase upto 5 million shares of the Company’s common stock. On August 9, 2000, theCompany announced its intention to repurchase up to an additional 5 millionshares of the Company’s common stock. On August 7, 2001, the Company announcedits intention to repurchase up to 3 million shares of the Company’s commonstock. On April 24, 2003, the Company announced its intention to repurchase upto an additional 3 million shares of the Company’s common stock. In aggregate,these four announced repurchase programs and repurchases previously authorized,totaled 16.8 million shares since the Company initiated its repurchaseinitiative. At December 31, 2003,2.4 million shares remained available forrepurchase. As of December 31, 2003, the Company had repurchased 14,400,000shares of common stock at prices ranging from $15.25 to $29.29. The Companyrepurchased 1.7 million shares during 2003 at an average price of $26.93 pershare and 1.9 million shares during 2002 at an average price of $25.62 pershare.

 

In April 1998, in conjunction with the Company’s shareholder approvalof a charter amendment that facilitated a two-for-one split of the Company’scommon stock in the form of a 100 percent dividend paid to holders of record asof May 1,1998, the Company increased the number of authorized common sharesfrom 30,000,000 to 80,000,000. The number of authorized preferred sharesremained at 2,000,000.

 

**ASSET ANDLIABILITY MANAGEMENT**

 

**LIQUIDITYMANAGEMENT**

 

Liquiditymanagement is an effort of management to provide a continuing flow of funds tomeet its financial commitments, customer borrowing needs and deposit withdrawalrequirements. The liquidity position of the Company and its subsidiary bank ismonitored by the Asset and Liability Management Committee of the Company. Thelargest category of assets representing a ready source of liquidity for theCompany is its short-term financial instruments, which include federal fundssold, interest-bearing deposits at other financial institutions, U.S. Treasurysecurities and other securities maturing within one year. Liquidity is alsoprovided through the regularly scheduled maturities of assets. The investmentportfolio contains a number of high quality issues with varying maturities andregular principal payments. Maturities in the loan portfolio also provide asteady flow of funds, and strict adherence to the credit policies of theCompany helps ensure the collectibility of these loans. The liquidity positionof the Company is also greatly enhanced by its significant base of core deposits.

 

In the normal course of business, the Company is party to financialinstruments with off-balance-sheet risk. Because many of the commitments areexpected to expire without being drawn upon, total commitment amounts do notnecessarily represent the Company’s future liquidity requirements. Theseinstruments are further described in Note 9, Financial Instruments With OffBalance-Sheet Risk and Concentrations of Credit Risk.

 

The liquidity ratio is one measure of a bank’s ability to meet itscurrent obligations and is defined as the percentage of liquid assets todeposits. Liquid assets include cash and due from banks, unpledged investmentsecurities with maturities of less than one year and federal funds sold. Atyear-end 2003, 2002 and 2001, the liquidity ratio was 5.53%, 8.32%, and 6.72%,respectively. The level of loans maturing within one year greatly add to theCompany’s liquidity position. Including loans maturing within one year, theliquidity ratio was 21.87%, 27.94%, and 29.86%, respectively, for the sameperiods.

 

The Company has revolving lines of credit with its primary lenders,which provide for borrowing up to $85 million. These lines are utilized tofinance stock repurchase activity, underwrite commercial paper, and fund otheroperating expenses. At December 31, 2003, the Company had $20 million incommercial paper outstanding, underwritten by the Company’s revolving line ofcredit. At December 31, 2002, the Company had $32 million in commercial paperoutstanding, underwritten by the Company’s revolving line of credit.

 

                        The Company maintains availablelines of federal funds borrowings at various non-affiliated financialinstitutions. The Company’s subsidiary bank has the ability to borrow anaggregate of $132 million in federal funds from five nonaffiliated financialinstitutions. At December 31, 2003, the Company had no balance outstanding onthese lines. At December 31, 2003, the Company had $124 million outstandingbalance on an aggregate of $335 million in federal funds lines on a fundsavailable basis with seven non-affiliated institutions, four of which areadministered through a third party broker-dealer. At December 31, 2002, theCompany’s subsidiary bank had the ability to borrow an aggregate of $185million in Federal Funds from eight nonaffiliated financial institutions, withan outstanding balance of $87 million.

 

The Company also has a $192 million line of credit from the FederalReserve under its Primary Credit Program, which permits financial institutionswith collateralized lines of credit at the

 

11

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FederalReserve to borrow funds on a short term basis. Funds are priced at a spreadabove the Federal Funds target rate and are available on an as needed basis. AtDecember 31, 2003, the Company had no balance outstanding on its line.

 

Additionally, the Company’s subsidiary bank is a member of the FederalHome Loan Bank (“FHLB”) System. As part of membership, the Company’s subsidiarybank purchased a modest amount of stock of FHLB and obtained advance lines ofcredit which represent an aggregate of $364 million in additional fundingcapacity. At December 31, 2003, the Company had $20 million outstanding on thisline. At December 31, 2002, the Company had $44 million outstanding on anaggregate of $458 million of additional funding capacity with the FHLB.

 

**INTERESTRATE SENSITIVITY**

 

Interest ratesensitivity indicates the exposure of a financial institution’s earnings tofuture fluctuations in interest rates. Management of interest rate sensitivityis accomplished through the composition of loans and investments and byadjusting the maturities on earning assets and interest-bearing liabilities.Rate sensitivity and liquidity are related since both are affected by maturingassets and liabilities. However, interest rate sensitivity also takes intoconsideration those assets and liabilities with interest rates that are subjectto change prior to maturity.

 

Management attempts to structure the Company’s balance sheet to providefor an approximately equal amount of rate sensitive assets and rate sensitiveliabilities. In addition to facilitating liquidity needs, this strategy assistsmanagement in maintaining relative stability in net interest income despiteunexpected fluctuations in interest rates. Management uses three methods formeasuring and managing interest rate risk: Balance Sheet Simulation Modeling,Repricing Mismatch Analysis, and Equity Fair Value Modeling.

 

**BALANCESHEET SIMULATION MODELING**

 

Balance Sheet Simulation Modeling allows management to analyze theshort-term (12 months or less) impact of interest rate fluctuations onprojected earnings. Using financial simulation computer software, managementhas built a model that projects a number of interest rate scenarios. Each scenariocaptures the impact of contractual obligations embedded in the Company’s assetsand liabilities. These contractual obligations include maturities, loan andsecurity payments, repricing dates, interest rate caps, and interest ratefloors. The projection results also measure the impact of various managementassumptions including loan and deposit volume targets, security and loanprepayments, pricing spreads and implied repricing caps and floors on variablerate non-maturity deposits. Management completes an earnings simulationquarterly. The simulation process is the Company’s primary interest rate riskmanagement tool.

 

While management strives to use the best assumptions possible in thesimulation process, all assumptions are uncertain by definition. Due tonumerous market factors, and the potential for changes in management strategyover time, actual results may deviate from model projections.

 

Based on the results of the simulation model as of December 31, 2003,management would expect net interest income to decline 2.00%, assuming a 100basis point rate increase in market rates. This expected result exceedsmanagement established guidelines of 1.40%. Assuming rates dropped 100 basispoints, management would expect net interest income to decline 3.09%. Thisdecline exceeds management guidelines of 1.40%. At December 31, 2002, theimpact of a 100 basis point drop would be a decrease of approximately 2.41% anda 100 basis point increase would be a decrease of approximately 0.85%,respectively, of net income.

 

Several factors mitigate the Company’s projected exposure to changinginterest rates. First, management-established risk guidelines are measuredagainst instantaneous rate shocks. Gradual rate shifts over several monthsreduce the level of projected risk, assuming rising rates. Also, the currentmodel assumes that there is no room to downprice non-maturity transactiondeposits. As an abundance of caution, management believes this is anappropriate assumption for risk management purposes, but management believesthere would be the potential for some downpricing on this sizeable volume ofaccounts if rates were to decline further. Given the current interest rateenvironment, the Board has discussed and accepted operating outside the appovedguidelines.

 

In addition to earnings at risk, the simulation process is also used asa tool in liquidity and capital management. Management models the impact ofinterest rate fluctuation on the anticipated cash flows from various financialinstruments. Management also reviews the implications of strategies that impactasset mix and capital levels from an interest rate risk and capital managementperspective in one integrated model.

 

**REPRICINGMISMATCH ANALYSIS**

 

Managementperforms a Repricing Mismatch Analysis (“Gap Analysis”) which represents apoint in time net position of assets, liabilities and off-balance sheetinstruments subject to repricing in specified time periods. Gap Analysis isperformed quarterly. However, management believes Gap Analysis alone does notaccurately measure the magnitude of changes in net interest income sincechanges in interest rate do not impact all categories of assets, liabilitiesand off-balance sheet instruments equally or simultaneously. A summary of theGap Analysis is presented at the end of this section.

 

**EQUITY FAIRVALUE MODELING**

 

BecauseBalance Sheet Simulation Modeling is dependent on accurate volume forecasts,its usefulness as a risk management tool is limited to relatively short timeframes. As a complement to the simulation process, management uses Equity FairValue Modeling to measure long-term interest rate risk exposure. This methodestimates the impact of interest rate changes on the discounted future cashflows of the Company’s current assets, liabilities and off-balance sheetinstruments. This risk model does not incorporate projected volume assumptions.

 

Similar to the simulation process, fair value results are heavilydriven by management assumptions. While management strives to use the bestassumptions possible, due to numerous market factors, actual results maydeviate from model projections.

 

Based on the model results from December 31, 2003, management wouldexpect equity fair value to decline 5.40% assuming a 100 basis point increasein rates. This exposure is within management’s established guidelines of10.00%. Assuming rates declined 100 basis points, the model projects a declinein equity fair value of 0.76%. This exposure is also within management’sestablished policy guidelines of 10.00%.

 

The Company does not engage in the speculative use of derivativefinancial instruments.

 

Based on traditional GAP methods of measuring interest rate risk,management believes the Company was liability sensitive as

 

12

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of December 31, 2003. The following table sets forth the Company’sinterest rate sensitivity analysis by contractual repricing or maturity atDecember 31, 2003:

 
|                                            |   | **Repricing or Maturing in** |       |
|-------------------------------------------------|--------|------------------------------|------------|
| **(In thousands)**                              |   | **1 Year  or Less**          |       | **Over 1  to 5 Years** |   | **Over 5  Years** |   | **Total** |   |
| Rate  sensitive assets:                         |   |                         |       |   |   |   |   |   |   |
| Loans                                           |   | $                            | 1,456,229  |   | $ | 1,488,386 |   | $ | 378,957 |   | $ | 3,323,572 |   |
| Available-for-sale  securities                  |   | 261,319                      |       | 684,930 |   | 617,170 |   | 1,563,419 |   |
| Bank  owned life insurance                      |   | —                       |       | — |   | 82,591 |   | 82,591 |   |
| Other  interest-bearing assets                  |   | 3,319                        |       | — |   | — |   | 3,319 |   |
| Total  rate sensitive assets                    |   | $                            | 1,720,867  |   | $ | 2,173,316 |   | $ | 1,078,718 |   | $ | 4,972,901 |   |
| Rate  sensitive liabilities:                    |   |                         |       |   |   |   |   |   |   |
| Savings  deposits and interest-bearing checking |   | $                            | 2,552,056  |   | $ | — |   | $ | — |   | $ | 2,552,056 |   |
| Time  deposits                                  |   | 1,038,959                    |       | 350,192 |   | 355 |   | 1,389,506 |   |
| Short-term  borrowings                          |   | 442,266                      |       | — |   | — |   | 442,266 |   |
| Long-term  borrowings                           |   | 50,000                       |       | 46,500 |   | 125,711 |   | 222,211 |   |
| Total  rate sensitive liabilities               |   | $                            | 4,083,281  |   | $ | 396,692 |   | $ | 126,066 |   | $ | 4,606,039 |   |
| Rate  sensitive gap                             |   | $                            | (2,362,414 | ) | $ | 1,776,624 |   | $ | 952,652 |   | $ | 366,862 |   |
| Cumulative  rate sensitive gap                  |   | (2,362,414                   | )          | (585,790 | ) | 366,862 |   | 366,862 |   |

 

The following sets forth the Company’s interest rate sensitivityanalysis at December 31, 2003, with respect to the individual categories ofloans and provides separate analyses with respect to fixed interest rate loansand floating interest rate loans:

 
|                          |   | **Repricing or Maturing in** |      |
|-------------------------------|--------|------------------------------|-----------|
| **(In thousands)**            |   | **1 Year  or Less**          |      | **Over 1  to 5 Years** |   | **Over 5  Years** |   | **Total** |   |
| Loan  category:               |   |                         |      |   |   |   |   |   |   |
| Real  estate                  |   | $                            | 471,288   |   | $ | 811,255 |   | $ | 279,900 |   | $ | 1,562,443 |   |
| Real  estate construction     |   | 321,323                      |      | — |   | — |   | 321,323 |   |
| Agriculture                   |   | 141,595                      |      | 35,693 |   | 1,200 |   | 178,488 |   |
| Commercial                    |   | 307,860                      |      | 209,970 |   | 65,031 |   | 582,861 |   |
| Consumer  and other           |   | 214,163                      |      | 431,468 |   | 32,826 |   | 678,457 |   |
| Total  loans                  |   | $                            | 1,456,229 |   | $ | 1,488,386 |   | $ | 378,957 |   | $ | 3,323,572 |   |
| Floating  interest rate loans |   | $                            | 740,461   |   | $ | 239,768 |   | $ | 19,795 |   | $ | 1,000,024 |   |
| Fixed  interest rate loans    |   | 715,768                      |      | 1,248,618 |   | 359,162 |   | 2,323,548 |   |
| Total  loans                  |   | $                            | 1,456,229 |   | $ | 1,488,386 |   | $ | 378,957 |   | $ | 3,323,572 |   |

 

**CAPITALMANAGEMENT**

 

Risk-basedcapital guidelines established by regulatory agencies require the Company tomaintain minimum amounts and ratios of total and Tier 1 capital torisk-weighted assets, and of Tier 1 capital to average assets.

 

As of December 31, 2003, the Company is considered well capitalizedunder the regulatory framework for prompt corrective action. To be categorizedas well capitalized, the Company must maintain minimum total risk-based, Tier 1risk-based and Tier 1 leverage ratios as set forth in the table.

 
|                                 |   | **Regulatory Capital Requirements** |   |
|--------------------------------------|--------|-------------------------------------|--------|
| **(Dollars in thousands)**           |   | **Tier 1  Capital**                 |   | **Total Risk-  Based Capital** |   | **Leverage** |   | **Total Risk-  Based Assets** |   |
| Minimum                              |   | 4.00                                | %      | 8.00 | % | 3.00 | % | N/A |   |
| Well  Capitalized                    |   | 6.00                                | %      | 10.00 | % | 5.00 | % | N/A |   |
|                                 |   |                                |   |   |   |   |   |   |   |
| **Community First Bankshares, Inc.** |   |                                |   |   |   |   |   |   |   |
| December  31, 2003                   |   | 9.76                                | %      | 11.42 | % | 6.99 | % | $ | 3,884,282 |   |
| December  31, 2002                   |   | 8.98                                | %      | 11.04 | % | 6.52 | % | $ | 4,202,131 |   |

 

Due to the Company’s level of Tier 1 capital and substantial level ofearning assets invested in low risk government agency and mortgage-backedsecurities, the Company’s risk-based capital ratios significantly exceed theregulatory minimums. The Company conducts an ongoing assessment of its capitalneeds in order to maintain an adequate level of capital to support businessgrowth, to ensure depositor protection and to facilitate corporate expansion.Portions of the subordinated debt financing referred to in Note 13, Long-TermDebt, are treated as Tier 2 capital.

 

**OFF-BALANCESHEET ARRANGEMENTS, CONTRACTUAL OBLIGATIONS AND OTHER COMMERCIAL COMMITMENTS**

 

**Off-BalanceSheet Arrangements:**

 

In the normalcourse of business, the Company enters into various business arrangementswherein it may be required by the terms of the arrangement to guarantee orinvest additional capital as a result of investment opportunities and financialperformance.

 

***Mortgage Loan Joint Venture:***TheCompany, through its subsidiary bank, and Wells Fargo & Company formed ajoint venture mortgage company for the purpose of providing mortgageorigination, documentation, servicing process and support for substantially allthe residential mortgage business of the Company. The Company has 50% ownershipand 50% voting rights over the affairs of the joint venture and accordinglyrecords its investment and its continuing share of the income or loss of thejoint venture under the equity method of accounting. As a 50% holder of thejoint venture, the Company may be required to increase its investment in thejoint venture in the event additional investment capital were required. As ofDecember 31, 2003, the Company’s investment in the joint venture totaled$253,000.

 

***Federal Reserve Stock:***The Company’s affiliate bank is required by Federal banking regulationsto be a member of the Federal Reserve System. As a member of the FederalReserve System, the Company must maintain stock ownership in the FederalReserve System in an amount equal to six percent of the affiliate bank’spaid-in capital and surplus. The affiliate bank is required and currently haspurchased an amount of common stock equal to three percent, or one-half thebank’s subscription amount. At the discretion of the Federal Reserve System,the bank may be required to increase its investment to an amount equal to thefull six percent of its total paid-in capital and surplus. At December 31,2003, the Company’s investment in the Federal Reserve System totaled $9.6million, which is included in available-for-sale securities.

 

**CONTRACTUALOBLIGATIONS AND OTHER COMMERCIAL COMMITMENTS:**

 

In the normal course of business, the Company arranges financingthrough entering into debt arrangements with various creditors for the purposeof financing specific assets or providing a funding source. Also, the Companyis party to financial instruments with off-balance-sheet risk. Thesetransactions enable customers to meet their financing needs and enable theCompany to manage its interest rate risk. These financial instruments includecommitments to extend credit and letters of credit. Other commercialcommitments are further discussed in Note 9, Financial Instruments with Off-Balance-Sheet Risk and Concentrations of Credit. The contractual

 

13

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amounts of the Company’s contractual obligations at December 31, 2003,as well as the maturity of these commitments are:

 
|                                            |   | **Payments Due by Period** |      |
|-------------------------------------------------|--------|----------------------------|-----------|
| **(In thousands)**                              |   | **Total**                  |      | **Less Than  1 Year** |   | **1-3  Years** |   | **4-5  Years** |   | **After 5  Years** |   |
| Capital  lease obligations                      |   | $                          | 6,114     |   | $ | 1,356 |   | $ | 3,081 |   | $ | 1,578 |   | $ | 99 |   |
| Operating  leases                               |   | 6,378                      |      | 1,736 |   | 1,636 |   | 1,068 |   | 1,938 |   |
| Demand  deposits                                |   | 447,648                    |      | 447,648 |   | — |   | — |   | — |   |
| Savings  deposits and interest-bearing checking |   | 2,552,056                  |      | 2,552,056 |   | — |   | — |   | — |   |
| Time  deposits                                  |   | 1,389,506                  |      | 1,038,959 |   | 261,767 |   | 88,425 |   | 355 |   |
| Federal  funds purchased                        |   | 124,000                    |      | 124,000 |   | — |   | — |   | — |   |
| Securities  sold under agreement to repurchase  |   | 292,689                    |      | 292,689 |   | — |   | — |   | — |   |
| Long-term  debt                                 |   | 222,211                    |      | 50,000 |   | 17,000 |   | 29,500 |   | 125,711 |   |
| Lines  of credit                                |   | 665,151                    |      | 471,801 |   | 62,187 |   | 18,973 |   | 112,190 |   |
| Standby  letters of credit                      |   | 21,474                     |      | 15,245 |   | 5,183 |   | 223 |   | 823 |   |
| Commercial  letters of credit                   |   | 7,255                      |      | 7,063 |   | 89 |   | 5 |   | 98 |   |
| Total                                           |   | $                          | 5,734,482 |   | $ | 5,002,553 |   | $ | 350,943 |   | $ | 139,772 |   | $ | 241,214 |   |

 

***Capital Lease Obligations:***The Companyfrequently acquires the rights to equipment used in the operation of theCompany by entering into long-term capital leases. At December 31, 2003, theCompany was liable for the payment of lease schedules associated with theacquisition of equipment and premises totaling $5,230,000, exclusive of financecharges. The effect of capital leases recorded at December 31, 2003 issummarized in the table above. Capital lease obligations are also discussed inNote 18, Commitments and Contingent Liabilities.

 

***Operating Leases:***Inthe normal course of business the Company enters into operating leasearrangements for the use of premises and equipment. Operating leases includerental agreements with tenants providing facilities through which the Companydelivers its products and services. Operating leases are also discussed in Note18, Commitments and Contingent Liabilities.

 

***Long-Term Debt:***At December 31,2003, the Company had long term debt outstanding of $222.2 million. Long-termdebt includes $50 million of unsecured subordinated notes payable, bearinginterest at a rate of 7.30%, payable semi-annually, that mature June 30, 2004.The subordinated notes, whose terms include certain covenants pertaining toregulatory compliance, financial performance timely reporting, failure to payprincipal at maturity, failure to make scheduled payments, and bankruptcy,insolvency or reorganization of the Company, may not be paid early. Managementis currently evaluating the available funding alternatives with regard to theJune 30, 2004 maturity of the 7.30% subordinated notes, including the impact ofvarious alternatives on the Company’s risk-based capital ratios. Long-term debtincludes $61,855,000 of 8.125% Junior Subordinated Debentures payable to CFBCapital III, an unconsolidated affiliate of the Company, bearing quarterlyinterest payments and maturing April 15,2032 and $61,856,000 of 7.60% JuniorSubordinated Debenture payable to CFB Capital IV, an unconsolidated affiliateof the Company, bearing quarterly interest payments and maturing March 15,2033.The subsidiary bank had Federal Home Loan Bank advances totaling $23.5 millionoutstanding at December 31, 2003, bearing interest rates ranging from 3.83% to6.55%, interest is payable monthly, with maturities ranging from January 25,2005 to May 8, 2009. Also at December 31, 2003, the subsidiary bank had a $25million unsecured subordinated term note payable to a non-affiliated bank, atan interest rate of LIBOR plus 140 basis points, payable quarterly, with amaturity date of December 22, 2007. The subsidiary bank note payable is subjectto covenants including remaining in compliance with all regulatory agencyrequirements, providing timely financial information and providing access to certainCompany records. The debt facilities are described in Note 13, Long-term Debt.At December 31, 2003, the Company was in compliance with all debt covenants.

 

***Junior subordinated debentures:*******The Company hasunconditionally guaranteed the obligation of CFB Capital III, under the $60million, 8.125% junior subordinated debentures issued March 27, 2002 and theobligation of CFB Capital IV, under the $60 million 7.60% junior subordinateddebentures issued March 4, 2003. The $60 million Capital III securities, whichmature April 15,2032 may be redeemed any time on or after April 15, 2007. The$60 million Capital IV securities, which mature March 15,2033, may be redeemedat any time on or after March 15, 2008. See Note 13, Long-Term Debt foradditional information.

 

***Commitments toextend credit***are legally binding and have fixedexpiration dates or other termination clauses. The Company’s exposure to creditloss on commitments to extend credit, in the event of nonperformance by thecounterparty, is represented by the contractual amounts of the commitments. TheCompany monitors its credit risk for commitments to extend credit by applyingthe same credit policies in making commitments as it does for loans and byobtaining collateral to secure commitments based on management’s creditassessment of the counterparty. Collateral held by the Company may includemarketable securities, receivables, inventory, agricultural commodities,equipment and real estate. Because many of the commitments are expected toexpire without being drawn upon, total commitment amounts do not necessarilyrepresent the Company’s future liquidity requirements. In addition, the Companyalso offers various consumer credit line products to its customers that arecancelable upon notification by the Company, which are included above incommitments to extend credit.

 

***Standby letters ofcredit***are conditional commitments issued by theCompany to guarantee the financial performance of a customer to a third party.Those guarantees are primarily issued to support public and private borrowingarrangements.

 

***Commercial lettersof credit***are issued by the Company on behalf ofcustomers to ensure payments of amounts owed or collection of amountsreceivable in connection with trade transactions. The Company’s exposure tocredit loss in the event of nonperformance by the counterparty is thecontractual amount of the letter of credit and represents the same exposure asthat involved in extending loans.

 

***FORWARD-LOOKING STATEMENTS***

 

*This Annual Report contains forward-lookingstatements under the Private Securities Litigation Reform Act of 1995 that aresubject to certain risks and uncertainties that could cause actual results todiffer materially from historical earnings and those presently anticipated orprojected. The Company wishes to caution readers not to place undue reliance onany such forward-looking statements, which speak only as of the date made.Factors that could cause actual results to differ from the results discussed inthe forward-looking statements include, but are not limited to: risks of loansand investments, including dependence on local economic conditions; competitionfor the Company’s customers from other providers of financial services;possible adverse effects of changes in interest rates; execution andimplementation of a series of previously announced strategic initiatives;balance sheet and critical ratio risks related to the share repurchase program;risks related to the Company’s acquisition and market extension strategy,including risks of adversely changing results of operations and possiblefactors affecting the Company’s ability to consummate further acquisitions; orextend its markets and other risks detailed in the Company’s Form 10-K filedwith the Securities and Exchange Commission, all of which are difficult topredict and many of which are beyond the control of the Company.*

 

14

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| **** |   | **CONSOLIDATED STATEMENTS OF FINANCIAL  CONDITION** |   | COMMUNITY  FIRST BANKSHARES, INC. |
|------|--------|-----------------------------------------------------|--------|-----------------------------------|

 
| **December 31 (Dollars in  thousands, except share data)**                                                  |   | **2003**      |          | **2002**   |   |
|-------------------------------------------------------------------------------------------------------------|--------|---------------|---------------|------------|--------|
|                                                                                                        |   |          |          |       |   |
| **ASSETS**                                                                                                  |   |          | ** **    |       |   |
| Cash  and due from banks                                                                                    |   | **$**         | **234,076**   | ** ** | $      | 242,887 |   |
| Interest-bearing  deposits                                                                                  |   | **3,319**     | ** **    | 4,613      |   |
| Available-for-sale  securities                                                                              |   | **1,563,419** | ** **    | 1,672,445  |   |
| Loans                                                                                                       |   | **3,323,572** | ** **    | 3,577,893  |   |
| Less:  Allowance for loan losses                                                                            |   | **(52,231**   | **)**         | (56,156    | )      |
| Net  loans                                                                                                  |   | **3,271,341** | ** **    | 3,521,737  |   |
| Bank  premises and equipment, net                                                                           |   | **131,008**   | ** **    | 132,122    |   |
| Accrued  interest receivable                                                                                |   | **28,696**    | ** **    | 34,863     |   |
| Bank  owned life insurance                                                                                  |   | **82,591**    | ** **    | 80,165     |   |
| Goodwill                                                                                                    |   | **63,448**    | ** **    | 62,903     |   |
| Other  intangibles                                                                                          |   | **30,402**    | ** **    | 32,577     |   |
| Other  assets                                                                                               |   | **56,807**    | ** **    | 46,538     |   |
| Total  assets                                                                                               |   | **$**         | **5,465,107** | ** ** | $      | 5,830,850 |   |
|                                                                                                        |   |          | ** **    |       |   |
| **LIABILITIES AND SHAREHOLDERS’ EQUITY**                                                               |   |          | ** **    |       |   |
| Deposits:                                                                                                   |   |          | ** **    |       |   |
| Noninterest-bearing                                                                                         |   | **$**         | **447,648**   | ** ** | $      | 470,900 |   |
| Interest-bearing:                                                                                           |   |          | ** **    |       |   |
| Savings  and NOW accounts                                                                                   |   | **2,552,056** | ** **    | 2,424,943  |   |
| Time  accounts over $100,000                                                                                |   | **501,440**   | ** **    | 670,187    |   |
| Other  time accounts                                                                                        |   | **888,066**   | ** **    | 1,103,716  |   |
| Total  deposits                                                                                             |   | **4,389,210** | ** **    | 4,669,746  |   |
| Federal  funds purchased and securities sold under agreements to repurchase                                 |   | **416,689**   | ** **    | 377,230    |   |
| Other  short-term borrowings                                                                                |   | **25,577**    | ** **    | 76,260     |   |
| Long-term  debt                                                                                             |   | **222,211**   | ** **    | 251,211    |   |
| Accrued  interest payable                                                                                   |   | **13,081**    | ** **    | 20,274     |   |
| Other  liabilities                                                                                          |   | **36,539**    | ** **    | 57,680     |   |
| Total  liabilities                                                                                          |   | **5,103,307** | ** **    | 5,452,401  |   |
| Shareholders’  equity:                                                                                 |   |          | ** **    |       |   |
| Common  stock, par value $.01 per share:                                                                    |   |          | ** **    |       |   |
| Authorized  Shares – 80,000,000                                                                        |   |          | ** **    |       |   |
| Shares  – 51,021,896                                                                                   |   | **510**       | ** **    | 510        |   |
| Capital  surplus                                                                                            |   | **194,911**   | ** **    | 193,887    |   |
| Retained  earnings                                                                                          |   | **432,574**   | ** **    | 393,550    |   |
| Accumulated  other comprehensive income, net of tax                                                         |   | **7,053**     | ** **    | 23,826     |   |
| Less  cost of common stock in treasury – 2003 – 13,664,482 shares; 2002 –  12,343,096 shares |   | **(273,248**  | **)**         | (233,324   | )      |
| Total  shareholders’ equity                                                                            |   | **361,800**   | ** **    | 378,449    |   |
| Total  liabilities and shareholders’ equity                                                            |   | **$**         | **5,465,107** | ** ** | $      | 5,830,850 |   |

 

*Seeaccompanying notes.*

 

15

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| **** |   | **CONSOLIDATED STATEMENTS OF INCOME** |   | COMMUNITY  FIRST BANKSHARES, INC. |
|------|--------|---------------------------------------|--------|-----------------------------------|

 
| **Years ended December 31 (Dollars  in thousands, except per share data)** |   | **2003**       |        | **2002**   |   | **2001**   |   |
|----------------------------------------------------------------------------|--------|----------------|-------------|------------|--------|------------|--------|
| **INTEREST INCOME:**                                                       |   |           | ** **  |       |   |       |   |
| Loans                                                                      |   | **$**          | **241,442** | ** ** | $      | 276,846    |   | $ | 336,937 |   |
| Investment  securities                                                     |   | **67,748**     | ** **  | 77,654     |   | 93,145     |   |
| Interest-bearing  deposits                                                 |   | **49**         | ** **  | 41         |   | 192        |   |
| Federal  funds sold and resale agreements                                  |   | **3**          | ** **  | 160        |   | 199        |   |
| Total  interest income                                                     |   | **309,242**    | ** **  | 354,701    |   | 430,473    |   |
|                                                                       |   |           | ** **  |       |   |       |   |
| **INTEREST EXPENSE:**                                                      |   |           | ** **  |       |   |       |   |
| Deposits                                                                   |   | **48,559**     | ** **  | 75,572     |   | 138,542    |   |
| Short-term  and other borrowings                                           |   | **4,940**      | ** **  | 6,340      |   | 15,001     |   |
| Long-term  debt                                                            |   | **17,039**     | ** **  | 18,743     |   | 19,268     |   |
| Total  interest expense                                                    |   | **70,538**     | ** **  | 100,655    |   | 172,811    |   |
| Net  interest income                                                       |   | **238,704**    | ** **  | 254,046    |   | 257,662    |   |
| Provision  for loan losses                                                 |   | **12,602**     | ** **  | 13,262     |   | 17,520     |   |
| Net  interest income after provision for loan losses                       |   | **226,102**    | ** **  | 240,784    |   | 240,142    |   |
|                                                                       |   |           | ** **  |       |   |       |   |
| **NONINTEREST INCOME:**                                                    |   |           | ** **  |       |   |       |   |
| Service  charges on deposit accounts                                       |   | **40,239**     | ** **  | 40,121     |   | 41,850     |   |
| Insurance  commissions                                                     |   | **15,223**     | ** **  | 13,822     |   | 12,535     |   |
| Security  sales commissions                                                |   | **9,057**      | ** **  | 9,526      |   | 6,644      |   |
| Fees  from fiduciary activities                                            |   | **5,264**      | ** **  | 5,405      |   | 5,661      |   |
| Bank  owned life insurance income                                          |   | **4,433**      | ** **  | 3,632      |   | 3,543      |   |
| Net  gains on sales of securities                                          |   | **4,334**      | ** **  | 373        |   | 804        |   |
| Gain  on sales of loans                                                    |   | **4,104**      | ** **  | 2,784      |   | 1,557      |   |
| Other                                                                      |   | **10,039**     | ** **  | 9,460      |   | 10,842     |   |
| Total  noninterest income                                                  |   | **92,693**     | ** **  | 85,123     |   | 83,436     |   |
|                                                                       |   |           | ** **  |       |   |       |   |
| **NONINTEREST EXPENSE:**                                                   |   |           | ** **  |       |   |       |   |
| Salaries  and employee benefits                                            |   | **112,886**    | ** **  | 113,994    |   | 115,743    |   |
| Net  occupancy                                                             |   | **33,490**     | ** **  | 32,832     |   | 31,593     |   |
| FDIC  insurance                                                            |   | **720**        | ** **  | 800        |   | 915        |   |
| Legal  and accounting                                                      |   | **2,691**      | ** **  | 3,138      |   | 3,764      |   |
| Other  professional services                                               |   | **4,503**      | ** **  | 4,340      |   | 4,634      |   |
| Advertising                                                                |   | **3,881**      | ** **  | 3,983      |   | 5,037      |   |
| Telephone                                                                  |   | **5,780**      | ** **  | 5,575      |   | 5,633      |   |
| Restructuring  charge                                                      |   | **—**     | ** **  | —     |   | 7,656      |   |
| Data  processing                                                           |   | **7,036**      | ** **  | 7,210      |   | 6,940      |   |
| Amortization  of intangibles                                               |   | **3,374**      | ** **  | 3,318      |   | 9,928      |   |
| Other                                                                      |   | **32,498**     | ** **  | 31,960     |   | 33,200     |   |
| Total  noninterest expense                                                 |   | **206,859**    | ** **  | 207,150    |   | 225,043    |   |
| Income  before income taxes                                                |   | **111,936**    | ** **  | 118,757    |   | 98,535     |   |
| Provision  for income taxes                                                |   | **36,915**     | ** **  | 39,549     |   | 33,476     |   |
| Net  income                                                                |   | **$**          | **75,021**  | ** ** | $      | 79,208     |   | $ | 65,059 |   |
| Earnings  per common and common equivalent share:                          |   |           | ** **  |       |   |       |   |
| Basic  net income                                                          |   | **$**          | **1.97**    | ** ** | $      | 2.00       |   | $ | 1.59 |   |
| Diluted  net income                                                        |   | **$**          | **1.95**    | ** ** | $      | 1.97       |   | $ | 1.57 |   |
| Average  common and common equivalent shares outstanding:                  |   |           | ** **  |       |   |       |   |
| Basic                                                                      |   | **38,107,796** | ** **  | 39,564,912 |   | 40,905,545 |   |
| Diluted                                                                    |   | **38,553,806** | ** **  | 40,243,135 |   | 41,471,404 |   |

 

*See accompanyingnotes.*

 

16

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| **** |   | **CONSOLIDATED STATEMENTS OF COMPREHENSIVE  INCOME** |   | COMMUNITY  FIRST BANKSHARES, INC. |
|------|--------|------------------------------------------------------|--------|-----------------------------------|

 
| **Years ended December 31 (Dollars  in thousands, except per share data)** |   | **2003**    |       | **2002**   |   | **2001** |   |
|----------------------------------------------------------------------------|--------|-------------|------------|------------|--------|----------|--------|
| Net  income                                                                |   | **$**       | **75,021** | ** ** | $      | 79,208   |   | $ | 65,059 |   |
| Other  comprehensive income:                                               |   |        | ** ** |       |   |     |   |
| Unrealized  (losses) gains on securities:                                  |   |        | ** ** |       |   |     |   |
| Unrealized  holding (losses) gains arising during period                   |   | **(23,435** | **)**      | 33,450     |   | 22,885   |   |
| Related  taxes                                                             |   | **9,262**   | ** ** | (13,247    | )      | (9,070   | )      |
| Less:  Reclassification adjustment for gains included in net income        |   | **(4,334**  | **)**      | (373       | )      | (804     | )      |
| Related  taxes                                                             |   | **1,734**   | ** ** | 149        |   | 322      |   |
| Other  comprehensive (loss) income                                         |   | **(16,773** | **)**      | 19,979     |   | 13,333   |   |
| Comprehensive  income                                                      |   | **$**       | **58,248** | ** ** | $      | 99,187   |   | $ | 78,392 |   |

 

*See accompanyingnotes.*

 
| **** |   | **CONSOLIDATED STATEMENTS OF SHAREHOLDERS’  EQUITY** |   | COMMUNITY  FIRST BANKSHARES, INC. |
|------|--------|-----------------------------------------------------------|--------|-----------------------------------|

 
|                                                                                              |   |             |       |        |    |         |   |              |       | **Accumulated  Other** |        |       |   |       |       |           |       |
|---------------------------------------------------------------------------------------------------|--------|------------------|------------|-------------|---------|--------------|--------|-------------------|------------|------------------------|-------------|------------|--------|------------|------------|----------------|------------|
| **Years ended December 31, 2003,  2002, 2001**                                                    |   | **Common Stock** |       | **Capital** |    | **Retained** |   | **Comprehensive** |       | **Treasury Stock**     |        |       |   |
| **(Dollars in thousands, except per  share data)**                                                |   | **Shares**       |       | **Amount**  |    | **Surplus**  |   | **Earnings**      |       | **Income**             |        | **Shares** |   | **Amount** |       | **Total**      |       |
| **Balance  at December 31, 2000**                                                                 |   | **51,021,896**   | ** ** | **$**       | **510** | ** **   | **$**  | **192,368**       | ** ** | **$**                  | **315,091** | ** ** | **$**  | **(9,486** | **)**      | **9,155,144**  | ** ** | **$** | **(153,052** | **)** | **$** | **345,431** | ** ** |
| Net income                                                                                        |   | —           |       | —      |    | —       |   | 65,059            |       | —                 |        | —     |   | —     |       | 65,059         |       |
| Common stock dividends  ($0.68 per share)                                                         |   | —           |       | —      |    | —       |   | (27,793           | )          | —                 |        | —     |   | —     |       | (27,793        | )          |
| Purchases of common  stock for treasury, at cost                                                  |   | —           |       | —      |    | —       |   | —            |       | —                 |        | 2,010,172  |   | (43,020    | )          | (43,020        | )          |
| Exercise of options, net  of stock tendered in payment                                            |   | —           |       | —      |    | 735          |   | (4,256            | )          | —                 |        | (389,459   | )      | 7,216      |       | 3,695          |       |
| Change in unrealized  gain on available-for-sale securities, net of income taxes of $8,748        |   | —           |       | —      |    | —       |   | —            |       | 13,333                 |        | —     |   | —     |       | 13,333         |       |
| **Balance  at December 31, 2001**                                                                 |   | **51,021,896**   | ** ** | **$**       | **510** | ** **   | **$**  | **193,103**       | ** ** | **$**                  | **348,101** | ** ** | **$**  | **3,847**  | ** ** | **10,775,857** | ** ** | **$** | **(188,856** | **)** | **$** | **356,705** | ** ** |
| Net income                                                                                        |   | —           |       | —      |    | —       |   | 79,208            |       | —                 |        | —     |   | —     |       | 79,208         |       |
| Common stock dividends  ($0.80 per share)                                                         |   | —           |       | —      |    | —       |   | (31,664           | )          | —                 |        | —     |   | —     |       | (31,664        | )          |
| Common stock dividends                                                                            |   |             |       |        |    |         |   |              |       |                   |        |       |   |       |       |           |       |
| Purchases of common  stock for treasury, at cost                                                  |   | —           |       | —      |    | —       |   | —            |       | —                 |        | 1,958,641  |   | (50,187    | )          | (50,187        | )          |
| Exercise of options, net  of stock tendered in payment                                            |   | —           |       | —      |    | 1,902        |   | (2,073            | )          | —                 |        | (425,929   | )      | 6,489      |       | 6,318          |       |
| Purchase of treasury  stock for employee benefit plans                                            |   | —           |       | —      |    | —       |   | (22               | )          | —                 |        | 34,527     |   | (770       | )          | (792           | )          |
| Net cost of redemption  of company-obligated mandatorily redeemable preferred securities          |   | —           |       | —      |    | (1,118       | )      | —            |       | —                 |        | —     |   | —     |       | (1,118         | )          |
| Change in unrealized  gain on available-for-sale securities, net of income taxes of $13,098       |   | —           |       | —      |    | —       |   | —            |       | 19,979                 |        | —     |   | —     |       | 19,979         |       |
| **Balance  at December 31, 2002**                                                                 |   | **51,021,896**   | ** ** | **$**       | **510** | ** **   | **$**  | **193,887**       | ** ** | **$**                  | **393,550** | ** ** | **$**  | **23,826** | ** ** | **12,343,096** | ** ** | **$** | **(233,324** | **)** | **$** | **378,449** | ** ** |
| Net income                                                                                        |   | —           |       | —      |    | —       |   | 75,021            |       | —                 |        | —     |   | —     |       | 75,021         |       |
| Common stock dividends  ($0.90 per share)                                                         |   | —           |       | —      |    | —       |   | (34,250           | )          | —                 |        | —     |   | —     |       | (34,250        | )          |
| Purchases of common  stock for treasury, at cost                                                  |   | —           |       | —      |    | —       |   | —            |       | —                 |        | 1,746,923  |   | (47,051    | )          | (47,051        | )          |
| Exercise of options, net  of stock tendered in payment                                            |   | —           |       | —      |    | 2,031        |   | (1,747            | )          | —                 |        | (425,537   | )      | 7,127      |       | 7,411          |       |
| Net cost of redemption  of company-obligated mandatorily redeemable preferred securities          |   | —           |       | —      |    | (1,007       | )      | —            |       | —                 |        | —     |   | —     |       | (1,007         | )          |
| Change in unrealized  gain on available-for-sale securities, net of income tax credits of $10,996 |   | —           |       | —      |    | —       |   | —            |       | (16,773                | )           | —     |   | —     |       | $              | (16,773    | ) |
| **Balance  at December 31, 2003**                                                                 |   | **51,021,896**   | ** ** | **$**       | **510** | ** **   | **$**  | **194,911**       | ** ** | **$**                  | **432,574** | ** ** | **$**  | **7,053**  | ** ** | **13,664,482** | ** ** | **$** | **(273,248** | **)** | **$** | **361,800** | ** ** |

 

*See accompanying notes.*

 

17

----

 
| **** |   | **CONSOLIDATED STATEMENTS OF CASH FLOWS** |   | COMMUNITY  FIRST BANKSHARES, INC. |
|------|--------|-------------------------------------------|--------|-----------------------------------|

 
| **Years ended December 31 (In  thousands)**                                        |   | **2003**       |        | **2002**   |   | **2001** |   |
|------------------------------------------------------------------------------------|--------|----------------|-------------|------------|--------|----------|--------|
| **CASH FLOWS FROM OPERATING ACTIVITIES**                                           |   |           | ** **  |       |   |     |   |
| Net  income                                                                        |   | **$**          | **75,021**  | ** ** | $      | 79,208   |   | $ | 65,059 |   |
| Adjustments  to reconcile net income to net cash provided by operating activities: |   |           | ** **  |       |   |     |   |
| Provision  for loan losses                                                         |   | **12,602**     | ** **  | 13,262     |   | 17,520   |   |
| Depreciation                                                                       |   | **17,397**     | ** **  | 14,841     |   | 13,553   |   |
| Amortization  of intangibles                                                       |   | **3,374**      | ** **  | 3,318      |   | 9,928    |   |
| Net  amortization (accretion) of premiums and discounts on securities              |   | **8,806**      | ** **  | 1,740      |   | (582     | )      |
| Net  (gain) on sale of available-for-sale securities                               |   | **(4,334**     | **)**       | (373       | )      | (804     | )      |
| Deferred  income tax benefit (expense)                                             |   | **3,289**      | ** **  | 5,237      |   | (2,223   | )      |
| Tax  benefit from employee exercise of non-qualified stock options                 |   | **1,197**      | ** **  | 1,092      |   | 467      |   |
| Decrease  in interest receivable                                                   |   | **6,167**      | ** **  | 4,628      |   | 13,003   |   |
| Decrease  in interest payable                                                      |   | **(7,193**     | **)**       | (11,076    | )      | (15,494  | )      |
| Other,  net                                                                        |   | **(28,880**    | **)**       | 21,979     |   | 11,879   |   |
| Net  cash provided by operating activities                                         |   | **87,446**     | ** **  | 133,856    |   | 112,306  |   |
|                                                                               |   |           | ** **  |       |   |     |   |
| **CASH FLOWS FROM INVESTING ACTIVITIES**                                           |   |           | ** **  |       |   |     |   |
| Net  decrease (increase) in interest-bearing deposits                              |   | **1,294**      | ** **  | (4,272     | )      | 769      |   |
| Purchases  of available-for-sale securities                                        |   | **(1,314,637** | **)**       | (1,487,117 | )      | (724,534 | )      |
| Maturities  of available-for-sale securities                                       |   | **1,125,647**  | ** **  | 1,210,824  |   | 985,009  |   |
| Proceeds  from sales of available-for-sale securities                              |   | **265,775**    | ** **  | 72,624     |   | 40,436   |   |
| Net  decrease (increase) in loans                                                  |   | **237,794**    | ** **  | 146,702    |   | (13,187  | )      |
| Net  increase in bank premises and equipment                                       |   | **(16,283**    | **)**       | (21,016    | )      | (17,825  | )      |
| Net  cash provided by (used in) investing activities                               |   | **299,590**    | ** **  | (82,255    | )      | 270,668  |   |
|                                                                               |   |           | ** **  |       |   |     |   |
| **CASH FLOWS FROM FINANCING ACTIVITIES**                                           |   |           | ** **  |       |   |     |   |
| Net  increase in demand deposits, NOW accounts and savings accounts                |   | **103,861**    | ** **  | 40,724     |   | 4,679    |   |
| Net  decrease in time accounts                                                     |   | **(384,397**   | **)**       | (121,791   | )      | (273,757 | )      |
| Net  (decrease) increase in short-term and other borrowings                        |   | **(11,224**    | **)**       | 110,851    |   | (67,071  | )      |
| Proceeds  from issuance of long term debt                                          |   | **63,856**     | ** **  | 81,856     |   | 25,000   |   |
| Repayment  of long term debt                                                       |   | **(92,856**    | **)**       | (91,197    | )      | (12,116  | )      |
| Net  purchase of common stock held in treasury                                     |   | **(47,051**    | **)**       | (50,979    | )      | (43,020  | )      |
| Net  sale of common stock held in treasury                                         |   | **6,214**      | ** **  | 5,226      |   | 3,228    |   |
| Cash  dividends                                                                    |   | **(34,250**    | **)**       | (31,664    | )      | (27,793  | )      |
| Net  cash used in financing activities                                             |   | **(395,847**   | **)**       | (56,974    | )      | (390,850 | )      |
| Net  decrease in cash and cash equivalents                                         |   | **(8,811**     | **)**       | (5,373     | )      | (7,876   | )      |
| Cash  and cash equivalents at beginning of year                                    |   | **242,887**    | ** **  | 248,260    |   | 256,136  |   |
| Cash  and cash equivalents at end of year                                          |   | **$**          | **234,076** | ** ** | $      | 242,887  |   | $ | 248,260 |   |

 

*See accompanying notes.*

 

18

----

 

 
|  | **   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS** | COMMUNITY FIRST BANKSHARES, INC. |
|--|--------------------------------------------------------|----------------------------------|

 

**1.SIGNIFICANT ACCOUNTING POLICIES**

 

CommunityFirst Bankshares, Inc. (the “Company”) is a bank holding company which, at theend of 2003, served 136 communities in Arizona, California, Colorado, Iowa,Minnesota, Nebraska, New Mexico, North Dakota, South Dakota, Utah, Wisconsinand Wyoming. The Company’s community banks provide a full range of financialservices through its 92 Regional Financial Centers and branches, and 44Community Financial Centers, primarily in small and medium-sized communitiesand the surrounding areas. In addition to its primary emphasis on commercialand consumer banking services, the Company offers trust, mortgage, insuranceand nondeposit investment products and services.

 

**BASIS OFPRESENTATION**

 

Theconsolidated financial statements include the accounts of Community FirstBankshares, Inc., its wholly-owned data processing, credit origination andinsurance agency subsidiaries and its wholly-owned subsidiary bank. Allsignificant intercompany accounts and transactions have been eliminated inconsolidation.  Certain amounts in priorperiods have been reclassified to conform to the current presentation.

 

**SEGMENTDISCLOSURES**

 

Operating segments arecomponents of a business about which separate financial information isavailable and that are evaluated regularly by the chief operating decision makerin deciding how to allocate resources and assessing performance. Publiccompanies are required to report certain financial information about operatingsegments in interim and annual financial statements. The Company’s chiefoperating decision maker evaluates the operations of the Company as oneoperating segment, commercial banking, due to the materiality of the commercialbanking operation to the Company’s financial condition and results ofoperations, taken as a whole, and as a result, separate segment disclosures arenot required. The Company offers the following products and services toexternal customers: deposits, loans, insurance, securities and trust services.Revenues for each of these products and services are disclosed separately inthe Consolidated Statements of Income. 

 

**USE OFESTIMATES**

 

Thepreparation of financial statements in conformity with accounting principlesgenerally accepted in the United States requires management to make estimatesand assumptions that affect the reported amounts of assets and liabilities anddisclosure of contingent assets and liabilities at the date of the financialstatements and the reported amounts of revenues and expenses during thereporting period. Actual results could differ from those estimates.

 

**HELD-TO-MATURITYAND AVAILABLE-FOR-SALE SECURITIES**

 

Management determines theclassification of debt securities at the time of purchase and re-evaluates suchdesignation as of each balance sheet date. Debt securities are classified asheld-to-maturity when the Company has the positive intent and ability to holdthe securities to maturity. Held-to-maturity securities are stated at amortizedcost.

 

Debt securities notclassified as held-to-maturity and equity securities are classified asavailable-for-sale. Available-for-sale securities are stated at fair value,with the unrealized gains and losses, net of tax, reported within othercomprehensive income in shareholders’ equity.

 

The amortizedcost of debt securities classified as held-to-maturity or available-for-sale isadjusted for amortization of premiums and accretion of discounts to maturityor, in the case of mortgage-backed securities, over the estimated life of thesecurity. Such amortization and accretion is included as an adjustment tointerest income from investment securities. Realized gains and losses anddeclines in value judged to be other than temporary are included in netsecurities gains (losses). The cost of securities sold is based on the specificidentification method.

 

**LOANS**

 

Loans are stated at theirprincipal balance outstanding, less the allowance for loan losses. Interest onloans is recognized on an accrual basis. Loans are placed on nonaccrual whenthey become past due over 90 days, unless well secured and in the process ofcollection, or earlier, if the collection of interest or principal isconsidered unlikely. Thereafter, no interest income is recognized unlessreceived in cash and until such time as the borrower demonstrates the abilityto pay interest and principal. Consumer loans are generally charged off whenthey become 90 days contractually past due. All other loans are charged offwhen considered uncollectible based on both quantitative and qualitativefactors determined on an individual loan basis.

 

Loans held forsale are carried at the lower of aggregate cost or fair value.

 

**LOAN FEEINCOME**

 

The Companyrecognizes loan fees and certain direct origination costs, utilizing a methodthat approximates a constant rate of return over the estimated life of theloan.

 

**OTHER REALESTATE OWNED**

 

Other realestate owned includes properties acquired in partial or total satisfaction ofcertain loans and is included in other assets. Properties are recorded at thelower of the recorded investment in the loans for which the propertiespreviously served as collateral or the fair value, which represents theestimated sales price of the properties on the date acquired less estimatedselling costs. Any write-downs in the carrying value of a property at the timeof acquisition are charged against the allowance for loan losses. Managementperiodically reviews the carrying value of foreclosed real estate properties.Any write-downs of the properties subsequent to acquisition, as well as gainsor losses on disposition and income or expense from the operations of otherreal estate owned, are recognized in operating results in the period they arerealized. At December 31, 2003 and 2002, other real estate owned totaled $5.5million and $6.0 million, respectively.

 

**ALLOWANCEFOR LOAN LOSSES**

 

The allowancefor loan losses in maintained at the level believed adequate by management toabsorb probable losses that are inherent in the loan portfolio. The allowancefor loan losses is maintained through charges to expense at an amount that willprovide for estimated loan losses. The current level of the allowance for loanlosses is a result of management’s assessment of the risks within the portfoliobased on the information revealed in credit evaluation processes. Thisassessment of risk takes into account the composition of the loan portfolio,previous loan experience, current economic conditions and other factors that,in management’s judgment, deserve recognition. An allowance is recorded forindividual loan categories based on the relative risk characteristics of theloan portfolios. Commercial, commercial real estate, construction andagricultural amounts are based on a quarterly review of the individual loansoutstanding, including outstanding commitments to lend. Residential real estateand consumer amounts are based on a quarterly analysis of the performance ofthe respective portfolios, including historical and expected delinquency andcharge-off statistics.

 

Ultimatelosses may vary from current estimates, and as adjustments become necessary,the allowance for loan losses is adjusted in the periods in which such lossesbecome known or fail to occur. Actual loan charge-offs and subsequentrecoveries are deducted from and added to the allowance, respectively.

 

**BANKPREMISES AND EQUIPMENT**

 

Bank premises and equipment are stated at cost less accumulateddepreciation. Depreciation for financial reporting purposes is provided on thestraight-line method over the estimated lives of the assets and includesamortization of assets recorded under capital leases. Estimated lives rangefrom three to twenty and fifteen to thirty-nine years for equipment andpremises, respectively. Accelerated 

 

19

----

 

depreciationmethods are used for income tax reporting purposes.

 

**BANK OWNEDLIFE INSURANCE**

 

Bank ownedlife insurance (“BOLI”) is recorded as an asset at the amount that would berealized under the insurance contract as of the date of the ConsolidatedStatement of Financial Condition. The change in cash surrender value during theperiod is an adjustment of premiums paid in determining the expense or incometo be recognized under the contract for the period. This change, as well asperiodic redemption of individual contracts, is recorded as BOLI income innoninterest income on the Consolidated Statement of Income.

 

**INTANGIBLEASSETS**

 

Goodwill, theexcess cost over the fair value of net assets acquired, was amortized over aperiod of fifteen years, until December 31, 2001. As described in Note 3,Accounting Changes, goodwill is no longer amortized, but is reviewed forimpairment. At December 31, 2003, goodwill totaled $63,448,000, net ofaccumulated amortization of $36,292,000. Other intangible assets, principallydeposit based intangibles, unexpired premium lists and noncompetitionagreements, totaled $30,402,000, net of accumulated amortization of$20,461,000, and are amortized over their estimated useful lives ranging fromthree to fifteen years. The Company assesses the recoverability of goodwill andother intangibles on an annual basis, or more frequently if certain impairmentindicators arise, to determine whether any impairment exists. This ongoingassessment includes understanding and evaluating qualitative factors that wouldindicate the potential for impairment. If the Company believes a potentialimpairment exists, the Company estimates the relative market value of thecorresponding business activity to determine whether a permanent impairmentexists.

 

**ADVERTISINGCOSTS**

 

Alladvertising costs incurred by the Company are expensed in the period in whichthey are incurred.

 

**INCOME TAXES**

 

The Companyprovides for income taxes based on income reported for financial statementpurposes, rather than amounts currently payable under statutory tax laws.Deferred taxes are recorded to reflect the tax consequences on future years’differences between the tax bases of assets and liabilities and the financialreporting amounts at each year-end. Valuation allowances are established, whennecessary, to reduce deferred tax assets to the amount expected to be realized.

 

**COMPREHENSIVEINCOME**

 

Comprehensiveincome is the total of reported net income and all other revenues, expenses,gains and losses that under accounting principles generally accepted in theUnited States are not included in the determination of reported net income. TheCompany includes changes in unrealized gains or losses, net of tax, onavailable for sale securities in other comprehensive income and is presented inthe Consolidated Statements of Comprehensive Income.

 

**EARNINGS PERSHARE**

 

Basic earningsper common share is calculated by dividing net income applicable to commonequity by the weighted-average number of shares of common stock outstanding forthe period.

 

Dilutedearnings per common share is calculated by adjusting the weighted-averagenumber of shares of common stock outstanding for shares that would be issuedassuming the exercise of stock options during each period. Such adjustments tothe weighted-average number of shares of common stock outstanding are made onlywhen such adjustments dilute earnings per share, and are computed based on thetreasury stock method using the average market price for the period.

 

**CASH ANDCASH EQUIVALENTS**

 

Cash and cashequivalents is defined as cash and due from banks, federal funds sold andsecurities purchased under agreements to resell.

 

**STOCK-BASEDCOMPENSATION**

 

At December31, 2003, the Company had one stock-based employee compensation plan, which isdescribed more fully in Note 15, Employee Benefit Plans. The Company accountsfor this plan under the recognition and measurement principles of APB OpinionNo. 25, Accounting for Stock Issued to Employees, and Related Interpretations.No stock-based employee compensation cost is reflected in net income, as alloptions granted under this plan have an exercise price equal to the marketvalue of the underlying common stock on the date of grant. The following tableillustrates the effect on net income and earnings per share if the Company hadapplied the fair value recognition provisions of FASB Statement No. 123,Accounting for Stock-Based Compensation, to stock-based employee compensation:

 
|                                                                                                                                         |   | **Year Ended December 31** |       |
|----------------------------------------------------------------------------------------------------------------------------------------------|--------|----------------------------|------------|
| **(Dollars in thousands, except per share data)**                                                                                            |   | **2003**                   |       | **2002** |   | **2001** |   |
| Net  income, as reported                                                                                                                     |   | **$**                      | **75,021** |   | $ | 79,208 |   | $ | 65,059 |   |
| Deduct:  Total stock-based employee compensation expense determined under fair value  based method for all awards, net of related tax effect |   | **(2,714**                 | )          | (2,836 | ) | (2,289 | ) |
| Pro  forma net income                                                                                                                        |   | **$**                      | **72,307** |   | $ | 76,372 |   | $ | 62,770 |   |
| Earnings  per share:                                                                                                                         |   |                       |       |   |   |   |   |
| Basic  – as reported                                                                                                                    |   | **$**                      | **1.97**   |   | $ | 2.00 |   | $ | 1.59 |   |
| Basic  – pro forma                                                                                                                      |   | **$**                      | **1.90**   |   | $ | 1.93 |   | $ | 1.53 |   |
| Diluted  – as reported                                                                                                                  |   | **$**                      | **1.95**   |   | $ | 1.97 |   | $ | 1.57 |   |
| Diluted  – pro forma                                                                                                                    |   | **$**                      | **1.88**   |   | $ | 1.90 |   | $ | 1.51 |   |

 

The fair value of the optionswas estimated at the grant date using a Black-Scholes option pricing model.Option valuation models require the input of highly subjective assumptions.Because the Company’s employee stock options have characteristics significantlydifferent from traded options, and because changes in the subjective inputassumptions can materially affect the fair value estimate, in management’sopinion, the existing models do not necessarily provide a reliable singlemeasure of the fair value of its employee stock options.

 

The followingweighted-average assumptions were used in the valuation model for the yearsended December 31:

 
|                     |   | **2003** |       | **2002** |   | **2001** |   |
|--------------------------|--------|----------|------------|----------|--------|----------|--------|
| Risk  free interest rate |   | **3.57** | **%**      | 3.61     | %      | 4.88     | %      |
| Dividend  yield          |   | **3.43** | **%**      | 3.17     | %      | 2.65     | %      |
| Price  volatility        |   | **.256** | ** ** | .265     |   | .329     |   |
| Expected  life (years)   |   | **7.1**  | ** ** | 7.5      |   | 7.5      |   |

 

**2. BUSINESSCOMBINATIONS**

 

Through itsinsurance subsidiary, the Company completed the purchase of five insuranceagencies during 2003. These included the November 4, 2003 purchase of ColoradoBenefits Services, a limited services agency in Englewood, Colorado; theOctober 1, 2003 purchase of Summit Insurance Group, an insurance agency inFrisco, Colorado, with offices in Frisco, Vail and Leadville, Colorado; theJune 2, 2003 purchase of the Larry Levitt Insurance Agency, in Rock Springs,Wyoming; the May 1, 2003 purchase of Kraft Insurance Services, Inc., aninsurance agency in Grand Junction, Colorado and the April 1, 2003 purchase ofCarr Agency, an insurance agency in Thornton, Colorado;. At the time of thetransactions, the five agencies combined, had approximately $1.3 million inannual commission revenue. The Company recorded $1.7 million of intangibleassets, including $526,000 of unamortizing goodwill, related to theseacquisitions.

 

20

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**3.ACCOUNTING CHANGES**

 

Statement of FinancialAccounting Standards (“SFAS”) Nos. 141 and 142 – Business Combinations andGoodwill and Other Intangible Assets – In June 2001, the Financial AccountingStandards Board (“FASB”) issued SFAS Nos. 141 and 142. Statement 141 requiresthat the purchase method of accounting be used for all business combinationsinitiated after June 30, 2001. Statement 142 prohibits the amortization ofgoodwill and intangible assets with indefinite useful lives. Statement 142requires that these assets be reviewed for impairment at least annually.Intangible assets with finite lives will continue to be amortized over theirestimated useful lives.

 

Effective January 1, 2002,the Company adopted Statement 142. During the first quarter of 2002, theCompany performed the first of the required impairment tests of goodwill as ofJanuary 1, 2002. The Company tested for impairment using the two-step processdescribed in Statement 142. The first step was a review for potentialimpairment, while the second step measures the amount of the impairment, ifany. The Company found no impairment of goodwill; therefore, the Company didnot record any transitional impairment as a cumulative effect of a change inaccounting principle.

 

The followingtable sets forth the computation of net income and basic and diluted earningsper share as though goodwill amortization had not been recorded as an expenseduring 2002 and 2001.

 
|                                                     |   | **For the Years Ended** |       |
|----------------------------------------------------------|--------|-------------------------|------------|
| **(Dollars in thousands, except per share data)**        |   | **2003**                |       | **2002** |   | **2001** |   |
| Reported  net income                                     |   | **$**                   | **75,021** |   | $ | 79,208 |   | $ | 65,059 |   |
| Effect  of SFAS 142                                      |   |                    |       |   |   |   |   |
| After-tax  goodwill amortization  included in net income |   | **—**              |       | — |   | 4,984 |   |
| Adjusted  net income                                     |   | **$**                   | **75,021** |   | $ | 79,208 |   | $ | 70,043 |   |
| Adjusted  basic earnings per share                       |   | **$**                   | **1.97**   |   | $ | 2.00 |   | $ | 1.71 |   |
| Adjusted  diluted earnings per share                     |   | **$**                   | **1.95**   |   | $ | 1.97 |   | $ | 1.69 |   |

 

The aggregateamortization expense of intangible assets other than goodwill for the yearsended December 31, 2003 and 2002 was $3,374,000 and $3,318,000, respectively.The following table sets forth estimated amortization expense for intangibleassets other than goodwill for each of the five years subsequent to December31, 2003 (in thousands):

 

| 2004 |   | $     | 3,424  |   |
|------|--------|-------|--------|--------|
| 2005 |   | 3,379 |   |
| 2006 |   | 3,282 |   |
| 2007 |   | 3,233 |   |
| 2008 |   | 3,213 |   |

 

All of theCompany’s intangible assets other than goodwill are subject to amortization.The following table sets forth the gross carrying amount and accumulatedamortization, in total and by major class of intangible assets, as of December31, 2003 (dollars in thousands):

 
|                          |   | **Gross Carrying  Amount** |   | **Accumulated  Amortization** |   |
|-------------------------------|--------|----------------------------|--------|-------------------------------|--------|
| Amortized  intangible assets: |   |                       |   |                          |   |
| Deposit-based  intangibles    |   | $                          | 39,620 |                          | $      | 16,798 |   |
| Insurance  list premiums      |   | 10,323                     |   | 3,045                         |   |
| Non-compete  agreements       |   | 920                        |   | 618                           |   |
| Total                         |   | $                          | 50,863 |                          | $      | 20,461 |   |

 

In November2002, the FASB issued Interpretation No. 45, (“FIN 45”) Guarantor’s Accountingand Disclosure for Guarantees, Including Indirect Guarantees of Indebtedness ofOthers. FIN 45 requires certain guarantees to be recorded at fair value andapplies to contracts or indemnification agreements that contingently requirethe guarantor to make payments to the guaranteed party based on changes in anunderlying condition that is related to an asset, liability or equity securityof the guaranteed party. Examples of contracts meeting these characteristicsinclude standby and performance letters of credit. The recognition requirementsof FIN 45 were applied prospectively to guarantees issued or modifiedsubsequent to December 31, 2002. FIN 45 also expands the disclosures to be madeby guarantors, effective as of December 31, 2002, to include the nature of theguarantee, the maximum potential amount of future payments that the guarantorcould be required to make under the guarantee, and the current amount of theliability, if any, for the guarantor’s obligation under the guarantee.Significant guarantees that have been entered into by the Company are disclosedin Note 9, Financial Instruments with Off-Balance-Sheet Risk. The adoption ofFIN 45 did not have a material impact on the Company’s results of operations,financial position or liquidity. 

 

In January2003, the FASB issued FIN 46, Consolidation of Variable Interest Entities. FIN46 clarifies the application of Accounting Research Bulletin No. 51,Consolidated Financial Statement, to certain entities in which equity investorsdo not have the characteristics of a controlling financial interest or do nothave sufficient equity at risk for the entity to finance its activities withoutadditional subordinated financial support from other parties. The recognitionand measurement provisions of this Interpretation are effective for newlycreated variable interest entities formed after January 31, 2003, and forexisting variable interest entities, until the end of the first interim orannual reporting period beginning after December 15, 2003. Previously, the FASBhad announced the effective date for existing variable interest entities asbeing on the first interim or annual reporting period beginning after June 15,2003, but delayed the effective date to provide further guidance. The Companyadopted the disclosure provisions of FIN 46 effective December 31, 2002. TheCompany adopted the accounting provisions of FIN 46 for existing variableinterest entities on October 1, 2003 and elected to apply the provisions byrestating prior periods financial statements. Upon adoption of FIN 46, theCompany de-consolidated its subsidiary trusts, which issued Company-obligatedmandatorily redeemable preferred securities (“Trust Preferred Securities”).Prior to the adoption of FIN 46, the Company consolidated the trusts and thebalance sheet included the Trust Preferred Securities of the trusts in themezzanine section of the Statement of Financial Condition. Upon adoption of theaccounting provisions of FIN 46, the trusts were de-consolidated and the juniorsubordinated debentures of the Company owned by the trusts are reflected in theStatements of Financial Condition as long term debt. The Trust PreferredSecurities currently qualify as Tier 1 capital of the Company for regulatorycapital purposes. The banking regulatory agencies have not issued any guidancethat would change the capital treatment for Trust Preferred Securities based onthe impact of the adoption of FIN 46. As provided by FIN 46, the Companyrestated its financial statements to reflect the adoption for all periodspresented. 

 

                        In December 2002, the FASBissued Statement No. 148 (“SFAS 148”), Accounting for Stock-BasedCompensation-Transition and Disclosure, an amendment to FASB Statement No. 123(“SFAS 123”), Accounting for Stock-Based Compensation. In addition, SFAS 148amends the disclosure requirements of SFAS 123, to require prominentdisclosures in both annual and interim financial statements about the method ofaccounting for stock-based employee compensation and the effect of the methodused on reported results. The Company adopted the disclosure provisions of SFAS148 effective December 31, 2002. 

 

In May 2003, the FASB issuedStatement No. 150 (“SFAS 150”), Accounting for Certain Financial Instrumentswith Characteristics of both Liabilities and Equity, which establishesstandards for how an issuer classifies and measures certain financialinstruments with characteristics of both liabilities and equities. SFAS 150 waseffective immediately for financial instruments entered into or modified afterMay 31, 2003, and otherwise was effective at the beginning of the first interimperiod beginning after June 15, 2003. However, in

 

21

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November 2003, the FASBannounced that the provisions as they relate to certain mandatorily redeemablesecurities (including the Company’s Trust Preferred Securities), were delayedindefinitely. The banking regulatory agencies have not issued any guidance thatwould change the capital treatment of the Trust Preferred Securities based onthe impact, if any, of the adoption of SFAS 150. As a result of the Company’sadoption of FIN 46 and the resulting reporting of the junior subordinateddebentures as long term debt, the adoption of SFAS 150 is not expected toimpact the Company.

 

**4.RESTRUCTURING CHARGE**

 

During thefirst quarter of 2001, the Company recorded a $5.1 million after-tax,non-recurring charge as a result of a series of strategic initiatives designedto reduce costs, improve customer service and strengthen the Company’s positionas a provider of diversified financial services. As part of this strategy, theCompany designated each of its offices as either a Regional Financial Center ora Community Financial Center. Regional Financial Centers are those locationsexhibiting strong commercial banking potential, while Community FinancialCenters offer greater retail opportunities. As a consequence of the newdelivery structure, the Company sold 13 offices and closed eight additionaloffices. A further consequence was to achieve a reduction in work force throughimplementation of an early-out program, which was accepted by 21 eligiblemanagement personnel. The restructuring charge included approximately $3.1million related to asset write-down, data processing, and legal and accountingfees. Additionally, the Company recorded an after-tax expense of approximately$2.0 million to provide for severance-related costs associated with theearly-out and reduction-in-force programs.

 

**5.SECURITIES**

 

The following is a summary of available-for-sale securities at December31, 2003 (in thousands):

 
|                                 |   | **AVAILABLE-FOR-SALE SECURITIES** |      |
|--------------------------------------|--------|-----------------------------------|-----------|
|                                 |   | **Amortized  Cost**               |      | **Gross  Unrealized  Gains** |   | **Gross  Unrealized  Losses** |   | **Estimated  Fair  Value** |   |
| United  States Treasury              |   | $                                 | 41,764    |   | $ | 322 |   | $ | 38 |   | $ | 42,048 |   |
| United  States Government agencies   |   | 321,018                           |      | 1,554 |   | 3,805 |   | 318,767 |   |
| Mortgage-backed  securities          |   | 1,054,655                         |      | 12,518 |   | 4,233 |   | 1,062,940 |   |
| Collateralized  mortgage obligations |   | 1,860                             |      | 12 |   | 8 |   | 1,864 |   |
| State  and political securities      |   | 58,877                            |      | 2,707 |   | — |   | 61,584 |   |
| Other  securities                    |   | 73,568                            |      | 3,001 |   | 353 |   | 76,216 |   |
| Total                                |   | $                                 | 1,551,742 |   | $ | 20,114 |   | $ | 8,437 |   | $ | 1,563,419 |   |

 

The following is a summary ofavailable-for-sale securities at December 31, 2002 (in thousands):

 
|                                 |   | **AVAILABLE-FOR-SALE SECURITIES** |
|--------------------------------------|--------|-----------------------------------|
|                                 |   | **Amortized  Cost**               |   | **Gross  Unrealized  Gains** | ** ** | **Gross  Unrealized  Losses** | ** ** | **Estimated  Fair  Value** | ** ** |
| United  States Treasury              |   | $                                 | 52,474 |   | $ | 994 |   | $ | — |   | $ | 53,468 |   |
| United  States Government agencies   |   | 286,706                           |   | 6,521 |   | — |   | 293,227 |   |
| Mortgage-backed  securities          |   | 1,007,049                         |   | 31,071 |   | 76 |   | 1,038,044 |   |
| Collateralized  mortgage obligations |   | 3,476                             |   | 36 |   | — |   | 3,512 |   |
| State  and political securities      |   | 68,665                            |   | 2,463 |   | 33 |   | 71,095 |   |
| Other  securities                    |   | 214,629                           |   | 684 |   | 2,214 |   | 213,099 |   |
| Total                                |   | $                                 | 1,632,999 |   | $ | 41,769 |   | $ | 2,323 |   | $ | 1,672,445 |   |

 

The Company had noheld-to-maturity securities at December 31, 2003 and 2002.

 

Proceeds from the sale ofavailable-for-sale securities during the years ended December 31, 2003, 2002and 2001, were $265,775,000, $72,624,000, and $40,436,000, respectively. Grossgains of $4,431,000, $2,606,000, and $1,088,000 and gross losses of $97,000,$2,233,000, and $284,000 were realized on those sales during 2003, 2002 and2001, respectively. The tax effect on the net gains during 2003, 2002 and 2001was approximately $1,517,000, $131,000, and $281,000, respectively. There wereno sales or transfers of held-to-maturity securities during 2003, 2002 or 2001.

 

The amortizedcost and estimated fair value of debt securities at December 31, 2003, bycontractual maturity, are shown below. Expected maturities may differ fromcontractual maturities because borrowers may have the right to call or prepayobligations with or without call or prepayment penalties.

 
| **Available-for-Sale****(In thousands)** |   | **Amortized  Cost** |      | **Estimated  Fair Value** |   |
|------------------------------------------|--------|---------------------|-----------|---------------------------|--------|
| Due  in one year or less                 |   | $                   | 34,259    |                      | $      | 34,641 |   |
| Due  after one year through five years   |   | 220,001             |      | 221,118                   |   |
| Due  after five years through ten years  |   | 137,270             |      | 135,268                   |   |
| Due  after ten years                     |   | 103,697             |      | 107,588                   |   |
|                                     |   | 495,227             |      | 498,615                   |   |
| Mortgage-backed  securities              |   | 1,054,655           |      | 1,062,940                 |   |
| Collateralized  mortgage obligations     |   | 1,860               |      | 1,864                     |   |
| Total                                    |   | $                   | 1,551,742 |                      | $      | 1,563,419 |   |

 

Available-for-salesecurities carried at $1,174,551,000 and $1,262,239,000 at December 31, 2003 and 2002, respectively, were pledgedto secure borrowings, public and trust deposits and for other purposes requiredby law. Securities sold under agreement to repurchase were collateralized byavailable-for-sale securities with an aggregate carrying value of $292,689,000and $260,730,000  at December 31, 2003and 2002, respectively.

 

Provided belowis a summary of available-for-sale securities which were in an unrealized lossposition at December 31, 2003. Approximately 3.7% of the unrealized loss wascomprised of securities in a continuous loss position for twelve months or morewhich consisted primarily of other corporate securities. The Company has theability and intent to hold these securities until such time as the valuerecovers or the securities mature. Further, the Company believes thedeterioration in value is attributable to changes in market interest rates andnot credit quality of the issuer.

 
|                                 |   | **At December 31, 2003** |    |
|--------------------------------------|--------|--------------------------|---------|
|                                 |   | **Less than 12 Months**  |    | **12 Months or More** |   | **Total** |   |
| **(In thousands)**                   |   | **Fair  Value**          |    | **Unrealized  Losses** |   | **Fair  Value** |   | **Unrealized  Losses** |   | **Fair  Value** |   | **Unrealized  Losses** |   |
| United  States Treasury              |   | $                        | 6,631   |   | $ | (38 | ) | $ | — |   | $ | — |   | $ | 6,631 |   | $ | (38 | ) |
| United  States Government agencies   |   | 141,487                  |    | (3,805 | ) | — |   | — |   | 141,487 |   | (3,805 | ) |
| Mortgage-backed  securities          |   | 437,826                  |    | (4,220 | ) | 986 |   | (13 | ) | 438,812 |   | (4,233 | ) |
| Collateralized  mortgage obligations |   | 567                      |    | (8 | ) | — |   | — |   | 567 |   | (8 | ) |
| State  and political securities      |   | —                   |    | — |   | — |   | — |   | — |   | — |   |
| Other  securities                    |   | 3,617                    |    | (53 | ) | 11,368 |   | (300 | ) | 14,985 |   | (353 | ) |
| Total                                |   | $                        | 590,128 |   | $ | (8,124 | ) | $ | 12,354 |   | $ | (313 | ) | $ | 602,482 |   | $ | (8,437 | ) |

 

22

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**6. LOANS**

 

The composition of the loanportfolio at December 31 was as follows (in thousands):

 
|                              |   | **2003**    |          | **2002**   |   |
|-----------------------------------|--------|-------------|---------------|------------|--------|
| Real  estate                      |   | **$**       | **1,562,443** | ** ** | $      | 1,568,710 |   |
| Real  estate construction         |   | **321,323** | ** **    | 439,536    |   |
| Commercial                        |   | **582,861** | ** **    | 723,530    |   |
| Consumer  and other               |   | **678,457** | ** **    | 625,429    |   |
| Agriculture                       |   | **178,488** | ** **    | 220,688    |   |
|                              |   | **$**       | **3,323,572** |       | $      | 3,577,893 |   |
| Less  : Allowance for loan losses |   | **(52,231** | **)**         | (56,156    | )      |
| Net  loans                        |   | **$**       | **3,271,341** | ** ** | $      | 3,521,737 |   |

 

Real estateloans totaling $533,770,000 and $261,627,000 at December 31, 2003 and 2002,respectively, were pledged to secure borrowings. Loans held for sale totaled $1,671,000and $2,669,000 at December 31, 2003 and 2002, respectively, and consisted ofreal estate loans at the Company’s affiliate bank. 

 

**7. ALLOWANCEFOR LOAN LOSSES**

 

Activity in the allowance wasas follows (in thousands):

 
|                                     |   | **2003**    |       | **2002**   |   | **2001** |   |
|------------------------------------------|--------|-------------|------------|------------|--------|----------|--------|
| Balance  at beginning of year            |   | **$**       | **56,156** | ** ** | $      | 54,991   |   | $ | 52,168 |   |
| Provision  charged to  operating expense |   | **12,602**  | ** ** | 13,262     |   | 17,520   |   |
| Loans  charged off                       |   | **(22,610** | **)**      | (20,049    | )      | (19,869  | )      |
| Recoveries  of loans charged off         |   | **6,083**   | ** ** | 7,952      |   | 5,172    |   |
| Balance  at end of year                  |   | **$**       | **52,231** | ** ** | $      | 56,156   |   | $ | 54,991 |   |

 

Other realestate owned totaled $5,461,000, $5,990,000, and  $2,869,000 at December 31, 2003, 2002, and 2001, respectively.

 

Nonaccrual loans totaled$20,630,000, $22,728,000, and $20,818,000 at December 31, 2003, 2002 and 2001, respectively. Interest income of$2,846,000, $3,615,000, and $2,722,000 on nonaccrual loans would have beenrecorded during 2003, 2002 and 2001, respectively, if the loans had beencurrent in accordance with their original terms.  The Company recorded interest income of $540,000, $679,000, and$1,113,000 related to loans that were on nonaccrual status as of December 31,2003, 2002 and 2001, respectively.

 

The Companyconsiders all non-accrual loans impaired under SFAS No. 114, Accounting byCreditors for the Impairment of Loans. A portion of the allowance for loanlosses is allocated to loans deemed impaired. A summary of these loans andtheir related allowance for loan losses is as follows:

 
|                                                          |   | **2003**                 |       | **2002**                 |   | **2001**                 |   |
|---------------------------------------------------------------|--------|--------------------------|------------|--------------------------|--------|--------------------------|--------|
| **(In thousands)**                                            |   | **Recorded  Investment** |       | **Valuation  Allowance** |   | **Recorded  Investment** |   | **Valuation  Allowance** |   | **Recorded  Investment** |   | **Valuation  Allowance** |   |
| Impaired  loans                                               |   | **$**                    | **28,285** | ** **               | **$**  | **7,095**                |   | $ | 35,468 |   | $ | 6,448 |   | $ | 32,056 |   | $ | 7,204 |   |
| Average  balance of impaired loans during the year            |   | **31,877**               | ** ** |                     |   | 33,762                   |   |   |   | 32,557 |   |   |   |
| Interest  income recognized on impaired loans during the year |   | **62**                   | ** ** |                     |   | 40                       |   |   |   | 140 |   |   |   |
|                                                               |        |                          |            |                          |        |                          |        |  |  |  |  |  |  |  |  |  |  |  |  |

 

**8. FAIRVALUE OF FINANCIAL INSTRUMENTS**

 

Due to thenature of its business and the financing needs of its customers, the Companyhas a financial interest in a large number of financial instruments, themajority for which an active market does not exist. Accordingly, the Companyhas used various valuation techniques to estimate the fair value of itsfinancial instruments. These techniques are significantly affected by theassumptions used, including the discount rate, the estimated timing and amountof cash flows and the aggregation methods used to value similar instruments. Inthis regard, the resulting fair value estimates cannot be substantiated by comparisonto independent markets and, in a majority of cases, could not be realized bythe immediate sale or settlement of the instrument. Also, the estimates reflecta point-in-time valuation that could change significantly based on changes inoutside economic factors, such as the general level of interest rates. Therequired disclosures exclude the estimated values of nonfinancial instrumentcash flows and are not intended to provide or estimate a market value of theCompany. The following assumptions were used by the Company in estimating thefair value of the specific financial instruments.

 

**CASH AND DUEFROM BANKS**

 

The carryingamounts reported in the Statements of Financial Condition approximate fairvalues for these items that have no interest rate or credit risk.

 

**INTEREST-BEARINGDEPOSITS**

 

The fair valueof interest-bearing deposits is estimated using a discounted cash flow analysisusing current market rates of interest-bearing deposits with similar maturitiesto discount the future cash flows. 

 

**AVAILABLE-FOR-SALESECURITIES**

 

Fair values ofsecurities are based on available market quotes. If market quotes are notavailable, fair values are based on market quotes of comparable securities.

 

**LOANS**

 

The loanportfolio consists of both variable and fixed rate loans. The fair value ofvariable rate loans, a majority of which reprice within the next three monthsand for which there has been no significant change in credit risk, are assumedto approximate their carrying amounts. The fair values for fixed rate loans areestimated using discounted cash flow analyses. The discount rates applied arebased on the current interest rates for loans with similar terms to borrowersof similar credit quality. The impact of credit risk on the present value ofthe loan portfolio was accomplished through use of the allowance for loanlosses, which is believed to represent the current fair value of all probablelosses for purposes of the fair value calculation.

 

**ACCRUEDINTEREST RECEIVABLE**

 

The fair valueof accrued interest receivable is estimated to be equal to the carrying value.Substantially all accrued interest receivable is scheduled and expected to bereceived within one year. 

 

**BANK OWNEDLIFE INSURANCE**

 

Bank ownedlife insurance is recorded at the amount that would be realized under theinsurance contract at the date of the financial statements, thus the recordedand fair value are equal. 

 

**DEPOSITLIABILITIES**

 

The fair valueof demand deposits, savings accounts and certain money market deposits isdefined by SFAS No. 107 to be equal to the amount payable on demand at the dateof the financial statements. Fair values for fixed rate certificates of depositare estimated using a discounted cash flow analysis that uses the interestrates currently being offered on certificates of deposit to discount theaggregated expected monthly maturities.

 

**SHORT-TERMBORROWINGS**

 

Federal fundspurchased, borrowings under repurchase agreements and other short-termborrowings are at variable rates or have short-term maturities, and their fairvalue is assumed to approximate their carrying value.

 

**LONG-TERMDEBT**

 

The fair value of long-termdebt is estimated using a discounted

 

23

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cash flowanalysis using current market rates of debt with similar maturities to discountthe future cash flows.

 

**ACCRUEDINTEREST PAYABLE**

 

The fair valueof accrued interest payable is estimated to be equal to the carrying value.Substantially all accrued interest payable is scheduled to be paid within oneyear.

 

**LOANCOMMITMENTS AND LETTERS OF CREDIT**

 

The majorityof the Company’s commitments have variable rates and do not expose the Companyto interest rate risk. The Company’s commitments for fixed rate loans areevaluated, and it is estimated the probability of additional loans being issuedunder these commitments is not significant and there is not a fair valueliability. 

 

The estimatedfair values of the Company’s financial instruments at December 31 are shown inthe table below (in thousands):

 
|                                               |   | **2003**             |        | **2002**        |   |
|----------------------------------------------------|--------|----------------------|-------------|-----------------|--------|
|                                               |   | **Carrying  Amount** |        | **Fair  Value** |   | **Carrying  Amount** |   | **Fair  Value** |   |
| Financial  assets:                                 |   |                 |        |            |   |   |   |   |   |
| Cash  and due from banks                           |   | **$**                | **234,076** | ** **      | **$**  | **234,076** |   | $ | 242,887 |   | $ | 242,887 |   |
| Interest-bearing  deposits                         |   | **3,319**            | ** **  | **3,319**       |   | 4,613 |   | 4,613 |   |
| Available-for-sale  securities                     |   | **1,563,419**        | ** **  | **1,563,419**   |   | 1,672,445 |   | 1,672,445 |   |
| Loans                                              |   | **3,323,572**        | ** **  | **3,378,282**   |   | 3,577,893 |   | 3,629,191 |   |
| Allowance  for loan losses                         |   | **(52,231**          | **)**       | **(52,231**     | **)**  | (56,156 | ) | (56,156 | ) |
| Net  loans                                         |   | **3,271,341**        | ** **  | **3,326,051**   |   | 3,521,737 |   | 3,573,035 |   |
| Accrued  interest receivable                       |   | **28,696**           | ** **  | **28,696**      |   | 34,863 |   | 34,863 |   |
| Bank  owned life insurance                         |   | **82,591**           | ** **  | **82,591**      |   | 80,165 |   | 80,165 |   |
| Financial  liabilities:                            |   |                 |        |            |   |   |   |   |   |
| Deposits:                                          |   |                 |        |            |   |   |   |   |   |
| Noninterest-bearing                                |   | **$**                | **447,648** | ** **      | **$**  | **447,648** |   | $ | 470,900 |   | $ | 470,900 |   |
| Interest-bearing:                                  |   |                 | ** **  |            |   |   |   |   |   |
| Savings  and NOW                                   |   | **2,552,056**        | ** **  | **2,552,056**   |   | 2,424,943 |   | 2,424,943 |   |
| Time  accounts over $100,000                       |   | **501,440**          | ** **  | **507,467**     |   | 670,187 |   | 680,086 |   |
| Other  time accounts                               |   | **888,066**          | ** **  | **897,273**     |   | 1,103,716 |   | 1,121,184 |   |
| Total  deposits                                    |   | **4,389,210**        | ** **  | **4,404,444**   |   | 4,669,746 |   | 4,697,113 |   |
| Federal  funds purchased and repurchase agreements |   | **416,689**          | ** **  | **416,689**     |   | 377,230 |   | 377,230 |   |
| Other  short-term borrowings                       |   | **25,577**           | ** **  | **25,577**      |   | 76,260 |   | 76,260 |   |
| Long-term  debt                                    |   | **222,211**          | ** **  | **228,995**     |   | 251,211 |   | 257,373 |   |
| Accrued  interest payable                          |   | **13,081**           | ** **  | **13,081**      |   | 20,274 |   | 20,274 |   |

 

**9. FINANCIALINSTRUMENTS WITH OFF-BALANCE-SHEET RISK AND CONCENTRATIONS OF CREDIT RISK**

 

In the normalcourse of business, the Company is party to financial instruments withoff-balance-sheet risk. These transactions enable customers to meet theirfinancing needs and enable the Company to manage its interest rate risk. Thesefinancial instruments include commitments to extend credit and letters ofcredit. The contract or notional amounts of these financial instruments atDecember 31, 2003 and 2002 were as follows (in thousands):

 
|                          |   | **2003**        |        | **2002**           |       |
|-------------------------------|--------|-----------------|-------------|--------------------|------------|
|                          |   | **Fixed  Rate** |        | **Variable  Rate** |       | **Total** |   | **Fixed  Rate** |   | **Variable  Rate** |   | **Total** |   |
| Commitments  to extend credit |   | **$**           | **325,924** | ** **         | **$**      | **339,227** | ** ** | **$** | **665,151** |   | $ | 168,275 |   | $ | 491,334 |   | $ | 659,609 |   |
| Standby  letters of credit    |   | **21,474**      | ** **  | **—**         | ** ** | **21,474** |   | 19,716 |   | — |   | 19,716 |   |
| Commercial  letters of credit |   | **7,221**       | ** **  | **34**             | ** ** | **7,255** |   | 4,405 |   | 6,257 |   | 10,662 |   |
| Total                         |   | **$**           | **354,619** | ** **         | **$**      | **339,261** | ** ** | **$** | **693,880** |   | $ | 192,396 |   | $ | 497,591 |   | $ | 689,987 |   |

 

Commitments toextend credit are legally binding and have fixed expiration dates or othertermination clauses. The Company’s exposure to credit loss on commitments toextend credit, in the event of nonperformance by the counterparty, isrepresented by the contractual amounts of the commitments. The Company monitorsits credit risk for commitments to extend credit by applying the same creditpolicies in making commitments as it does for loans and by obtaining collateralto secure commitments based on management’s credit assessment of thecounterparty. Collateral held by the Company may include marketable securities,receivables, inventory, agricultural commodities, equipment and real estate.Because many of the commitments are expected to expire without being drawnupon, total commitment amounts do not necessarily represent the Company’sfuture liquidity requirements. In addition, the Company also offers variousconsumer credit line products to its customers that are cancelable uponnotification by the Company, which are included above in commitments to extendcredit.

 

Standbyletters of credit are conditional commitments issued by the Company toguarantee the financial performance of a customer to a third party. Thoseguarantees are primarily issued to support public and private borrowingarrangements. 

 

Commercialletters of credit are issued by the Company on behalf of customers to ensurepayments of amounts owed or collection of amounts receivable in connection withtrade transactions. The Company’s exposure to credit loss in the event ofnonperformance by the counterparty is the contractual amount of the letter ofcredit and represents the same exposure as that involved in extending loans. 

 

The amount ofcollateral obtained to support letters of credit is based on a creditassessment of the counterparty. Collateral held may include marketablesecurities, receivables, inventory, agricultural commodities, equipment andreal estate. Because the conditions under which the Company is required to fundletters of credit may not materialize, the liquidity requirements of letters ofcredit are expected to be less than the total outstanding commitments.

 

The Company’sbank subsidiary grants real estate, agricultural, commercial, consumer andother loans and commitments and letters of credit to customers throughoutArizona, California, Colorado, Iowa, Minnesota, Nebraska, New Mexico, NorthDakota, South Dakota, Utah, Wisconsin and Wyoming. Although the Company has adiversified loan portfolio, the ability of a significant portion of its debtorsto honor their contracts is dependent upon their local economic sector. Themaximum exposure to accounting loss that could occur, if the borrowers fail toperform according to the loan agreements and the underlying collateral proved tobe of no value, is the total loan portfolio balances and contractual amounts ofcommitments and letters of credit. 

 

**10. BANKPREMISES AND EQUIPMENT**

 

Bank premisesand equipment at December 31 consisted of the following (in thousands):

 
|                                             |   | **2003**    |        | **2002** |   |
|--------------------------------------------------|--------|-------------|-------------|----------|--------|
| Land                                             |   | **$**       | **22,054**  |     | $      | 22,100 |   |
| Buildings                                        |   | **140,477** |        | 134,675  |   |
| Furniture,  fixtures and equipment               |   | **96,575**  |        | 95,018   |   |
| Leased  property under capital lease obligations |   | **13,041**  |        | 12,561   |   |
|                                             |   | **272,147** |        | 264,354  |   |
| Less  accumulated depreciation                   |   | **141,139** |        | 132,232  |   |
|                                             |   | **$**       | **131,008** |     | $      | 132,122 |   |

 

24

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**11. DEPOSITS**

 

The followingtable sets forth a summary of deposits of the Company at December 31 (inthousands):

 
|                                 |   | **2003**      |          | **2002**  |   |
|--------------------------------------|--------|---------------|---------------|-----------|--------|
| Deposits                             |   |          |          |      |   |
| Noninterest-bearing                  |   | **$**         | **447,648**   |      | $      | 470,900 |   |
| Interest-bearing:                    |   |          |          |      |   |
| Savings  and NOW accounts            |   | **2,552,056** |          | 2,424,943 |   |
| Time  accounts less than $100,000    |   | **888,066**   |          | 1,103,716 |   |
| Time  accounts greater than $100,000 |   | **501,440**   |          | 670,187   |   |
| Total  deposits                      |   | **$**         | **4,389,210** |      | $      | 4,669,746 |   |

 

At December31, 2003, the Company had $1.4 billion in time deposits with maturities rangingfrom less than one year to over five years. Although time deposits have astated maturity, a substantial number of time deposits have an automaticrenewal feature wherein the deposit will be renewed for a similar time periodat the rate of interest offered by the Company at the time of maturity. Thefollowing schedule identifies the Company’s time deposits at December 31, 2003by expected year of maturity (in thousands):

 
| Maturing  in 2004           |   | $       | 1,038,959 |   |
|-----------------------------|--------|---------|-----------|--------|
| Maturing  in 2005           |   | 198,689 |      |
| Maturing  in 2006           |   | 63,078  |      |
| Maturing  in 2007           |   | 60,142  |      |
| Maturing  in 2008           |   | 28,283  |      |
| Maturing  in 2009 and later |   | 355     |      |
| Total                       |   | $       | 1,389,506 |   |

 

**12.SHORT-TERM BORROWINGS**

 

As of December 31, 2003, theCompany’s subsidiary bank had $6 million in Federal Home Loan Bank (“FHLB”)borrowings, which are collateralized by various investment securities and realestate loans. The interest rates on FHLB borrowings are variable rates based onshort-term market conditions and the term of the advance, and range from 3.64%to 4.12% at December 31, 2003.  TheCompany’s subsidiaries had no additional short-term borrowings outstanding atDecember 31, 2003.

 

The Companyhas a short-term line of credit bearing interest at a variable rate of LIBORplus .75% that provides for borrowing up to $35 million through October 26,2004, with a commitment fee of .25% of the revolving commitment amount. As ofDecember 31, 2003, the Company had no balance outstanding under this line ofcredit. The Company has a short term line of credit bearing interest at avariable rate of 1.25% above the LIBOR rate that provides for borrowing up to$50 million, with a commitment fee of .25% of the revolving commitment amount.This line may be accessed to fund the repurchase of the Company’s common stock,fund operating expenses and secure the Company’s outstanding commercial paperobligations. As of December 31, 2003, there was a $20 million commercial paperbalance outstanding with a blended rate of 1.36%. The terms of the lines ofcredit include certain covenants with which the Company must comply. AtDecember 31, 2003, the Company was in compliance with all covenants pertainingto the lines of credit. 

 

The Company’ssubsidiary bank enters into sales of securities under agreements to repurchase(repurchase agreements). Fixed-coupon repurchase agreements are treated asfinancings, and the obligations to repurchase securities sold are reflected asborrowed funds in the consolidated statements of condition. The dollar amountof securities underlying the agreements remain in the asset accounts. Thebalance of securities sold under agreement to repurchase at December 31, 2003and December 31, 2002 were $292,689,000 and $210,730,000, respectively.

 

**13. LONG-TERMDEBT**

 

Long-term debt consisted ofthe following at December 31 (in thousands):

 
|                                                                                                                                                          |   | **2003**   |        | **2002** |   |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|------------|-------------|----------|--------|
| Parent  Company:                                                                                                                                              |   |       |        |     |   |
| Subordinated  notes payable, interest at 7.30%, payable semi-annually, maturing June 30,  2004, unsecured.                                                    |   | **$**      | **50,000**  |     | $      | 60,000 |   |
| Junior  subordinated debentures, interest at 8.125%, payable quarterly, maturing  April 15, 2032.                                                             |   | **61,855** |        | 61,855   |   |
| Junior  subordinated debentures, interest at 7.60%, payable quarterly, maturing March  15, 2033.                                                              |   | **61,856** |        |     |   |
| Junior  subordinated debentures, interest at 8.20%, payable quarterly, maturing  December 15, 2027.                                                           |   | **—** |        | 61,856   |   |
| Subsidiaries:                                                                                                                                                 |   |       |        |     |   |
| Federal  Home Loan Bank advances, interest rates ranging from 3.83% to 6.55%, payable  monthly, with maturities ranging from January 25, 2005 to May 8, 2009. |   | **23,500** |        | 42,500   |   |
| Subordinated  term note payable to bank, interest of LIBOR plus 140 basis points, payable  quarterly, maturing December 22, 2007, unsecured.                  |   | **25,000** |        | 25,000   |   |
| Total                                                                                                                                                         |   | **$**      | **222,211** |     | $      | 251,211 |   |

 

The 7.30% subordinated notespayable are not redeemable, in whole or in part, by the Company. These notesare direct obligations of the Company and are subordinated to all otherindebtedness of the Company. The terms of the subordinated notes payableinclude certain covenants with which the Company must comply. At December 31,2003, the Company was in compliance with all covenants pertaining to thesubordinated notes payable.

 

Long-term debt includes$61,855,000 of 8.125% junior subordinated debentures payable to CFB CapitalIII, an unconsolidated affiliate of the Company, bearing quarterly interestpayments and maturing April 15, 2032 and $61,856,000 of 7.60% juniorsubordinated debenture payable to CFB Capital IV, an unconsolidated affiliateof the Company, bearing quarterly interest payments and maturing March 15,2033.

 

Maturities oflong-term debt outstanding, at December 31, 2003, were (in thousands):

 
| 2004       |   | $       | 50,000  |   |
|------------|--------|---------|---------|--------|
| 2005       |   | 13,000  |    |
| 2006       |   | 4,000   |    |
| 2007       |   | 27,000  |    |
| 2008       |   | 2,500   |    |
| Thereafter |   | 125,711 |    |
| Total      |   | $       | 222,211 |   |

 

25

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On March 4,2003, the Company issued $60 million of 7.60% Cumulative Capital Securities,through CFB Capital IV, a Delaware statutory trust subsidiary organized inFebruary 2003. The proceeds of the offering were invested by CFB Capital IV injunior subordinated debentures of the Company. The Company used the netproceeds to redeem on April 4, 2003, all of the 8.20% junior subordinateddebentures that it issued in 1997, thereby triggering the redemption of all2,400,000 of the 8.20% Cumulative Capital Securities issued by CFB II, aDelaware statutory trust. With regulatory approval, the new debentures may beredeemed no earlier than March 15, 2008, and mature March 15, 2033. The capitalsecurities qualified as Tier 1 Capital under capital guidelines of the FederalReserve. 

 

On March 27,2002, the Company issued $60 million of 8.125% Cumulative Capital Securities,through CFB Capital III, a Delaware statutory trust subsidiary organized inFebruary 2002. The proceeds of the offering were invested by CFB Capital III injunior subordinated debentures of the Company. With regulatory approval, thedebentures can be redeemed no earlier than April 15, 2007, and mature April 15,2032. The capital securities qualified as Tier 1 capital under capitalguidelines of the Federal Reserve. On May 1, 2002, the Company used the netproceeds to redeem all of the 8 7/8% junior subordinated debentures that itissued in 1997, thereby triggering the redemption of all 2,400,000 of the 87/8% Cumulative Capital Securities issued by CFB Capital I, a Delaware businesstrust. 

 

On December 10, 1997, theCompany issued $60 million of 8.20% Cumulative Capital Securities, through CFBCapital II, a statutory trust subsidiary organized in December 1997. Theproceeds of the offering were invested by CFB Capital II in junior subordinateddebentures of the Company.

 

At December 31, 2003, $118million of the Company’s $120 million in capital securities qualified as Tier 1capital under capital guidelines of the Federal Reserve. Refer to Note 3 –Accounting Changes for a discussion of FIN 46 and their impact on the recordingand reporting of these securities on the Company’s financial statements.

 

CFB Capital III and IV are100% owned finance subsidiaries of the Company and the Company has fully andunconditionally guaranteed the Cumulative Capital Securities of CFB Capital IIIand IV. The ability of CFB Capital III and CFB Capital IV to pay timelydistributions on its Cumulative Capital Securities depends upon the Companymaking the related payments on the junior subordinated debentures when due.

 

**14. SHAREHOLDER’S EQUITY**

 

On June 16, 2003, the Companyfiled a shelf registration statement with the Securities and ExchangeCommission for the purpose of issuing up to $120 million of debt securities,common stock, preferred stock, and other securities. The Company expects to usethe proceeds from the shelf offering to redeem or repurchase outstandingsecurities, repay debt, acquisitions and for general working capital. AtDecember 31, 2003, $120 million remains available for issuance of debt andequity securities.

 

On February22, 2002, the Company filed a shelf registration statement with the Securitiesand Exchange Commission for the purpose of issuing $180 million of various debtand equity securities.  At December 31,2003, $60 million remains available for issuance of debt and equity securities.

 

**PREFERRED STOCK SHAREHOLDERS’ RIGHTS PLAN**

 

The Company adopted ashareholders’ rights plan in January 1995 that attached one right to each shareof common stock outstanding on January 19, 1995. Each right entitles the holderto purchase one one-hundredth of a share of a new series of juniorparticipating preferred stock of the Company, which has an initial exerciseprice of $31.50. The rights become exercisable only upon the acquisition of 15percent or more of the Company’s voting stock, or an announcement of a tenderoffer or exchange offer to acquire an interest of 15 percent or more by aperson or group, without the prior consent of the Company. If exercised, or ifthe Company is acquired, the rights entitle the holders (not including theperson or persons acquiring or proposing to acquire an amount of common stockequal to 15 percent or more of the Company) to purchase, at the exercise price,common stock with a market value equal to two times the exercise price. Therights, which may be redeemed by the Company in certain circumstances, expireJanuary 5, 2005.

 

**CAPITALREQUIREMENTS**

 

The Company is subject tovarious regulatory capital requirements administered by the federal bankingagencies. Failure to meet minimum capital requirements can initiate certainmandatory, and possibly additional discretionary, actions by regulators that,if undertaken, could have a direct material effect on the Company’sconsolidated financial statements. Under capital adequacy guidelines and theregulatory framework for prompt corrective action, the Company must meetspecific capital guidelines that involve quantitative measures of the Company’sassets, liabilities and certain off-balance sheet items as calculated underregulatory accounting practices. The Company’s capital amounts andclassification are also subject to qualitative judgments by the regulatorsabout components, risk weightings and other factors.

 

Quantitative measuresestablished by regulation to ensure capital adequacy require the Company tomaintain minimum amounts and ratios of total and Tier 1 capital torisk-weighted assets, and of Tier 1 capital to average assets.

 

As of December31, 2003, the Company is considered well capitalized under the regulatoryframework for prompt corrective action. To be categorized as well capitalized,the Company must maintain minimum total risk-based, Tier 1 risk-based, and Tier1 leverage ratios as set forth in the following table.

 
|                                                           |   | **At December 31, 2003** |   |
|----------------------------------------------------------------|--------|--------------------------|--------|
| **Regulatory Capital Requirements:****(Dollars in thousands)** |   | **Tier 1  Capital**      |   | **Total Risk-  Based  Capital** |   | **Leverage** |   | **Total Risk-  Weighted  Assets** |   |
| Minimum                                                        |   | 4.00                     | %      | 8.00 | % | 3.00 | % | N/A |   |
| Well  Capitalized                                              |   | 6.00                     | %      | 10.00 | % | 5.00 | % | N/A |   |
| **Bank Subsidiary:**                                           |   |                     |   |   |   |   |   |   |   |
| Community  First National Bank, Fargo                          |   | 10.73                    | %      | 12.36 | % | 7.75 | % | $ | 3,867,010 |   |
| Community  First Bankshares, Inc.                              |   | 9.76                     | %      | 11.42 | % | 6.99 | % | $ | 3,884,282 |   |

 
|                                                           |   | **At December 31, 2002** | ** ** |
|----------------------------------------------------------------|--------|--------------------------|------------|
| **Regulatory Capital Requirements:****(Dollars in thousands)** |   | **Tier 1  Capital**      | ** ** | **Total Risk-  Based  Capital** | ** ** | **Leverage** | ** ** | **Total Risk-  Weighted  Assets** | ** ** |
| Minimum                                                        |   | 4.00                     | %          | 8.00 | % | 3.00 | % | N/A |   |
| Well  Capitalized                                              |   | 6.00                     | %          | 10.00 | % | 5.00 | % | N/A |   |
| **Bank Subsidiary:**                                           |   |                     |       |   |   |   |   |   |   |
| Community  First National Bank, Fargo                          |   | 10.35                    | %          | 12.08 | % | 7.72 | % | $ | 4,159,134 |   |
| Community  First Bankshares, Inc.                              |   | 8.98                     |       | 11.04 |   | 6.52 | % | $ | 4,202,131 |   |

 

26

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**15. EMPLOYEE BENEFIT PLANS**

 

**STOCK OPTIONPLAN**

 

During 1996,the Company approved the 1996 Stock Option Plan under which 4 million shares ofthe Company’s common stock were reserved for granting of future stockoptions.  Under the 1996 stock optionplan, the Company may grant key employees, directors and service providers incentiveor nonqualified options to purchase common stock of the Company.  Incentive stock options must have anexercise price of at least fair market value on the date of the grant, asdetermined by the Company.  The optionsgenerally vest ratably over a three-year period and are exercisable over five-or ten-year terms.

 

On April 22,2003, the Company’s 1996 Stock Option Plan was amended to increase the numberof shares of common stock eligible for option grants from 4 million to 5.9million shares and permit shares of common stock tendered for payment of theexercise price of an option to be available for subsequent issuance.

 

Stock optionsoutstanding under the plans are as follows:

 
|                        |   | **Year Ended December 31,** |       |
|-----------------------------|--------|-----------------------------|------------|
|                        |   | **2003**                    |       | **2002** |   | **2001** |   |
|                        |   | **Options  Outstanding**    |       | **Weighted  Average  Price Per  Share** |   | **Options  Outstanding** |   | **Weighted  Average  Price Per  Share** |   | **Options  Outstanding** |   | **Weighted  Average  Price Per  Share** |   |
| Beginning  of year          |   | **2,464,297**               | ** ** | **$** | **20.26** | ** ** | 2,437,234 |   | $ | 17.98 |   | 2,441,862 |   | $ | 16.32 |   |
| Options  granted            |   | **905,337**                 | ** ** | **26.48** | ** ** | 835,453 |   | 24.60 |   | 682,800 |   | 19.45 |   |
| Options  exercised          |   | **(646,177**                | **)**      | **18.86** | ** ** | (666,319 | ) | 17.44 |   | (507,061 | ) | 11.16 |   |
| Options  forfeited          |   | **(189,508**                | **)**      | **24.32** | ** ** | (142,071 | ) | 19.93 |   | (180,367 | ) | 20.25 |   |
| End  of year                |   | **2,533,949**               | ** ** | **22.52** | ** ** | 2,464,297 |   | $ | 20.26 |   | 2,437,234 |   | 17.98 |   |
| Exercisable  at end of year |   | **1,344,703**               | ** ** | **$** | **20.54** | ** ** | 1,300,277 |   | $ | 19.34 |   | 1,212,469 |   | $ | 18.55 |   |

 
|                                            |   | **2003** |     | **2002** |   | **2001** |   |
|-------------------------------------------------|--------|----------|----------|----------|--------|----------|--------|
| Weighted-average  fair value of options granted |   | **$**    | **5.51** |     | $      | 5.64     |   | $ | 6.34 |   |
|                                                 |        |          |          |          |        |          |        |  |  |  |

 

The range of exercise pricesand the weighted-average remaining contractual life of the options outstandingat December 31, 2003 were as follows:

 
| **Range of Exercise  Prices Per Share** |   | **Options  Outstanding at  December 31,  2003** |   | **Weighted  Average  Exercise Price  Per Share** |   | **Weighted  Average  Remaining  Contractual Life** |        |
|-----------------------------------------|--------|-------------------------------------------------|--------|--------------------------------------------------|--------|----------------------------------------------------|-------------|
| $24.25  – $28.85                   |   | 1,590,793                                       |   | $                                                | 25.63  |                                               | 8.29  Years |   |
| $19.3125  – $21.49                 |   | 600,647                                         |   | $                                                | 19.51  |                                               | 6.75  Years |   |
| $12.82  – $15.875                  |   | 313,724                                         |   | $                                                | 14.05  |                                               | 6.04  Years |   |
| $5.87  – $6.160                    |   | 28,785                                          |   | $                                                | 6.03   |                                               | 2.73  Years |   |

 

At December31, 2003, a total of 3,225,887 shares of authorized common stock was reservedfor exercise of options granted under the 1996 Stock Option Plan.

 

**PROFIT-SHARINGPLAN**

 

The Companyoffers a contributory profit-sharing and thrift plan that qualifies undersection 401(k) of the Internal Revenue Code. The plan covers all employees whoare 21 years of age and scheduled to work 1,000 hours or more per year.  The plan provides for an employer-matchingcontribution of 100% of the first 3% and 50% of the next 3% of eachparticipant’s eligible contribution, subject to a limitation of the lesser ofthe participant’s contribution or the maximum amount prescribed by the InternalRevenue Code.  The Company’scontribution was $2,448,000, $2,172,000, and $2,743,000 in 2003, 2002 and 2001,respectively.

 

**16.  RESTRICTIONS ON CASH AND DUE FROM BANKS**

 

Banksubsidiaries are required to maintain average reserve balances with the FederalReserve Bank.  Balances were $36,025,000and $46,845,000 at December 31, 2003 and 2002, respectively.

 

**17.  INCOME TAXES**

 

The componentsof the provision for income taxes were (in thousands):

 
|                        |   | **Year ended December 31,** |       |
|-----------------------------|--------|-----------------------------|------------|
|                        |   | **2003**                    |       | **2002** |   | **2001** |   |
| Federal:                    |   |                        |       |   |   |   |   |
| Current                     |   | **$**                       | **30,189** |   | $ | 31,592 |   | $ | 32,587 |   |
| Deferred                    |   | **3,127**                   |       | 5,141 |   | (1,961 | ) |
|                        |   | **33,316**                  |       | 36,733 |   | 30,626 |   |
| State:                      |   |                        |       |   |   |   |   |
| Current                     |   | **3,437**                   |       | 2,720 |   | 3,112 |   |
| Deferred                    |   | **162**                     |       | 96 |   | (262 | ) |
|                        |   | **3,599**                   |       | 2,816 |   | 2,850 |   |
| Provision  for income taxes |   | **$**                       | **36,915** |   | $ | 39,549 |   | $ | 33,476 |   |

 

The reconciliation betweenthe provision for income taxes and the amount computed by applying thestatutory federal income tax rate was as follows (in thousands):

 
|                                          |   | **2003**   |       | **2002**   |   | **2001** |   |
|-----------------------------------------------|--------|------------|------------|------------|--------|----------|--------|
| Tax  at statutory rate (35%)                  |   | **$**      | **39,177** |       | $      | 41,565   |   | $ | 34,487 |   |
| State  income tax, net of federal tax benefit |   | **2,340**  | ** ** | 1,830      |   | 1,853    |   |
| Tax-exempt  interest                          |   | **(3,566** | **)**      | (3,944     | )      | (4,094   | )      |
| Amortization  of goodwill                     |   | **—** | ** ** | —     |   | 919      |   |
| Other                                         |   | **(1,036** | **)**      | 98         |   | 311      |   |
| Provision  for income taxes                   |   | **$**      | **36,195** | ** ** | $      | 39,549   |   | $ | 33,476 |   |

 

27

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Deferredincome tax assets and liabilities reflect the net tax effect of temporarydifferences between the carrying amounts of assets and liabilities forfinancial reporting purposes and the amounts used for income tax reportingpurposes.  Significant components of theCompany’s deferred tax assets and liabilities as of December 31, 2003 and 2002,are as follows (in thousands):

 
|                                                   |   | **2003**   |       | **2002**   |   |
|--------------------------------------------------------|--------|------------|------------|------------|--------|
| Deferred  tax assets:                                  |   |       | ** ** |       |   |
| Loan  loss reserves                                    |   | **$**      | **19,978** | ** ** | $      | 21,480 |   |
| Other  reserves                                        |   | **101**    | ** ** | 478        |   |
| Deferred  compensation                                 |   | **1,861**  | ** ** | 1,857      |   |
| Other                                                  |   | **1,744**  | ** ** | 2,175      |   |
|                                                   |   | **23,684** |       | 25,990     |   |
| Deferred  tax liabilities:                             |   |       | ** ** |       |   |
| Unrealized  net gains on available-for-sale securities |   | **4,624**  | ** ** | 15,693     |   |
| Depreciation                                           |   | **3,891**  | ** ** | 3,739      |   |
| Deductible  goodwill                                   |   | **3,003**  | ** ** | 1,502      |   |
| Purchase  accounting                                   |   | **122**    | ** ** | 135        |   |
| Other                                                  |   | **78**     | ** ** | 121        |   |
|                                                   |   | **11,718** |       | 21,190     |   |
| Net  deferred tax asset                                |   | **$**      | **11,966** | ** ** | $      | 4,800 |   |

 

Therealization of the Company’s deferred tax assets is dependent upon theCompany’s ability to generate taxable income in future periods and the reversalof deferred tax liabilities during the same period.  The Company has evaluated the available evidence supporting therealization of its deferred tax assets and determined it is more likely thannot that the assets will be realized.

 

**18.  COMMITMENTS AND CONTINGENT LIABILITIES**

 

Total rentexpense was $4,710,000, $4,852,000, $5,273,000 in 2003, 2002 and 2001,respectively.

 

Future minimumpayments, by year and in the aggregate, under noncancelable leases with initialor remaining terms of one year or more, consisted of the following at December31, 2003 (in thousands):

 
|                                         |   | **Operating** |   | **Capital** |   |
|----------------------------------------------|--------|---------------|--------|-------------|--------|
| 2004                                         |   | $             | 1,736  |        | 1,479  |   |
| 2005                                         |   | 901           |   | 1,479       |   |
| 2006                                         |   | 735           |   | 1,479       |   |
| 2007                                         |   | 586           |   | 1,479       |   |
| 2008                                         |   | 482           |   | 108         |   |
| Thereafter                                   |   | 1,938         |   | 90          |   |
|                                         |   | $             | 6,378  |        |   |   |
| Net  minimum lease payments                  |   |          |   | $           | 6,114  |   |
| Less:                                        |   |          |   |        |   |
| Amount  representing interest                |   |          |   | (884        | )      |
| Present  value of net minimum lease payments |   |          |   | $           | 5,230  |   |

 

The netpresent value of net minimum lease payments at December 31, 2002 was$5,461,000, net of $1,214,000 representing interest.

 

In the normalcourse of business, there are various outstanding legal proceedings, claims,commitments and contingent liabilities. In the opinion of management, the Company and its subsidiaries will notbe materially affected by the outcome of such matters.

** **

**19.  COMMUNITY FIRST BANKSHARES, INC.**

 

*(ParentCompany Only)*

 

**CONDENSEDSTATEMENTS OF FINANCIAL CONDITION**

 
| **December 31 (In thousands)**                   |   | **2003**    |        | **2002**   |       |
|--------------------------------------------------|--------|-------------|-------------|------------|------------|
| **ASSETS**                                       |   |        | ** **  |       |       |
| Cash  and due from subsidiary bank               |   | **$**       | **4,692**   | ** ** | $          | 681 |   |
| Interest-bearing  deposits                       |   | **392**     | ** **  | 4,150      |       |
| Available-for-sale  securities                   |   | **189**     | ** **  | 114        |       |
| Investment  in subsidiaries                      |   | **525,067** | ** **  | 560,319    |       |
| Furniture  and equipment                         |   | **11,817**  | ** **  | 11,951     |       |
| Receivable  from subsidiaries                    |   | **4,747**   | ** **  | 7,188      |       |
| Other  assets                                    |   | **13,859**  | ** **  | 13,333     |       |
| Total  assets                                    |   | **$**       | **560,763** | ** ** | $          | 597,736 |   |
| **LIABILITIES AND SHAREHOLDERS’ EQUITY**    |   |        | ** **  |       | ** ** |
| Short-term  borrowings                           |   | **$**       | **13,484**  | ** ** | $          | 24,720 |   |
| Long-term  debt                                  |   | **173,711** | ** **  | 183,711    |       |
| Other  liabilities                               |   | **11,768**  | ** **  | 10,856     |       |
| Shareholders’  equity                       |   | **361,800** | ** **  | 378,449    |       |
| Total  liabilities and shareholders’ equity |   | **$**       | **560,763** | ** ** | $          | 597,736 |   |

 

**CONDENSEDSTATEMENTS OF INCOME**

 
| **Years ended December 31(In  thousands)**                                           |   | **2003**   |       | **2002** |   | **2001** |   |
|--------------------------------------------------------------------------------------|--------|------------|------------|----------|--------|----------|--------|
| Income:                                                                              |   |       |       |     |   |     |   |
| Dividends  from subsidiaries                                                         |   | **$**      | **65,295** |     | $      | 87,125   |   | $ | 126,117 |   |
| Service  fees from subsidiaries                                                      |   | **—** |       | —   |   | 329      |   |
| Interest  income                                                                     |   | **211**    |       | 739      |   | 614      |   |
| Other                                                                                |   | **660**    |       | (801     | )      | 1,552    |   |
| Total  income                                                                        |   | **66,166** |       | 87,063   |   | 128,612  |   |
| Expense:                                                                             |   |       |       |     |   |     |   |
| Interest  expense                                                                    |   | **14,505** |       | 15,806   |   | 16,471   |   |
| Other  expense                                                                       |   | **27,311** |       | 28,023   |   | 29,839   |   |
| Total  expense                                                                       |   | **41,816** |       | 43,829   |   | 46,310   |   |
| Income  before income tax benefit and equity in undistributed income of subsidiaries |   | **24,350** |       | 43,234   |   | 82,302   |   |
| Income  tax benefit                                                                  |   | **14,394** |       | 14,587   |   | 14,849   |   |
| Income  before undistributed income of subsidiaries                                  |   | **38,744** |       | 57,821   |   | 97,151   |   |
| Equity  in undistributed (overdistributed) income of subsidiaries                    |   | **36,277** |       | 21,387   |   | (32,092  | )      |
| Net  income                                                                          |   | **$**      | **75,021** |     | $      | 79,208   |   | $ | 65,059 |   |

 

28

----

 

**CONDENSED STATEMENTS OF CASH FLOWS**

 
| **Years ended December 31(In  thousands)**                                         |   | **2003**     |       | **2002**   |   | **2001** |   |
|------------------------------------------------------------------------------------|--------|--------------|------------|------------|--------|----------|--------|
| **Cash flows from operating activities:**                                          |   |         | ** ** |       |   |     |   |
| Net  income                                                                        |   | **$**        | **75,021** | ** ** | $      | 79,208   |   | $ | 65,059 |   |
| Adjustments  to reconcile net income to net cash provided by operating activities: |   |         | ** ** |       |   |     |   |
| Equity  in (undistributed) overdistributed income of subsidiaries                  |   | **(36,277**  | **)**      | (21,387    | )      | 32,092   |   |
| Depreciation                                                                       |   | **1,175**    | ** ** | 1,029      |   | 730      |   |
| Increase  (decrease) in interest payable                                           |   | **371**      | ** ** | (161       | )      | (2,450   | )      |
| Other,  net                                                                        |   | **1,114**    | ** ** | 591        |   | 9,485    |   |
| Net  cash provided by operating activities                                         |   | **41,404**   | ** ** | 59,280     |   | 104,916  |   |
|                                                                               |   |         | ** ** |       |   |     |   |
| **Cash flows from investing activities:**                                          |   |         | ** ** |       |   |     |   |
| Equity  distribution from (to) subsidiaries                                        |   | **54,743**   | ** ** | 2,819      |   | (1,763   | )      |
| Net  loans to subsidiaries                                                         |   | **2,441**    | ** ** | 5,821      |   | (90      | )      |
| Purchases  of available-for-sale securities                                        |   | **(114,161** | **)**      | (255,903   | )      | (355,456 | )      |
| Sales  of available-for-sale securities, net of gains                              |   | **—**   | ** ** | 21,132     |   | 3,767    |   |
| Maturities  of investment securities                                               |   | **113,000**  | ** ** | 247,112    |   | 348,779  |   |
| Net  increase in furniture and equipment                                           |   | **(1,041**   | **)**      | (5,096     | )      | (1,917   | )      |
| Net  decrease (increase) in interest-bearing deposits                              |   | **3,758**    | ** ** | (4,119     | )      | (29      | )      |
| Net  cash provided by (used in) investing activities                               |   | **58,740**   | ** ** | 11,766     |   | (6,709   | )      |
|                                                                               |   |         | ** ** |       |   |     |   |
| **Cash flows from financing activities:**                                          |   |         | ** ** |       |   |     |   |
| Net  (decrease) increase in short-term borrowings                                  |   | **(11,236**  | **)**      | 4,940      |   | (29,172  | )      |
| Common  stock dividends paid                                                       |   | **(34,250**  | **)**      | (31,664    | )      | (27,793  | )      |
| Repayment  of long-term debt                                                       |   | **(10,000**  | **)**      | (2,560     | )      | (213     | )      |
| Net  proceeds from issuance of junior subordinated debentures                      |   | **61,856**   | ** ** | 61,856     |   |     |   |
| Repayment  of junior subordinated debentures                                       |   | **(62,863**  | **)**      | (62,974    | )      | —   |   |
| Net  sales of common stock held in treasury                                        |   | **7,411**    | ** ** | 6,318      |   | 3,695    |   |
| Net  purchases of common stock held in treasury                                    |   | **(47,051**  | **)**      | (50,979    | )      | (43,020  | )      |
| Net  cash used in financing activities                                             |   | **(96,133**  | **)**      | (75,063    | )      | (96,503  | )      |
| Net  increase (decrease) in cash and cash equivalents                              |   | **4,011**    | ** ** | (4,017     | )      | 1,704    |   |
| Cash  and cash equivalents at beginning of year                                    |   | **681**      | ** ** | 4,698      |   | 2,994    |   |
| Cash  and cash equivalents at end of year                                          |   | **$**        | **4,692**  | ** ** | $      | 681      |   | $ | 4,698 |   |

 

Certainrestrictions exist regarding the extent to which the bank subsidiary maytransfer funds to the Company in the form of dividends, loans or advances.  Federal law prevents the Company fromborrowing from its bank subsidiary unless the loans are secured by specifiedU.S.  obligations.  Secured loans to the Company or anyindividual affiliate are generally limited in amount to 10% of the bank’sequity. Further, loans to the Company and all affiliates in total are limitedto 20% of the bank’s equity.  As ofDecember 31, 2003 and 2002, $51,417,000 and $54,960,000, respectively, ofindividual subsidiary bank’s capital was available for credit extension to theparent company.  At December 31, 2003and 2002, the bank subsidiary had no credit extended to the Company.

 

Payment ofdividends to the Company by its subsidiary bank is subject to various limitationsby bank regulatory agencies. Undistributed earnings of the bank subsidiaryavailable for distribution as dividends under these limitations were$25,296,000 and $0 as of December 31, 2003 and 2002, respectively.

 

**20.  RELATED PARTY TRANSACTIONS**

 

Certaindirectors and executive officers of the Company and its subsidiaries, includingtheir immediate families, companies in which they are principal owners andtrusts in which they are involved, are loan customers of the bank subsidiary.  The aggregate dollar amounts of these loansdid not exceed five percent of stockholders’ equity at December 31, 2003, 2002and 2001.

 

**21.  EARNINGS PER SHARE**

 

The followingtable sets forth the computation of basic and diluted earnings per share(dollars in thousands, except per share data):

 
| **Years ended December 31**                         |   | **2003**       |       | **2002**   |   | **2001**   |   |
|-----------------------------------------------------|--------|----------------|------------|------------|--------|------------|--------|
| **Numerator:**                                      |   |           | ** ** |       |   |       |   |
| Net  income                                         |   | **$**          | **75,021** | ** ** | $      | 79,208     |   | $ | 65,059 |   |
| Numerator  for basic and diluted earnings per share |   | **75,021**     | ** ** | 79,208     |   | 65,059     |   |
| **Denominator:**                                    |   |           | ** ** |       |   |       |   |
| Denominator  for basic earnings per share:          |   |           | ** ** |       |   |       |   |
| Weighted-average  shares outstanding                |   | **38,107,796** | ** ** | 39,564,912 |   | 40,905,545 |   |
| Effect  of dilutive securities:                     |   |           | ** ** |       |   |       |   |
| Employee  stock options                             |   | **429,940**    | ** ** | 640,937    |   | 565,859    |   |
| Employee  benefit plan shares                       |   | **16,070**     | ** ** | 37,286     |   | —     |   |
| Dilutive  potential common shares                   |   | **446,010**    | ** ** | 678,223    |   | 565,859    |   |
| Denominator  for diluted earnings per share         |   | **38,553,806** | ** ** | 40,243,135 |   | 41,471,404 |   |
| Basic  earnings per share                           |   | **$**          | **1.97**   | ** ** | $      | 2.00       |   | $ | 1.59 |   |
| Diluted  earnings per share                         |   | **$**          | **1.95**   | ** ** | $      | 1.97       |   | $ | 1.57 |   |

 

**22.  SUPPLEMENTALDISCLOSURES TO CONSOLIDATED STATEMENTS OF CASH FLOWS**

 
| **Years ended December 31 (in  thousands)**                 |   | **2003**   |        | **2002** |   | **2001** |   |
|-------------------------------------------------------------|--------|------------|-------------|----------|--------|----------|--------|
| Change  in unrealized gain on available-for-sale securities |   | **$**      | **(27,769** | **)**    | $      | 33,076   |   | $ | 22,081 |   |
| Income  taxes paid                                          |   | **31,832** | ** **  | 35,058   |   | 36,514   |   |
| Interest  paid                                              |   | **77,731** | ** **  | 111,731  |   | 188,305  |   |
|                                                             |        |            |             |          |        |          |        |  |  |  |

 

**23.  SUBSEQUENT EVENT**

 

On January 2,2004, the Company, through its insurance subsidiary, acquired Arnold &Arnold, Inc., an insurance agency located in Littleton, Colorado.  At the time of acquisition, the agency hadapproximately $250,000 in annual commission revenue.

 

29

----

 
| **** |   | **REPORT OF INDEPENDENT AUDITORS** | COMMUNITY FIRST BANKSHARES, INC. |
|------|--------|------------------------------------|----------------------------------|

 

*The Boardof Directors and Shareholders,*

*CommunityFirst Bankshares, Inc.*

 

*We have audited the accompanying consolidated statements of financialcondition of Community First Bankshares, Inc. and subsidiaries as of December 31, 2003 and 2002, and the relatedconsolidated statements of income, comprehensive income, shareholders’ equityand cash flows for each of the three years in the period ended December 31,2003.  These financial statements arethe responsibility of the Company’s management.  Our responsibility is to express an opinion on these financialstatements based on our audits.*

* *

*We conducted our audits in accordance with auditing standards generallyaccepted in the United States.  Thosestandards require that we plan and perform the audit to obtain reasonableassurance about whether the financial statements are free of materialmisstatement. An audit includes examining, on a test basis, evidence supportingthe amounts and disclosures in the financial statements.  An audit also includes assessing the accountingprinciples used and significant estimates made by management, as well asevaluating the overall financial statement presentation.  We believe that our audits provide areasonable basis for our opinion.*

* *

*In our opinion, the financial statements referred to above presentfairly, in all material respects, the consolidated financial position ofCommunity First Bankshares, Inc., and subsidiaries at December 31, 2003 and2002 and the consolidated results of their operations and their cash flows foreach of the three years in the period ended December 31, 2003, in conformitywith accounting principles generally accepted in the United States.*

* *

*As discussed in Note 3, in 2003, the Company changed its method ofaccounting for variable interest entities, and in 2002, the Company changed itsmethod of accounting for goodwill.*

 

 
|                           |   |
|---------------------------|--------|
| *Minneapolis,  Minnesota* |
| *January  15, 2004*       |

 

 
| **** | **CONSOLIDATED STATEMENT OF CONDITION – FIVE YEAR SUMMARY** | COMMUNITY FIRST BANKSHARES, INC. |
|------|------------------------------------------------------------------|----------------------------------|

 

 
| **December 31 (In thousands)**                                         |   | **2003**      |          | **2002**  |   | **2001**  |   | **2000**  |      | **1999**  |   |
|------------------------------------------------------------------------|--------|---------------|---------------|-----------|--------|-----------|--------|-----------|-----------|-----------|--------|
| **ASSETS**                                                             |   |          |          |      |   |      |   |      |      |      |   |
| Cash  and due from banks                                               |   | **$**         | **234,076**   |      | $      | 242,887   |   | $         | 248,260   |      | $      | 256,136 |   | $ | 247,051 |   |
| Federal  funds sold and securities purchased under agreement to resell |   | **—**    |          | —    |   | —    |   | —    |      | 4,775     |   |
| Interest-bearing  deposits                                             |   | **3,319**     |          | 4,613     |   | 341       |   | 1,110     |      | 4,648     |   |
| Available-for-sale  securities                                         |   | **1,563,419** |          | 1,672,445 |   | 1,437,066 |   | 1,714,510 |      | 1,937,517 |   |
| Held-to-maturity  securities                                           |   | **—**    |          | —    |   | —    |   | —    |      | 4,339     |   |
| Total  securities                                                      |   | **1,563,419** |          | 1,672,445 |   | 1,437,066 |   | 1,714,510 |      | 1,941,856 |   |
| Loans                                                                  |   | **3,323,572** |          | 3,577,893 |   | 3,736,692 |   | 3,738,202 |      | 3,690,353 |   |
| Less:  Allowance for loan losses                                       |   | **52,231**    |          | 56,156    |   | 54,991    |   | 52,168    |      | 48,878    |   |
| Net  loans                                                             |   | **3,271,341** |          | 3,521,737 |   | 3,681,701 |   | 3,686,034 |      | 3,641,475 |   |
| Other  assets                                                          |   | **392,952**   |          | 389,168   |   | 408,410   |   | 435,429   |      | 466,066   |   |
| Total  assets                                                          |   | **$**         | **5,465,107** |      | $      | 5,830,850 |   | $         | 5,775,778 |      | $      | 6,093,219 |   | $ | 6,305,871 |   |
|                                                                   |   |          |          |      |   |      |   |      |      |      |   |
| **LIABILITIES AND SHAREHOLDERS’ EQUITY**                          |   |          |          |      |   |      |   |      |      |      |   |
| Deposits:                                                              |   |          |          |      |   |      |   |      |      |      |   |
| Noninterest-bearing                                                    |   | **$**         | **447,648**   |      | $      | 470,900   |   | $         | 487,864   |      | $      | 500,834 |   | $ | 616,861 |   |
| Interest-bearing                                                       |   | **3,941,562** |          | 4,198,846 |   | 4,262,949 |   | 4,519,057 |      | 4,293,002 |   |
| Total  deposits                                                        |   | **4,389,210** |          | 4,669,746 |   | 4,750,813 |   | 5,019,891 |      | 4,909,863 |   |
| Short-term  borrowings                                                 |   | **442,266**   |          | 453,490   |   | 342,639   |   | 409,710   |      | 724,425   |   |
| Long-term  debt                                                        |   | **222,211**   |          | 251,211   |   | 260,552   |   | 247,668   |      | 199,333   |   |
| Other  liabilities                                                     |   | **49,620**    |          | 77,954    |   | 65,069    |   | 70,519    |      | 64,981    |   |
| Total  liabilities                                                     |   | **5,103,307** |          | 5,452,401 |   | 5,419,073 |   | 5,747,788 |      | 5,898,602 |   |
| Shareholders’  equity                                             |   | **361,800**   |          | 378,449   |   | 356,705   |   | 345,431   |      | 407,269   |   |
| Total  liabilities and shareholders’ equity                       |   | **$**         | **5,465,107** |      | $      | 5,830,850 |   | $         | 5,775,778 |      | $      | 6,093,219 |   | $ | 6,305,871 |   |

 

30

----

 
| **** | **CONSOLIDATED STATEMENT OF INCOME – FIVE YEAR SUMMARY** | COMMUNITY FIRST BANKSHARES, INC. |
|------|---------------------------------------------------------------|----------------------------------|

 
| **December 31 (In thousands)**                            |   | **2003**       |        | **2002**   |   | **2001**   |   | **2000**   |    | **1999**   |   |
|-----------------------------------------------------------|--------|----------------|-------------|------------|--------|------------|--------|------------|---------|------------|--------|
|                                                      |   |           |        |       |   |       |   |       |    |       |   |
| **INTEREST INCOME:**                                      |   |           | ** **  |       |   |       |   |       |    |       |   |
| Loans                                                     |   | **$**          | **241,442** | ** ** | $      | 276,846    |   | $          | 336,937 |       | $      | 353,405 |   | $ | 332,974 |   |
| Investment  securities                                    |   | **67,748**     | ** **  | 77,654     |   | 93,145     |   | 120,172    |    | 127,632    |   |
| Other                                                     |   | **52**         | ** **  | 201        |   | 391        |   | 628        |    | 1,277      |   |
| Total  interest income                                    |   | **309,242**    | ** **  | 354,701    |   | 430,473    |   | 474,205    |    | 461,883    |   |
|                                                      |   |           | ** **  |       |   |       |   |       |    |       |   |
| **INTEREST EXPENSE:**                                     |   |           | ** **  |       |   |       |   |       |    |       |   |
| Deposits                                                  |   | **48,559**     | ** **  | 75,572     |   | 138,542    |   | 169,281    |    | 151,138    |   |
| Short-term  and other borrowings                          |   | **4,940**      | ** **  | 6,340      |   | 15,001     |   | 34,303     |    | 28,052     |   |
| Long-term  debt                                           |   | **17,039**     | ** **  | 18,743     |   | 19,268     |   | 17,259     |    | 17,190     |   |
| Total  interest expense                                   |   | **70,538**     | ** **  | 100,655    |   | 172,811    |   | 220,843    |    | 196,380    |   |
| Net  interest income                                      |   | **238,704**    | ** **  | 254,046    |   | 257,662    |   | 253,362    |    | 265,503    |   |
| Provision  for loan losses                                |   | **12,602**     | ** **  | 13,262     |   | 17,520     |   | 15,781     |    | 20,184     |   |
| Net  interest income after provision for loan losses      |   | **226,102**    | ** **  | 240,784    |   | 240,142    |   | 237,581    |    | 245,319    |   |
|                                                      |   |           | ** **  |       |   |       |   |       |    |       |   |
| **NONINTEREST INCOME:**                                   |   |           | ** **  |       |   |       |   |       |    |       |   |
| Service  charges on deposit accounts                      |   | **40,239**     | ** **  | 40,121     |   | 41,850     |   | 42,192     |    | 39,246     |   |
| Insurance  commissions                                    |   | **15,223**     | ** **  | 13,822     |   | 12,535     |   | 10,550     |    | 8,791      |   |
| Securities  sales commissions                             |   | **9,057**      | ** **  | 9,526      |   | 6,644      |   | 6,805      |    | 5,258      |   |
| Fees  from fiduciary activities                           |   | **5,264**      | ** **  | 5,405      |   | 5,661      |   | 5,811      |    | 5,148      |   |
| Bank  owned life insurance income                         |   | **4,433**      | ** **  | 3,632      |   | 3,543      |   | 3,457      |    | 3,442      |   |
| Net  gains on sales of securities                         |   | **4,334**      | ** **  | 373        |   | 804        |   | 65         |    | 2,175      |   |
| Gain  on sales of loans                                   |   | **4,104**      | ** **  | 2,784      |   | 1,557      |   | 1,031      |    | 1,226      |   |
| Other                                                     |   | **10,039**     | ** **  | 9,460      |   | 10,842     |   | 11,619     |    | 13,096     |   |
| Total  noninterest income                                 |   | **92,693**     | ** **  | 85,123     |   | 83,436     |   | 81,530     |    | 78,382     |   |
|                                                      |   |           | ** **  |       |   |       |   |       |    |       |   |
| **NONINTEREST EXPENSE:**                                  |   |           | ** **  |       |   |       |   |       |    |       |   |
| Salaries  and employee benefits                           |   | **112,886**    | ** **  | 113,994    |   | 115,743    |   | 110,024    |    | 106,542    |   |
| Net  occupancy                                            |   | **33,490**     | ** **  | 32,832     |   | 31,593     |   | 31,941     |    | 32,726     |   |
| FDIC  insurance                                           |   | **720**        | ** **  | 800        |   | 915        |   | 1,039      |    | 625        |   |
| Professional  service fees                                |   | **7,194**      | ** **  | 7,478      |   | 8,398      |   | 8,289      |    | 8,819      |   |
| Advertising                                               |   | **3,881**      | ** **  | 3,983      |   | 5,037      |   | 4,545      |    | 4,065      |   |
| Telephone                                                 |   | **5,780**      | ** **  | 5,575      |   | 5,633      |   | 5,203      |    | 4,807      |   |
| Amortization  of intangibles                              |   | **3,374**      | ** **  | 3,318      |   | 9,928      |   | 10,481     |    | 10,500     |   |
| Acquisition,  integration and conforming                  |   | **—**     | ** **  | —     |   | —     |   | —     |    | 3,053      |   |
| Restructuring  charge                                     |   | **—**     | ** **  | —     |   | 7,656      |   | —     |    | —     |   |
| Data  processing                                          |   | **7,036**      | ** **  | 7,210      |   | 6,940      |   | 7,200      |    | 6,349      |   |
| Other                                                     |   | **32,498**     | ** **  | 31,960     |   | 33,200     |   | 33,007     |    | 32,729     |   |
| Total  noninterest expense                                |   | **206,859**    | ** **  | 207,150    |   | 225,043    |   | 211,729    |    | 210,215    |   |
| Income  from operations                                   |   | **111,936**    | ** **  | 118,757    |   | 98,535     |   | 107,382    |    | 113,486    |   |
| Provision  for income taxes                               |   | **36,915**     | ** **  | 39,549     |   | 33,476     |   | 35,748     |    | 38,573     |   |
| Net  income                                               |   | **$**          | **75,021**  | ** ** | $      | 79,208     |   | $          | 65,059  |       | $      | 71,634 |   | $ | 74,913 |   |
| Earnings  per common and common equivalent share:         |   |           | ** **  |       |   |       |   |       |    |       |   |
| Basic                                                     |   | **$**          | **1.97**    | ** ** | $      | 2.00       |   | $          | 1.59    |       | $      | 1.55 |   | $ | 1.50 |   |
| Diluted                                                   |   | **$**          | **1.95**    | ** ** | $      | 1.97       |   | $          | 1.57    |       | $      | 1.54 |   | $ | 1.48 |   |
| Average  common and common equivalent shares outstanding: |   |           | ** **  |       |   |       |   |       |    |       |   |
| Basic                                                     |   | **38,107,796** | ** **  | 39,564,912 |   | 40,905,545 |   | 46,219,120 |    | 50,061,972 |   |
| Diluted                                                   |   | **38,553,806** | ** **  | 40,243,135 |   | 41,471,404 |   | 46,578,750 |    | 50,670,559 |   |

 

31

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| **** | **QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)** | COMMUNITY FIRST BANKSHARES, INC. |
|------|-------------------------------------------------|----------------------------------|

 

Thefollowing is a summary of the quarterly results of operations for the yearsended December 31, 2003 and 2002 (in thousands, except per share data):

 
|                                                 |   | **First  Quarter** |   | **Second  Quarter** |       | **Third  Quarter** |       | **Fourth  Quarter** |       |
|------------------------------------------------------|--------|--------------------|--------|---------------------|------------|--------------------|------------|---------------------|------------|
| **Year ended December 31, 2003**                     |   |               |   |                |       |               |       |                |       |
| Interest  income                                     |   | $                  | 82,005 |                | $          | 79,078             |       | $                   | 74,923     |   | $ | 73,236 |   |
| Interest  expense                                    |   | 20,841             |   | 18,362              |       | 16,228             |       | 15,107              |       |
| Net  interest income                                 |   | 61,164             |   | 60,716              |       | 58,695             |       | 58,129              |       |
| Provision  for loan losses                           |   | 3,487              |   | 3,487               |       | 3,403              |       | 2,225               |       |
| Net  interest income after provision for loan losses |   | 57,677             |   | 57,229              |       | 55,292             |       | 55,904              |       |
| Net  gains on sales of securities                    |   | 464                |   | 1,795               |       | 444                |       | 1,631               |       |
| Noninterest  income                                  |   | 21,402             |   | 21,289              |       | 24,077             |       | 21,591              |       |
| Noninterest  expense                                 |   | 50,689             |   | 51,997              |       | 52,564             |       | 51,609              |       |
| Income  before income taxes                          |   | 28,854             |   | 28,316              |       | 27,249             |       | 27,517              |       |
| Provision  for income taxes                          |   | 9,453              |   | 9,230               |       | 8,908              |       | 9,324               |       |
| Net  income                                          |   | $                  | 19,401 |                | $          | 19,086             |       | $                   | 18,341     |   | $ | 18,193 |   |
| Earnings  per common and common equivalent shares:   |   |               |   |                |       |               |       |                |       |
| Basic  net income                                    |   | $                  | 0.50   |                | $          | 0.50               |       | $                   | 0.48       |   | $ | 0.48 |   |
| Diluted  net income                                  |   | $                  | 0.50   |                | $          | 0.49               |       | $                   | 0.48       |   | $ | 0.48 |   |
| Average  common and common equivalent shares:        |   |               |   |                |       |               |       |                |       |
| Basic                                                |   | 38,601,216         |   | 38,371,159          |       | 37,936,390         |       | 37,536,006          |       |
| Diluted                                              |   | 39,111,903         |   | 38,928,709          |       | 38,462,034         |       | 38,020,515          |       |
|                                                 |   |               |   |                |       |               |       |                |       |
|                                                 |   | **First  Quarter** |   | **Second  Quarter** | ** ** | **Third  Quarter** | ** ** | **Fourth  Quarter** | ** ** |
| **Year ended December 31, 2002**                     |   |               |   |                |       |               |       |                |       |
| Interest  income                                     |   | $                  | 90,890 |                | $          | 89,664             |       | $                   | 88,380     |   | $ | 85,767 |   |
| Interest  expense                                    |   | 27,850             |   | 25,369              |       | 24,207             |       | 23,229              |       |
| Net  interest income                                 |   | 63,040             |   | 64,295              |       | 64,173             |       | 62,538              |       |
| Provision  for loan losses                           |   | 3,315              |   | 3,297               |       | 3,352              |       | 3,298               |       |
| Net  interest income after provision for loan losses |   | 59,725             |   | 60,998              |       | 60,821             |       | 59,240              |       |
| Net  gains (losses) on sales of securities           |   | 17                 |   | (188                | )          | 56                 |       | 488                 |       |
| Noninterest  income                                  |   | 19,914             |   | 21,928              |       | 21,634             |       | 21,274              |       |
| Noninterest  expense                                 |   | 50,494             |   | 52,809              |       | 51,921             |       | 51,926              |       |
| Income  before income taxes                          |   | 29,162             |   | 29,929              |       | 30,590             |       | 29,076              |       |
| Provision  for income taxes                          |   | 9,901              |   | 10,072              |       | 10,221             |       | 9,355               |       |
| Net  income                                          |   | $                  | 19,261 |                | $          | 19,857             |       | $                   | 20,369     |   | $ | 19,721 |   |
| Earnings  per common and common equivalent shares:   |   |               |   |                |       |               |       |                |       |
| Basic  net income                                    |   | $                  | 0.48   |                | $          | 0.50               |       | $                   | 0.52       |   | $ | 0.50 |   |
| Diluted  net income                                  |   | $                  | 0.47   |                | $          | 0.49               |       | $                   | 0.51       |   | $ | 0.50 |   |
| Average  common and common equivalent shares:        |   |               |   |                |       |               |       |                |       |
| Basic                                                |   | 39,984,092         |   | 39,772,344          |       | 39,424,624         |       | 39,080,638          |       |
| Diluted                                              |   | 40,644,637         |   | 40,515,906          |       | 40,073,077         |       | 39,740,426          |       |

 

32

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**SHAREHOLDERS**

 

As of February 17, 2004, the Company had 2,116 shareholders ofrecord and an estimated 9,000 additional beneficial holders whose stock washeld in street name by brokerage houses.

 

**DIVIDEND POLICY**

 

The Board of Directors has adopted a policy of declaring regularquarterly dividends.  A dividend of 16cents was paid for the first and second quarters of 2001. A dividend of 18cents per share was paid for the third and fourth quarters of 2001.  A dividend of 19 cents per share was paidfor the first and second quarters of 2002. A dividend of 21 cents per share was paid for the third and fourthquarters of 2002.  A dividend of 22cents was paid for the first and second quarters of 2003.  A dividend of 23 cents was paid for thethird and fourth quarters of 2003.

 

**MARKET PRICE RANGE OF COMMON SHARES**

 

The Company’s common stock trades on the Nasdaq Stock Market(R)under the symbol CFBX.  The followingtable sets forth the high, low and closing sales prices for the Company’scommon stock during the periods indicated.

 
|           |   | **2003** |   | **2002** |   |
|----------------|--------|----------|--------|----------|--------|
|           |   | **High** |   | **Low**  |   | **Close** |   | **High** |   | **Low** |   | **Close** |   |
| First Quarter  |   | 27.23    |   | 24.35    |   | 25.55 |   | 26.37 |   | 24.14 |   | 25.86 |   |
| Second Quarter |   | 28.60    |   | 25.87    |   | 27.23 |   | 28.45 |   | 24.99 |   | 26.09 |   |
| Third Quarter  |   | 29.01    |   | 26.04    |   | 26.62 |   | 28.15 |   | 22.36 |   | 27.88 |   |
| Fourth Quarter |   | 29.26    |   | 26.20    |   | 28.94 |   | 28.13 |   | 24.41 |   | 26.46 |   |

 

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