**UNITED STATES**

**SECURITIESAND EXCHANGE COMMISSION**

 

**Washington, D.C. 20549**

 

**FORM10-QSB**

 

**ý****QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)OF THE SECURITIES EXCHANGE ACT OF 1934**

 

**Forthe Quarterly Period Ended June 30, 2004**

 

**OR**

 

**o****TRANSITION REPORT PURSUANT TO SECTION 13 OR15 (d)OF THE SECURITIES EXCHANGE ACT OF 1934**

 

**Forthe Transition Periodfrom             to             **

 

**Commission file****number 000-27719**

 

**Greenville FirstBancshares, Inc.**

(Exact name ofregistrant as specified in its charter)

 

| **South Carolina**                        | ** ** | **58-2459561**                        |
|-------------------------------------------|------------|---------------------------------------|
| (State of  Incorporation)                 |       | (I.R.S.  Employer Identification No.) |
|                                      |       |                                  |
| **112 Haywood Road  Greenville, S.C.**    | ** ** | **29607**                             |
| (Address of  principal executive offices) |       | (Zip Code)                            |

 

**864-679-9000**

(TelephoneNumber)

 

**NotApplicable**

(Former name,former address

and former fiscal year,

if changed since last report)

 

Check whether the issuer (1) has filed all reports required to be filedby Section 13 or 15(d) of the Exchange Act during the past 12 months (orfor such shorter period that the registrant was required to file such reports),and (2) has been subject to such filing requirements for the past 90days.  Yes ý No o

 

APPLICABLEONLY TO CORPORATE ISSUERS

 

State thenumber of shares outstanding of each of the issuer’s classes of common equity,as of the latest practicable date:

 

1,727,994 shares of common stock, $.01 par value per share, issued andoutstanding as of July 9, 2004.

 

TransitionalSmall Business Disclosure Format (check one): YES o  NO ý

 

 

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**GREENVILLEFIRST BANCSHARES, INC.**

 

**PARTI.  FINANCIAL INFORMATION**

 

**Item1.****  Financial Statements**

 

The financialstatements of Greenville First Bancshares, Inc. and Subsidiary are set forth inthe following pages.

 

2

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***GREENVILLE FIRST BANCSHARES, INC. ANDSUBSIDIARY***

***CONSOLIDATED BALANCE SHEETS***

 
| ** **                                                                                                                                                            | ** ** | **June 30,  2004** | ** **  | **December 31,  2003** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------|-------------|-----------------------------|------------|
| ** **                                                                                                                                                            | ** ** | **(Unaudited)**         | ** **  | **(Audited)**               | ** ** |
| **Assets**                                                                                                                                                            |       |                    |        |                        |       |
| Cash and due from banks                                                                                                                                               |       | $                       | 2,613,413   |                        | $          | 4,104,697 |   |
| Federal funds sold                                                                                                                                                    |       | 1,365,400               |        | 2,842,594                   |       |
| Investment securities available for sale                                                                                                                              |       | 3,078,733               |        | 3,628,996                   |       |
| Investment securities held to maturity-  (market value $13,658,094 and $9,761,305)                                                                                    |       | 14,215,247              |        | 9,834,324                   |       |
| Other investments, at cost                                                                                                                                            |       | 3,591,373               |        | 2,296,150                   |       |
| Loans, net                                                                                                                                                            |       | 244,407,022             |        | 206,076,833                 |       |
| Accrued interest                                                                                                                                                      |       | 871,930                 |        | 756,905                     |       |
| Property and equipment, net                                                                                                                                           |       | 1,557,915               |        | 824,259                     |       |
| Other real estate owned                                                                                                                                               |       | 305,485                 |        | —                      |       |
| Other assets                                                                                                                                                          |       | 1,386,183               |        | 476,463                     |       |
| Total assets                                                                                                                                                          |       | $                       | 273,392,701 |                        | $          | 230,841,221 |   |
|                                                                                                                                                                  |       |                    |        |                        |       |
| **Liabilities**                                                                                                                                                       |       |                    |        |                        |       |
| Deposits                                                                                                                                                              |       | $                       | 177,987,321 |                        | $          | 168,963,595 |   |
| Official checks outstanding                                                                                                                                           |       | 1,104,261               |        | 1,575,357                   |       |
| Federal funds purchased and repurchase  agreements                                                                                                                    |       | 13,565,000              |        | 9,296,999                   |       |
| Federal Home Loan Bank advances                                                                                                                                       |       | 58,400,000              |        | 32,500,000                  |       |
| Note payable                                                                                                                                                          |       | 3,000,000               |        | —                      |       |
| Junior subordinate debentures                                                                                                                                         |       | 6,186,000               |        | 6,186,000                   |       |
| Accrued interest payable                                                                                                                                              |       | 724,534                 |        | 572,272                     |       |
| Accounts payable and accrued expenses                                                                                                                                 |       | 485,023                 |        | 560,030                     |       |
| Total liabilities                                                                                                                                                     |       | 261,452,139             |        | 219,654,253                 |       |
|                                                                                                                                                                  |       |                    |        |                        |       |
| **Shareholders’  equity**                                                                                                                                        |       |                    |        |                        |       |
| Preferred stock, par value $.01 per share,  10,000,000 shares authorized, no shares issued                                                                            |       | —                  |        | —                      |       |
| Common stock, par value $.00667  Authorized, 10,000,000 shares. Issued 1,727,994  and 1,724,994 at June 30, 2004  and December 31, 2003, respectively. |       | 11,520                  |        | 11,500                      |       |
| Additional paid-in capital                                                                                                                                            |       | 10,655,190              |        | 10,635,200                  |       |
| Accumulated other comprehensive income                                                                                                                                |       | 28,780                  |        | 96,997                      |       |
| Retained earnings                                                                                                                                                     |       | 1,245,072               |        | 443,271                     |       |
| Total shareholders’ equity                                                                                                                                       |       | 11,940,562              |        | 11,186,968                  |       |
| Total liabilities and shareholders’ equity                                                                                                                       |       | $                       | 273,392,701 |                        | $          | 230,841,221 |   |

 

See notes to consolidated financialstatements that are an integral part of these consolidated statements.

 

3

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***GREENVILLE FIRST BANCSHARES, INC. ANDSUBSIDIARY***

***CONSOLIDATED STATEMENTS OF INCOME***

 
| ** **                                            | ** ** | **For the Three months ended  June 30,** | ** ** |
|-------------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                            | ** ** | **2004**                                      | ** ** | **2003** | ** ** |
| ** **                                            | ** ** | **(Unaudited)**                               | ** ** | **(Unaudited)** | ** ** |
| **Interest income**                                   |       |                                          |       |   |   |
| Loans                                                 |       | $                                             | 2,950,548  |   | $ | 2,219,654 |   |
| Investment securities                                 |       | 220,364                                       |       | 62,569 |   |
| Federal funds sold                                    |       | 4,703                                         |       | 5,179 |   |
| Total interest income                                 |       | 3,175,615                                     |       | 2,287,402 |   |
| **Interest expense**                                  |       |                                          |       |   |   |
| Deposits                                              |       | 840,564                                       |       | 682,896 |   |
| Borrowings                                            |       | 374,606                                       |       | 177,924 |   |
| Total interest expense                                |       | 1,215,170                                     |       | 860,820 |   |
| Net interest income before provision for  loan losses |       | 1,960,445                                     |       | 1,426,582 |   |
| Provision for loan losses                             |       | 300,000                                       |       | 200,000 |   |
| Net interest income after provision for  loan losses  |       | 1,660,445                                     |       | 1,226,582 |   |
| **Noninterest income**                                |       |                                          |       |   |   |
| Loan fee income                                       |       | 40,789                                        |       | 59,312 |   |
| Service fees on deposit accounts                      |       | 72,978                                        |       | 63,567 |   |
| Write-down on real estate owned                       |       | —                                        |       | (100,000 | ) |
| Other income                                          |       | 86,810                                        |       | 61,075 |   |
| Total noninterest income                              |       | 200,577                                       |       | 83,954 |   |
| **Noninterest  expenses**                             |       |                                          |       |   |   |
| Compensation and benefits                             |       | 600,877                                       |       | 488,564 |   |
| Professional fees                                     |       | 50,882                                        |       | 40,958 |   |
| Marketing                                             |       | 74,679                                        |       | 43,396 |   |
| Insurance                                             |       | 31,146                                        |       | 26,580 |   |
| Occupancy                                             |       | 149,129                                       |       | 137,965 |   |
| Data processing and related costs                     |       | 215,304                                       |       | 154,473 |   |
| Telephone                                             |       | 6,836                                         |       | 5,717 |   |
| Other                                                 |       | 64,661                                        |       | 42,794 |   |
| Total noninterest expenses                            |       | 1,193,514                                     |       | 940,447 |   |
| Income before income tax expense                      |       | 667,508                                       |       | 370,089 |   |
| **Income tax expense**                                |       | 253,657                                       |       | 140,634 |   |
| **Net income**                                        |       | $                                             | 413,851    |   | $ | 229,455 |   |
| **Earnings per common  share:**                       |       |                                          |       |   |   |
| Basic                                                 |       | $                                             | 0.24       |   | $ | 0.13 |   |
| Diluted                                               |       | $                                             | 0.21       |   | $ | 0.12 |   |
| **Weighted average  common shares outstanding**       |       |                                          |       |   |   |
| Basic                                                 |       | 1,725,494                                     |       | 1,724,994 |   |
| Diluted                                               |       | 1,988,584                                     |       | 1,886,399 |   |

 

See notes to consolidated financialstatements that are an integral part of these consolidated statements.

 

4

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***GREENVILLE FIRST BANCSHARES, INC. ANDSUBSIDIARY***

***CONSOLIDATED STATEMENTS OF INCOME***

 
| ** **                                            | ** ** | **For the Six months ended  June 30,** | ** ** |
|-------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                            | ** ** | **2004**                                    | ** ** | **2003** | ** ** |
| ** **                                            | ** ** | **(Unaudited)**                             | ** ** | **(Unaudited)** | ** ** |
| **Interest income**                                   |       |                                        |       |   |   |
| Loans                                                 |       | $                                           | 5,688,464  |   | $ | 4,307,650 |   |
| Investment securities                                 |       | 445,178                                     |       | 199,113 |   |
| Federal funds sold                                    |       | 9,293                                       |       | 11,668 |   |
| Total interest income                                 |       | 6,142,935                                   |       | 4,518,431 |   |
| **Interest expense**                                  |       |                                        |       |   |   |
| Deposits                                              |       | 1,568,286                                   |       | 1,412,376 |   |
| Borrowings                                            |       | 681,219                                     |       | 340,394 |   |
| Total interest expense                                |       | 2,249,505                                   |       | 1,752,770 |   |
| Net interest income before provision for  loan losses |       | 3,893,430                                   |       | 2,765,661 |   |
| Provision for loan losses                             |       | 650,000                                     |       | 500,000 |   |
| Net interest income after provision for  loan losses  |       | 3,243,430                                   |       | 2,265,661 |   |
| **Noninterest income**                                |       |                                        |       |   |   |
| Loan fee income                                       |       | 66,824                                      |       | 103,666 |   |
| Service fees on deposit accounts                      |       | 139,728                                     |       | 123,296 |   |
| Write-down on real estate owned                       |       | —                                      |       | (100,000 | ) |
| Other income                                          |       | 156,348                                     |       | 104,145 |   |
| Total noninterest income                              |       | 362,900                                     |       | 231,107 |   |
| **Noninterest  expenses**                             |       |                                        |       |   |   |
| Compensation and benefits                             |       | 1,199,522                                   |       | 967,842 |   |
| Professional fees                                     |       | 99,815                                      |       | 74,559 |   |
| Marketing                                             |       | 125,958                                     |       | 78,745 |   |
| Insurance                                             |       | 61,662                                      |       | 53,265 |   |
| Occupancy                                             |       | 289,899                                     |       | 299,362 |   |
| Data processing and related costs                     |       | 396,775                                     |       | 287,530 |   |
| Telephone                                             |       | 13,306                                      |       | 11,187 |   |
| Other                                                 |       | 126,159                                     |       | 84,955 |   |
| Total noninterest expenses                            |       | 2,313,096                                   |       | 1,857,445 |   |
| Income before income tax expense                      |       | 1,293,234                                   |       | 639,323 |   |
| **Income tax expense**                                |       | 491,433                                     |       | 242,942 |   |
| **Net income**                                        |       | $                                           | 801,801    |   | $ | 396,381 |   |
| **Earnings per common  share:**                       |       |                                        |       |   |   |
| Basic                                                 |       | $                                           | 0.46       |   | $ | 0.23 |   |
| Diluted                                               |       | $                                           | 0.40       |   | $ | 0.21 |   |
| **Weighted average  common shares outstanding**       |       |                                        |       |   |   |
| Basic                                                 |       | 1,725,294                                   |       | 1,724,994 |   |
| Diluted                                               |       | 1,998,109                                   |       | 1,860,371 |   |

 

See notes to consolidated financialstatements that are an integral part of these consolidated statements.

 

5

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***GREENVILLE FIRST BANCSHARES, INC. ANDSUBSIDIARY***

***CONSOLIDATED STATEMENTS OF SHAREHOLDERS’EQUITY***

***AND COMPREHENSIVE INCOME***

***FOR THE SIX MONTHS ENDED JUNE 30, 2004AND 2003***

***(Unaudited)***

 
| ** **                                                | ** ** | **Common Stock** | ** ** | **Additional  paid-in  capital** | ** ** | **Accumulated  other  comprehensive  income** | ** ** | **Retained  earnings  (deficit)** | ** ** | **Total  shareholders  equity** | ** ** |
|-----------------------------------------------------------|------------|------------------|------------|----------------------------------|------------|-----------------------------------------------|------------|-----------------------------------|------------|---------------------------------|------------|
| ** **                                                | **Shares** | ** **       | **Amount** | ** **                       | ** ** | ** **                                    | ** ** | ** **                        |
|                                                      |       |             |       |                             |       |                                          |       |                              |       |                            |       |   |   |
| **December 31,  2002**                               |       | 1,150,000        |       | $                                | 11,500     |                                          | $          | 10,635,200                        |       | $                               | 147,733    |   | $ | (562,644 | ) | $ | 10,231,789 |   |
|                                                      |       |             |       |                             |       |                                          |       |                              |       |                            |       |   |   |
| Net income                                                |       | —           |       | —                           |       | —                                        |       | —                            |       | 396,381                         |       | 396,381 |   |
|                                                      |       |             |       |                             |       |                                          |       |                              |       |                            |       |   |   |
| Comprehensive loss, net of tax -                          |       |             |       |                             |       |                                          |       |                              |       |                            |       |   |   |
| Unrealized holding gain on securities  available for sale |       | —           |       | —                           |       | —                                        |       | (27,614                           | )          | —                          |       | (27,614 | ) |
|                                                      |       |             |       |                             |       |                                          |       |                              |       |                            |       |   |   |
| Comprehensive income                                      |       | —           |       | —                           |       | —                                        |       | —                            |       | —                          |       | 368,767 |   |
|                                                      |       |             |       |                             |       |                                          |       |                              |       |                            |       |   |   |
| **June 30, 2003**                                    |       | 1,150,000        |       | $                                | 11,500     |                                          | $          | 10,635,200                        |       | $                               | 120,119    |   | $ | (166,263 | ) | $ | 10,600,556 |   |
|                                                      |       |             |       |                             |       |                                          |       |                              |       |                            |       |   |   |
|                                                      |       |             |       |                             |       |                                          |       |                              |       |                            |       |   |   |
| **December 31,  2003**                               |       | 1,724,994        |       | $                                | 11,500     |                                          | $          | 10,635,200                        |       | $                               | 96,997     |   | $ | 443,271 |   | $ | 11,186,968 |   |
|                                                      |       |             |       |                             |       |                                          |       |                              |       |                            |       |   |   |
| Net income                                                |       | —           |       | —                           |       | —                                        |       | —                            |       | 801,801                         |       | 801,801 |   |
|                                                      |       |             |       |                             |       |                                          |       |                              |       |                            |       |   |   |
| Comprehensive income, net of tax -                        |       |             |       |                             |       |                                          |       |                              |       |                            |       |   |   |
| Unrealized holding loss on securities  available for sale |       | —           |       | —                           |       | —                                        |       | (68,217                           | )          | —                          |       | (68,217 | ) |
|                                                      |       |             |       |                             |       |                                          |       |                              |       |                            |       |   |   |
| Comprehensive income                                      |       | —           |       | —                           |       | —                                        |       | —                            |       | —                          |       | 733,584 |   |
|                                                      |       |             |       |                             |       |                                          |       |                              |       |                            |       |   |   |
| Exercise of warrants                                      |       | 3,000            |       | 20                               |       | 19,990                                        |       | —                            |       | —                          |       | 20,010 |   |
|                                                      |       |             |       |                             |       |                                          |       |                              |       |                            |       |   |   |
| **June 30, 2004**                                    |       | 1,727,994        |       | $                                | 11,520     |                                          | $          | 10,655,190                        |       | $                               | 28,780     |   | $ | 1,245,072 |   | $ | 11,940,562 |   |

 

See notes to consolidated financialstatements that are an integral part of these consolidated statements.

 

6

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***GREENVILLE FIRST BANCSHARES, INC. ANDSUBSIDIARY***

***CONSOLIDATED STATEMENTS OF CASH FLOWS***

 
| ** **                                                                     | ** ** | **For the Six months ended  June 30,** | ** ** |
|--------------------------------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                                                     | ** ** | **2004**                                    | ** ** | **2003** | ** ** |
| ** **                                                                     | ** ** | **(Unaudited)**                             | ** ** | **(Unaudited)** | ** ** |
| **Operating activities**                                                       |       |                                        |       |   |   |
| Net income                                                                     |       | $                                           | 801,801    |   | $ | 396,381 |   |
| Adjustments to reconcile net income to cash  provided by operating activities: |       |                                        |       |   |   |
| Provision for loan losses                                                      |       | 650,000                                     |       | 500,000 |   |
| Depreciation and other amortization                                            |       | 73,553                                      |       | 69,704 |   |
| Accretion and amortization of securities discounts  and premiums, net          |       | 50,756                                      |       | 50,869 |   |
| Increase in other assets, net                                                  |       | (1,024,744                                  | )          | (631,328  | ) |
| Increase (decrease) in other liabilities, net                                  |       | (358,699                                    | )          | 2,959,721 |   |
|                                                                           |       |                                        |       |   |   |
| Net cash provided by operating activities                                      |       | 192,667                                     |       | 3,345,347 |   |
|                                                                           |       |                                        |       |   |   |
| **Investing activities**                                                       |       |                                        |       |   |   |
| Origination of loans, net                                                      |       | (39,285,674                                 | )          | (26,005,362 | ) |
| Purchase of property and equipment                                             |       | (807,209                                    | )          | (33,042 | ) |
| Purchase of investment securities:                                             |       |                                        |       |   |   |
| Held to maturity                                                               |       | (5,585,942                                  | )          | — |   |
| Other investments                                                              |       | (2,510,000                                  | )          | (800,000 | ) |
| Payments and maturity of investment securities:                                |       |                                        |       |   |   |
| Available for sale                                                             |       | 429,286                                     |       | 9,889,791 |   |
| Held to maturity                                                               |       | 1,171,657                                   |       | — |   |
| Other investments                                                              |       | 1,215,000                                   |       | — |   |
|                                                                           |       |                                        |       |   |   |
| Net cash used for investing activities                                         |       | (45,372,882                                 | )          | (16,948,613 | ) |
|                                                                           |       |                                        |       |   |   |
| **Financing activities**                                                       |       | ** **                                  |       |   |   |
| Increase in deposits, net                                                      |       | 9,023,726                                   |       | 10,983,054 |   |
| Increase (decrease) in short-term borrowings                                   |       | 4,268,001                                   |       | (9,107,000 | ) |
| Increase (decrease) in other borrowings                                        |       | 3,000,000                                   |       | (2,500,000 | ) |
| Proceeds from junior subordinate debentures                                    |       | —                                      |       | 6,186,000 |   |
| Proceeds from exercise of stock warrants, net                                  |       | 20,010                                      |       | — |   |
| Increase in Federal Home Loan Bank advances                                    |       | 25,900,000                                  |       | 12,500,000 |   |
|                                                                           |       |                                        |       |   |   |
| Net cash provided by financing activities                                      |       | 42,211,737                                  |       | 18,062,054 |   |
|                                                                           |       |                                        |       |   |   |
| Net increase (decrease) in cash and cash  equivalents                          |       | (2,968,478                                  | )          | 4,458,788 |   |
|                                                                           |       |                                        |       |   |   |
|                                                                           |       |                                        |       |   |   |
| **Cash and cash equivalents at  beginning of the period**                      |       | 6,947,291                                   |       | 4,471,026 |   |
|                                                                           |       |                                        |       |   |   |
| **Cash and cash equivalents at end  of the period**                            |       | $                                           | 3,978,813  |   | $ | 8,929,814 |   |
|                                                                           |       |                                        |       |   |   |
| **Supplemental information**                                                   |       |                                        |       |   |   |
| **Cash paid for**                                                              |       |                                        |       |   |   |
| Interest                                                                       |       | $                                           | 2,097,244  |   | $ | 1,416,591 |   |
|                                                                           |       |                                        |       |   |   |
| Income taxes                                                                   |       | $                                           | 1,266,585  |   | $ | 479,527 |   |
|                                                                           |       |                                        |       |   |   |
| **Schedule of non-cash  transactions**                                    |       |                                        |       |   |   |
| Foreclosure of real estate                                                     |       | $                                           | 305,485    |   | $ | — |   |
|                                                                           |       |                                        |       |   |   |
| Unrealized loss on securities, net of income taxes                             |       | $                                           | (68,217    | ) | $ | (27,614 | ) |

 

See notes to consolidated financial statements that are an integral partof these consolidated statements.

 

7

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***GREENVILLE FIRST BANCSHARES, INC.  AND SUBSIDIARY***

***NOTES TO CONSOLIDATED FINANCIAL STATEMENTS***

 

**Note 1 – Nature of Business and Basis of Presentation**

 

**Business activity**

 

Greenville First Bancshares, Inc.** (the “company”) is aSouth Carolina corporation that owns all of the capital stock of GreenvilleFirst Bank, N.A.**** (the “bank”) and allof the stock of Greenville First Statutory Trust I (the “Trust”).  The bank is a national bank organized underthe laws of the United States located in Greenville County, SouthCarolina.  The bank is primarily engagedin the business of accepting demand deposits and savings deposits insured bythe Federal Deposit Insurance Corporation, and providing commercial, consumerand mortgage loans to the general public. The Trust is a special purpose subsidiary for the sole purpose ofissuing trust preferred securities.

 

**Basis of Presentation**

 

Theaccompanying financial statements have been prepared in accordance withgenerally accepted accounting principles for interim financial information andwith the instructions to Form 10-QSB. Accordingly, they do not include all the information and footnotesrequired by accounting principles generally accepted in the United States ofAmerica for complete financial statements. In the opinion of management, all adjustments (consisting of normalrecurring accruals) considered necessary for a fair presentation have beenincluded.  Operating results for thesix-month period ended June 30, 2004 are not necessarily indicative of theresults that may be expected for the year ending December 31, 2004.  For further information, refer to the consolidatedfinancial statements and footnotes thereto included in the company’s Form10-KSB (Registration Number 000-27719) as filed with the Securities andExchange Commission.  The consolidatedfinancial statements include the accounts of Greenville First Bancshares, Inc.,and its wholly owned subsidiary Greenville First Bank,N.A.  As discussed in Note 6, thefinancial statements related to the special purpose subsidiary, GreenvilleFirst Statutory Trust I, have not been consolidated in accordance with FASBInterpretation No. 46.

 

**Cash andCash Equivalents**

 

For purposes of the Consolidated Statement of Cash Flows, cash andfederal funds sold are included in “cash and cash equivalents.”  These assets have contractual maturities ofless than three months.

 

**Note 2 – Reclassifications**

 

Certain amounts, previously reported, have been reclassified to stateall periods on a comparable basis that had no effect on shareholder’s equity ornet income.

 

**Note 3 – Stock Split**

 

On November 17, 2003, shareholders of record as ofNovember 3, 2003, received one additional share of stock for every twoshares of stock owned prior to the 3 for 2 stock split.  All factional shares were paid in cash.  The earnings per share amounts for allperiods shown have been adjusted to reflect the 3 for 2 split.

 

**Note 4 – Note Payable**

 

At June 30, 2004, the company had a $4.5 million revolving line ofcredit with another bank.  AtJune 30, 2004, the outstanding balance was $3.0 million.  This line of credit has a maturity ofMarch 20, 2005. The line of credit bears interest at a rate of three-monthlibor plus 2.00%, which at June 30, 2004 was 3.11%.  The company has pledged the stock of the bankas collateral for this line of credit. The line of credit agreement containsvarious covenants related to earnings and asset quality.  As of June 30, 2004, the companybelieves it is in compliance with all covenants.

 

8

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**Note 5 – Earnings per Share**

 

The following schedule reconciles the numeratorsand denominators of the basic and diluted earnings per share computations forthe three months and six months ended June 30, 2004 and 2003.  Dilutive common shares arise from thepotentially dilutive effect of Greenville First Bancshares, Inc.’s stockoptions and warrants that are outstanding. The assumed conversion of stock options and warrants can create adifference between basic and dilutive net income per common share.  The average dilutive shares have beencomputed utilizing the “treasury stock” method. The numbers of shares and the earnings per share have been adjusted forthe 3 for 2 stock split.

 

 
| ** **                        | ** ** | **Three months ended June 30,** | ** ** |
|-----------------------------------|------------|--------------------------------------|------------|
| ** **                        | ** ** | **2004**                             | ** ** | **2003** | ** ** |
|                              |       |                                 |       |   |   |
| Basic Earnings Per Share          |       |                                 |       |   |   |
| Average common shares             |       | 1,725,494                            |       | 1,724,994 |   |
| Net income                        |       | $                                    | 413,851    |   | $ | 229,455 |   |
| Earnings per share                |       | $                                    | 0.24       |   | $ | 0.13 |   |
|                              |       |                                 |       |   |   |
| Diluted Earnings Per Share        |       |                                 |       |   |   |
| Average common shares outstanding |       | 1,725,494                            |       | 1,724,994 |   |
| Average dilutive common shares    |       | 263,090                              |       | 161,405 |   |
| Adjusted average common shares    |       | 1,988,584                            |       | 1,886,399 |   |
| Net income                        |       | $                                    | 413,851    |   | $ | 229,455 |   |
| Earnings per share                |       | $                                    | 0.21       |   | $ | 0.12 |   |

 
| ** **                        | ** ** | **Six months ended June 30,** | ** ** |
|-----------------------------------|------------|------------------------------------|------------|
| ** **                        | ** ** | **2004**                           | ** ** | **2003** | ** ** |
|                              |       |                               |       |   |   |
| Basic Earnings Per Share          |       |                               |       |   |   |
| Average common shares             |       | 1,725,294                          |       | 1,724,994 |   |
| Net income                        |       | $                                  | 801,801    |   | $ | 396,381 |   |
| Earnings per share                |       | $                                  | 0.46       |   | $ | 0.23 |   |
|                              |       |                               |       |   |   |
| Diluted Earnings Per Share        |       |                               |       |   |   |
| Average common shares outstanding |       | 1,725,294                          |       | 1,724,994 |   |
| Average dilutive common shares    |       | 272,815                            |       | 135,377 |   |
| Adjusted average common shares    |       | 1,998,109                          |       | 1,860,371 |   |
| Net income                        |       | $                                  | 801,801    |   | $ | 396,381 |   |
| Earnings per share                |       | $                                  | 0.40       |   | $ | 0.21 |   |

 

**Note 6 – Accounting for Variable Interest Entities**

 

Effective January 1,2004, the Company adopted FASB Interpretation No. 46, (“FIN 46”),“Consolidation of Variable Interest Entities.” In accordance with FIN 46, the$186,000 investment by the parent company, Greenville First Bancshares,Inc,  in the special purpose subsidiary,Greenville First Statutory Trust I, results in the special purpose subsidiary being treated as a “variableinterest entity” as defined in FIN 46. Therefore, in accordance with the revised rules, the Company did notconsolidate its special purpose trust subsidiary.  Prior to the January 1, 2004, theeffective date on the adoption of FIN 46, the company had consolidated thespecial purpose subsidiary.  The 2003,consolidated financial statements have been restated, resulting in the“deconsolidation” of this wholly-owned subsidiary.  The deconsolidation of this wholly-ownedsubsidiary, increased both the Company’s other assets by $186,000, and the debtassociated with the junior subordinate debentures.  The company’s maximum exposure to loss is the$186,000 invested in the special purpose subsidiary.  In addition to the loss exposure related tothe investment in the special purpose subsidiary, the Company has a full andunconditional guarantee for the $6,000,000 junior subordinate debentures thatwere issued.  The special purposesubsidiary was formed for the sole purpose of issuing the junior subordinatedebentures.

 

9

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**Note 7 – Stock Based Compensation**

 

The companyhas a stock-based employee compensation plan. The company accounts for the plan under the recognition and measurementprinciples of Accounting Principles Board (“APB”) Opinion No. 25, *Accounting for Stock Issued to Employees,* and relatedInterpretations.  No stock-based employeecompensation cost is reflected in net income, as all stock options grantedunder these plans had an exercise price equal to the market value of theunderlying common stock on the date of grant. The following table illustrates the effect on net income and earningsper share if the company had applied the fair value recognition provisions ofFinancial Accounting Standards Board (“FASB”), Statement of FinancialAccounting Standards (“SFAS”) No. 123, *Accounting for Stock-BasedCompensation,* to stock-based employee compensation.

 
| ** **                                                                                                                                          | ** ** | **For the Three months ended June 30,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------|------------|
| ** **                                                                                                                                          | ** ** | **2004**                                     | ** ** | **2003** | ** ** |
|                                                                                                                                                |       |                                         |       |   |   |
| Net income, as reported                                                                                                                             |       | $                                            | 413,851    |   | $ | 229,455 |   |
| Deduct:   Total stock-based employee compensation expense determined under fair  value based method for all awards, net of related tax effects |       | (20,719                                      | )          | (19,613 | ) |
|                                                                                                                                                |       |                                         |       |   |   |
| Pro forma net income                                                                                                                                |       | $                                            | 393,132    |   | $ | 209,842 |   |
|                                                                                                                                                |       |                                         |       |   |   |
| Earnings per common share-adjusted for 3  for 2 stock split:                                                                                        |       |                                         |       |   |   |
| Basic - as reported                                                                                                                                 |       | $                                            | 0.24       |   | $ | 0.13 |   |
| Basic - pro forma                                                                                                                                   |       | $                                            | 0.23       |   | $ | 0.12 |   |
|                                                                                                                                                |       |                                         |       |   |   |
| Diluted - as reported                                                                                                                               |       | $                                            | 0.21       |   | $ | 0.12 |   |
| Diluted - pro-forma                                                                                                                                 |       | $                                            | 0.20       |   | $ | 0.11 |   |

 
| ** **                                                                                                                                          | ** ** | **For the Six months ended June 30,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                                                                                          | ** ** | **2004**                                   | ** ** | **2003** | ** ** |
|                                                                                                                                                |       |                                       |       |   |   |
| Net income, as reported                                                                                                                             |       | $                                          | 801,801    |   | $ | 396,381 |   |
| Deduct:   Total stock-based employee compensation expense determined under fair  value based method for all awards, net of related tax effects |       | (41,438                                    | )          | (39,226 | ) |
|                                                                                                                                                |       |                                       |       |   |   |
| Pro forma net income                                                                                                                                |       | $                                          | 760,363    |   | $ | 357,155 |   |
|                                                                                                                                                |       |                                       |       |   |   |
| Earnings per common share-adjusted for 3  for 2 stock split:                                                                                        |       |                                       |       |   |   |
| Basic - as reported                                                                                                                                 |       | $                                          | 0.46       |   | $ | 0.23 |   |
| Basic - pro forma                                                                                                                                   |       | $                                          | 0.44       |   | $ | 0. 21 |   |
|                                                                                                                                                |       |                                       |       |   |   |
| Diluted - as reported                                                                                                                               |       | $                                          | 0.40       |   | $ | 0.21 |   |
| Diluted - pro-forma                                                                                                                                 |       | $                                          | 0.38       |   | $ | 0.19 |   |

 

The fair value of the option grant is estimated on thedate of grant using the Black-Scholes option-pricing model.  The following assumptions were used forgrants: expected volatility of 10% for 2004 and 2003, risk-free interest rate of3.00% for 2004 and 2003 respectively, expected lives of the options 10 years,and the assumed dividend rate was zero.

 

10

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**Item 2.**

 

**MANAGEMENT’S DISCUSSION AND ANALYSIS**

 

*The following discussion reviews our resultsof operations and assesses our financial condition.  You should read the following discussion andanalysis in conjunction with the accompanying consolidated financialstatements.  The commentary should be readin conjunction with the discussion of forward-looking statements, the financialstatements and the related notes and the other statistical information includedin this report.*

 

**DISCUSSION OF FORWARD-LOOKING STATEMENTS**

 

This reportcontains “forward-looking statements” relating to, without limitation, futureeconomic performance, plans and objectives of management for future operations,and projections of revenues and other financial items that are based on thebeliefs of management, as well as assumptions made by and information currentlyavailable to management.  The words“may,” “will,” “anticipate,” “should,” “would,” “believe,” “contemplate,”“expect,” “estimate,” “continue,” and “intend,” as well as other similar wordsand expressions of the future, are intended to identify forward-lookingstatements.  Our actual results may differmaterially from the results discussed in the forward-looking statements, andour operating performance each quarter is subject to various risks anduncertainties that are discussed in detail in our filings with the Securitiesand Exchange Commission, including, without limitation:

 

•                  significant increases in competitive pressure in the bankingand financial services industries;

•                  changes in the interest rate environment which could reduceanticipated or actual margins;

•                  changes in political conditions or the legislative orregulatory environment;

•                  general economic conditions, either nationally or regionallyand especially in primary service area, becoming less favorable than expectedresulting in, among other things, a deterioration in credit quality;

•                  changesoccurring in business conditions and inflation;

•                  changes in technology;

•                  changes in monetary and tax policies;

•                  the level of allowance for loan loss;

•                  the rate of delinquencies and amounts of charge-offs;

•                  the rates of loan growth;

•                  adverse changes in asset quality and resulting creditrisk-related losses and expenses;

•                  loss of consumer confidence and economicdisruptions resulting from terrorist activities;

•                  changes in thesecurities markets; and

•                  other risks and uncertainties detailed from time to time inour filings with the Securities and Exchange Commission.

 

**Overview**

 

We were incorporated in March 1999 toorganize and serve as the holding company for Greenville First Bank, N.A.  Since we opened our bank inJanuary 2000, we have experienced consistent growth in total assets,loans, deposits, and shareholders’ equity, which has continued during the firstsix months of 2004.

 

Likemost community banks, we derive the majority of our income from interestreceived on our loans and investments. Our primary source of funds for making these loans and investments isour deposits, on which we pay interest. Consequently, one of the key measures of our success is our amount ofnet interest income, or the difference between the income on our interest-earningassets, such as loans and investments, and the expense on our interest-bearingliabilities, such as deposits and borrowings. Another key measure is the spread between the yield we earn on theseinterest-earning assets and the rate we pay on our interest-bearingliabilities, which is called our net interest spread.

 

Thereare risks inherent in all loans, so we maintain an allowance for loan losses toabsorb probable losses on existing loans that may become uncollectible.  We maintain this allowance by charging aprovision for loan losses against our operating earnings for each period.  We have included a detailed discussion ofthis process, as well as several tables describing our allowance for loanlosses.

 

Inaddition to earning interest on our loans and investments, we earn incomethrough fees and other charges to our customers.  We have also included a discussion of thevarious components of this noninterest income, as well as of our noninterestexpense.

 

11

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The followingdiscussion and analysis also identifies significant factors that have affectedour financial position and operating results during the periods included in theaccompanying financial statements.  Weencourage you to read this discussion and analysis in conjunction with ourfinancial statements and the other statistical information included in ourfilings with the Securities and Exchange Commission.

 

#### **CriticalAccounting Policies**

#### ** **

We have adopted various accounting policies that govern the applicationof accounting principles generally accepted in the United States and withgeneral practices within the banking industry in the preparation of ourfinancial statements.  Our significantaccounting policies are described in the footnotes to our audited consolidatedfinancial statements as of December 31, 2003, as filed in our annualreport on Form 10-KSB.

 

Certain accounting policies involve significant judgments andassumptions by us that have a material impact on the carrying value of certainassets and liabilities.  We considerthese accounting policies to be critical accounting policies.  The judgment and assumptions we use are basedon historical experience and other factors, which we believe to be reasonableunder the circumstances.  Because of thenature of the judgment and assumptions we make, actual results could differfrom these judgments and estimates that could have a material impact on thecarrying values of our assets and liabilities and our results of operations.

 

We believe theallowance for loan losses is the critical accounting policy that requires themost significant judgment and estimates used in preparation of our consolidatedfinancial statements.  Some of the morecritical judgments supporting the amount of our allowance for loan lossesinclude judgments about the credit worthiness of borrowers, the estimated valueof the underlying collateral, the assumptions about cash flow, determination ofloss factors for estimating credit losses, the impact of current events, andconditions, and other factors impacting the level of probable inherentlosses.  Under different conditions orusing different assumptions, the actual amount of credit losses incurred by usmay be different from management’s estimates provided in our consolidatedfinancial statements.  Refer to theportion of this discussion that addresses our allowance for loan losses for amore complete discussion of our processes and methodology for determining ourallowance for loan losses.

 

**Effect ofEconomic Trends**

 

Duringthe three years ended December 31, 2003, and the six months endedJune 30, 2004, our rates on both short-term or variable rateearning-assets and short-term or variable rate interest-bearing liabilitiesdeclined primarily as a result of the actions taken by the Federal Reserve.

 

Duringmost of 2001 and during 2002, the United States experienced an economicdecline.  During this period, the economywas affected by lower returns of the stock markets.  Economic data led the Federal Reserve tobegin an aggressive program of reducing rates that moved the Federal Funds ratedown 11 times during 2001 for a total reduction of 475 basis points.  During the fourth quarter of 2002 and thefirst six months of 2003, the Federal Reserve reduced the Federal Funds ratedown an additional 75 basis points, bringing the Federal Funds rate to itslowest level in 40 years.

 

Despitesharply lower short-term rates, stimulus to the economy during 2003 was mutedand consumer demand and business investment activity remained weak.  During all of 2003 and substantially all ofthe six months ended June 30, 2004, the financial markets operated underhistorically low interest rates. As a result of these unusual conditions,Congress passed an economic stimulus plan in 2003.  During the first six months of 2004, manyeconomists believed the economy began to show signs of strengthening and at theend of the second quarter the Federal Reserve increased the short-term interestrate by 25 basis points.  Many economistsbelieve that the Federal Reserve will continue to increase rates during theremainder of 2004 and during most of 2005. However, no assurance can be given that the Federal Reserve will takesuch action.

 

12

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**Results ofOperations**

 

***Income Statement Review***

 

*Summary*

 

*Three months ended June 30, 2004 and 2003*

 

Ournet income was $413,851 and $229,455 for the three months ended June 30,2004 and 2003, respectively, an increase of $184,396, or 80.4%.  Our income was fully taxable in both threemonth periods.  The $184,396 increase innet income resulted primarily from increases of $533,863 in net interest incomeand $116,623 in noninterest income. These increases were partly offset by $253,067 of additional noninterestexpense, a $100,000 increase in provisions for loan losses, and a $113,023 increase in income tax expense.  Our efficiency ratio continues to improvebecause we are earning more income without substantially increasing ouroverhead expenses.  Our efficiency ratiowas 55.23% and 62.26% for the three months ended June 30, 2004 and 2003,respectively.

 

S*ix months ended June 30, 2004 and 2003*

 

Ournet income was $801,801 and $396,381 for the six months ended June 30,2004 and 2003, respectively, an increase of $405,420, or 102.3%.  Our income was fully taxable in both sixmonth periods.  The $405,420 increase innet income resulted primarily from increases of $1.1 million in net interestincome and $131,793 in noninterest income. These increases were partly offset by $455,651 of additional noninterestexpense, a $150,000 increase in provisions for loan losses, and a $248,491increase in income tax expense.  Ourefficiency ratio continues to improve because we are earning more income withoutsubstantially increasing our overhead expenses. Our efficiency ratio was 54.35% and 61.96% for the six months endedJune 30, 2004 and 2003, respectively.

 

*Net InterestIncome*

 

Ourlevel of net interest income is determined by the level of earning assets andthe management of our net interest margin. The continuous growth in our loan portfolio is the primary driver of theincrease in net interest income.  Duringthe three months ended June 30, 2004, our loan portfolio had increased anaverage of $17.2 million compared to first quarter of 2004.  The growth in the first six months of 2004was $38.3 million.  We anticipate thegrowth in loans will continue to drive the growth in assets and the growth innet interest income.  However, noassurance can be given that we will be able to continue to increase loans atthe same levels we have experienced in the past.

 

Ourdecision to grow the loan portfolio at the current pace created the need for ahigher level of capital and the need to increase deposits and borrowings.  This loan growth strategy also resulted in asignificant portion of our assets being in higher earning loans than in loweryielding investments.  At June 30,2004, loans represented 89.4% of total assets, while investments and federalfunds sold represented 8.1% of total assets. While we plan to continue our focus on increasing the loan portfolio, asrates on investment securities begin to rise and additional capital anddeposits are obtained, we also anticipate increasing the size of the investmentportfolio.

 

Thehistorically low interest rate environment in the last three years allowed usto obtain short-term borrowings and wholesale certificates of deposit at ratesthat were lower than certificate of deposit rates being offered in our localmarket.  Therefore, we decided not tobegin our retail deposit expansion program until the end of 2004.  This funding strategy allowed us to continueto operate in one location, maintain a smaller staff, and not incur marketingcosts to advertise deposit rates, which in turn allowed us to focus on the fastgrowing loan portfolio.  At June 30,2004, retail deposits represented $106.9 million, or 39.1% of total assets,borrowings represented $81.2 million, or 29.7% of total assets, and wholesaleout-of-market deposits represented $71.1 million, or 26.0% of total assets.

 

Inanticipation of rising interest rates, we are planning to open two retaildeposit offices, one in the fourth quarter of 2004 and the other in the secondquarter of 2005.  We plan to focus ourefforts in these two locations to obtain low cost transaction accounts that areless affected by rising rates.  Also, inanticipation of rising rates, during the first six months of 2004, we offeredaggressive promotional rates on new checking accounts and new money marketaccounts.  The promotional rates offeredare 2.00% on checking accounts and 2.25% on money market accounts and areguaranteed until January 31, 2005. Based on prior experience, we anticipate the majority of these funds tobe retained at the end of the promotion. Our goal is to increase both the percentage of assets being funded by“in market” retail deposits and to

 

13

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increase the percentage of low-cost transaction accounts tototal deposits.  No assurance can begiven that these objectives will be achieved; however, we anticipate that thetwo additional retail deposit offices will assist us in meeting theseobjectives.  We also anticipate thecurrent deposit promotion and the opening of the two new offices will have anegative impact on earnings in the years ending 2004 and 2005.  However, we believe that these two strategieswill provide additional clients in our local market and will provide a loweralternative cost of funding in a higher or rising interest rate environment, whichwe believe will increase earnings in future periods.

 

Asmore fully discussed in the – “Market Risk” and – “Liquidity and Interest RateSensitivity” sections below, at June 30, 2004, 68.0% of our loans hadvariable rates.  Given our highpercentage of rate-sensitive loans, our primary focus during the three yearsended December 31, 2003 and for first six months of 2004 has been toobtain short-term liabilities to fund our asset growth.  This strategy allows us to manage the impacton our earnings resulting from changes in market interest rates.  At December 31, 2003, 83.4% ofinterest-bearing liabilities had a maturity of less than one year.

 

Inanticipation of rising rates, in May 2004 we converted a total of $25.0 millionof short-term deposits and borrowings with a term of less than three monthsinto $25.0 million of deposits and borrowings with a weighted average life offive years.  As of June 30, 2004,80.2% of interest-bearing liabilities had a maturity of less than oneyear.  We believe that we are positionedto benefit from future increases in short-term rates.  At June 30, 2004, we had $23.5 millionmore assets than liabilities that reprice within the next three months.

 

Weintend to maintain a capital level for the bank that exceeds the OCC requirementsto be classified as a “well capitalized” bank. To provide the additional capital needed to support our bank’s growth inassets, we issued $6.2 million in junior subordinated debentures in connectionwith our trust preferred securities offering, and we have borrowed $3.0 millionunder a short-term holding company line of credit.

 

Inaddition to the growth in both assets and liabilities, and the timing ofrepricing of our assets and liabilities, net interest income is also affectedby the ratio of interest-earning assets to interest-bearing liabilities and thechanges in interest rates earned on our assets and interest rates paid on ourliabilities.

 

Ournet interest income for the three months ended June 30, 2004 and the sixmonths ended June 30, 2004 increased because we had more interest-earningassets than interest-bearing liabilities. For the three and six months ended June 30, 2004, interest-earningassets exceeded interest-bearing liabilities by $6.6 million and $7.0 million,respectively.  The estimated $2.5 millioncost of the two additional retail offices will reduce the amount by whichinterest-earning assets exceed interest-bearing liabilities.

 

Duringthe three months and the six months ended June 30, 2004, our rates on bothshort-term or variable rate earning-assets and short-term or variable rateinterest-bearing liabilities declined primarily as a result of the actionstaken by the Federal Reserve to lower short-term rates.

 

Theimpact of the Federal Reserve’s actions resulted in a decline in both theyields on our variable rate assets and the rates that we paid for ourshort-term deposits and borrowings.  Ournet interest spread and net interest margins also declined since more of ourrate sensitive assets repriced sooner than our rate sensitive liabilitiesduring the three month and six month periods ending June 30, 2004.  Our net interest margin for the three monthand six month periods were 3.07% and 3.15%, respectively.

 

Weanticipate that the 25 basis point increase in short-term rates at the end ofthe second quarter of 2004 will result in an increase in loan yields, while our$25.0 million of longer-term, higher interest deposits and borrowings willresult in a higher cost of funds to us.  Accordingly,we believe that our net interest margin may continue to decline until furtheraction is taken by the Federal Reserve to increase short-term rates.

 

We have included a number of tables to assist in our description ofvarious measures of our financial performance. For example, the “Average Balances” tables show the average balance ofeach category of our assets and liabilities as well as the yield we earned orthe rate we paid with respect to each category during both the three monthsended June 30, 2004 and 2003 and the first six months of 2004 and2003.  A review of these tables showsthat our loans typically provide higher interest yields than do other types ofinterest-earning assets, which is why we direct a substantial percentage of ourearning assets into our loan portfolio. Similarly, the “Rate/Volume Analysis” tables help demonstrate the effectof changing interest rates and changing volume of assets and liabilities on ourfinancial condition during the periods shown. We also track the sensitivity of our various categories of assets andliabilities to changes in interest rates, and we have included tables toillustrate our interest rate sensitivity with respect to interest-earningaccounts and interest-

 

14

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bearingaccounts.  Finally, we have includedvarious tables that provide detail about our investment securities, our loans,our deposits, and other borrowings.

 

Thefollowing tables set forth information related to our average balance sheets,average yields on assets, and average costs of liabilities.  We derived these yields by dividing income orexpense by the average balance of the corresponding assets or liabilities.  We derived average balances from the dailybalances throughout the periods indicated. During the six months ended June 30, 2004 and 2003, all investmentswere taxable.  During the same period, wehad no interest-bearing deposits in other banks or any securities purchasedwith agreements to resell.  Allinvestments were owned at an original maturity of over one year.  Nonaccrual loans are included in thefollowing tables.  Loan yields have beenreduced to reflect the negative impact on our earnings of loans on nonaccrualstatus.  The net of capitalized loancosts and fees are amortized into interest income on loans.

 
| ** **                                            | ** ** | **Average Balances, Income and Expenses, and Rates  For the Three Months Ended June 30,** | ** ** |
|-------------------------------------------------------|------------|------------------------------------------------------------------------------------------------|------------|
| ** **                                            | ** ** | **2004**                                                                                       | ** ** | **2003** | ** ** |
| ** **                                            | ** ** | **Average  Balance**                                                                           | ** ** | **Income/  Expense** | ** ** | **Yield/  Rate(1)** | ** ** | **Average  Balance** | ** ** | **Income  Expense** | ** ** | **Yield/  Rate(1)** | ** ** |
| ** **                                            | ** ** | **(In thousands)**                                                                             | ** ** |
| Earning assets:                                       |       |                                                                                           |       |   |   |   |   |   |   |   |   |   |   |
| Federal funds sold                                    |       | $                                                                                              | 1,914      |   | $ | 5 |   | 1.05 | % | $ | 1,558 |   | $ | 5 |   | 1.29 | % |
| Investment securities                                 |       | 21,145                                                                                         |       | 220 |   | 4.18 | % | 6,815 |   | 63 |   | 3.71 | % |
| Loans                                                 |       | 234,057                                                                                        |       | 2,951 |   | 5.07 | % | 165,143 |   | 2,219 |   | 5.39 | % |
| Total earning-assets                                  |       | 257,116                                                                                        |       | 3,176 |   | 4.97 | % | 173,516 |   | 2,287 |   | 5.29 | % |
| Non-earning assets                                    |       | 7,566                                                                                          |       |   |   |   |   | 6,404 |   |   |   |   |   |
| Total assets                                          |       | $                                                                                              | 264,682    |   |   |   |   |   | $ | 179,920 |   |   |   |   |   |
| Interest-bearing liabilities:                         |       |                                                                                           |       |   |   |   |   |   |   |   |   |   |   |
| NOW accounts                                          |       | $                                                                                              | 38,631     |   | $ | 75 |   | .78 | % | $ | 28,902 |   | $ | 27 |   | .37 | % |
| Savings & money market                            |       | 39,543                                                                                         |       | 143 |   | 1.45 | % | 20,922 |   | 29 |   | .56 | % |
| Time deposits                                         |       | 99,392                                                                                         |       | 622 |   | 2.52 | % | 87,040 |   | 627 |   | 2.89 | % |
| Total interest-bearing deposits                       |       | 177,566                                                                                        |       | 840 |   | 1.90 | % | 136,864 |   | 683 |   | 2.00 | % |
| FHLB advances                                         |       | 50,131                                                                                         |       | 257 |   | 2.06 | % | 26,099 |   | 148 |   | 2.27 | % |
| Other borrowings                                      |       | 22,808                                                                                         |       | 118 |   | 2.08 | % | 3,807 |   | 30 |   | 3.16 | % |
| Total interest-bearing liabilities                    |       | 250,505                                                                                        |       | 1,215 |   | 1.95 | % | 166,770 |   | 861 |   | 2.07 | % |
| Non-interest bearing liabilities                      |       | 2,427                                                                                          |       |   |   |   |   | 2,396 |   |   |   |   |   |
| Shareholders’ equity                             |       | 11,750                                                                                         |       |   |   |   |   | 10,754 |   |   |   |   |   |
| Total liabilities and shareholders’  equity |       | $                                                                                              | 264,682    |   |   |   |   |   | $ | 179,920 |   |   |   |   |   |
| Net interest spread                                   |       |                                                                                           |       |   |   | 3.02 | % |   |   |   |   | 3.22 | % |
| Net interest income / margin                          |       |                                                                                           |       | $ | 1,961 |   | 3.07 | % |   |   | $ | 1,426 |   | 3.30 | % |

 

----

(1) Annualized for the three month period.

 

Ournet interest spread was 3.02% for the three months ended June 30, 2004,compared to 3.22% for the three months ended June 30, 2003.

 

Ournet interest margin for the three months ended June 30, 2004 was 3.07%,compared to 3.30% for the three months ended June 30, 2003.  During the three months ended June 30,2004, earning assets averaged $257.1 million, compared to $173.5 million in thethree months ended June 30, 2003.

 

Thelower rate on loans for the three months ended June 30, 2004 compared tothe three months ended June 30, 2003 resulted primarily from a reductionin the prime rate of 25 basis points in the second quarter of 2003.  The deposit and borrowing cost did notdecline as much as the reduction in the rates earned on interest-earning assetsbecause of our decision to aggressively market interest-bearing transactionaccounts by paying an above market rate. Also, we extended the maturity dates on various jumbo time deposits andFHLB advances.  These decisions wereintended to compensate for anticipated higher rates in the future.

 

Netinterest income, the largest component of our income, was $2.0 million and $1.4million for the three months ended June 30, 2004 and 2003,respectively.  The significant increasein 2004 related to higher levels of both average earning 

 

15

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assets and interest-bearing liabilities, offset by a slightlylower net interest margin.  Averageearning assets increased $83.6 million during the three months endedJune 30, 2004 compared to the same period in 2003.

 

Aspreviously discussed, our net interest margin for the three months endedJune 30, 2004 and 2003, was 3.07% and 3.30%, respectively.

 

The$533,863 increase in net interest income for the three months endedJune 30, 2004 compared to the same period in 2003 resulted primarily froma $570,000 increase in net income offset by a $66,000 decrease in net interestincome.  The increase in net incomerelated to higher average earning assets and interest—bearing liabilities.  The decrease in net interest income wasrelated to the lower net interest margin.

 

Interestincome for the three months ended June 30, 2004 was $3.2 million,consisting of $3.0 million on loans, $220,364 on investments, and $4,703 onfederal funds sold.  Interest income forthe three months ended June 30, 2003 was $2.3 million, consisting of $2.2million on loans, $62,569 on investments, and $5,179 on federal fundssold.  Interest on loans for the threemonths ended June 30, 2004 and 2003 represented 92.9% and 97.0%,respectively, of total interest income, while income from investments andfederal funds sold represented only 7.1% and 2.7% of total interestincome.  The high percentage of interestincome from loans was related to our strategy to maintain a significant portionof our assets in higher earning loans compared to lower yieldinginvestments.  Average loans represented91.0% and 95.2% of average interest—earning assets for the three months endedJune 30, 2004 and 2003, respectively. Included in interest income on loans for the three months endedJune 30, 2004 and 2003, was $131,810 and $95,258, respectively, related tothe net amortization of loan fees and capitalized loan origination costs.

 

Interestexpense for the three months ended June 30, 2004 was $1.2 million,consisting of $840,564 related to deposits and $374,606 related toborrowings.  Interest expense for thethree months ended June 30, 2003 was $860,820, consisting of $682,896related to deposits and $177,924 related to borrowings.  Interest expense on deposits for the threemonths ended June 30, 2004 and 2003 represented 69.2% and 79.3%,respectively, of total interest expense, while interest expense on borrowingsrepresented 30.8% and 20.7%, respectively, of total interest expense for thethree months ended June 30, 2004 and 2003. The lower percentage of interest expense on deposits and the higherpercentage of interest on borrowings for the three months ended June 30,2004 compared to the three months ended June 30, 2003 resulted from ourdecisions to delay our retail deposit office expansion program and insteadutilize additional borrowings from the FHLB and from the sale of securitiesunder agreements to repurchase with brokers. During the three months ended June 30, 2004, averageinterest—bearing deposits increased by $40.7 million over the same period in2003, while other borrowing during the three months ended June 30, 2004increased $43.0 million over the same period in 2003.  During the three months ended June 30,2004, we were able to pledge additional collateral to the FHLB, allowing us theability to increase our FHLB borrowings. Both the short—term borrowings from the FHLB and the sale of securitiesunder agreements to repurchase provide us with the opportunity to obtain lowcost funding with various maturities similar to the maturities on our loans andinvestments.

 

16

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| ** **                                            | ** ** | **Average Balances, Income and Expenses, and Rates  For the Six Months Ended June 30,** | ** ** |
|-------------------------------------------------------|------------|----------------------------------------------------------------------------------------------|------------|
| ** **                                            | ** ** | **2004**                                                                                     | ** ** | **2003** | ** ** |
| ** **                                            | ** ** | **Average  Balance**                                                                         | ** ** | **Income/  Expense** | ** ** | **Yield/  Rate(1)** | ** ** | **Average  Balance** | ** ** | **Income  Expense** | ** ** | **Yield/  Rate(1)** | ** ** |
| ** **                                            | ** ** | **(In thousands)**                                                                           | ** ** |
| Earning assets:                                       |       |                                                                                         |       |   |   |   |   |   |   |   |   |   |   |
| Federal funds sold                                    |       | $                                                                                            | 2,032      |   | $ | 9 |   | 0.89 | % | $ | 1,953 |   | $ | 12 |   | 1.24 | % |
| Investment securities                                 |       | 20,824                                                                                       |       | 445 |   | 4.30 | % | 10,274 |   | 199 |   | 3.91 | % |
| Loans                                                 |       | 225,469                                                                                      |       | 5,688 |   | 5.07 | % | 159,722 |   | 4,308 |   | 5.44 | % |
| Total earning-assets                                  |       | 248,325                                                                                      |       | 6,142 |   | 4.97 | % | 171,949 |   | 4,519 |   | 5.30 | % |
| Non-earning assets                                    |       | 6,981                                                                                        |       |   |   |   |   | 6,306 |   |   |   |   |   |
| Total assets                                          |       | $                                                                                            | 255,306    |   |   |   |   |   | $ | 178,255 |   |   |   |   |   |
| Interest-bearing liabilities:                         |       |                                                                                         |       |   |   |   |   |   |   |   |   |   |   |
| NOW accounts                                          |       | $                                                                                            | 35,980     |   | $ | 122 |   | 0.68 | % | $ | 28,248 |   | $ | 59 |   | 0.42 | % |
| Savings & money market                            |       | 33,486                                                                                       |       | 202 |   | 1.21 | % | 20,712 |   | 62 |   | 0.60 | % |
| Time deposits                                         |       | 103,489                                                                                      |       | 1,244 |   | 2.42 | % | 85,908 |   | 1,291 |   | 3.03 | % |
| Total interest-bearing deposits                       |       | 172,955                                                                                      |       | 1,568 |   | 1.82 | % | 134,868 |   | 1,412 |   | 2.11 | % |
| FHLB advances                                         |       | 46,988                                                                                       |       | 446 |   | 1.91 | % | 23,646 |   | 266 |   | 2.27 | % |
| Other borrowings                                      |       | 21,430                                                                                       |       | 235 |   | 2.21 | % | 6,739 |   | 75 |   | 2.24 | % |
| Total interest-bearing liabilities                    |       | 241,373                                                                                      |       | 2,249 |   | 1.87 | % | 165,253 |   | 1,753 |   | 2.17 | % |
| Non-interest bearing liabilities                      |       | 2,369                                                                                        |       |   |   |   |   | 2,375 |   |   |   |   |   |
| Shareholders’ equity                             |       | 11,564                                                                                       |       |   |   |   |   | 10,627 |   |   |   |   |   |
| Total liabilities and shareholders’  Equity |       | $                                                                                            | 255,306    |   |   |   |   |   | $ | 178,255 |   |   |   |   |   |
| Net interest spread                                   |       |                                                                                         |       |   |   | 3.10 | % |   |   |   |   | 3.13 | % |
| Net interest income / margin                          |       |                                                                                         |       | $ | 3,893 |   | 3.15 | % |   |   | $ | 2,766 |   | 3.24 | % |

 

----

(1)  Annualized for the six-month period.

 

Ournet interest spread was 3.10% for the six months ended June 30, 2004,compared to 3.13% for the six months ended June 30, 2003.

 

Ournet interest margin for the period ended June 30, 2004 was 3.15%, comparedto 3.24% for the six months ended June 30, 2003.  During the first six months of 2004, earningassets averaged $248.3 million, compared to $171.9 million in the first sixmonths of 2003.

 

Thelower rate on loans for the six months ended June 30, 2004 compared to thesix months ended June 30, 2003 resulted primarily from a of 25 basispoints in the second quarter of 2003. The deposit and borrowing cost did not decline as much as the reductionin the rates earned on interest-earning assets because of our decision toaggressively market interest-bearing transaction accounts by paying an abovemarket rate.  Also, we extended thematurity dates on various jumbo time deposits and FHLB advances.  These decisions were intended to compensatefor anticipated higher rates in the future.

 

Netinterest income, the largest component of our income, was $3.9 million and $2.8million for the six months ended June 30, 2004 and 2003,respectively.  The significant increasein 2004 related to higher levels of both average earning assets andinterest-bearing liabilities, offset by a slightly lower net interestmargin.  Average earning assets increased$76.4 million during the six months ended June 30, 2004 compared to thesame period in 2003.

 

As previously discussed, our net interest margin for thesix months ended June 30, 2004 and 2003, was 3.15% and 3.24%,respectively.

 

17

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The$1.1 million increase in net interest income for the six months endedJune 30, 2004 compared to the same period in 2003 resulted from a $1.2million increase in net income offset by a $37,000 decrease in net interestincome.  The increase in net incomerelated to higher average earning assets and interest-bearing liabilities.  The decrease in net interest income wasrelated to the lower net interest margin.

 

Interestincome for the six months ended June 30, 2004 was $6.1 million, consistingof $5.7 million on loans, $445,178 on investments, and $9,293 on federal fundssold.  Interest income for the six monthsended June 30, 2003 was $4.5 million, consisting of $4.3 million on loans,$199,113 on investments, and $11,668 on federal funds sold.  Interest on loans for the six months endedJune 30, 2004 and 2003 represented 92.6% and 95.3%, respectively, of totalinterest income, while income from investments and federal funds soldrepresented only 7.4% and 4.7% of total interest income.  The high percentage of interest income fromloans was related to our strategy to maintain a significant portion of ourassets in higher earning loans compared to lower yielding investments.  Average loans represented 90.8% and 92.9% ofaverage interest-earning assets for the six months ended June 30, 2004 and2003, respectively.  Included in interestincome on loans for the six months ended June 30, 2004 and 2003, was$232,319 and $179,933, respectively, related to the net amortization of loanfees and capitalized loan origination costs.

 

Interestexpense for the six months ended June 30, 2004 was $2.2 million,consisting of $1.6 million related to deposits and $681,219 related toborrowings.  Interest expense for the sixmonths ended June 30, 2003 was $1.8 million, consisting of $1.4 millionrelated to deposits and $340,394 related to borrowings.  Interest expense on deposits for the sixmonths ended June 30, 2004 and 2003 represented 69.7% and 80.6%,respectively, of total interest expense, while interest expense on borrowingsrepresented 30.3% and 19.4%, respectively, of total interest expense for thesix months ended June 30, 2004 and 2003. The lower percentage of interest expense on deposits and the higherpercentage of interest on borrowings for the six months ended June 30, 2004compared to the six months ended June 30, 2003 resulted from our decisionsto delay our retail deposit office expansion program and instead utilizeadditional borrowings from the FHLB and from the sale of securities underagreements to repurchase with brokers.  Duringthe six months ended June 30, 2004, average deposits increased by $40.7million over the same period in 2003, while other borrowing during the sixmonths ended June 30, 2004 increased $43.0 million over the same period in2003.  During the six months endedJune 30, 2004, we were able to pledge additional collateral to the FHLB,allowing us the ability to increase our FHLB borrowings.  Both the short-term borrowings from the FHLBand the sale of securities under agreements to repurchase provide us with theopportunity to obtain low cost funding with various maturities similar to thematurities on our loans and investments.

 

18

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*Rate/VolumeAnalysis*

 

Netinterest income can be analyzed in terms of the impact of changing interestrates and changing volume.  The followingtables set forth the effect which the varying levels of interest-earning assetsand interest-bearing liabilities and the applicable rates have had on changesin net interest income for the periods presented.

 
| ** **              | ** ** | **Three Months Ended**          | ** ** |
|-------------------------|------------|---------------------------------|------------|
| ** **              | ** ** | **June 30, 2004 vs. 2003** | ** ** | **June 30, 2003 vs. 2002** | ** ** |
| ** **              | ** ** | **Increase (Decrease) Due to**  | ** ** | **Increase (Decrease) Due to** | ** ** |
| ** **              | ** ** | **Volume**                      | ** ** | **Rate** | ** ** | **Rate/  Volume** | ** ** | **Total** | ** ** | **Volume** | ** ** | **Rate** | ** ** | **Rate/  Volume** | ** ** | **Total** | ** ** |
| ** **              | ** ** | **(In thousands)**              | ** ** |
| **Interest income**     |       |                            |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Loans                   |       | $                               | 926        |   | (131 | ) | (63 | ) | 732 |   | 763 |   | (194 | ) | (85 | ) | 484 |   |
| Investment securities   |       | 132                             |       | 8 |   | 16 |   | 156 |   | (105 | ) | (45 | ) | 25 |   | (125 | ) |
| Federal funds sold      |       | 1                               |       | (1 | ) | — |   | — |   | (7 | ) | (4 | ) | 2 |   | (9 | ) |
| Total interest income   |       | 1,059                           |       | (124 | ) | (47 | ) | 888 |   | 651 |   | (243 | ) | (58 | ) | 350 |   |
|                    |       |                            |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| **Interest expense**    |       |                            |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Deposits                |       | 203                             |       | (34 | ) | (12 | ) | 157 |   | 97 |   | (230 | ) | (26 | ) | (159 | ) |
| FHLB advances           |       | 136                             |       | (14 | ) | (14 | ) | 108 |   | 277 |   | (19 | ) | (146 | ) | 112 |   |
| Other borrowings        |       | 150                             |       | (10 | ) | (51 | ) | 89 |   | 12 |   | 4 |   | 7 |   | 23 |   |
| Total interest expense  |       | 489                             |       | (58 | ) | (77 | ) | 354 |   | 386 |   | (245 | ) | (165 | ) | (24 | ) |
|                    |       |                            |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| **Net interest income** |       | $                               | 570        |   | (66 | ) | 30 |   | 534 |   | 265 |   | 2 |   | 107 |   | 374 |   |

 
| ** **              | ** ** | **Six Months Ended**            | ** ** |
|-------------------------|------------|---------------------------------|------------|
| ** **              | ** ** | **June 30, 2004 vs. 2003** | ** ** | **June 30, 2003 vs. 2002** | ** ** |
| ** **              | ** ** | **Increase (Decrease) Due to**  | ** ** | **Increase (Decrease) Due to** | ** ** |
| ** **              | ** ** | **Volume**                      | ** ** | **Rate** | ** ** | **Rate/  Volume** | ** ** | **Total** | ** ** | **Volume** | ** ** | **Rate** | ** ** | **Rate/  Volume** | ** ** | **Total** | ** ** |
| ** **              | ** ** | **(In thousands)**              | ** ** |
| **Interest income**     |       |                            |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Loans                   |       | $                               | 1,783      |   | (291 | ) | (112 | ) | 1,380 |   | 1,515 |   | (363 | ) | (166 | ) | 986 |   |
| Investment securities   |       | 205                             |       | 20 |   | 21 |   | 246 |   | (106 | ) | (90 | ) | 26 |   | (170 | ) |
| Federal funds sold      |       | —                          |       | (3 | ) | — |   | (3 | ) | (19 | ) | (11 | ) | 6 |   | (24 | ) |
| Total interest income   |       | 1,988                           |       | (274 | ) | (91 | ) | 1,623 |   | 1,390 |   | (464 | ) | (134 | ) | 792 |   |
|                    |       |                            |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| **Interest expense**    |       |                            |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Deposits                |       | 401                             |       | (194 | ) | (51 | ) | 156 |   | 270 |   | (402 | ) | (67 | ) | (199 | ) |
| FHLB advances           |       | 264                             |       | (42 | ) | (42 | ) | 180 |   | 374 |   | (36 | ) | (157 | ) | 181 |   |
| Other borrowings        |       | 164                             |       | (1 | ) | (3 | ) | 160 |   | 45 |   | (2 | ) | (2 | ) | 41 |   |
| Total interest expense  |       | 829                             |       | (237 | ) | (96 | ) | 496 |   | 689 |   | (440 | ) | (226 | ) | 23 |   |
|                    |       |                            |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| **Net interest income** |       | $                               | 1,159      |   | (37 | ) | 5 |   | 1,127 |   | 701 |   | (24 | ) | 92 |   | 769 |   |

 

19

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*Provision forLoan Losses*

 

We have established an allowance for loanlosses through a provision for loan losses charged as an expense on ourstatement of income.  We review our loanportfolio periodically to evaluate our outstanding loans and to measure boththe performance of the portfolio and the adequacy of the allowance for loan losses.  Please see the discussion below under“Balance Sheet Review - Provision and Allowance for Loan Losses” for adescription of the factors we consider in determining the amount of theprovision we expense each period to maintain this allowance.

 

*Three months ended June 20, 2004 and 2003*

 

For the three months ended June 30, 2004 and2003, there was a noncash expense related to the provision for loan losses of$300,000 and $200,000, respectively.  Theadditional provisions added to our allowance for loan losses in the threemonths ended June 30, 2004 and 2003 resulted in a net increase in theallowance for loan losses of $132,525 in the three months ended June 30,2004 and $194,194 in the three months ended June 30, 2003.  The allowance for loan losses did notincrease by the entire amount of the provisions for loan losses because wereported net charge-offs of $167,475 and $5,806 for the three months endedJune 30, 2004 and 2003, respectively. The $167,475 net charge-offs during the second three month period of2004, represented 0.07% of the average outstanding loans portfolio for thethree months ended June 30, 2004. The $5,806 net charge-offs during the second three month period of 2003represented less than 0.01% of the average outstanding loan portfolio for thethree months ended June 30, 2003. The $132,525 and the $194,194 increases in the allowance for the threemonths ended June 30, 2004 and 2003, respectively, related to our decisionto increase the allowance in response to the $18.0 million and the $15.8million growth in loans for the three months ended June 30, 2004 and 2003,respectively.  The loan loss reserve was$3.2 million and $2.3 million as of June 30, 2004 and 2003, respectively.  The allowance for loan losses as a percentageof gross loans was 1.28% at June 30, 2004 and 1.32% at June 30, 2003,while the percentage of nonperforming loans to gross loans was 0.18% and 0.14%at June 30, 2004 and 2003, respectively

 

*Six months ended June 20, 2004 and 2003*

 

For the six months ended June 30, 2004 and 2003,there was a noncash expense related to the provision for loan losses of$650,000 and $500,000, respectively.  Theadditional provisions added to our allowance for loan losses in the six monthsended June 30, 2004 and 2003 resulted in a net increase in the allowancefor loan losses of $470,480 in the six months ended June 30, 2004 and$489,225 in the six months ended June 30, 2003.  The allowance for loan losses did notincrease by the entire amount of the provisions for loan losses because wereported net charge-offs of $179,520 and $10,775 for the six months endedJune 30, 2004 and 2003, respectively. The $179,520 net charge-offs during the first six months of 2004,represented 0.08% of the average outstanding loans portfolio for the six monthsended June 30, 2004.  The $10,775net charge-offs during the first six months of 2003 represented 0.01% of theaverage outstanding loan portfolio for the six months ended June 30, 2003.  The $470,480 and the $489,225 increases inthe allowance for the six months ended June 30, 2004 and 2003,respectively, related to our decision to increase the allowance in response tothe $38.8 million and the $26.0 million growth in loans for the six monthsended June 30, 2004 and 2003, respectively.  The loan loss reserve was $3.2 million and$2.3 million as of June 30, 2004 and 2003, respectively.  The allowance for loan losses as a percentageof gross loans was 1.28% at June 30, 2004 and 1.32% at June 30, 2003,while the percentage of nonperforming loans to gross loans was 0.18% and 0.14%at June 30, 2004 and 2003, respectively.

 

We expect that our net income will continue to benegatively affected by larger than normal provisions for loan losses as wecontinue to focus on growing our loan portfolio.  During the three months and the six monthsended June 30, 2004, 44.2%, and 72.5%, respectively, of the provision forloan losses was related primarily to the growth in loans, with 55.8%, and27.5%, respectively, related to net charge-offs.  If the quality of the loan portfolio declinesor a higher percentage of the portfolio is charged-off, additional provisionsmay be required.

 

20

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***Noninterest Income***

 

The following tables set forth information related to our noninterest income.

 
| ** **                            | ** ** | **Three months ended  June 30,** | ** ** | **Six months ended  June 30,** | ** ** |
|---------------------------------------|------------|---------------------------------------|------------|-------------------------------------|------------|
| ** **                            | ** ** | **2004**                              | ** ** | **2003**                            | ** ** | **2004** | ** ** | **2003** | ** ** |
|                                  |       |                                  |       |                                |       |   |   |   |   |
| Loan fee income                       |       | $                                     | 40,789     |                                | 59,312     |   | 66,824 |   | 103,666 |   |
| Service fees on deposits              |       | 72,978                                |       | 63,567                              |       | 139,728 |   | 123,296 |   |
| Write-down on real estate owned... |       | —                                |       | (100,000                            | )          | — |   | (100,000 | ) |
| Other income                          |       | 86,810                                |       | 61,075                              |       | 156,348 |   | 104,145 |   |
| Total noninterest income              |       | $                                     | 200,577    |                                | 83,954     |   | 362,900 |   | 231,107 |   |

 

*Three months ended June 30, 2004 and 2003*

 

Noninterest income in the second three month period of2004 was $200,577, an increase of 138.9% over noninterest income of $83,954 inthe same period of 2003.  Noninterestincome in the three months ended June 30, 2003 was reduced by a $100,000write-down on real estate owned. Excluding the 2003 write-down, noninterest income increased $16,623, or9.0%, for the second three month period of 2004 compared to the same period in2003.

 

Loan fees consist primarily of late charge fees andmortgage origination fees we receive on residential loans funded and closed bya third party.  Loan fees were $40,789and $59,312 for the three months ended June 30, 2004 and June 30,2003, respectively.  The $18,523 decreaserelated primarily to the lower amount of mortgage origination fees that wereceived in the three months ended June 30, 2004 compared to the threemonths ended June 30, 2003. Mortgage origination fees were $2,673 and $34,178 for the three monthsended June 30, 2004 and 2003, respectively.  The reduction related to the significantdecline in volume of residential mortgage refinanced in the second three monthperiod of 2004 compared to the same period in 2003.  We received $22,282 in fees on lines ofcredit in the second three month period of 2004 compared to $13,745 in thesecond three month period of 2003.  Latecharge fees were $15,834 and $11,316 for the three months ended June 30,2004 and 2003, respectively.  Theincrease in late charges related to our larger loan portfolio in 2004 comparedto 2003.

 

Deposit fees were $72,978 and $63,567 for the threemonths ended June 30, 2004 and 2003. The additional $9,411 of income related to both higher service chargesand an increase of NSF transactions resulting from the larger number of clientaccounts.  NSF income was $44,575 and$39,960 for the three months ended June 30, 2004 and 2003, respectively,representing 61.1% of total service fees on deposits in the 2004 periodcompared to 62.9% of total service fees on deposits in the 2003 period.

 

Other income was $86,810 and $61,075 for the threemonths ended June 30, 2004 and 2003, respectively.  The $25,735 increase resulted primarily froman increase in the volume of ATM transactions for which we receive fees.  ATM transaction fees were $79,310 and $54,142for the three months ended June 30, 2004 and 2003, respectively.  ATM transaction fees represented 91.4% and88.6% of total other income for the three months ended June 30, 2004 and2003, respectively.  Included innoninterest outside service expense is $68,852 and $31,990 related tocorresponding transaction costs associated with ATM transaction fees for thethree months ended June 30, 2004 and 2003, respectively.  The net impact of the fees received and therelated cost of the ATM transactions on earnings for the years endedDecember 31, 2003 and 2002 was $10,458 and $22,152, respectively**.**

 

21

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*Six months ended June 30, 2004 and 2003*

 

Noninterest income in the first six months of 2004 was$362,900, an increase of 57.0% over noninterest income of $231,107 in the sameperiod of 2003.  Noninterest income inthe six months ended June 30, 2003 was reduced by a $100,000 write-down onreal estate owned.  Excluding the 2003write-down, noninterest income increased $31,793, or 9.6%, for the first sixmonths of 2004 compared to the same period in 2003.

 

Loan fees consist primarily of late charge fees andmortgage origination fees we receive on residential loans funded and closed bya third party.  Loan fees were $66,824and $103,666 for the six months ended June 30, 2004 and June 30,2003, respectively.  The $36,842 decreaserelated primarily to the lower amount of mortgage origination fees that wereceived in the six months ended June 30, 2004 compared to the six monthsended June 30, 2003.  Mortgageorigination fees were $3,423 and $63,623 for the six months ended June 30,2004 and 2003, respectively.  Thereduction related to the significant decline in volume of residential mortgagerefinanced in the first six months of 2004 compared to the same period in2003.  We received $31,721 in fees onlines of credit in the first six months of 2004 compared to $15,602 in thefirst six months of 2003.  Late chargefees were $31,680 and $24,442 for the six months ended June 30, 2004 and2003, respectively.  The increase in latecharges related to our larger loan portfolio in 2004 compared to 2003.

 

Deposit fees were $139,728 and $123,296 for the sixmonths ended June 30, 2004 and 2003. The additional $16,432 of income related to both higher service chargesand an increase of NSF transactions resulting from the larger number of clientaccounts.  NSF income was $84,955 and$77,490 for the six months ended June 30, 2004 and 2003, respectively,representing 60.8% of total service fees on deposits in the 2004 periodcompared to 62.8% of total service fees on deposits in the 2003 period.

 

Other income was $156,348 and $104,145 for the sixmonths ended June 30, 2004 and 2003, respectively.  The $52,203 increase resulted primarily froman increase in the volume of ATM transactions for which we receive fees.  ATM transaction fees were $140,141 and$90,336 for the six months ended June 30, 2004 and 2003,respectively.  ATM transaction feesrepresented 89.6% and 86.7% of total other income for the six months endedJune 30, 2004 and 2003, respectively. Included in noninterest outside service expense is $123,860 and $90,277related to corresponding transaction costs associated with ATM transaction feesfor the six months ended June 30, 2004 and 2003, respectively.  The net impact of the fees received and therelated cost of the ATM transactions on earnings for the years endedDecember 31, 2003 and 2002 was $16,281 and $59, respectively.

 

*Noninterest expenses*

 

The following tables set forth information related toour noninterest expenses.

 
| ** **                        | ** ** | **Three months ended  June 30,** | ** ** | **Six months ended  June 30,** | ** ** |
|-----------------------------------|------------|---------------------------------------|------------|-------------------------------------|------------|
| ** **                        | ** ** | **2004**                              | ** ** | **2003**                            | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                        | ** ** | ** **                            | ** ** | ** **                          | ** ** | ** ** | ** ** | ** ** | ** ** |
| Compensation and benefits         |       | $                                     | 600,877    |                                | 488,564    |   | 1,199,522 |   | 967,842 |   |
| Professional fees                 |       | 50,882                                |       | 40,958                              |       | 99,815 |   | 74,559 |   |
| Marketing                         |       | 74,679                                |       | 43,396                              |       | 125,958 |   | 78,745 |   |
| Insurance                         |       | 31,146                                |       | 26,580                              |       | 61,662 |   | 53,265 |   |
| Occupancy                         |       | 149,129                               |       | 137,965                             |       | 289,899 |   | 299,362 |   |
| Data processing and related costs |       | 215,304                               |       | 154,473                             |       | 396,775 |   | 287,530 |   |
| Telephone                         |       | 6,836                                 |       | 5,717                               |       | 13,306 |   | 11,187 |   |
| Other                             |       | 64,661                                |       | 42,794                              |       | 126,159 |   | 84,955 |   |
| Total noninterest expense         |       | $                                     | 1,193,514  |                                | 940,447    |   | 2,313,096 |   | 1,857,445 |   |

 

22

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*Three months ended June 30, 2004 and 2003*

 

We incurred noninterest expenses of $1.2 million forthe three months ended June 30, 2004 compared to $940,447 for the threemonths ended June 30, 2003.  Averageinterest earning assets increased 48.2% during this period, while general andadministrative expense increased only 26.9%.

 

The $112,313 increase in compensation and benefits and$60,831 in additional data processing and related costs accounted for 68.4% ofthe $253,067 increase in noninterest expense for the three months endedJune 30, 2004 compared to the same period in 2003.  The remaining $79,923 increase resultedprimarily from increases of $9,924 in professional fees, $31,283 in marketingcosts, and $21,867 in other expenses.  Asignificant portion of the increase in professional fees related to additionalaudit expenses.  The increase inmarketing expenses related to expanding our market awareness in the Greenvillemarket, while a significant portion of the increase in other expenses was dueto increased costs of postage and office supplies, additional staff educationand training, and higher dues and subscription costs.

 

Occupancy expense, which represented 12.5% and 14.7%of total noninterest expense for the three months ended June 30, 2004 and2003, respectively, increased $11,164. Occupancy expense was $149,129 and $137,965 for the three months endedJune 30, 2004 and 2003, respectively.

 

*Six months ended June 30, 2004 and 2003*

 

We incurred noninterest expenses of $2.3 million forthe six months ended June 30, 2004 compared to $1.9 million for the sixmonths ended June 30, 2003.  Averageinterest earning assets increased 44.4% during this period, while general andadministrative expense increased only 24.5%.

 

The $231,680 increase in compensation and benefits and$109,245 in additional data processing and related costs accounted for 74.8% ofthe $455,651 increase in noninterest expense for the six months endedJune 30, 2004 compared to the same period in 2003.  The remaining $114,726 increase resultedprimarily from increases of $25,256 in professional fees, $47,213 in marketingcosts, and $41,204 in other expenses.  Asignificant portion of the increase in professional fees related to additionalaudit expenses.  The increase inmarketing expenses related to expanding our market awareness in the Greenvillemarket, while a significant portion of the increase in other expenses was dueto increased costs of postage and office supplies, additional staff educationand training, and higher dues and subscription costs.

 

Occupancy expense, which represented 12.5% and 16.1%of total noninterest expense for the six months ended June 30, 2004 and2003, respectively, remained virtually unchanged.  Occupancy expense was $289,899 and $299,362for the six months ended June 30, 2004 and 2003, respectively.

 

The following tables set forth information related toour compensation and benefits.

 
| ** **                         | ** ** | **Three months ended  June 30,** | ** ** | **Six months ended  June 30,** | ** ** |
|------------------------------------|------------|---------------------------------------|------------|-------------------------------------|------------|
| ** **                         | ** ** | **2004**                              | ** ** | **2003**                            | ** ** | **2004** | ** ** | **2003** | ** ** |
|                               |       |                                  |       |                                |       |   |   |   |   |
| Base compensation                  |       | $                                     | 409,918    |                                | 323,902    |   | 811,087 |   | 687,313 |   |
| Incentive compensation             |       | 150,000                               |       | 119,500                             |       | 270,000 |   | 182,000 |   |
| Total compensation                 |       | 559,918                               |       | 443,402                             |       | 1,081,087 |   | 869,313 |   |
| Benefits                           |       | 73,008                                |       | 81,177                              |       | 179,095 |   | 156,104 |   |
| Capitalized loan origination costs |       | (32,050                               | )          | (36,015                             | )          | (60,660 | ) | (57,575 | ) |
| Total compensation and benefits    |       | $                                     | 600,877    |                                | 488,564    |   | 1,199,522 |   | 967,842 |   |

 

23

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*Three months ended June 30, 2004 and 2003*

 

Compensation and benefits expense was $600,877 and$488,564 for the three months ended June 30, 2004 and 2003,respectively.  Compensation and benefitsrepresented 50.3% and 52.0% of our total noninterest expense for the threemonths ended June 30, 2004 and 2003, respectively.  The $112,313 increase in compensation andbenefits in the first three months of 2004 compared to the same period in 2003resulted from increases of $86,016 in base compensation, $30,500 in additionalincentive compensation, and an decrease of $3,965 in loan originationcompensation expense, which is required to be capitalized and amortized overthe life of the loan as a reduction of loan interest income.  These amounts were partly off set by $8,169in lower benefits cost.

 

The $86,016 increase in base compensation expenserelated to the cost of two additional employees as well as annual salaryincreases.  Incentive compensationrepresented 25.0% and 24.5% of total compensation and benefits for the threemonths ended June 30, 2004 and 2003, respectively.  The incentive compensation expense recordedfor the second three month period of 2004 and 2003 represented an accrual ofthe portion of the estimated incentive compensation earned during the secondthree month period of the respective year. Benefits expense decreased $8,169 in the second three month period of2004 compared to the same period in 2003. Benefits expense represented 13.0% and 18.3% of the total compensationfor the three months ended June 30, 2004 and 2003, respectively.

 

*Six months ended June 30, 2004 and*2003

 

Compensation and benefits expense was $1.2 million and$967,842 for the six months ended June 30, 2004 and 2003, respectively.  Compensation and benefits represented 51.9%and 52.1% of our total noninterest expense for the six months endedJune 30, 2004 and 2003, respectively. The $231,680 increase in compensation and benefits in the first sixmonths of 2004 compared to the same period in 2003 resulted from increases of$123,774 in base compensation, $88,000 in additional incentive compensation,and $22,991 in higher benefit costs, offset by an increase of $3,085 in loanorigination compensation expense, which is required to be capitalized andamortized over the life of the loan as a reduction of loan interest income.

 

The $123,774 increase in base compensation expenserelated to the cost of two additional employees as well as annual salaryincreases.  Incentive compensationrepresented 22.5% and 18.8% of total compensation and benefits for the sixmonths ended June 30, 2004 and 2003, respectively.  The incentive compensation expense recordedfor the first six months of 2004 and 2003 represented an accrual of the portionof the estimated incentive compensation earned during the first six months ofthe respective year.  Benefits expensesincreased $22,991 in the first six months of 2004 compared to the same periodin 2003.  Benefits expense represented16.6% and 18.0% of the total compensation for the six months endedJune 30, 2004 and 2003, respectively.

 

The following tables set forth information related toour data processing and related costs.

 
| ** **                              | ** ** | **Three months ended  June 30,** | ** ** | **Six months ended  June 30,** | ** ** |
|-----------------------------------------|------------|---------------------------------------|------------|-------------------------------------|------------|
| ** **                              | ** ** | **2004**                              | ** ** | **2003**                            | ** ** | **2004** | ** ** | **2003** | ** ** |
|                                    |       |                                  |       |                                |       |   |   |   |   |
| Data processing costs                   |       | $                                     | 108,312    |                                | 88,934     |   | 204,348 |   | 134,093 |   |
| ATM transaction expense                 |       | 68,852                                |       | 31,990                              |       | 123,860 |   | 90,277 |   |
| Courier expense                         |       | 19,282                                |       | 8,337                               |       | 36,023 |   | 30,807 |   |
| Other expenses                          |       | 18,858                                |       | 25,212                              |       | 32,544 |   | 32,353 |   |
| Total data processing and related costs |       | $                                     | 215,304    |                                | 154,473    |   | 396,775 |   | 287,530 |   |

 

Data processing and related costs were $215,304 and$154,473 for the three months ended June 30, 2004 and 2003,respectively.  During the first sixmonths of 2004 and the same period of 2003, our data processing and relatedcosts were $396,775 and $287,530, respectively.

 

During the three months ended June 30, 2004, ourdata processing costs for our core processing system were $108,312 compared to$88,934 for the three months ended June 30, 2004.  We have contracted with an outside computer****service company to provide our core data processingservices.  During the six months endedJune 30, 2004 and****2003, the dataprocessing costs were $204,348 and $134,093, respectively.

 

24

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Data processing costs increased $19,378, or 21.8%, forthe three months ended June 30, 2004 compared to the same period in2003.  For the six months endedJune 30, 2004, data processing costs increased $70,255, or 52.4%, comparedto the same period in 2003.  Theincreases in costs were caused by the higher number of loan and depositaccounts.  A significant portion of thefee charged by the third party processor is directly related to the number ofloan and deposit accounts and the related number of transactions.

 

We receive ATM transaction income from transactionsperformed by our clients.  Since we alsooutsource this service, we are charged related transaction fees from our ATMservice provider.  ATM transactionexpense was $68,852 and $31,990 for the three months ended June 30, 2004and 2003, respectively.  During the firstsix months of 2004 and the same period of 2003, the ATM transaction expense was$123,860 and $90,277, respectively.  Theincreases in each period related to the higher transaction volume during therespective periods.

 

Income tax expense was $253,657 for the three monthsended June 30, 2004 compared to $140,634 during the same period in2003.  For the six months endedJune 30, 2004, income tax expense was $491,433 compared to $242,942 duringthe same period of 2003.  The increaserelated to the higher level of income before taxes.

 

Balance Sheet Review

 

*General*

 

At December 31,2003, we had total assets of $230.8 million, consisting principally of $206.1million in loans, $15.8 million in investments, $2.8 million in federal fundssold, and $4.1 million in cash and due from banks.  Our liabilities at December 31, 2003totaled $219.7 million, consisting principally of $169.0 million in deposits,$32.5 million in FHLB advances, $9.3 million of short-term borrowings, and $6.2million of junior subordinated debentures. At December 31, 2003, our shareholders’ equity was $11.2 million.

 

At June 30, 2004, wehad total assets of $273.4 million, consisting principally of $244.4 million inloans, $20.9 million in investments, $1.4 million in federal funds sold, and$2.6 million in cash and due from banks. Our liabilities at June 30, 2004 totaled $261.5 million, whichconsisted principally of $178.0 million in deposits, $58.4 million in FHLBadvances, $16.6 million in short-term borrowings, and $6.2 million in juniorsubordinated debentures.  AtJune 30, 2004, our shareholders’ equity was $11.9 million.

 

*Federal Funds Sold*

 

At December 31, 2003, our $2.8 million in short-term investmentsin federal funds sold on an overnight basis comprised 1.2% of totalassets.  At June 30, 2004, ourfederal funds sold were $1.4 million, or 0.5% of total assets.  As a result of the historically low yieldspaid for federal funds sold during the last one and one-half years, we havemaintained a lower than normal level of federal funds.

 

25

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*Investments*

 

AtDecember 31, 2003, the $15.8 million in our investment securities portfoliorepresented approximately 6.8% of our total assets.  We held U.S. Government agency securities andmortgage-backed securities with a fair value of $15.7 million and an amortizedcost of $15.6 million for an unrealized gain of $74,000.  As a result of the strong growth in our loanportfolio and the historical low fixed rates that were available during thelast two and one-half years, we have maintained a lower than normal level ofinvestments.  As rates on investmentsecurities rise and additional capital and deposits are obtained, we anticipateincreasing the size of the investment portfolio.

 

Contractualmaturities and yields on our investments at December 31, 2003 are shown inthe following table.  Expected maturitiesmay differ from contractual maturities because issuers may have the right tocall or prepay obligations with or without call or prepayment penalties.  At December 31, 2003, we had nosecurities with a maturity of less than one year or more than 10 years.

 
| ** **                                   | ** ** | **One to five Years** | ** ** | **Five to Ten Years** | ** ** | **Total**  | ** ** |
|----------------------------------------------|------------|-----------------------|------------|-----------------------|------------|------------|------------|
| ** **                                   | ** ** | **Amount**            | ** ** | **Yield**             | ** ** | **Amount** | ** ** | **Yield** | ** ** | **Amount** | ** ** | **Yield** | ** ** |
|                                         |       |                  |       |                  |       |       |       |   |   |   |   |   |   |
| **Available for Sale**                       |       |                  |       |                  |       |       |       |   |   |   |   |   |   |
| U.S. Government/ Government sponsored Agency |       | $                     | 1,098      |                  | 5.34       | %          | $          | — |   | — |   | $ | 1,098 |   | 5.34 | % |
| Mortgage-backed securities                   |       | —                |       | —                |       | 2,531      |       | 3.40 | % | 2,531 |   | 3.40 | % |
| Total                                        |       | $                     | 1,098      |                  | 5.34       | %          | $          | 2,531 |   | 3.40 | % | $ | 3,629 |   | 4.30 | % |
| **Held to Maturity**                         |       |                  |       |                  |       |       |       |   |   |   |   |   |   |
| Mortgage-backed securities                   |       | $                     | —     |                  | —     | %          | $          | 9,834 |   | — | % | $ | 9,834 |   | 4.70 | % |

 

AtDecember 31, 2003, our investments included securities issued by FederalHome Loan Bank, Federal Home Loan Mortgage Corporation, and Federal NationalMortgage Association with carrying values of $1.1 million, $354,067, and $12.0million, respectively.

 

Otherinvestments at December 31, 2003 consisted of Federal Reserve Bank stockwith a cost of $485,150, an investment in Greenville First Statutory Trust I of$186,000, and Federal Home Loan Bank stock with a cost of $1.6 million.

 

AtJune 30, 2004, the $20.9 million in our investment securities portfoliorepresented approximately 7.6% of our total assets.  We held U.S. Government agency securities andmortgage-backed securities with a fair value of $16.7 million and an amortizedcost of $17.2 million for an unrealized loss of $513,547.

 

26

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Contractualmaturities and yields on our investments that are available for sale and areheld to maturity at June 30, 2004 are shown in the following table.  Expected maturities may differ fromcontractual maturities because issuers may have the right to call or prepayobligations with or without call or prepayment penalties.  At June 30, 2004, we had no securitieswith a maturity of less than one year or more than 10 years.

 
| ** **                                    | ** ** | **One to five Years** | ** ** | **Five to Ten Years** | ** ** | **Total**  | ** ** |
|-----------------------------------------------|------------|-----------------------|------------|-----------------------|------------|------------|------------|
| ** **                                    | ** ** | **Amount**            | ** ** | **Yield**             | ** ** | **Amount** | ** ** | **Yield** | ** ** | **Amount** | ** ** | **Yield** | ** ** |
| ** **                                    | ** ** | **(In thousands)**    | ** ** |
| **Available for Sale**                        |       |                  |       |                  |       |       |       |   |   |   |   |   |   |
| U.S. Government/Government sponsored Agencies |       | $                     | 1,062      |                  | 5.40       | %          | $          | — |   | — |   | $ | 1,062 |   | 5.40 | % |
| Mortgage-backed securities                    |       | —                |       | —                |       | 2,017      |       | 3.40 | % | 2,017 |   | 3.40 | % |
| Total                                         |       | $                     | 1,062      |                  | 5.40       | %          | $          | 2,017 |   | 3.40 | % | $ | 3,079 |   | 4.09 | % |
| **Held to Maturity**                          |       |                  |       |                  |       |       |       |   |   |   |   |   |   |
| Mortgage-backed securities                    |       | —                |       | —                | %          | $          | 14,215     |   | 4.25 | % | $ | 14,215 |   | 4.25 | % |

 

AtJune 30, 2004, our investments included securities issued by Federal HomeLoan Bank, Federal Home Loan Mortgage Corporation, and Federal NationalMortgage Association with carrying values of $1.1 million, $5.4 million, and$10.8 million, respectively.

 

Theamortized costs and the fair value of our investments at June 30, 2004 andDecember 31, 2003, are shown in the following table.

 

| ** **                                       | ** ** | **June 30, 2004** | ** ** | **December 31, 2003** | ** ** |
|--------------------------------------------------|------------|------------------------|------------|----------------------------|------------|
| ** **                                       | ** ** | **Amortized  Cost**    | ** ** | **Fair Value**             | ** ** | **Amortized  Cost** | ** ** | **Fair Value** | ** ** |
| ** **                                       | ** ** | **(In thousands)**     | ** ** |
| **Available for Sale**                           |       |                   |       |                       |       |   |   |   |   |
| U.S. Government / government sponsored  agencies |       | $                      | 1,018      |                       | $          | 1,062 |   | $ | 1,022 |   | $ | 1,098 |   |
| Mortgage-backed Securities                       |       | 2,017                  |       | 2,017                      |       | 2,460 |   | 2,531 |   |
| Total                                            |       | 3,035                  |       | 3,079                      |       | 3,482 |   | 3,629 |   |
| **Held to Maturity**                             |       |                   |       |                       |       |   |   |   |   |
| Mortgage-backed Securities                       |       | $                      | 14,215     |                       | $          | 13,658 |   | $ | 9,834 |   | $ | 9,761 |   |

 

Other investments totaled $3.6 million and $2.3 million atJune 30, 2004 and December 31, 2003, respectively.  Other investments at June 30, 2004consisted of Federal Reserve Bank stock with a cost of $485,150, an investmentin Greenville First Statutory Trust I of $186,000, and Federal Home Loan Bankstock with a cost of $2.9 million.

 

27

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*Loans*

 

Sinceloans typically provide higher interest yields than other types of interestearning assets, a substantial percentage of our earning assets are invested inour loan portfolio.  Average loans forthe years ended December 31, was $174.3 million.  Before allowance for loan losses, total loansoutstanding at December 31, 2003 were $208.8 million.  For the six months ended June 30, 2004and 2003, average loans were $225.5 million and $159.7 million,respectively.  Before allowance for loanlosses, total loans outstanding at June 30, 2004 were $247.6 million.

 

Theprincipal component of our loan portfolio is loans secured by real estate mortgages.  Most of our real estate loans are secured byresidential or commercial property.  Wedo not generally originate traditional long term residential mortgages, but wedo issue traditional second mortgage residential real estate loans and homeequity lines of credit.  We obtain asecurity interest in real estate whenever possible, in addition to any otheravailable collateral.  This collateral istaken to increase the likelihood of the ultimate repayment of the loan.  Generally, we limit the loan-to-value ratioon loans we make to 80%.  Due to theshort time our portfolio has existed, the current mix may not be indicative ofthe ongoing portfolio mix.  We attempt tomaintain a relatively diversified loan portfolio to help reduce the riskinherent in concentration in certain types of collateral.

 

Thefollowing table summarizes the composition of our loan portfolio atJune 30, 2004 and December 31, 2003.

 
| ** **                              | ** ** | **June 30, 2004** | ** ** | **December 31, 2003** | ** ** |
|-----------------------------------------|------------|------------------------|------------|----------------------------|------------|
| ** **                              | ** ** | **Amount**             | ** ** | **% of Total**             | ** ** | **Amount** | ** ** | **% of Total** | ** ** |
| Real estate:                            |       |                   |       |                       |       |   |   |   |   |
| Commercial                              |       |                   |       |                       |       |   |   |   |   |
| Owner occupied                          |       | $                      | 39,935     |                       | 16.13      | % | $ | 39,301 |   | 18.82 | % |
| Non-owner occupied                      |       | 64,888                 |       | 26.21                      | %          | 53,898 |   | 25.82 | % |
| Construction                            |       | 17,817                 |       | 7.20                       | %          | 10,878 |   | 5.21 | % |
| Total commercial real estate            |       | 122,640                |       | 49.54                      | %          | 104,077 |   | 49.85 | % |
| Consumer                                |       |                   |       |                       |       |   |   |   |   |
| Residential                             |       | 41,173                 |       | 16.63                      | %          | 35,823 |   | 17.16 | % |
| Home equity                             |       | 30,880                 |       | 12.47                      | %          | 24,278 |   | 11.63 | % |
| Construction                            |       | 5,544                  |       | 2.24                       | %          | 4,365 |   | 2.09 | % |
| Total consumer real estate              |       | 77,597                 |       | 31.34                      | %          | 64,466 |   | 30.88 | % |
| Total real estate                       |       | 200,237                |       | 80.88                      | %          | 168,543 |   | 80.73 | % |
| Commercial business                     |       | 42,272                 |       | 17.07                      | %          | 36,107 |   | 17.29 | % |
| Consumer-other                          |       | 5,667                  |       | 2.29                       | %          | 4,662 |   | 2.23 | % |
| Deferred origination fees, net          |       | (593                   | )          | (0.24%                     | )          | (530 | ) | (.025% | ) |
| Total gross loans, net of deferred fees |       | 247,583                |       | 100                        | %          | 208,782 |   | 100 | % |
| Less-allowance for loan losses          |       | (3,176                 | )          |                       |       | (2,705 | ) |   |   |
| Total loans, net                        |       | $                      | 244,407    |                       |       |   | $ | 206,077 |   |   |   |

 

28

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*Maturities and Sensitivity of Loans to Changes in InterestRates*

 

The information in the following tables is based on thecontractual maturities of individual loans, including loans which may besubject to renewal at their contractual maturity.  Renewal of such loans is subject to reviewand credit approval, as well as modification of terms upon maturity.  Actual repayments of loans may differ fromthe maturities reflected below because borrowers have the right to prepayobligations with or without prepayment penalties.

 

The following table summarizes the loan maturitydistribution by type and related interest rate characteristics atDecember 31, 2003.

 
| ** **                              | ** ** | **One year  or less** | ** ** | **After one  but within  five years** | ** ** | **After five  years** | ** ** | **Total**  | ** ** |
|-----------------------------------------|------------|-----------------------|------------|---------------------------------------|------------|-----------------------|------------|------------|------------|
| ** **                              | ** ** | **(In thousand)**     | ** ** |
| ** **                              | ** ** | ** **            | ** ** | ** **                            | ** ** | ** **            | ** ** | ** ** | ** ** |
| Real estate - mortgage                  |       | $                     | 21,466     |                                  | 122,731    |                  | 9,102      |       | 153,299    |   |
| Real estate - construction              |       | 6,752                 |       | 5,152                                 |       | 3,340                 |       | 15,244     |       |
| Total real estate                       |       | 28,218                |       | 127,883                               |       | 12,442                |       | 168,543    |       |
|                                    |       |                  |       |                                  |       |                  |       |       |       |
| Commercial business                     |       | 21,296                |       | 14,799                                |       | 12                    |       | 36,107     |       |
| Consumer-other                          |       | 2,103                 |       | 2,007                                 |       | 552                   |       | 4,662      |       |
| Deferred origination fees, net          |       | (95                   | )          | (397                                  | )          | (38                   | )          | (530       | )          |
| Total gross loans, net of deferred fees |       | $                     | 51,522     |                                  | 144,292    |                  | 12,968     |       | 208,782    |   |
| Loans maturing after one year with:     |       |                  |       |                                  |       |                  |       |       |       |
| Fixed interest rates                    |       |                  |       |                                  |       |                  |       | $          | 51,437     |   |
| Floating interest rates                 |       |                  |       |                                  |       |                  |       | $          | 105,823    |   |

 

The following table summarizes the loan maturitydistribution by type and related interest rate characteristics at June 30,2004.

 
| ** **                              | ** ** | **One year  or less** | ** ** | **After one  but within  five years** | ** ** | **After five  years** | ** ** | **Total** | ** ** |
|-----------------------------------------|------------|-----------------------|------------|---------------------------------------|------------|-----------------------|------------|-----------|------------|
| ** **                              | ** ** | **(In thousands)**    | ** ** |
| Real estate - mortgage                  |       | $                     | 25,510     |                                  | 131,354    |                  | 20,012     |      | 176,876    |   |
| Real estate - construction              |       | 7,973                 |       | 6,720                                 |       | 8,668                 |       | 23,361    |       |
| Total real estate                       |       | 33,483                |       | 138,074                               |       | 28,680                |       | 200,237   |       |
|                                    |       |                  |       |                                  |       |                  |       |      |       |
| Commercial business                     |       | 25,087                |       | 17,143                                |       | 42                    |       | 42,272    |       |
| Consumer - other                        |       | 2,956                 |       | 2,429                                 |       | 282                   |       | 5,667     |       |
| Deferred origination fees, net          |       | (112                  | )          | (400                                  | )          | (81                   | )          | (593      | )          |
| Total gross loans, net of deferred fees |       | $                     | 61,414     |                                  | 157,246    |                  | 28,923     |      | 247,583    |   |
| Loans maturing after one year with:     |       |                  |       |                                  |       |                  |       |      |       |
| Fixed interest rates                    |       |                  |       |                                  |       |                  |       | $         | 59,016     |   |
| Floating interest rates                 |       |                  |       |                                  |       |                  |       | $         | 127,153    |   |

 

29

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*Provision andAllowance for Loan Losses*

 

Wehave established an allowance for loan losses through a provision for loanlosses charged to expense on our statement of income.  The allowance for loan losses represents anamount which we believe will be adequate to absorb probable losses on existingloans that may become uncollectible.  Ourjudgment as to the adequacy of the allowance for loan losses is based on anumber of assumptions about future events, which we believe to be reasonable,but which may or may not prove to be accurate. Our determination of the allowance for loan losses is based onevaluations of the collectibility of loans, including consideration of factorssuch as the balance of impaired loans, the quality, mix, and size of ouroverall loan portfolio, economic conditions that may affect the borrower’sability to repay, the amount and quality of collateral securing the loans, ourhistorical loan loss experience, and a review of specific problem loans.  We also consider subjective issues such aschanges in the lending policies and procedures, changes in the local/nationaleconomy, changes in volume or type of credits, changes in volume/severity ofproblem loans, quality of loan review and board of director oversight,concentrations of credit, and peer group comparisons.  Due to our limited operating history, theprovision for loan losses has been made primarily as a result of our assessmentof general loan loss risk compared to banks of similar size and maturity.  Periodically, we adjust the amount of theallowance based on changing circumstances. We charge recognized losses to the allowance and add subsequentrecoveries back to the allowance for loan losses.  There can be no assurance that charge-offs ofloans in future periods will not exceed the allowance for loan losses asestimated at any point in time or that provisions for loan losses will not besignificant to a particular accounting period.

 

Thefollowing table summarizes the activity related to our allowance for loanlosses for the six months ended June 30, 2004 and 2003:

 

| ** **                                 | ** ** | **June 30,**  | ** ** |
|--------------------------------------------|------------|--------------------|------------|
| ** **                                 | ** ** | **2004**           | ** ** | **2003** | ** ** |
|                                       |       | **(In thousands)** |       |
|                                       |       |               |       |   |   |
| Balance, beginning of period               |       | $                  | 2,705      |   | 1,824 |   |
|                                       |       |               |       |   |   |
| Loans charged-off                          |       | (192               | )          | (14 | ) |
|                                       |       |               |       |   |   |
| Recoveries of loans previously charged-off |       | 13                 |       | 3 |   |
|                                       |       |               |       |   |   |
| Net loans charged-off                      |       | $                  | (179       | ) | (11 | ) |
|                                       |       |               |       |   |   |
| Provision for loan losses                  |       | 650                |       | 500 |   |
|                                       |       |               |       |   |   |
| Balance, end of period                     |       | $                  | 3,176      |   | 2,313 |   |
|                                       |       |               |       |   |   |
| Allowance for loan losses to gross loans   |       | 1.28               | %          | 1.32 | % |
|                                       |       |               |       |   |   |
| Net charge-offs to average loans           |       | 0.08               | %          | 0.01 | % |

 

Wedo not allocate the allowance for loan losses to specific categories ofloans.  Instead, we evaluate the adequacyof the allowance for loan losses on an overall portfolio basis utilizing ourcredit grading system which we apply to each loan.  We have retained an independent consultant toreview the loan files on a test basis to confirm the grading of each loan.

 

30

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*NonperformingAssets*

 

Thefollowing table shows the nonperforming assets, percentages of net charge-offs,and the related percentage of allowance for loan losses for the six monthsended June 30, 2004 and the year ended December 31, 2003.

 

| ** **                                                   | ** ** | **June 30,  2004**    | ** ** | **December 31,  2003** | ** ** |
|--------------------------------------------------------------|------------|----------------------------|------------|-----------------------------|------------|
| ** **                                                   | ** ** | **(Dollars in thousands)** | ** ** |
|                                                         |       |                       |       |                        |       |
| Loans over 90 days past due                                  |       | $                          | 229        |                        | 396        |   |
|                                                         |       |                       |       |                        |       |
| Loans on nonaccrual:                                         |       |                       |       |                        |       |
| Mortgage                                                     |       | 364                        |       | 150                         |       |
| Commercial                                                   |       | 63                         |       | 224                         |       |
| Consumer                                                     |       | 7                          |       | 70                          |       |
| Total nonaccrual loans                                       |       | 434                        |       | 444                         |       |
|                                                         |       |                       |       |                        |       |
| Troubled debt restructuring                                  |       | —                     |       | —                      |       |
|                                                         |       |                       |       |                        |       |
| Total of nonperforming loans                                 |       | 434                        |       | 444                         |       |
|                                                         |       |                       |       |                        |       |
| Other nonperforming assets                                   |       | 306                        |       | —                      |       |
|                                                         |       |                       |       |                        |       |
| Total nonperforming assets                                   |       | $                          | 740        |                        | 444        |   |
|                                                         |       |                       |       |                        |       |
| Percentage of total assets                                   |       | 0.27                       | %          | 0.19                        | %          |
|                                                         |       |                       |       |                        |       |
| Percentage of nonperforming loans and  assets to gross loans |       | 0.30                       | %          | 0.21                        | %          |
|                                                         |       |                       |       |                        |       |
| Allowance for loan losses to gross loans                     |       | 1.28                       | %          | 1.30                        | %          |
|                                                         |       |                       |       |                        |       |
| Net charge-offs to average loans                             |       | 0.08                       | %          | 0.10                        | %          |

 

At June 30, 2004 and December 31, 2003, theallowance for loan losses was $3.2 million and $2.7 million, respectively, or1.28% and 1.30%., respectively, of outstanding loans.  During the year ended December 31, 2003,we charged off loans of $172,646.  Duringthe six months ended June 30, 2004 and 2003, our net charged-off loanswere $179,520 and $10,775, respectively.

 

At June 30, 2004 and December 31, 2003,nonaccrual loans represented 0.18% and 0.21% of total loans, respectively.  At June 30, 2004 and December 31,2003, we had $434,419 and $443,939 of loans, respectively, on nonaccrualstatus.  The increase in mortgage loanson nonaccrual status related primarily to one loan that was adequately securedby real estate.  Generally, a loan isplaced on nonaccrual status when it becomes 90 days past due as to principal orinterest, or when we believe, after considering economic and businessconditions and collection efforts, that the borrower’s financial condition issuch that collection of the loan is doubtful. A payment of interest on a loan that is classified as nonaccrual isrecognized as income when received**.**

 

Theamount of foregone interest income on the nonaccrual loans in the first sixmonths of 2004 was approximately $10,400. The amount of interest income recorded in the first six months of 2004for loans that were on nonaccrual at June 30, 2004 was $2,000.

 

31

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*Deposits and Other Interest-Bearing Liabilities*

 

Ourprimary source of funds for loans and investments is our deposits, advancesfrom the FHLB, and short-term repurchase agreements.  National and local market trends over thepast several years suggest that consumers have moved an increasing percentageof discretionary savings funds into investments such as annuities, stocks, andfixed income mutual funds.  Accordingly,it has become more difficult to attract deposits.  We have chosen to obtain a portion of ourcertificates of deposits from areas outside of our market.  The deposits obtained outside of our marketarea generally have lower rates than rates being offered for certificates ofdeposits in our local market.  We alsoutilize out-of-market deposits in certain instances to obtain longer-termdeposits than are readily available in our local market.  We anticipate that the amount ofout-of-market deposits will decline after we open additional retail depositoffices.  The amount of out-of-marketdeposits was $79.6 million at December 31, 2003 and $71.1 at June 30,2004.  The decrease in the first sixmonths of 2004 resulted primarily from the replacement of a portion of ourout-of-market deposits with additional NOW accounts and money market funds thatwe obtained from a retail deposit promotion.

 

Weanticipate being able to either renew or replace these out-of-market depositswhen they mature, although we may not be able to replace them with depositswith the same terms or rates.  Ourloan-to-deposit ratio was 139% and 124%, at June 30, 2004 andDecember 31, 2003, respectively.

 

Thefollowing table shows the average balance amounts and the average rates paid ondeposits held by us for the six months ended June 30, 2004 and 2003.

 
| ** **                          | ** ** | **2004**                   | ** ** | **2003** | ** ** |
|-------------------------------------|------------|----------------------------|------------|----------|------------|
| ** **                          | ** ** | **Amount**                 | ** ** | **Rate** | ** ** | **Amount** | ** ** | **Rate** | ** ** |
| ** **                          | ** ** | **(Dollars in thousands)** | ** ** |
|                                |       |                       |       |     |       |   |   |   |   |
| Noninterest bearing demand deposits |       | $                          | 14,948     |     | —     | % | $ | 13,771 |   | — | % |
| Interest bearing demand deposits    |       | 21,032                     |       | 1.17     | %          | 14,477 |   | 0.82 | % |
| Money market accounts               |       | 32,068                     |       | 1.25     | %          | 18,796 |   | 0.62 | % |
| Saving accounts                     |       | 1,418                      |       | 0.34     | %          | 1,916 |   | 0.47 | % |
| Time deposits less than $100,000    |       | 30,227                     |       | 2.62     | %          | 32,258 |   | 3.29 | % |
| Time deposits greater than $100,000 |       | 73,262                     |       | 2.33     | %          | 53,650 |   | 2.87 | % |
| Total deposits                      |       | $                          | 172,955    |     | 1.82       | % | $ | 134,868 |   | 2.11 | % |

 

Coredeposits, which exclude time deposits of $100,000 or more, provide a relativelystable funding source for our loan portfolio and other earning assets.  Our core deposits were $107.8 million and$89.9 million, at June 30, 2004 and December 31, 2003, respectively.

 

Allof our time deposits are certificates of deposits.  The maturity distribution of our timedeposits of $100,000 or more at June 30, 2004 and December 31, 2003 isas follows:

 

| ** **                       | ** ** | **June 30,  2004** | ** ** | **December 31,  2003** | ** ** |
|----------------------------------|------------|-------------------------|------------|-----------------------------|------------|
| ** **                       | ** ** | **(In thousands)**      | ** ** |
|                             |       |                    |       |                        |       |
| Three months or less             |       | $                       | 21,386     |                        | $          | 19,272 |   |
| Over three through six months    |       | 12,917                  |       | 16,416                      |       |
| Over three through twelve months |       | 8,017                   |       | 24,983                      |       |
| Over twelve months               |       | 27,853                  |       | 18,437                      |       |
| Total                            |       | $                       | 70,173     |                        | $          | 79,108 |   |

 

Thedecrease in time deposits of $100,000 or more for the six months endedJune 30, 2004 resulted from the repayment of maturing deposits that wereobtained outside of our primary market with the additional NOW accounts andmoney market funds that we obtained from a retail deposit promotion.

 

32

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*Capital Resources*

 

Total shareholders’ equity was $11.2 million atDecember 31, 2003.  At June 30,2004, total shareholders’ equity was $11.9 million.  The increase during the first six months of2004 resulted from the $801,801 of net income earned during the first sixmonths and the additional capital of $20,010 obtained from the exercise ofwarrants that were outstanding.  Theadditions to capital were partly offset by a $68,217 reduction in unrealizedgain on investment securities, net of tax.

 

The following table shows the return on average assets(net income divided by average total assets), return on average equity (net incomedivided by average equity), and equity to assets ratio (average equity dividedby average total assets) for the six months ended June 30, 2004 and theyear ended December 31, 2003.  Sinceour inception, we have not paid cash dividends.

 

| ** **               | ** ** | **June 30, 2004** | ** ** | **December 31, 2003** | ** ** |
|--------------------------|------------|------------------------|------------|----------------------------|------------|
| ** **               | ** ** | ** **             | ** ** | ** **                 | ** ** |
| Return on average assets |       | 0.65                   | %          | 0.52                       | %          |
|                     |       |                   |       |                       |       |
| Return on average equity |       | 13.95                  | %          | 9.28                       | %          |
|                     |       |                   |       |                       |       |
| Equity to assets ratio   |       | 4.53                   | %          | 5.57                       | %          |

 

The Federal Reserve Board and bank regulatory agenciesrequire bank holding companies and financial institutions to maintain capitalat adequate levels based on a percentage of assets and off-balance sheetexposures, adjusted for risk weights ranging from 0% to 100%.

 

Underthe capital adequacy guidelines, regulatory capital is classified into twotiers.  These guidelines require aninstitution to maintain a certain level of Tier 1 and Tier 2 capital torisk-weighted assets.  Tier 1 capitalconsists of common shareholders’ equity, excluding the unrealized gain or losson securities available for sale, minus certain intangible assets.  In determining the amount of risk-weightedassets, all assets, including certain off-balance sheet assets, are multipliedby a risk-weight factor of 0% to 100% based on the risks believed to beinherent in the type of asset.  Tier 2capital consists of Tier 1 capital plus the general reserve for loan losses,subject to certain limitations.  We arealso required to maintain capital at a minimum level based on total averageassets, which is known as the Tier 1 leverage ratio.

 

Atboth the holding company and bank level, we are subject to various regulatorycapital requirements administered by the federal banking agencies.  To be considered “adequately capitalized”under these capital guidelines, we must maintain a minimum total risk-basedcapital of 8%, with at least 4% being Tier 1 capital.  In addition, we must maintain a minimum Tier1 leverage ratio of at least 4%.  To beconsidered “well-capitalized,” we must maintain total risk-based capital of atleast 10%, Tier 1 capital of at least 6%, and a leverage ratio of at least 5%.

 

Thefollowing table sets forth the holding company’s andthe bank’s various capital ratios at June 30, 2004 and atDecember 31, 2003.  For all periods,the bank was considered “well capitalized” and the holding company met orexceeded its applicable regulatory capital requirements.

 

| ** **                | ** ** | **June 30, 2004** | ** ** | **December 31, 2003** | ** ** |
|---------------------------|------------|------------------------|------------|----------------------------|------------|
| ** **                | ** ** | **Holding  Company**   | ** ** | **Bank**                   | ** ** | **Holding  Company** | ** ** | **Bank** | ** ** |
|                      |       |                   |       |                       |       |   |   |   |   |
| Total risk-based capital  |       | 9.2                    | %          | 10.5                       | %          | 10.2 | % | 10.1 | % |
| Tier 1 risk-based capital |       | 7.1                    | %          | 9.2                        | %          | 7.8 | % | 8.8 | % |
| Leverage capital          |       | 6.0                    | %          | 7.8                        | %          | 6.1 | % | 7.7 | % |

 

33

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*Borrowings*

 

The following tableoutlines our various sources of borrowed funds during the six months endedJune 30, 2004 and the year ended December 31, 2003, the amountsoutstanding at the end of each period, at the maximum point for each componentduring the periods and on average for each period, and the average interestrate that we paid for each borrowing source.  The maximum month-end balance represents thehigh indebtedness for each component of borrowed funds at any time during eachof the periods shown.

 
| ** **                                             | ** ** | **Ending  Balance** | ** ** | **Period-  End Rate** | ** **  | **Maximum  Month-end  Balance** | ** ** | **Average for the Period** | ** ** |
|--------------------------------------------------------|------------|---------------------|------------|-----------------------|-------------|---------------------------------|------------|----------------------------|------------|
| ** **                                             | ** ** | ** **          | ** ** | ** **            | **Balance** | ** **                      | **Rate**   | ** **                 |
| ** **                                             |       | **(In thousands)**  |       |
| ** **                                             |       |                |       |                  |        |                            |       |                       |       |   |   |
| **At or for the Six  Months Ended June 30, 2004** |       |                |       |                  |        |                            |       |                       |       |   |   |
| Federal Home Loan Bank advances                        |       | $                   | 58,400     |                  | 1.70        | %                               | $          | 58,400                     |       | $ | 46,988 |   | 1.91 | % |
| Securities sold under agreement to                     |       |                |       |                  |        |                            |       |                       |       |   |   |
| repurchase                                             |       | 13,565              |       | 1.23                  | %           | 14,637                          |       | 13,798                     |       | 1.11 | % |
| Federal funds purchased                                |       | —              |       | 1.79                  | %           | —                          |       | 412                        |       | 1.46 | % |
| Correspondent bank line of credit                      |       | 3,000               |       | 3.61                  | %           | 3,000                           |       | 1,034                      |       | 3.11 | % |
| Junior subordinated debentures                         |       | 6,186               |       | 4.50                  | %           | 6,186                           |       | 6,186                      |       | 4.55 | % |
|                                                   |       |                |       |                  |        |                            |       |                       |       |   |   |
| **At or for the Year  Ended December 31, 2003**   |       |                |       |                  |        |                            |       |                       |       |   |   |
| Federal Home Loan Bank advances                        |       | $                   | 32,500     |                  | 2.00        | %                               | $          | 40,000                     |       | $ | 27,569 |   | 2.14 | % |
| Securities sold under agreement to                     |       |                |       |                  |        |                            |       |                       |       |   |   |
| repurchase                                             |       | 9,297               |       | 1.12                  | %           | 9,865                           |       | 5,589                      |       | 1.23 | % |
| Federal funds purchased                                |       | —              |       | 1.25                  | %           | 1,556                           |       | 450                        |       | 1.56 | % |
| Correspondent bank line of credit                      |       | —              |       | 3.12                  | %           | 3,000                           |       | 1,332                      |       | 3.23 | % |
| Junior subordinated debentures                         |       | 6,186               |       | 4.27                  | %           | 6,186                           |       | 3,107                      |       | 4.54 | % |
|                                                   |       |                |       |                  |        |                            |       |                       |       |   |   |

 

*Effect ofInflation and Changing Prices*

 

Theeffect of relative purchasing power over time due to inflation has not beentaken into account in our consolidated financial statements.  Rather, our financial statements have beenprepared on an historical cost basis in accordance with generally acceptedaccounting principles.

 

Unlikemost industrial companies, our assets and liabilities are primarily monetary innature.  Therefore, the effect of changesin interest rates will have a more significant impact on our performance thanwill the effect of changing prices and inflation in general.  In addition, interest rates may generallyincrease as the rate of inflation increases, although not necessarily in thesame magnitude.  As discussed previously,we seek to manage the relationships between interest sensitive assets and liabilitiesin order to protect against wide rate fluctuations, including those resultingfrom inflation.

 

34

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*Off-Balance Sheet Risk*

 

Commitments to extend credit are agreements to lend to a client as longas the client has not violated any material condition established in thecontract.  Commitments generally havefixed expiration dates or other termination clauses and may require the paymentof a fee.  At December 31, 2003,unfunded commitments to extend credit were $51.2 million, of which $16.1million was at fixed rates and $35.1 million was at variable rates.  At June 30, 2004, unfunded commitmentsto extend credit were $47.3 million, of which $6.5 million was at fixed ratesand $40.9 million was at variable rates. A significant portion of the unfunded commitments related to consumerequity lines of credit.  Based onhistorical experience, we anticipate that a significant portion of these linesof credit will not be funded.  Weevaluate each client’s credit worthiness on a case-by-case basis.  The amount of collateral obtained, if deemednecessary by us upon extension of credit, is based on our credit evaluation ofthe borrower.  The type of collateralvaries but may include accounts receivable, inventory, property, plant andequipment, and commercial and residential real estate.

 

At December 31, 2003, there was a $1.7 million commitment under aletter of credit.  At June 30, 2004,there was a $2.1 million commitment under a letter of credit.  The credit risk and collateral involved inissuing letters of credit is essentially the same as that involved in extendingloan facilities to customers.  Since mostof the letters of credit are expected to expire without being drawn upon, theydo not necessarily represent future cash requirements.

 

Except as disclosed in this document, we are not involved inoff-balance sheet contractual relationships, unconsolidated related entitiesthat have off-balance sheet arrangements or transactions that could result inliquidity needs or other commitments that significantly impact earnings.

 

*Market Risk*

 

Market risk is the risk of loss from adverse changes in market pricesand rates, which principally arises from interest rate risk inherent in ourlending, investing, deposit gathering, and borrowing activities.  Other types of market risks, such as foreigncurrency exchange rate risk and commodity price risk, do not generally arise inthe normal course of our business.

 

Weactively monitor and manage our interest rate risk exposure principally bymeasuring our interest sensitivity “gap,” which is the positive or negativedollar difference between assets and liabilities that are subject to interestrate repricing within a given period of time. Interest rate sensitivity can be managed by repricing assets orliabilities, selling securities available for sale, replacing an asset orliability at maturity, or adjusting the interest rate during the life of anasset or liability.  Managing the amountof assets and liabilities repricing in this same time interval helps to hedgethe risk and minimize the impact on net interest income of rising or fallinginterest rates.  We generally wouldbenefit from increasing market rates of interest when we have an asset-sensitivegap position and generally would benefit from decreasing market rates ofinterest when we are liability-sensitive.

 

Approximately68.0% of our loans were variable rate loans at December 31, 2003 andJune 30, 2004, and we were asset sensitive during most of the year endedDecember 31, 2003 and the six months ended June 30, 2004.  As of June 30, 2004, we expect to beasset sensitive for the next three months. After September 30, 2004, we expect to be liability sensitive forthe next nine months because substantially all of our variable rate loansrepriced within the first three months of the year but a majority of ourdeposits will reprice over a 12-month period. The ratio of cumulative gap to total earning assets after 12 months was(1.2%) because $3.2 million more liabilities will reprice in a 12 month periodthan assets.  However, our gap analysisis not a precise indicator of our interest sensitivity position.  The analysis presents only a static view ofthe timing of maturities and repricing opportunities, without taking into considerationthat changes in interest rates do not affect all assets and liabilitiesequally.  For example, rates paid on asubstantial portion of core deposits may change contractually within arelatively short time frame, but those rates are viewed by us as significantlyless interest-sensitive than market-based rates such as those paid on noncoredeposits.  Net interest income may beaffected by other significant factors in a given interest rate environment,including changes in the volume and mix of interest-earning assets andinterest-bearing liabilities.

 

*Liquidity andInterest Rate Sensitivity*

 

Liquidityrepresents the ability of a company to convert assets into cash or cashequivalents without significant loss, and the ability to raise additional fundsby increasing liabilities.  Liquiditymanagement involves monitoring our sources and uses of funds in order to meetour day-to-day cash flow requirements while maximizing profits.  Liquidity management is made more complicatedbecause different balance sheet components are subject to varying degrees of

 

35

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management control.  Forexample, the timing of maturities of our investment portfolio is fairlypredictable and subject to a high degree of control at the time investmentdecisions are made.  However, net depositinflows and outflows are far less predictable and are not subject to the samedegree of control.

 

AtJune 30, 2004, our liquid assets, consisting of cash and due from banksand federal funds sold, amounted to $4.0 million, or 1.5% of total assets.  Our investment securities at June 30,2004 amounted to $20.3 million, or 7.4% of total assets.  At December 31, 2003, our liquid assetsamounted to $6.9 million, or 3.0% of total assets.  Our investment securities atDecember 31, 2003 amounted to $13.5 million or 5.8% of total assets.  Investment securities traditionally provide asecondary source of liquidity since they can be converted into cash in a timelymanner.  However, substantially all ofthese securities are pledged against outstanding debt.  Therefore, the related debt would need to berepaid prior to the securities being sold in order for these securities to beconverted to cash.

 

Ourability to maintain and expand our deposit base and borrowing capabilitiesserves as our primary source of liquidity. We plan to meet our future cash needs through the liquidation oftemporary investments, the generation of deposits, and the net proceeds fromfuture stock offerings.  In addition, wewill receive cash upon the maturity and sale of loans and the maturity ofinvestment securities.  During most of2003 and 2004, as a result of historically low rates that were being earned onshort-term liquidity investments, we chose to maintain a lower than normal levelof short-term liquidity securities.  Inaddition, we maintain two federal funds purchased lines of credit withcorrespondent banks totaling $7.0 million. We are also a member of the Federal Home Loan Bank of Atlanta, fromwhich applications for borrowings can be made for leverage purposes.  The FHLB requires that securities, qualifyingmortgage loans, and stock of the FHLB owned by the bank be pledged to secureany advances from the FHLB.  The unusedborrowing capacity currently available from the FHLB at June 30, 2004 was$11.1 million, assuming that the bank’s $2.9 million investment in FHLB stock,as well as qualifying mortgages, would be available to secure any futureborrowings.

 

Webelieve that our existing stable base of core deposits, borrowings from theFHLB, short-term repurchase agreements, and proceeds from future offerings willenable us to successfully meet our long-term liquidity needs.

 

Asset/liabilitymanagement is the process by which we monitor and control the mix andmaturities of our assets and liabilities. The essential purposes ofasset/liability management are to ensure adequate liquidity and to maintain anappropriate balance between interest sensitive assets and liabilities in orderto minimize potentially adverse impacts on earnings from changes in marketinterest rates.  Our asset/liabilitymanagement committee (“ALCO”) monitors and considers methods of managingexposure to interest rate risk.  We haveboth an internal ALCO consisting of senior management that meets at various timesduring each month and a board ALCO that meets monthly.  The ALCOs are responsible for maintaining thelevel of interest rate sensitivity of our interest sensitive assets andliabilities within board-approved limits.

 

36

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Thefollowing table sets forth information regarding our rate sensitivity, as ofDecember 31, 2003, at each of the time intervals.  The information in the table may not beindicative of our rate sensitivity position at other points in time.  In addition, the maturity distributionindicated in the table may differ from the contractual maturities of theearning assets and interest-bearing liabilities presented due to considerationof prepayment speeds under various interest rate change scenarios in theapplication of the interest rate sensitivity methods described above.

 
| ** **                                       | ** ** | **Within  three  months** | ** ** | **After three  but  within twelve  months** | ** ** | **After one but  within five  years** | ** ** | **After  five  years** | ** ** | **Total** | ** ** |
|--------------------------------------------------|------------|---------------------------|------------|---------------------------------------------|------------|---------------------------------------|------------|------------------------|------------|-----------|------------|
| ** **                                       | ** ** | **(In thousands)**        | ** ** |
| Interest-earning assets:                         |       |                      |       |                                        |       |                                  |       |                   |       |      |       |
| Federal funds sold                               |       | $                         | 2,843      |                                        | $          | —                                |       | $                      | —     |      | $          | — |   | $ | 2,843 |   |
| Investment securities                            |       | 501                       |       | 1,503                                       |       | 8,906                                 |       | 2,553                  |       | 13,463    |       |
| Loans                                            |       | 148,763                   |       | 10,492                                      |       | 42,092                                |       | 7,222                  |       | 208,569   |       |
|                                             |       |                      |       |                                        |       |                                  |       |                   |       |      |       |
| Total earning assets                             |       | $                         | 152,107    |                                        | $          | 11,995                                |       | $                      | 50,998     |      | $          | 9,775 |   | $ | 224,875 |   |
|                                             |       |                      |       |                                        |       |                                  |       |                   |       |      |       |
| Interest-bearing liabilities:                    |       |                      |       |                                        |       |                                  |       |                   |       |      |       |
| Money market and NOW                             |       | $                         | 42,253     |                                        | $          | —                                |       | $                      | —     |      | $          | — |   | $ | 42,253 |   |
| Regular savings                                  |       | 1,589                     |       | —                                      |       | —                                |       | —                 |       | 1,589     |       |
| Time deposits                                    |       | 26,088                    |       | 57,463                                      |       | 25,269                                |       | —                 |       | 108,820   |       |
| Repurchase agreements                            |       | 9,297                     |       | —                                      |       | —                                |       | —                 |       | 9,297     |       |
| FHLB advances                                    |       | 24,500                    |       | —                                      |       | 8,000                                 |       | —                 |       | 32,500    |       |
| Junior subordinated debentures                   |       | 6,186                     |       | —                                      |       | —                                |       | —                 |       | 6,186     |       |
|                                             |       |                      |       |                                        |       |                                  |       |                   |       |      |       |
| Total interest-bearing liabilities               |       | $                         | 109,913    |                                        | $          | 57,463                                |       | $                      | 33,269     |      | $          | — |   | $ | 200,645 |   |
|                                             |       |                      |       |                                        |       |                                  |       |                   |       |      |       |
| Period gap                                       |       | $                         | 42,194     |                                        | $          | (45,468                               | )          | $                      | 17,729     |      | $          | 9,775 |   |   |   |
| Cumulative gap                                   |       | 42,194                    |       | (3,274                                      | )          | 14,455                                |       | 24,230                 |       |      |       |
|                                             |       |                      |       |                                        |       |                                  |       |                   |       |      |       |
| Ratio of cumulative gap to total earning  assets |       | 18.8                      | %          | (1.5                                        | )%         | 6.4                                   | %          | 10.8                   | %          |      |       |

 

37

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Thefollowing table sets forth information regarding our rate sensitivity as ofJune 30, 2004 for each of the time intervals indicated.

 
| ** **                                       | ** ** | **Within  three  months** | ** ** | **After three  but  within twelve  months** | ** ** | **After one but  within five  years** | ** ** | **After  five  years** | ** ** | **Total** | ** ** |
|--------------------------------------------------|------------|---------------------------|------------|---------------------------------------------|------------|---------------------------------------|------------|------------------------|------------|-----------|------------|
| ** **                                       | ** ** | **(In thousands)**        | ** ** |
|                                             |       |                      |       |                                        |       |                                  |       |                   |       |      |       |
| Interest-earning assets:                         |       |                      |       |                                        |       |                                  |       |                   |       |      |       |
| Federal funds sold                               |       | $                         | 1,365      |                                        | $          | —                                |       | $                      | —     |      | $          | — |   | $ | 1,365 |   |
| Investment securities                            |       | 1,453                     |       | 4,359                                       |       | 11,481                                |       | —                 |       | 17,293    |       |
| Loans                                            |       | 177,672                   |       | 7,958                                       |       | 47,518                                |       | 14,000                 |       | 247,148   |       |
|                                             |       |                      |       |                                        |       |                                  |       |                   |       |      |       |
| Total earning assets                             |       | $                         | 180,490    |                                        | $          | 12,317                                |       | $                      | 58,999     |      | $          | 14,000 |   | $ | 265,806 |   |
|                                             |       |                      |       |                                        |       |                                  |       |                   |       |      |       |
| Interest-bearing liabilities:                    |       |                      |       |                                        |       |                                  |       |                   |       |      |       |
| Money market and NOW                             |       | $                         | 66,550     |                                        | $          | —                                |       | $                      | —     |      | $          | — |   | $ | 66,550 |   |
| Regular savings                                  |       | 1,321                     |       | —                                      |       | —                                |       | —                 |       | 1,321     |       |
| Time deposits                                    |       | 27,992                    |       | 33,968                                      |       | 27,733                                |       | 5,774                  |       | 95,467    |       |
| Repurchase agreements                            |       | 13,565                    |       | —                                      |       | —                                |       | —                 |       | 13,565    |       |
| Note payable                                     |       | 3,000                     |       | —                                      |       | —                                |       | —                 |       | 3,000     |       |
| FHLB advances                                    |       | 38,400                    |       | 5,000                                       |       | 5,000                                 |       | 10,000                 |       | 58,400    |       |
| Junior subordinated debentures                   |       | 6,186                     |       | —                                      |       | —                                |       | —                 |       | 6,186     |       |
|                                             |       |                      |       |                                        |       |                                  |       |                   |       |      |       |
| Total interest-bearing liabilities               |       | $                         | 157,014    |                                        | $          | 38,968                                |       | $                      | 32,733     |      | $          | 15,774 |   | $ | 244,489 |   |
|                                             |       |                      |       |                                        |       |                                  |       |                   |       |      |       |
| Period gap                                       |       | $                         | 23,476     |                                        | $          | (26,651                               | )          | $                      | 26,266     |      | $          | (1,774 | ) |   |   |
| Cumulative gap                                   |       | 23,476                    |       | (3,175                                      | )          | 23,091                                |       | 21,317                 |       |      |       |
|                                             |       |                      |       |                                        |       |                                  |       |                   |       |      |       |
| Ratio of cumulative gap to total earning  assets |       | 8.9                       | %          | (1.2                                        | )%         | 8.7                                   | %          | 8.0                    | %          |      |       |

 

38

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*Accounting,Reporting, and Regulatory Matters*

 

Recently Issued Accounting Standards

 

The following is a summary of recent authoritative pronouncements thataffect accounting, reporting, and disclosure of financial information by theCompany:

 

In March 2004, the FASB issued an exposure draft on “Share-BasedPayment”.  The proposed Statementaddresses the accounting for transactions in which an enterprise receivesemployee services in exchange for a) equity instruments of the enterprise or b)liabilities that are based on the fair value of the enterprise’s equityinstruments or that may be settled by the issuance of such equityinstruments.  This proposed Statementwould eliminate the ability to account for share-based compensationtransactions using APB Opinion No. 25, “Accounting for Stock Issued toEmployees”, and generally would require instead that such transactions beaccounted for using a fair-value-based method. This Statement, if approved, will be effective for awards that aregranted, modified, or settled in fiscal years beginning after a)December 15, 2004 for public entities and nonpublic entities that used thefair-value-based method of accounting under the original provisions ofStatement 123 for recognition or pro forma disclosure purposes and b)December 15, 2005 for all other nonpublic entities.  Earlier application is encouraged providedthat financial statements for those earlier years have not yet beenissued.  Retrospective application of thisStatement is not permitted.  The adoptionof this Statement, if approved, will not have any impact on the Company’sfinancial position or results of operations.

 

Other accounting standards that have been issued or proposed by theFASB or other standards-setting bodies that do not require adoption until afuture date are not expected to have a material impact on the consolidatedfinancial statements upon adoption.

 

**Item 3.****Controls and Procedures**

 

As of the end of the period covered by this report, we carried out anevaluation, under the supervision and with the participation of our management,including our Chief Executive Officer and Chief Financial Officer, of theeffectiveness of our disclosure controls and procedures as defined in ExchangeAct Rule 13a-15(e).  Based upon thatevaluation, our Chief Executive Officer and Chief Financial Officer haveconcluded that our current disclosure controls and procedures are effective asof June 30, 2004.  There havebeen no significant changes in our internal controls over financial reportingduring the fiscal quarter ended June 30, 2004 that have materiallyaffected, or are reasonably likely to materially affect, our internal controlsover financial reporting.

 

The design of anysystem of controls and procedures is based in part upon certain assumptionsabout the likelihood of future events. There can be no assurance that any design will succeed in achieving itsstated goals under all potential future conditions, regardless of how remote.

 

**PARTII.****  OTHER INFORMATION**

 

**Item 1.****                                   LegalProceedings**

 

There are no material pending legal proceedings to which the company is aparty or of which any of its property is the subject.

 

**Item 2.****                                   Changesin Securities**

 

None

 

**Item 3.****                                   DefaultsUpon Senior Securities**

 

Not applicable

 

**Item 4.****                                   Submissionof Matters to a Vote of Security Holders**

 

39

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At thecompany’s annual meeting of shareholders held May 12, 2004, the election offour members of the board of directors as Class II directors for a three-yearterm was the only matter submitted to a vote of security holders during thethree months ended June 30, 2004. The followingparagraph desciibes the matter voted upon at the annual meeting and sets forththe number of votes cast for, against or withheld and the number of abstentionsas to the matter (except as provided below, there were no broker non-votes).****

 

Our board ofdirectors is divided into three classes with each class to be nearly equal innumber as possible.  The three classes ofdirectors are to have staggered terms, so that the terms of only approximatelyone-third of the board members will expire at each annual meeting of meeting ofshareholders.  The current Class Idirectors are Mark A. Cothran, Rudolph G. Johnsonstone, III, M.D., Keith J.Marrero, and R. Arthur Seaver, Jr.  Thecurrent Class II directors are Leighton M. Cubbage, David G. Ellison, James B.Orders, and William B. Sturgis.  Thecurrent Class III directors are Andrew B. Cajka, Anne S. Ellefson, Fred Gilmer,Jr. and Tecumseh Hooper, Jr.

 

The previousterms of the Class II directors expired at the Annual Meeting.  Each of the four current Class II directorswas nominated for election and stood for election at the Annual Meeting on May12, 2004 for a three-year term.  The number of votes for the election of the Class II directors wereas follows: For Mr. Cubbage – 1,543,383; for Mr Ellison – 1,546,683; for Mr.Orders – 1,546,683; and for Mr. Sturgis – 1,546,683.  The number of votes againstthe directors were as follows: Mr. Cubbage – 3,000; Mr. Ellison – 0; Mr. Orders–0; and Mr. Sturgis –0.  No shareholders voted to abstain.

 

Since aplurality of the votes were attained for the directors that stood forre-election, the approval of the Class II directors to serve a three-year term,expiring at the 2007 annual meeting of shareholders was recorded in our minutebook from the annual meeting of shareholders. There were no other matters voted on by the company’s shareholders atour annual meeting held on May 12, 2004.

 

**Item 5.****                                   OtherInformation**

 

None

 

**Item 6.****                                   Exhibitsand Reports on Form 8-K**

 

(a)                                  Exhibits:  See Exhibit Index attached hereto.

 
| **Exhibit** | ** ** | **Description**                                                                                                                                 |
|-------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------|
|        |       |                                                                                                                                            |
| 10.1        |       | Employment Agreement dated April 1, 2004 between Greenville  First Bank, N.A., Greenville First Bancshares, Inc., and James M. Austin, III |
|        |       |                                                                                                                                            |
| 10.2        |       | Employment Agreement dated April 1, 2004 between Greenville  First Bank, N.A. and Frederick Gilmer, III                                    |
|        |       |                                                                                                                                            |
| 10.3        |       | Employment Agreement dated April 1, 2004 between Greenville  First Bank, N.A. and J. Edward Terrell                                        |
|        |       |                                                                                                                                            |
| 10.4        |       | Consulting Services Agreement between Greenville First Bank, N.A. and  Cothran Properties, LLC dated January 12, 2004                      |
|        |       |                                                                                                                                            |
| 10.5        |       | Consulting Services Agreement between Greenville First Bank, N.A. and  Cothran Properties, LLC dated June 14, 2004                         |
|        |       |                                                                                                                                            |
| 10.6        |       | Sublease Agreement between Greenville First Bank, N.A. and Augusta  Road Holdings, LLC dated February 26, 2004                             |
|        |       |                                                                                                                                            |
| 31.1        |       | Rule 13a-14(a) Certification of the Chief Executive Officer.                                                                                    |
|        |       |                                                                                                                                            |
| 31.2        |       | Rule 13a-14(a) Certification of the Chief Financial Officer.                                                                                    |
|        |       |                                                                                                                                            |
| 32          |       | Section 1350 Certifications.                                                                                                               |

 

40

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(b)                                 Reports on Form8-K

 

The following reports were filed on Form 8-K during the quarter endedJune 30, 2004.

 

The Company filed a Form 8-K on April 20, 2004 to disclose theissuance of a press release announcing its financial results for the quarterended March 31, 2004.

 

**SIGNATURES**

 

Pursuant tothe requirements of the Exchange Act, the registrant caused this report to besigned on its behalf by the undersigned, thereunto duly authorized.

 
|                       | GREENVILLE FIRST BANCSHARES, INC. |
|----------------------------|-----------------------------------|
|                       |                              |
|                       |                              |
| Date: August 10, 2004 |                              |
|                       |                              |
|                       | /s/  R. Arthur Seaver, Jr.   |   |
|                       | R. Arthur Seaver, Jr.             |
|                       | Chief Executive Officer           |
|                       |                              |
|                       |                              |
| Date: August 10, 2004 | /s/ James M. Austin, III          |   |
|                       | James M. Austin, III              |
|                       | Chief Financial Officer           |
|                            |                                   |  |  |

 

41

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INDEX TO EXHIBITS

 
| **Exhibit  Number** | ** ** | **Description**                                                                                                                                 |
|---------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------|
|                |       |                                                                                                                                            |
| 10.1                |       | Employment Agreement dated April 1, 2004 between Greenville  First Bank, N.A., Greenville First Bancshares, Inc., and James M. Austin, III |
|                |       |                                                                                                                                            |
| 10.2                |       | Employment Agreement dated April 1, 2004 between Greenville  First Bank, N.A. and Frederick Gilmer, III                                    |
|                |       |                                                                                                                                            |
| 10.3                |       | Employment Agreement dated April 1, 2004 between Greenville  First Bank, N.A. and J. Edward Terrell                                        |
|                |       |                                                                                                                                            |
| 10.4                |       | Consulting Services Agreement between Greenville First Bank, N.A. and  Cothran Properties, LLC dated January 12, 2004                      |
|                |       |                                                                                                                                            |
| 10.5                |       | Consulting Services Agreement between Greenville First Bank, N.A. and  Cothran Properties, LLC dated June 14, 2004                         |
|                |       |                                                                                                                                            |
| 10.6                |       | Sublease Agreement between Greenville First Bank, N.A. and Augusta  Road Holdings, LLC dated February 26, 2004                             |
|                |       |                                                                                                                                            |
| 31.1                |       | Rule 13a-14(a) Certification of the Chief Executive Officer.                                                                                    |
|                |       |                                                                                                                                            |
| 31.2                |       | Rule 13a-14(a) Certification of the Chief Financial Officer.                                                                                    |
|                |       |                                                                                                                                            |
| 32                  |       | Section 1350 Certifications.                                                                                                               |

 

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