** **

**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

 

**Washington, D.C. 20549**

 

**FORM 10-QSB**

 

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

 

**For the Quarterly Period EndedSeptember 30, 2004**

 

**OR**

 

**o****TRANSITION REPORT PURSUANT TOSECTION 13 OR 15 (d)OF THE SECURITIES EXCHANGE ACT OF 1934**

 

**For the Transition Period from             to**

 

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

 

**Greenville First Bancshares, Inc.**

(Exact name of registrant 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**

(Telephone Number)

 

**Not Applicable**

(Former name, former address

andformer fiscal year,

ifchanged since last report)

 

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

 

APPLICABLE ONLY TO CORPORATE ISSUERS

 

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

2,647,994 shares of common stock, $.01par value per share, issued and outstanding as of November 8, 2004.

 

Transitional Small Business Disclosure Format (checkone):  YES oNO ý

 

 

----

 

**GREENVILLE FIRST BANCSHARES, INC.**

 

**PART I.  FINANCIAL INFORMATION**

 

**Item 1.****  Financial Statements**

 

The financial statements of Greenville FirstBancshares, Inc. and Subsidiary are set forth in the following pages.

 

2

----

 

***GREENVILLEFIRST BANCSHARES, INC. AND SUBSIDIARY***

***CONSOLIDATEDBALANCE SHEETS***

 
| ** **                                                                                                                | ** ** | **September 30,  2004** | ** **  | **December 31,  2003** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------|------------|-------------------------|-------------|------------------------|------------|
| ** **                                                                                                                | ** ** | **(Unaudited)**         | ** **  | **(Audited)**          | ** ** |
| **Assets**                                                                                                                | ** ** | ** **              | ** **  | ** **             | ** ** |
| Cash and due  from banks                                                                                                  |       | $                       | 3,098,173   |                   | $          | 4,104,697 |   |
| Federal funds  sold                                                                                                       |       | 473,819                 |        | 2,842,594              |       |
| Investment  securities available for sale                                                                                 |       | 2,950,185               |        | 3,628,996              |       |
| Investment  securities held to maturity-  (market value $13,648,242 and $9,761,305)                                       |       | 13,696,642              |        | 9,834,324              |       |
| Other  investments, at cost                                                                                               |       | 3,886,150               |        | 2,296,150              |       |
| Loans, net                                                                                                                |       | 264,258,625             |        | 206,076,833            |       |
| Accrued interest                                                                                                          |       | 996,672                 |        | 756,905                |       |
| Property and  equipment, net                                                                                              |       | 1,736,579               |        | 824,259                |       |
| Other real  estate owned                                                                                                  |       | 305,485                 |        | —                 |       |
| Other assets                                                                                                              |       | 1,538,766               |        | 476,463                |       |
|                                                                                                                      |       |                    |        |                   |       |
| Total assets                                                                                                              |       | $                       | 292,941,096 |                   | $          | 230,841,221 |   |
|                                                                                                                      |       |                    |        |                   |       |
| **Liabilities**                                                                                                           | ** ** | ** **              | ** **  | ** **             | ** ** |
| Deposits                                                                                                                  |       | $                       | 183,232,228 |                   | $          | 168,963,595 |   |
| Official checks  outstanding                                                                                              |       | 2,045,465               |        | 1,575,357              |       |
| Federal funds  purchased and repurchase agreements                                                                        |       | 13,805,000              |        | 9,296,999              |       |
| Federal Home  Loan Bank advances                                                                                          |       | 60,610,000              |        | 32,500,000             |       |
| Junior  subordinated debentures                                                                                           |       | 6,186,000               |        | 6,186,000              |       |
| Accrued interest  payable                                                                                                 |       | 679,283                 |        | 572,272                |       |
| Accounts payable  and accrued expenses                                                                                    |       | 895,510                 |        | 560,030                |       |
|                                                                                                                      |       |                    |        |                   |       |
| Total  liabilities                                                                                                        |       | 267,453,486             |        | 219,654,253            |       |
|                                                                                                                      |       |                    |        |                   |       |
| **Shareholders’  equity**                                                                                            |       |                    |        |                   |       |
| Preferred stock,  par value $.01 per share, 10,000,000 shares authorized, no shares issued                                |       | —                  |        | —                 |       |
| Common stock,  par value $.01 per share                                                                                   |       |                    |        |                   |       |
| Authorized,  10,000,000 shares; issued 2,527,994 and 1,724,994 at September 30, 2004 and  December 31, 2003, respectively |       | 25,280                  |        | 17,250                 |       |
| Additional  paid-in capital                                                                                               |       | 23,650,354              |        | 10,629,450             |       |
| Accumulated  other comprehensive income                                                                                   |       | 59,998                  |        | 96,997                 |       |
| Retained  earnings                                                                                                        |       | 1,751,978               |        | 443,271                |       |
|                                                                                                                      |       |                    |        |                   |       |
| Total  shareholders’ equity                                                                                          |       | 25,487,610              |        | 11,186,968             |       |
|                                                                                                                      |       |                    |        |                   |       |
| Total  liabilities and shareholders’ equity                                                                          |       | $                       | 292,941,096 |                   | $          | 230,841,221 |   |

 

See notes toconsolidated financial statements that are an integral part of theseconsolidated statements.

 

3

----

 

***GREENVILLEFIRST BANCSHARES, INC. AND SUBSIDIARY***

***CONSOLIDATEDSTATEMENTS OF INCOME***

*** ***
| ** **                                            | ** ** | **For the three months ended  September 30,** | ** ** |
|-------------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                            | ** ** | **2004**                                      | ** ** | **2003** | ** ** |
| ** **                                            | ** ** | **(Unaudited)**                               | ** ** | **(Unaudited)** | ** ** |
| **Interest  income**                                  |       |                                          |       |   |   |
| Loans                                                 |       | $                                             | 3,404,077  |   | $ | 2,352,898 |   |
| Investment  securities                                |       | 224,993                                       |       | 139,249 |   |
| Federal funds  sold                                   |       | 6,184                                         |       | 2,957 |   |
| Total interest  income                                |       | 3,635,254                                     |       | 2,495,104 |   |
| **Interest  expense**                                 |       |                                          |       |   |   |
| Deposits                                              |       | 943,048                                       |       | 685,441 |   |
| Borrowings                                            |       | 501,075                                       |       | 246,944 |   |
| Total interest  expense                               |       | 1,444,123                                     |       | 932,385 |   |
|                                                  |       |                                          |       |   |   |
| Net interest  income before provision for loan losses |       | 2,191,131                                     |       | 1,562,719 |   |
| Provision for  loan losses                            |       | 375,000                                       |       | 250,000 |   |
| Net interest  income after provision for loan losses  |       | 1,816,131                                     |       | 1,312,719 |   |
|                                                  |       |                                          |       |   |   |
| **Noninterest****income**                             |       |                                          |       |   |   |
| Loan fee income                                       |       | 33,860                                        |       | 50,446 |   |
| Service fees on  deposit accounts                     |       | 71,977                                        |       | 67,838 |   |
| Write-down on  real estate owned                      |       | —                                        |       | (70,000 | ) |
| Other income                                          |       | 78,584                                        |       | 67,034 |   |
| Total noninterest income                              |       | 184,421                                       |       | 115,318 |   |
|                                                  |       |                                          |       |   |   |
| **Noninterest****expenses**                           |       |                                          |       |   |   |
| Compensation and  benefits                            |       | 612,118                                       |       | 494,979 |   |
| Professional  fees                                    |       | 41,711                                        |       | 56,947 |   |
| Marketing                                             |       | 61,985                                        |       | 44,128 |   |
| Insurance                                             |       | 33,006                                        |       | 28,171 |   |
| Occupancy                                             |       | 153,580                                       |       | 141,899 |   |
| Data processing  and related costs                    |       | 208,452                                       |       | 169,240 |   |
| Telephone                                             |       | 6,454                                         |       | 5,517 |   |
| Other                                                 |       | 65,464                                        |       | 55,733 |   |
| Total noninterest expenses                            |       | 1,182,770                                     |       | 996,614 |   |
| Income before  income tax expense                     |       | 817,782                                       |       | 431,423 |   |
| **Income  tax expense**                               |       | 310,876                                       |       | 163,941 |   |
| ** **                                            |       |                                          |       |   |   |
| **Net  income**                                       |       | $                                             | 506,906    |   | $ | 267,482 |   |
| ** **                                            | ** ** | ** **                                    | ** ** | ** ** | ** ** |
| **Earnings  per common share:**                       | ** ** | ** **                                    | ** ** | ** ** | ** ** |
| Basic                                                 |       | $                                             | 0.28       |   | $ | 0.16 |   |
| Diluted                                               |       | $                                             | 0.25       |   | $ | 0.14 |   |
|                                                  |       |                                          |       |   |   |
| **Weighted  average common shares outstanding**       | ** ** | ** **                                    | ** ** | ** ** | ** ** |
| Basic                                                 |       | 1,788,864                                     |       | 1,724,994 |   |
| Diluted                                               |       | 2,044,963                                     |       | 1,886,399 |   |

 

See notes toconsolidated financial statements that are an integral part of theseconsolidated statements.

 

4

----

 

***GREENVILLEFIRST BANCSHARES, INC. AND SUBSIDIARY***

***CONSOLIDATEDSTATEMENTS OF INCOME***

*** ***
| ** **                                            | ** ** | **For the nine months ended  September 30,** | ** ** |
|-------------------------------------------------------|------------|----------------------------------------------|------------|
| ** **                                            | ** ** | **2004**                                     | ** ** | **2003** | ** ** |
| ** **                                            | ** ** | **(Unaudited)**                              | ** ** | **(Unaudited)** | ** ** |
| **Interest  income**                                  |       |                                         |       |   |   |
| Loans                                                 |       | $                                            | 9,092,541  |   | $ | 6,660,548 |   |
| Investment  securities                                |       | 670,171                                      |       | 338,362 |   |
| Federal funds  sold                                   |       | 15,477                                       |       | 14,625 |   |
| Total interest  income                                |       | 9,778,189                                    |       | 7,013,535 |   |
| **Interest  expense**                                 |       |                                         |       |   |   |
| Deposits                                              |       | 2,511,334                                    |       | 2,097,817 |   |
| Borrowings                                            |       | 1,182,294                                    |       | 587,338 |   |
| Total interest  expense                               |       | 3,693,628                                    |       | 2,685,155 |   |
|                                                  |       |                                         |       |   |   |
| Net interest  income before provision for loan losses |       | 6,084,561                                    |       | 4,328,380 |   |
| Provision for  loan losses                            |       | 1,025,000                                    |       | 750,000 |   |
| Net interest  income after provision for loan losses  |       | 5,059,561                                    |       | 3,578,380 |   |
|                                                  |       |                                         |       |   |   |
| **Noninterest****income**                             |       |                                         |       |   |   |
| Loan fee income                                       |       | 100,684                                      |       | 154,112 |   |
| Service fees on  deposit accounts                     |       | 211,705                                      |       | 191,134 |   |
| Write-down on  real estate owned                      |       | —                                       |       | (170,000 | ) |
| Other income                                          |       | 234,932                                      |       | 171,178 |   |
| Total noninterest income                              |       | 547,321                                      |       | 346,424 |   |
|                                                  |       |                                         |       |   |   |
| **Noninterest****expenses**                           |       |                                         |       |   |   |
| Compensation and  benefits                            |       | 1,811,640                                    |       | 1,462,821 |   |
| Professional  fees                                    |       | 141,526                                      |       | 131,506 |   |
| Marketing                                             |       | 187,943                                      |       | 122,873 |   |
| Insurance                                             |       | 94,668                                       |       | 81,436 |   |
| Occupancy                                             |       | 443,479                                      |       | 441,261 |   |
| Data processing  and related costs                    |       | 605,227                                      |       | 456,770 |   |
| Telephone                                             |       | 19,760                                       |       | 16,704 |   |
| Other                                                 |       | 191,623                                      |       | 140,688 |   |
| Total noninterest expenses                            |       | 3,495,866                                    |       | 2,854,059 |   |
| Income before  income tax expense                     |       | 2,111,016                                    |       | 1,070,745 |   |
| **Income  tax expense**                               |       | 802,309                                      |       | 406,882 |   |
|                                                  |       |                                         |       |   |   |
| **Net  income**                                       |       | $                                            | 1,308,707  |   | $ | 663,863 |   |
| ** **                                            | ** ** | ** **                                   | ** ** | ** ** | ** ** |
| **Earnings  per common share:**                       | ** ** | ** **                                   | ** ** | ** ** | ** ** |
| Basic                                                 |       | $                                            | 0.75       |   | $ | 0.38 |   |
| Diluted                                               |       | $                                            | 0.65       |   | $ | 0.35 |   |
|                                                  |       |                                         |       |   |   |
| **Weighted  average common shares outstanding**       | ** ** | ** **                                   | ** ** | ** ** | ** ** |
| Basic                                                 |       | 1,746,617                                    |       | 1,724,994 |   |
| Diluted                                               |       | 2,013,727                                    |       | 1,874,780 |   |

 

See notes toconsolidated financial statements that are an integral part of theseconsolidated statements.

 

5

----

 

***GREENVILLEFIRST BANCSHARES, INC. AND SUBSIDIARY***

***CONSOLIDATEDSTATEMENTS OF SHAREHOLDERS’ EQUITY***

***ANDCOMPREHENSIVE INCOME***

***FORTHE NINE MONTHS ENDED SEPTEMBER 30, 2004 AND 2003***

***(Unaudited)***

 
| ** **                                                | ** ** | ** **        | ** ** | ** **  | ** ** | ** **        | ** ** | **Accumulated** | ** ** | ** **        | ** ** | **Total**  | ** ** |
|-----------------------------------------------------------|------------|-------------------|------------|-------------|------------|-------------------|------------|-----------------|------------|-------------------|------------|------------|------------|
| ** **                                                | ** ** | ** **        | ** ** | ** **  | ** ** | **Additional**    | ** ** | **other**       | ** ** | **Retained**      | ** ** | **share-** | ** ** |
| ** **                                                | ** ** | **Common  stock** | ** ** | **paid-in** | ** ** | **comprehensive** | ** ** | **earnings**    | ** ** | **holders’** | ** ** |
| ** **                                                | ** ** | **Shares**        | ** ** | **Amount**  | ** ** | **capital**       | ** ** | **income**      | ** ** | **(deficit)**     | ** ** | **equity** | ** ** |
| ** **                                                | ** ** | ** **        | ** ** | ** **  | ** ** | ** **        | ** ** | ** **      | ** ** | ** **        | ** ** | ** ** | ** ** |
| **December  31, 2002**                                    |       | 1,150,000         |       | $           | 11,500     |              | $          | 10,635,200      |       | $                 | 147,733    |       | $          | (562,644 | ) | $ | 10,231,789 |   |
|                                                      |       |              |       |        |       |              |       |            |       |              |       |       |       |
| Net income                                                |       | —            |       | —      |       | —            |       | —          |       | 663,863           |       | 663,863    |       |
|                                                      |       |              |       |        |       |              |       |            |       |              |       |       |       |
| Comprehensive  loss, net of tax -                         |       |              |       |        |       |              |       |            |       |              |       |       |       |
| Unrealized  holding gain on securities available for sale |       | —            |       | —      |       | —            |       | (68,408         | )          | —            |       | (68,408    | )          |
|                                                      |       |              |       |        |       |              |       |            |       |              |       |       |       |
| Comprehensive  income                                     |       | —            |       | —      |       | —            |       | —          |       | —            |       | 595,455    |       |
|                                                      |       |              |       |        |       |              |       |            |       |              |       |       |       |
| **September  30, 2003**                                   |       | 1,150,000         |       | $           | 11,500     |              | $          | 10,635,200      |       | $                 | 79,325     |       | $          | 101,219 |   | $ | 10,827,244 | ** ** |
| ** **                                                | ** ** | ** **        | ** ** | ** **  | ** ** | ** **        | ** ** | ** **      | ** ** | ** **        | ** ** | ** ** | ** ** |
| **December  31, 2003**                                    |       | 1,724,994         |       | $           | 17,250     |              | $          | 10,629,450      |       | $                 | 96,997     |       | $          | 443,271 |   | $ | 11,186,968 |   |
|                                                      |       |              |       |        |       |              |       |            |       |              |       |       |       |
| Net income                                                |       | —            |       | —      |       | —            |       | —          |       | 1,308,707         |       | 1,308,707  |       |
|                                                      |       |              |       |        |       |              |       |            |       |              |       |       |       |
| Comprehensive  income, net of tax -                       |       |              |       |        |       |              |       |            |       |              |       |       |       |
| Unrealized  holding loss on securities available for sale |       | —            |       | —      |       | —            |       | (36,999         | )          | —            |       | (36,999    | )          |
|                                                      |       |              |       |        |       |              |       |            |       |              |       |       |       |
| Comprehensive  income                                     |       | —            |       | —      |       | —            |       | —          |       | —            |       | 1,271,708  |       |
|                                                      |       |              |       |        |       |              |       |            |       |              |       |       |       |
| Proceeds from  sale of common stock, net                  |       | 800,000           |       | 8,000       |       | 13,000,924        |       | —          |       | —            |       | 13,008,924 |       |
|                                                      |       |              |       |        |       |              |       |            |       |              |       |       |       |
| Exercise of  warrants                                     |       | 3,000             |       | 30          |       | 19,980            |       | —          |       | —            |       | 20,010     |       |
|                                                      |       |              |       |        |       |              |       |            |       |              |       |       |       |
| **September  30, 2004**                                   |       | 2,527,994         |       | $           | 25,280     |              | $          | 23,650,3549     |       | $                 | 59,998     |       | $          | 1,751,978 |   | $ | 25,487,6101 | ** ** |

 

See notes toconsolidated financial statements that are an integral part of theseconsolidated statements.

 

6

----

 

***GREENVILLEFIRST BANCSHARES, INC. AND SUBSIDIARY***

***CONSOLIDATEDSTATEMENTS OF CASH FLOWS***

 
| ** **                                                                     | ** ** | **For the nine months ended   September 30,** | ** ** |
|--------------------------------------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                                                     | ** ** | **2004**                                      | ** ** | **2003** | ** ** |
| ** **                                                                     | ** ** | **(Unaudited)**                               | ** ** | **(Unaudited)** | ** ** |
| **Operating  activities**                                                      |       |                                          |       |   |   |
| Net income                                                                     |       | $                                             | 1,308,707  |   | $ | 663,863 |   |
| Adjustments to  reconcile net income to cash provided by operating activities: |       |                                          |       |   |   |
| Provision for  loan losses                                                     |       | 1,025,000                                     |       | 750,000 |   |
| Depreciation and  other amortization                                           |       | 117,663                                       |       | 109,904 |   |
| Accretion and  amortization of securities discounts and premiums, net          |       | 58,692                                        |       | 77,309 |   |
| Increase in  other assets, net                                                 |       | (1,302,070                                    | )          | (389,226 | ) |
| Increase  (decrease) in other liabilities, net                                 |       | 931,660                                       |       | (84,229 | ) |
| ** **                                                                     | ** ** | ** **                                    | ** ** | ** ** | ** ** |
| Net cash  provided by operating activities                                     |       | 2,139,652                                     |       | 1,127,621 |   |
| ** **                                                                     | ** ** | ** **                                    | ** ** | ** ** | ** ** |
| **Investing  activities**                                                      |       |                                          |       |   |   |
| Origination of  loans, net                                                     |       | (59,512,277                                   | )          | (38,560,872 | ) |
| Purchase of  property and equipment                                            |       | (1,029,983                                    | )          | (122,082 | ) |
| Purchase of  investment securities:                                            |       |                                          |       |   |   |
| Held to maturity                                                               |       | (5,585,719                                    | )          | (10,158,438 | ) |
| Other  investments                                                             |       | (3,585,000                                    | )          | (2,971,150 | ) |
| Payments and  maturity of investment securities:                               |       |                                          |       |   |   |
| Available for  sale                                                            |       | 601,689                                       |       | 10,484,108 |   |
| Held to maturity                                                               |       | 1,685,772                                     |       | 129,365 |   |
| Other  investments                                                             |       | 1,995,000                                     |       | 1,205,000 |   |
|                                                                           |       |                                          |       |   |   |
| Net cash used  for investing activities                                        |       | (65,430,518                                   | )          | (39,994,069 | ) |
|                                                                           |       |                                          |       |   |   |
| **Financing  activities**                                                      |       |                                          |       |   |   |
| Increase in  deposits, net                                                     |       | 14,268,633                                    |       | 22,530,448 |   |
| Increase  (decrease) in short-term borrowings                                  |       | 4,508,000                                     |       | (9,107,000 | ) |
| Increase  (decrease) in other borrowings                                       |       | —                                        |       | (2,500,000 | ) |
| Proceeds from  junior subordinate debentures                                   |       | —                                        |       | 6,186,000 |   |
| Proceeds from  issuances of common stock, net                                  |       | 13,008,924                                    |       | — |   |
| Proceeds from  exercise of stock warrants, net                                 |       | 20,010                                        |       | — |   |
| Increase in  Federal Home Loan Bank advances                                   |       | 28,110,000                                    |       | 27,000,000 |   |
|                                                                           |       |                                          |       |   |   |
| Net cash  provided by financing activities                                     |       | 59,915,567                                    |       | 44,109,448 |   |
|                                                                           |       |                                          |       |   |   |
| Net increase (decrease)  in cash and cash equivalents                          |       | (3,375,299                                    | )          | 5,243,000 |   |
|                                                                           |       |                                          |       |   |   |
| **Cash  and cash equivalents at beginning of the period**                      |       | 6,947,291                                     |       | 4,471,026 |   |
|                                                                           |       |                                          |       |   |   |
| **Cash  and cash equivalents at end of the period**                            |       | $                                             | 3,571,992  |   | $ | 9,714,026 |   |
|                                                                           |       |                                          |       |   |   |
| **Supplemental  information**                                                  |       |                                          |       |   |   |
| **Cash  paid for**                                                             |       |                                          |       |   |   |
| Interest                                                                       |       | $                                             | 3,586,617  |   | $ | 2,766,333 |   |
|                                                                           |       |                                          |       |   |   |
| Income taxes                                                                   |       | $                                             | 1,780,005  |   | $ | 37,188 |   |
|                                                                           |       |                                          |       |   |   |
| ** Schedule  of non-cash transactions**                                   |       |                                          |       |   |   |
| Foreclosure of  real estate                                                    |       | $                                             | 305,485    |   | $ | — |   |
|                                                                           |       |                                          |       |   |   |
| Unrealized loss  on securities, net of income taxes                            |       | $                                             | (36,999    | ) | $ | (120,119 | ) |

 

Seenotes to consolidated financial statements that are an integral part of theseconsolidated statements.

 

7

----

 

***GREENVILLEFIRST BANCSHARES, INC.  AND SUBSIDIARY***

***NOTESTO CONSOLIDATED FINANCIAL STATEMENTS***

 

**Note 1 – Nature of Business andBasis of Presentation**

 

**Business activity**

 

Greenville FirstBancshares, 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, South Carolina.  The bank is primarily engaged in the businessof accepting demand deposits and savings deposits insured by the FederalDeposit Insurance Corporation, and providing commercial, consumer and mortgageloans to the general public.  The Trustis a special purpose subsidiary for the sole purpose of issuing trust preferredsecurities.

 

**Basis of Presentation**

 

The accompanying financial statements have beenprepared in accordance with generally accepted accounting principles forinterim financial information and with the instructions to Form 10-QSB.  Accordingly,they do not include all the information and footnotes required by accountingprinciples generally accepted in the United States of America for completefinancial statements.  In the opinion ofmanagement, all adjustments (consisting of normal recurring accruals)considered necessary for a fair presentation have been included.  Operating results for the nine-month periodended September 30, 2004 are not necessarily indicative of the results that maybe expected for the year ending December 31, 2004.  For further information, refer to theconsolidated financial statements and footnotes thereto included in thecompany’s Form 10-KSB (Registration Number 000-27719)as filed with the Securities and Exchange Commission.  The consolidated financial statements includethe accounts of Greenville First Bancshares, Inc., and itswholly owned subsidiary Greenville First Bank, N.A.  As discussed in Note 7, the financialstatements related to the special purpose subsidiary, Greenville FirstStatutory Trust I, have not been consolidated in accordance with FASB Interpretation No. 46.

 

**Cash andCash Equivalents**

 

For purposes of theConsolidated Statement of Cash Flows, cash and federal funds sold are includedin “cash and cash equivalents.”  Theseassets have contractual maturities of less than three months.

 

**Note 2 – Reclassifications**

 

Certain amounts,previously reported, have been reclassified to state all periods on acomparable basis that had no effect on shareholders’ equity or net income.

 

**Note 3 – Stock Split**

 

On November 17, 2003,shareholders of record as of November 3, 2003, received one additional share ofstock for every two shares of stock owned prior to the 3 for 2 stock split.  All factionalshares were paid in cash.  The earningsper share amounts for all periods shown have been adjusted to reflect the 3 for2 split.

 

**Note 4 – Secondary Offering**

 

On September 24, 2004,the company received $14.3 million from the sale of 800,000 shares of commonstock at a price of $17.875.  On October15, 2004, the company’s underwriter exercised its option to purchase anadditional 120,000 shares at the same price. The total gross proceeds were $16.4 million.  The net proceeds to the company afteroffering costs and underwriter’s discount were approximately $15.0 million.

 

**Note 5 – Note Payable**

 

At September 30, 2004,the company had an unused $4.5 million revolving line of credit with anotherbank.  This line of credit has a maturityof March 20, 2005. At December 31, 2003, the outstanding balance was $3.0million.  The line of credit bearsinterest at a rate of three-month libor plus 2.00%,which at September 30, 2004 was 4.02%. The company has pledged the stock of the bank as collateral for thisline of credit. The line of credit agreement contains various covenants relatedto earnings and asset quality.  As ofSeptember 30, 2004, the company believes it is in compliance with allcovenants.

 

8

----

 

**Note 6 – Earnings per Share**

 

The following schedule reconcilesthe numerators and denominators of the basic and diluted earnings per sharecomputations for the three months and nine months ended September 30, 2004 and2003.  Dilutive common shares arise fromthe potentially 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 number of shares and the earnings per share havebeen adjusted for the 3 for 2 stock split.

 
| ** **                         | ** ** | **Three months ended September 30,** | ** ** |
|------------------------------------|------------|--------------------------------------|------------|
| ** **                         | ** ** | **2004**                             | ** ** | **2003** | ** ** |
|                               |       |                                 |       |   |   |
| Basic Earnings  Per Share          |       |                                 |       |   |   |
| Average common  shares             |       | 1,788,864                            |       | 1,724,994 |   |
| Net income                         |       | $                                    | 506,906    |   | $ | 267,482 |   |
| Earnings per  share                |       | $                                    | 0.28       |   | $ | 0.16 |   |
|                               |       |                                 |       |   |   |
| Diluted Earnings  Per Share        |       |                                 |       |   |   |
| Average common  shares outstanding |       | 1,788,864                            |       | 1,724,994 |   |
| Average dilutive  common shares    |       | 256,099                              |       | 161,405 |   |
| Adjusted average  common shares    |       | 2,044,963                            |       | 1,886,399 |   |
| Net income                         |       | $                                    | 506,906    |   | $ | 267,482 |   |
| Earnings per  share                |       | $                                    | 0.25       |   | $ | 0.14 |   |
|                               |       |                                 |       |   |   |

 
| ** **                         | ** ** | **Nine months ended September 30,** | ** ** |
|------------------------------------|------------|-------------------------------------|------------|
| ** **                         | ** ** | **2004**                            | ** ** | **2003** | ** ** |
|                               |       |                                |       |   |   |
| Basic Earnings  Per Share          |       |                                |       |   |   |
| Average common  shares             |       | 1,746,617                           |       | 1,724,994 |   |
| Net income                         |       | $                                   | 1,308,707  |   | $ | 663,863 |   |
| Earnings per  share                |       | $                                   | 0.75       |   | $ | 0.38 |   |
|                               |       |                                |       |   |   |
| Diluted Earnings  Per Share        |       |                                |       |   |   |
| Average common  shares outstanding |       | 1,746,617                           |       | 1,724,994 |   |
| Average dilutive  common shares    |       | 267,110                             |       | 149,786 |   |
| Adjusted average  common shares    |       | 2,013,727                           |       | 1,874,780 |   |
| Net income                         |       | $                                   | 1,308,707  |   | $ | 663,863 |   |
| Earnings per  share                |       | $                                   | 0.65       |   | $ | 0.35 |   |

 

**Note 7 – Accounting for VariableInterest Entities**

 

Effective January 1,2004, the company adopted FASB Interpretation No. 46,(“FIN 46”), “Consolidation of Variable Interest Entities.” In accordance withFIN 46, the $186,000 investment by the parent company, Greenville FirstBancshares, Inc, in the special purpose subsidiary, Greenville First StatutoryTrust 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, the effectivedate on the adoption of FIN 46, the company had consolidated the specialpurpose 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 subordinated 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

----

 

**Note 8 – Stock Based Compensation**

 

The company has a stock-based employee compensationplan.  The company accounts for the planunder the recognition and measurement principles of Accounting Principles Board(“APB”) Opinion No. 25, *Accounting for StockIssued to Employees,* and related Interpretations.  No stock-based employee compensation cost isreflected in net income, as all stock options granted under these plans had anexercise price equal to the market value of the underlying common stock on thedate of grant.  The following tableillustrates the effect on net income and earnings per share if the company hadapplied the fair value recognition provisions of Financial Accounting StandardsBoard (“FASB”), Statement of Financial AccountingStandards (“SFAS”) No. 123, *Accountingfor Stock-Based Compensation,* to stock-based employee compensation.

 
| ** **                                                                                                                                    | ** ** | **For the three months ended September 30,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------|------------|
| ** **                                                                                                                                    | ** ** | **2004**                                     | ** ** | **2003** | ** ** |
|                                                                                                                                          |       |                                         |       |   |   |
| Net income, as  reported                                                                                                                      |       | $                                            | 506,906    |   | $ | 267,482 |   |
| 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                                                                                                                         |       | $                                            | 486,187    |   | $ | 247,869 |   |
|                                                                                                                                          |       |                                         |       |   |   |
| Earnings per  common share-adjusted for 3 for 2 stock split:                                                                                  |       |                                         |       |   |   |
| Basic - as  reported                                                                                                                          |       | $                                            | 0.28       |   | $ | 0.16 |   |
| Basic - pro  forma                                                                                                                            |       | $                                            | 0.27       |   | $ | 0.14 |   |
|                                                                                                                                          |       |                                         |       |   |   |
| Diluted - as  reported                                                                                                                        |       | $                                            | 0.25       |   | $ | 0.14 |   |
| Diluted – pro-forma                                                                                                                      |       | $                                            | 0.24       |   | $ | 0.13 |   |

 
| ** **                                                                                                                                    | ** ** | **For the nine months ended September 30,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                                                                                                                    | ** ** | **2004**                                    | ** ** | **2003** | ** ** |
|                                                                                                                                          |       |                                        |       |   |   |
| Net income, as  reported                                                                                                                      |       | $                                           | 1,308,707  |   | $ | 663,863 |   |
| Deduct: Total  stock-based employee compensation expense determined under fair value based  method for all awards, net of related tax effects |       | (62,157                                     | )          | (58,839 | ) |
|                                                                                                                                          |       |                                        |       |   |   |
| Pro forma net  income                                                                                                                         |       | $                                           | 1,246,550  |   | $ | 605,024 |   |
|                                                                                                                                          |       |                                        |       |   |   |
| Earnings per  common share-adjusted for 3 for 2 stock split:                                                                                  |       |                                        |       |   |   |
| Basic - as  reported                                                                                                                          |       | $                                           | 0.75       |   | $ | 0.38 |   |
| Basic - pro  forma                                                                                                                            |       | $                                           | 0.71       |   | $ | 0.35 |   |
|                                                                                                                                          |       |                                        |       |   |   |
| Diluted - as  reported                                                                                                                        |       | $                                           | 0.65       |   | $ | 0.35 |   |
| Diluted –  pro-forma                                                                                                                     |       | $                                           | 0.62       |   | $ | 0.32 |   |
|                                                                                                                                          |       |                                        |       |   |   |

 

The fair value of the option grant is estimated on thedate of grant using the Black-Scholes option-pricingmodel.  The following assumptions wereused for grants: expected volatility of 10% for 2004 and 2003, risk-freeinterest rate of 3.00% for 2004 and 2003 respectively, expected lives of theoptions 10 years, and the assumed dividend rate was zero.

 

10

----

 

**Item 2.**

 

**MANAGEMENT’SDISCUSSION AND ANALYSIS**

 

*The following discussion reviews our results of operations andassesses our financial condition.  Youshould read the following discussion and analysis in conjunction with theaccompanying consolidated financial statements. The commentary should be read in conjunction with the discussion offorward-looking statements, the financial statements and the related notes andthe other statistical information included in this report.*

 

**DISCUSSIONOF 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 maydiffer materially from the results discussed in the forward-looking statements,and our 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 our primary service area, becoming less favorable thanexpected resulting 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;

•                  changesin the securities 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 to organize andserve as the holding company for Greenville First Bank, N.A.  Since we opened our bank in January 2000, wehave experienced consistent growth in total assets, loans, deposits, andshareholders’ equity, which has continued during the first nine months of 2004.

 

On September 24, 2004 and October 15, 2004, thecompany sold 800,000 and 120,000 shares, respectively, of common stock.  The net proceeds were approximately $15.0million.

 

Like most community banks, we derive the majority ofour income from interest received on our loans and investments.  Our primary source of funds for making theseloans and investments is our deposits, on which we pay interest.  Consequently, one of the key measures of oursuccess is our amount of net interest income, or the difference between theincome on our interest-earning assets, such as loans and investments, and theexpense on our interest-bearing liabilities, such as deposits andborrowings.  Another key measure is the spreadbetween the yield we earn on these interest-earning assets and the rate we payon our interest-bearing liabilities, which is called our net interest spread.

 

There are risks inherent in all loans, so we maintainan allowance for loan losses to absorb probable losses on existing loans thatmay become uncollectible.  We maintainthis allowance by charging a provision for loan losses against our operatingearnings for each period.  We haveincluded a detailed discussion of this process, as well as several tablesdescribing our allowance for loan losses.

 

11

----

 

In addition to earninginterest on our loans and investments, we earn income through fees and othercharges to our customers.  We have alsoincluded a discussion of the various components of this noninterestincome, as well as of our noninterest expense.

 

The following discussionand analysis also identifies significant factors that have affected ourfinancial 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.

 

#### **Critical Accounting Policies**

 

We have adopted variousaccounting policies that govern the application of accounting principlesgenerally accepted in the United States and with general practices within thebanking industry in the preparation of our financial statements.  Our significant accounting policies aredescribed in the footnotes to our audited consolidated financial statements asof December 31, 2003, as filed in our annual report on Form 10-KSB.

 

Certain accountingpolicies involve significant judgments and assumptions by us that have amaterial impact on the carrying value of certain assets and liabilities.  We consider these accounting policies to becritical accounting policies.  Thejudgment and assumptions we use are based on historical experience and otherfactors, which we believe to be reasonable under the circumstances.  Because of the nature of the judgment andassumptions we make, actual results could differ from these judgments andestimates that could have a material impact on the carrying values of ourassets and liabilities and our results of operations.

 

We believe the allowancefor loan losses is the critical accounting policy that requires the mostsignificant 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 of Economic Trends**

 

Duringthe three years ended December 31, 2003, and the first six months of 2004, ourrates on both short-term or variable rate earning assets and short-term orvariable rate interest-bearing liabilities declined primarily as a result ofthe actions taken by the Federal Reserve. Our rates on both short-term or variable earning assets and short-termor variable rate interest-bearing liabilities began to increase in the thirdquarter of 2004, as a result of actions taken by the Federal Reserve toincrease short-term rates.

 

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 nine 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.

 

Despite sharply lower short-term rates, stimulus tothe economy during 2003 was muted and consumer demand and business investmentactivity remained weak.  During all of2003 and substantially all of the nine months ended September 30, 2004, thefinancial markets operated under historically low interest rates. As a resultof these unusual conditions, Congress passed an economic stimulus plan in2003.  During the first nine months of2004, many economists believed the economy began to show signs of strengtheningand at the end of the second quarter and near the end of the third quarter, the Federal Reserve increased the short-terminterest rate each time by 25 basis points. Many economists believe that the Federal Reserve will continue toincrease rates during the remainder of 2004 and during most of 2005.  However, no assurance can be given that theFederal Reserve will take such action.

 

12

----

 

**Results of Operations**

 

***Income Statement Review***

 

*Summary*

 

*Three months ended September 30, 2004 and 2003*

 

Our net income was$506,906 and $267,482 for the three months ended September 30, 2004 and 2003,respectively, an increase of $239,424, or 89.5%.  Our income was fully taxable in both threemonth periods.  The $239,424 increase innet income resulted primarily from increases of $628,412 in net interest incomeand $69,103 in noninterest income.  These increases were partly offset by$186,156 of additional noninterest expense, a$125,000 increase in provisions for loan losses, and a $146,935 increase inincome tax expense.  Our efficiency ratiohas continued to improve because we have been earning more income withoutsubstantially increasing our overhead expenses. Our efficiency ratio was 49.79% and 59.39% for the three months endedSeptember 30, 2004 and 2003, respectively.

 

*Nine months ended September 30, 2004 and 2003*

 

Our net income was $1.3million and $663,863 for the nine months ended September 30, 2004 and 2003,respectively, an increase of $644,844, or 97.1%.  Our income was fully taxable in both ninemonth periods.  The $644,844 increase innet income resulted primarily from increases of $1.8 million in net interestincome and $200,897 in noninterest income.  These increases were partly offset by$641,807 of additional noninterest expense, a$275,000 increase in provisions for loan losses, and a $395,427 increase inincome tax expense.  Our efficiency ratiohas continued to improve because we have been earning more income withoutsubstantially increasing our overhead expenses. Our efficiency ratio was 52.71% and 61.05% for the nine months endedSeptember 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 September 30, 2004, our loan portfolio had increased anaverage of $19.8 million compared to the second quarter of 2004.  The growth in the first nine months of 2004was $58.2 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 September 30,2004, loans represented 90.2% of total assets, while investments and federalfunds sold represented 7.2% of total assets. While we plan to continue our focus on increasing the loan portfolio, asrates on investment securities begin to rise and additional deposits areobtained, we also anticipate increasing the size of the investment portfolio.

 

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 office expansion program until the beginning of2005.  This funding strategy allowed usto continue to operate in one location, maintain a smaller staff, and not incurmarketing costs to advertise deposit rates, which in turn allowed us to focuson the fast growing loan portfolio.  AtSeptember 30, 2004, retail deposits represented $114.3 million, or 39.0% oftotal assets, borrowings represented $80.6 million, or 27.5% of total assets,and wholesale out-of-market deposits represented $70.0 million, or 23.5% oftotal assets.

 

Inanticipation of rising interest rates, we are planning to open two retaildeposit offices, one in the first quarter of 2005 and the other in the thirdquarter 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 nine 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.  Basedon prior experience, we anticipate the majority of these funds to be retainedat the end of the promotion.  Our goal isto increase both the percentage of assets being funded by “in market” retaildeposits and to 

 

13

----

 

increase the percentage oflow-cost transaction accounts to total deposits.  No assurance can be given that theseobjectives will be achieved; however, we anticipate that the two additionalretail deposit offices will assist us in meeting these objectives.  We also anticipate the current depositpromotion and the opening of the two new offices will have a negative impact onearnings in the years ending 2004 and 2005. However, we believe that these two strategies will provide additionalclients in our local market and will provide a lower alternative cost offunding in a higher or rising interest rate environment, which we believe willincrease earnings in future periods.

 

Asmore fully discussed in the – “Market Risk” and – “Liquidity and Interest RateSensitivity” sections below, at September 30, 2004, 68.1% 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 nine months of 2004 has been to obtainshort-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% of interest-bearingliabilities had a maturity of less than one year.

 

Inanticipation of rising rates, in May 2004 we extended the maturities on $25.0million of short-term deposits and borrowings with a term of less than threemonths into $25.0 million of deposits and borrowings with a weighted averagelife of five years.  As of September 30,2004, 80.0% 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 September 30, 2004, we had $13.9 millionmore assets than liabilities that reprice within thenext three months.

 

Weintend to maintain a capital level for the bank that exceeds the OCC requirements to be classified as a “well capitalized”bank.  To provide the additional capitalneeded to support our bank’s growth in assets, we issued $6.2 million in juniorsubordinated debentures in connection with our trust preferred securitiesoffering in June 2003, and we borrowed during 2004, $3.0 million under a short-termholding company line of credit.  Thisholding company line of credit was repaid on September 24, 2004, utilizing $3.0million of the proceeds from the secondary offering that was completed onSeptember 24, 2004.  The company utilized$9.5 million of the proceeds to provide additional capital for the bank tosupport assets growth.  At September 30,2004, the additional capital reduced outstanding borrowings.

 

Inaddition to the growth in both assets and liabilities, and the timing of repricing of our assets and liabilities, net interestincome is also affected by the ratio of interest-earning assets tointerest-bearing liabilities and the changes in interest rates earned on ourassets and interest rates paid on our liabilities.

 

Ournet interest income for the three months ended September 30, 2004 and the ninemonths ended September 30, 2004 increased because we had more interest-earningassets than interest-bearing liabilities. For the three and nine months ended September 30, 2004, interest-earningassets exceeded interest-bearing liabilities by $7.9 million and $7.5 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 nine months ended September 30, 2004, our rates on both short-term orvariable rate earning-assets and short-term or variable rate interest-bearingliabilities declined primarily as a result of the actions taken by the FederalReserve in 2003 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 ratesensitive liabilities during the nine month periods ending September 30,2004.  Our net interest margin for thenine month period was 3.15%.

 

Weanticipate that the three 25 basis point increases in short-term rates willresult in an increase in loan yields and deposit and borrowing costs.  Accordingly, we believe that our net interestmargin may increase if further action is taken by the Federal Reserve toincrease short-term rates.

 

We have included anumber of tables to assist in our description of various measures of ourfinancial performance.  For example, the“Average Balances” tables show the average balance of each category of ourassets and liabilities as well as the yield we earned or the rate we paid withrespect to each category during both the three months ended September 30, 2004and 2003 and the first nine months of 2004 and 2003.  A review of these tables shows that our loanstypically 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 

 

14

----

 

interest rates, and we haveincluded tables to illustrate our interest rate sensitivity with respect tointerest-earning accounts and interest-bearing accounts.  Finally, we have included various tables thatprovide detail about our investment securities, our loans, our deposits, andother 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 nine months ended September 30, 2004 and 2003, allinvestments were taxable.  During thesame period, we had no interest-bearing deposits in other banks or anysecurities purchased with agreements to resell. All investments were owned at an original maturity of over oneyear.  Nonaccrualloans are included in the following tables. Loan yields have been reduced to reflect the negative impact on ourearnings of loans on nonaccrual status.  The net of capitalized loan costs and feesare amortized into interest income on loans.

 

 
| ** **                                       | ** ** | **Average Balances, Income and Expenses, and Rates  For the Three Months Ended September 30,** | ** ** |
|--------------------------------------------------|------------|------------------------------------------------------------------------------------------------|------------|
| ** **                                       | ** ** | **2004**                                                                                       | ** ** | **2003** | ** ** |
| ** **                                       | ** ** | **Average  Balance**                                                                           | ** ** | **Income/   Expense** | ** ** | **Yield/   Rate(1)** | ** ** | **Average  Balance** | ** ** | **Income  Expense** | ** ** | **Yield/  Rate(1)** | ** ** |
| ** **                                       | ** ** | **(In thousands)**                                                                             | ** ** |
| Earnings                                         |       |                                                                                           |       |   |   |   |   |   |   |   |   |   |   |
| Federal funds  sold                              |       | $                                                                                              | 1,760      |   | $ | 6 |   | 1.36 | % | $ | 1,182 |   | $ | 3 |   | 1.01 | % |
| Investment  securities                           |       | 20,883                                                                                         |       | 225 |   | 4.29 | % | 13,392 |   | 139 |   | 4.12 | % |
| Loans                                            |       | 253,807                                                                                        |       | 3,404 |   | 5.34 | % | 181,401 |   | 2,353 |   | 5.15 | % |
| Total  earning-assets                            |       | 276,450                                                                                        |       | 3,635 |   | 5.23 | % | 195,975 |   | 2,495 |   | 5.05 | % |
| Non-earning  assets                              |       | 7,903                                                                                          |       |   |   |   |   | 6,541 |   |   |   |   |   |
| Total assets                                     |       | $                                                                                              | 284,353    |   |   |   |   |   | $ | 202,516 |   |   |   |   |   |
| Interest-bearing  liabilities:                   |       |                                                                                           |       |   |   |   |   |   |   |   |   |   |   |
| NOW accounts                                     |       | $                                                                                              | 41,097     |   | $ | 97 |   | 0.94 | % | $ | 31,015 |   | $ | 33 |   | 0.42 | % |
| Savings &  money market                      |       | 48,971                                                                                         |       | 196 |   | 1.59 | % | 23,608 |   | 36 |   | 0.60 | % |
| Time deposits                                    |       | 92,828                                                                                         |       | 650 |   | 2.79 | % | 93,464 |   | 617 |   | 2.62 | % |
| Total  interest-bearing deposits                 |       | 182,896                                                                                        |       | 943 |   | 2.05 | % | 148,087 |   | 686 |   | 1.84 | % |
| FHLB  advances                                   |       | 63,071                                                                                         |       | 346 |   | 2.18 | % | 28,458 |   | 158 |   | 2.20 | % |
| Other borrowings                                 |       | 22,573                                                                                         |       | 155 |   | 2.73 | % | 12,814 |   | 88 |   | 2.72 | % |
| Total  interest-bearing liabilities              |       | 268,540                                                                                        |       | 1,444 |   | 2.14 | % | 189,359 |   | 932 |   | 1.95 | % |
| Non-interest  bearing liabilities                |       | 2,384                                                                                          |       |   |   |   |   | 2,302 |   |   |   |   |   |
| Shareholders’  equity                       |       | 13,429                                                                                         |       |   |   |   |   | 10,855 |   |   |   |   |   |
| Total  liabilities and shareholders’ equity |       | $                                                                                              | 284,353    |   |   |   |   |   | $ | 202,516 |   |   |   |   |   |
| Net interest  spread                             |       |                                                                                           |       |   |   | 3.09 | % |   |   |   |   | 3.10 | % |
| Net interest  income / margin                    |       |                                                                                           |       | $ | 2,191 |   | 3.15 | % |   |   | $ | 1,563 |   | 3.16 | % |

 

----

(1) Annualized for the three month period.

 

Ournet interest spread was 3.09% for the three months ended September 30, 2004,compared to 3.10% for the three months ended September 30, 2003.

 

Ournet interest margin for the three months ended September 30, 2004 was 3.15%,compared to 3.16% for the three months ended September 30, 2003.  During the three months ended September 30,2004, earning assets averaged $276.5 million, compared to $196.0 million in thethree months ended September 30, 2003.

 

Thehigher yields on loans for the three months ended September 30, 2004 comparedto the three months ended September 30, 2003 resulted primarily from a 75 basispoint increase in the prime rate.  Thedeposit cost increased as a result of our decision to aggressively marketinterest-bearing transaction accounts by paying an above market rate.  Also, we extended the maturity dates onvarious 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 $2.2 million and $1.6million for the three months ended September 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

 

15

----

 

$80.5 million during the three months ended September 30, 2004 comparedto the same period in 2003.

 

Aspreviously discussed, our net interest margin for the three months endedSeptember 30, 2004 and 2003, was 3.15% and 3.16%, respectively.

 

The$628,412 increase in net interest income for the three months ended September30, 2004 compared to the same period in 2003 resulted primarily from a $597,000increase in net income related to the impact of higher average earning assetsand interest-bearing liabilities in the three months ended September 30, 2004compared to the same period in 2003.  Thehigher rates in the 2004 third quarter compared to the 2003 third quartercontributed to the remaining increase in net interest income.

 

Interestincome for the three months ended September 30, 2004 was $3.6 million,consisting of $3.4 million on loans, $224,993 on investments, and $6,184 onfederal funds sold.  Interest income forthe three months ended September 30, 2003 was $2.5 million, consisting of $2.4million on loans, $139,249 on investments, and $2,957 on federal fundssold.  Interest on loans for the threemonths ended September 30, 2004 and 2003 represented 93.6% and 94.3%,respectively, of total interest income, while income from investments andfederal funds sold represented only 6.4% and 5.7% of total interestincome.  The high percentage of interestincome from loans relates to our strategy to maintain a significant portion ofour assets in higher earning loans compared to lower yielding investments.  Average loans represented 91.8% and 92.6% ofaverage interest-earning assets for the three months ended September 30, 2004and 2003, respectively.  Included ininterest income on loans for the three months ended September 30, 2004 and2003, was $115,641 and $86,231, respectively, related to the net amortizationof loan fees and capitalized loan origination costs.

 

Interestexpense for the three months ended September 30, 2004 was $1.4 million,consisting of $943,048 related to deposits and $501,075 related to borrowings.  Interest expense for the three months endedSeptember 30, 2003 was $932,385, consisting of $685,441 related to deposits and$246,944 related to borrowings.  Interestexpense on deposits for the three months ended September 30, 2004 and 2003 represented65.3% and 73.5%, respectively, of total interest expense, while interestexpense on borrowings represented 34.7% and 26.5%, respectively, of totalinterest expense for the three months ended September 30, 2004 and 2003.  The lower percentage of interest expense ondeposits and the higher percentage of interest on borrowings for the threemonths ended September 30, 2004 compared to the three months ended September30, 2003 resulted from our decisions to delay our retail deposit officeexpansion program and instead utilize additional borrowings from the FHLB and from the sale of securities under agreements torepurchase with brokers.   During thethree months ended September 30, 2004, average interest-bearing depositsincreased by $34.8 million over the same period in 2003, while other borrowingduring the three months ended September 30, 2004 increased $44.4 million overthe same period in 2003.  During thethree months ended September 30, 2004, we were able to pledge additionalcollateral to the FHLB, allowing us the ability toincrease our FHLB borrowings.  Both the short-term borrowings from the FHLB and the sale of securities under agreements torepurchase provide us with the opportunity to obtain low cost funding withvarious maturities similar to the maturities on our loans and investments.

 

16

----

 
| ** **                                       | ** ** | **Average Balances, Income and Expenses, and Rates  For the Nine Months Ended September 30,** | ** ** |
|--------------------------------------------------|------------|-----------------------------------------------------------------------------------------------|------------|
| ** **                                       | ** ** | **2004**                                                                                      | ** ** | **2003** | ** ** |
| ** **                                       | ** ** | **Average   Balance**                                                                         | ** ** | **Income/   Expense** | ** ** | **Yield/   Rate(1)** | ** ** | **Average   Balance** | ** ** | **Income   Expense** | ** ** | **Yield/   Rate(1)** | ** ** |
|                                             |       | **(In  thousands)**                                                                           |       |
| Earning assets:                                  |       |                                                                                          |       |   |   |   |   |   |   |   |   |   |   |
| Federal funds  sold                              |       | $                                                                                             | 1,937      |   | $ | 15 |   | 1.03 | % | $ | 1,693 |   | $ | 15 |   | 1.18 | % |
| Investment  securities                           |       | 20,736                                                                                        |       | 670 |   | 4.32 | % | 11,325 |   | 338 |   | 3.99 | % |
| Loans                                            |       | 234,965                                                                                       |       | 9,093 |   | 5.17 | % | 167,028 |   | 6,660 |   | 5.33 | % |
| Total  earning-assets                            |       | 257,638                                                                                       |       | 9,778 |   | 5.07 | % | 180,046 |   | 7,013 |   | 5.21 | % |
| Non-earning  assets                              |       | 7,421                                                                                         |       |   | * * | * * |   | 6,385 |   |   |   |   |   |
| Total assets                                     |       | $                                                                                             | 265,059    |   |   | * * | * * |   | $ | 186,431 |   |   |   |   |   |
| Interest-bearing  liabilities:                   |       |                                                                                          | * *   | * * | * * | * * | * * | * * |   |   |   |   |   |
| NOW accounts                                     |       | $                                                                                             | 37,662     |   | $ | 219 |   | 0.78 | % | $ | 29,180 |   | $ | 92 |   | 0.42 | % |
| Savings &  money market                      |       | 38,685                                                                                        |       | 394 |   | 1.36 | % | 21,688 |   | 98 |   | 0.60 | % |
| Time deposits                                    |       | 99,722                                                                                        |       | 1,898 |   | 2.54 | % | 88,454 |   | 1,908 |   | 2.88 | % |
| Total  interest-bearing deposits                 |       | 176,069                                                                                       |       | 2,511 |   | 1.90 | % | 139,322 |   | 2,098 |   | 2.01 | % |
| FHLB  advances                                   |       | 52,388                                                                                        |       | 792 |   | 2.02 | % | 25,268 |   | 424 |   | 2.24 | % |
| Other borrowings                                 |       | 21,691                                                                                        |       | 390 |   | 2.40 | % | 8,786 |   | 163 |   | 2.48 | % |
| Total  interest-bearing liabilities              |       | 250,148                                                                                       |       | 3,693 |   | 1.97 | % | 173,376 |   | 2,685 |   | 2.07 | % |
| Non-interest  bearing liabilities                |       | 2,555                                                                                         |       |   |   |   |   | 2,351 |   |   |   |   |   |
| Shareholders’  equity                       |       | 12,356                                                                                        |       |   |   |   |   | 10,704 |   |   |   |   |   |
| Total  liabilities and shareholders’ Equity |       | $                                                                                             | 265,059    |   |   |   |   |   | $ | 186,431 |   |   |   |   |   |
| Net interest  spread                             |       |                                                                                          |       |   |   | 3.10 | % |   |   |   |   | 3.14 | % |
| Net interest  income / margin                    |       |                                                                                          |       | $ | 6,085 |   | 3.15 | % |   |   | $ | 4,328 |   | 3.21 | % |

 

----

 (1) Annualized for the nine-month period.

 

Ournet interest spread was 3.10% for the nine months ended September 30, 2004,compared to 3.14 for the nine months ended September 30, 2003.

 

Ournet interest margin for the period ended September 30, 2004 was 3.15%, comparedto 3.21% for the nine months ended September 30, 2003.  During the first nine months of 2004, earningassets averaged $257.6 million, compared to $180.0 million in the first ninemonths of 2003.

 

Thelower yield on loans for the nine months ended September 30, 2004 compared tothe nine months ended September 30, 2003 resulted primarily from a reduction of25 basis points in the second quarter of 2003. The rates on loans did not begin to increase until the third quarter of2004, when the Federal Reserve increased rates 25 basis point on June 30, 2004and then again on September 21, 2004. The deposit rates did not decline as much as the reduction in the ratesearned on interest-earning assets because of our decision to aggressivelymarket interest-bearing transaction accounts by paying an above marketrate.  The borrowing rates declinedprimarily due to shorter term borrowings for most of the first six months of2004.  We extended the maturity dates onvarious jumbo time deposits and FHLB advances late inthe second quarter of 2004. These decisions were intended to compensate foranticipated higher rates in the future.

 

Netinterest income, the largest component of our income, was $6.1 million and $4.3million for the nine months ended September 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$77.6 million during the nine months ended September 30, 2004 compared to thesame period in 2003.

 

Aspreviously discussed, our net interest margin for the nine months endedSeptember 30, 2004 and 2003, was 3.15% and 3.21%, respectively.

 

17

----

 

The$1.8 million increase in net interest income for the nine months endedSeptember 30, 2004 compared to the same period in 2003 resulted substantiallyfrom higher average earning assets and interest-bearing liabilities.  The higher balances accounted from 99.3% ofthe increase.

 

Interestincome for the nine months ended September 30, 2004 was $9.8 million,consisting of $9.1 million on loans, $670,171 on investments, and $15,477 onfederal funds sold.  Interest income forthe nine months ended September 30, 2003 was $7.0 million, consisting of $6.7million on loans, $338,362 on investments, and $14,625 on federal funds sold.  Interest on loans for the nine months endedSeptember 30, 2004 and 2003 represented 93.0% and 95.0%, respectively, of totalinterest income, while income from investments and federal funds soldrepresented only 7.0% and 5.0% of total interest income.  The high percentage of interest income fromloans relates to our strategy to maintain a significant portion of our assetsin higher earning loans compared to lower yielding investments.  Average loans represented 91.2% and 92.8% ofaverage interest-earning assets for the nine months ended September 30, 2004and 2003, respectively.  Included ininterest income on loans for the nine months ended September 30, 2004 and 2003,was $347,960 and $266,164, respectively, related to the net amortization ofloan fees and capitalized loan origination costs.

 

Interestexpense for the nine months ended September 30, 2004 was $3.7 million,consisting of $2.5 million related to deposits and $1.2 million related toborrowings.  Interest expense for thenine months ended September 30, 2003 was $2.7 million, consisting of $2.1 millionrelated to deposits and $587,338 related to borrowings.  Interest expense on deposits for the ninemonths ended September 30, 2004 and 2003 represented 68.0% and 78.1%,respectively, of total interest expense, while interest expense on borrowings represented32.0% and 21.9%, respectively, of total interest expense for the nine monthsended September 30, 2004 and 2003.  Thelower percentage of interest expense on deposits and the higher percentage ofinterest on borrowings for the nine months ended September 30, 2004 compared tothe nine months ended September 30, 2003 resulted from our decisions to delayour retail deposit office expansion program and instead utilize additionalborrowings from the FHLB and from the sale ofsecurities under agreements to repurchase with brokers.   During the nine months ended September 30,2004, average deposits increased by $36.7 million over the same period in 2003,while other borrowing during the nine months ended September 30, 2004 increased$40.0 million over the same period in 2003. During the nine months ended September 30, 2004, we were able to pledgeadditional collateral to the FHLB, allowing us theability to increase our FHLB borrowings.  Both the short-term borrowings from the FHLB and the sale of securities under agreements torepurchase provide us with the opportunity to obtain low cost funding withvarious maturities similar to the maturities on our loans and investments.

 

18

----

 

*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**          | ** ** |
|--------------------------|------------|---------------------------------|------------|
| ** **               | ** ** | **September 30, 2004 vs. 2003** | ** ** | **September 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                    |       | $                               | 938        |   | 87 |   | 26 |   | 1,051 |   | 775 |   | (293 | ) | (114 | ) | 368 |   |
| Investment  securities   |       | 78                              |       | 6 |   | 2 |   | 86 |   | (19 | ) | (21 | ) | 2 |   | (38 | ) |
| Federal funds  sold      |       | 1                               |       | 1 |   | 1 |   | 3 |   | (2 | ) | (3 | ) | 1 |   | (4 | ) |
| Total interest  income   |       | 1,017                           |       | 94 |   | 29 |   | 1,140 |   | 754 |   | (317 | ) | (111 | ) | 326 |   |
|                     |       |                            |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| **Interest  expense**    |       |                            |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Deposits                 |       | 161                             |       | 79 |   | 17 |   | 257 |   | 129 |   | (201 | ) | (33 | ) | (105 | ) |
| FHLB  advances           |       | 192                             |       | (1 | ) | (3 | ) | 188 |   | 160 |   | (14 | ) | (42 | ) | 104 |   |
| Other borrowings         |       | 67                              |       | — |   | — |   | 67 |   | 34 |   | 8 |   | 7 |   | 49 |   |
| Total interest  expense  |       | 420                             |       | 78 |   | 14 |   | 512 |   | 323 |   | (207 | ) | (68 | ) | 48 |   |
|                     |       |                            |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| **Net  interest income** | ** ** | $                               | 597        |   | 16 |   | 15 |   | 628 |   | 431 |   | (110 | ) | (43 | ) | 278 |   |

 
| ** **               | ** ** | **Nine Months Ended**           | ** ** |
|--------------------------|------------|---------------------------------|------------|
| ** **               | ** ** | **September 30, 2004 vs. 2003** | ** ** | **September 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                    |       | $                               | 2,710      |   | (202 | ) | (74 | ) | 2,434 |   | 2,289 |   | (653 | ) | (282 | ) | 1,354 |   |
| Investment  securities   |       | 281                             |       | 28 |   | 23 |   | 332 |   | (123 | ) | (110 | ) | 25 |   | (208 | ) |
| Federal funds  sold      |       | —                          |       | — |   | — |   | — |   | (22 | ) | (15 | ) | 7 |   | (30 | ) |
| Total interest  income   |       | 2,991                           |       | (174 | ) | (51 | ) | 2,766 |   | 2,144 |   | (778 | ) | (250 | ) | 1,116 |   |
|                     |       |                            |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| **Interest  expense**    |       |                            |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Deposits                 |       | 551                             |       | (113 | ) | (25 | ) | 413 |   | 409 |   | (610 | ) | (104 | ) | (305 | ) |
| FHLB  advances           |       | 456                             |       | (42 | ) | (46 | ) | 368 |   | 521 |   | (50 | ) | (186 | ) | 285 |   |
| Other borrowings         |       | 240                             |       | (5 | ) | (8 | ) | 227 |   | 78 |   | 6 |   | 7 |   | 91 |   |
| Total interest  expense  |       | 1,247                           |       | (160 | ) | (79 | ) | 1,008 |   | 1,008 |   | (654 | ) | (283 | ) | 71 |   |
|                     |       |                            |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| **Net  interest income** | ** ** | $                               | 1,744      |   | (14 | ) | 28 |   | 1,758 |   | 1,136 |   | (124 | ) | 33 |   | 1,045 |   |

 

19

----

 

*Provision forLoan Losses*

 

We have established anallowance for loan losses through a provision for loan losses charged as anexpense on our statement of income.  Wereview our loan portfolio periodically to evaluate our outstanding loans and tomeasure both the performance of the portfolio and the adequacy of the allowancefor loan losses.  Please see thediscussion below under “Balance Sheet Review - Provision and Allowance for LoanLosses” for a description of the factors we consider in determining the amountof the provision we expense each period to maintain this allowance.

 

*Three months ended June 20, 2004 and 2003*

 

For the three months ended September 30, 2004 and2003, there was a noncash expense related to theprovision for loan losses of $375,000 and $250,000, respectively.  The additional provisions and recoveries oncharged-off loans added to our allowance for loan losses in the three monthsended September 30, 2004 and 2003.  Thenet increase in the allowance for loan losses in the three months endedSeptember 30, 2004 was $397,463 and was $147,936 in the three months endedSeptember 30, 2003.  The allowance forloan losses increased $22,463 more than the provision for loan losses in thethree months ended September 30, 2004 as a result of a $22,463 recoverycombined with no charge-offs in the three month period.  The allowance for loan losses at September30, 2003 did not increase by the entire amount of the provision for loan lossesbecause we reported net charge-offs of $102,064 for the three months endedSeptember 30, 2003.  The $102,064 netcharge-offs during the third quarter 2003 represented less than 0.05% of theaverage outstanding loan portfolio for the three months ended September 30,2003.  The $397,463 and the $147,936increases in the allowance for the three months ended September 30, 2004 and2003, respectively, related to our decision to increase the allowance inresponse to the $20.2 million and the $12.5 million growth in loans for thethree months ended September 30, 2004 and 2003, respectively.  The loan loss reserve was $3.6 million and$2.5 million as of September 30, 2004 and 2003, respectively.  The allowance for loan losses as a percentageof gross loans was 1.33% at September 30, 2004 and 1.31% at September 30, 2003,while the percentage of nonperforming loans to gross loans was 0.07% and 0.22%at September 30, 2004 and 2003, respectively

 

*Nine months ended June 20, 2004 and 2003*

 

For the nine months ended September 30, 2004 and 2003,there was a noncash expense related to the provisionfor loan losses of $1.0 million and $750,000, respectively.  The additional provisions added to ourallowance for loan losses in the nine months ended September 30, 2004 and 2003resulted in a net increase in the allowance for loan losses of $867,943 in thenine months ended September 30, 2004 and $637,161 in the nine months endedSeptember 30, 2003.  The allowance forloan losses did not increase by the entire amount of the provisions for loanlosses because we reported net charge-offs of $157,057 and $112,839 for thenine months ended September 30, 2004 and 2003, respectively.  The $157,057 net charge-offs during the firstnine months of 2004 represented 0.07% of the average outstanding loansportfolio for the nine months ended September 30, 2004.  The $112,839 net charge-offs during the firstnine months of 2003 represented 0.05% of the average outstanding loan portfoliofor the nine months ended September 30, 2003. The $867,943 and the $637,161 increases in the allowance for the ninemonths ended September 30, 2004 and 2003, respectively, related to our decisionto increase the allowance in response to the $59.0 million and the $38.8million growth in loans for the nine months ended September 30, 2004 and 2003,respectively.  The loan loss reserve was$3.6 million and $2.5 million as of September 30, 2004 and 2003,respectively.  The allowance for loanlosses as a percentage of gross loans was 1.33% at September 30, 2004 and 1.31%at September 30, 2003, while the percentage of nonperforming loans to grossloans was 0.07% and 0.22% at September 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 nine monthsended September 30, 2004, 100.0%, and 84.7%, respectively, of the provision forloan losses was related primarily to the growth in loans, with 0.0%, and 15.3%,respectively, related to net charge-offs. If the quality of the loan portfolio declines or a higher percentage ofthe portfolio is charged-off, additional provisions may be required.

 

20

----

 

***Noninterest Income***

 

The following tables setforth information related to our noninterest income.

** **
| ** **                       | ** ** | **Three months ended  September 30,** | ** ** | **Nine months ended  September 30,** | ** ** |
|----------------------------------|------------|---------------------------------------|------------|--------------------------------------|------------|
| ** **                       | ** ** | **2004**                              | ** ** | **2003**                             | ** ** | **2004** | ** ** | **2003** | ** ** |
|                             |       |                                  |       |                                 |       |   |   |   |   |
| Loan fee income                  | ** ** | $                                     | 33,860     |                                 | 50,446     |   | 100,684 |   | 154,112 |   |
| Service fees on  deposits        |       | 71,977                                |       | 67,838                               |       | 211,705 |   | 191,134 |   |
| Write-down on  real estate owned |       | —                                |       | (70,000                              | )          | — |   | (170,000 | ) |
| Other income                     |       | 78,584                                |       | 67,034                               |       | 234,932 |   | 171,178 |   |
| Total  noninterest income        | ** ** | $                                     | 184,421    |                                 | 115,318    |   | 547,321 |   | 346,424 |   |

 

*Three months ended September 30, 2004 and 2003*

 

Noninterest income in the third three month period of2004 was $184,421, an increase of 59.9% over noninterest income of $115,318 inthe same period of 2003.  Noninterestincome in the three months ended September 30, 2003 was reduced by a $70,000write-down on real estate owned. Excluding the 2003 write-down, noninterest income decreased $897, or0.5%, for the third 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 $33,860and $50,446 for the three months ended September 30, 2004 and September 30,2003, respectively.  The $16,586 decreaserelated primarily to the lower amount of mortgage origination fees that wereceived in the three months ended September 30, 2004 compared to the threemonths ended September 30, 2003. Mortgage origination fees were $2,398 and $31,806 for the three monthsended September 30, 2004 and 2003, respectively.  The reduction related to the significantdecline in volume of residential mortgage refinanced in the third three monthperiod of 2004 compared to the same period in 2003.  We received $15,770 in fees on lines ofcredit in the third three month period of 2004 compared to $3,228 in the thirdthree month period of 2003.  Late chargefees were $15,692 and $15,412 for the three months ended September 30, 2004 and2003, respectively.

 

Deposit fees were $71,977 and $67,838 for the threemonths ended September 30, 2004 and 2003. The additional $4,139 of income related to both higher service chargesand an increase of NSF transactions resulting from the larger number of clientaccounts.  NSF income was $45,440 and$45,420 for the three months ended September 30, 2004 and 2003, respectively,representing 63.1% of total service fees on deposits in the 2004 periodcompared to 67.0% of total service fees on deposits in the 2003 period.

 

Other income was $78,584 and $67,034 for the threemonths ended September 30, 2004 and 2003, respectively.  The $11,550 increase resulted primarily froman increase in the volume of ATM transactions for which we receive fees.  ATM transaction fees were $70,789 and $61,034for the three months ended September 30, 2004 and 2003, respectively.  ATM transaction fees represented 90.1% and91.0% of total other income for the three months ended September 30, 2004 and2003, respectively.  Included innoninterest outside service expense is $65,219 and $56,496 related tocorresponding transaction costs associated with ATM transaction fees for thethree months ended September 30, 2004 and 2003, respectively.  The net impact of the fees received and therelated cost of the ATM transactions on earnings for the years ended December31, 2003 and 2002 was $5,570 and $4,538, respectively.

 

21

----

 

*Ninemonths ended September 30, 2004 and 2003*

 

Noninterest income in the first nine months of 2004was $547,321, an increase of 58.0% over noninterest income of $346,424 in thesame period of 2003.  Noninterest incomein the nine months ended September 30, 2003 was reduced by a $170,000write-down on real estate owned. Excluding the 2003 write-down, noninterest income increased $30,897, or6.0%, for the first nine months 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 $100,684and $154,112 for the nine months ended September 30, 2004 and September 30,2003, respectively.  The $53,428 decreaserelated primarily to the lower amount of mortgage origination fees that wereceived in the nine months ended September 30, 2004 compared to the ninemonths ended September 30, 2003. Mortgage origination fees were $5,821 and $95,428 for the nine monthsended September 30, 2004 and 2003, respectively.  The reduction related to the significantdecline in volume of residential mortgage refinanced in the first nine monthsof 2004 compared to the same period in 2003. We received $47,491 in fees on lines of credit in the first nine monthsof 2004 compared to $18,830 in the first nine months of 2003.  Late charge fees were $47,372 and $39,854 forthe nine months ended September 30, 2004 and 2003, respectively.  The increase in late charges related to ourlarger loan portfolio in 2004 compared to 2003.

 

Deposit fees were $211,705 and $191,134 for the ninemonths ended September 30, 2004 and 2003. The additional $20,571 of income related to both higher service chargesand an increase of NSF transactions resulting from the larger number of clientaccounts.  NSF income was $130,395 and$122,910 for the nine months ended September 30, 2004 and 2003, respectively,representing 61.6% of total service fees on deposits in the 2004 periodcompared to 64.3% of total service fees on deposits in the 2003 period.

 

Other income was $234,932 and $171,178 for the ninemonths ended September 30, 2004 and 2003, respectively.  The $63,754 increase resulted primarily froman increase in the volume of ATM transactions for which we receive fees.  ATM transaction fees were $210,930 and$151,370 for the nine months ended September 30, 2004 and 2003,respectively.  ATM transaction feesrepresented 89.8% and 88.4% of total other income for the nine months endedSeptember 30, 2004 and 2003, respectively. Included in noninterest outside service expense is $189,079 and $146,773related to corresponding transaction costs associated with ATM transaction feesfor the nine months ended September 30, 2004 and 2003, respectively.  The net impact of the fees received and therelated cost of the ATM transactions on earnings for the years ended December31, 2003 and 2002 was $21,851 and $4,597, respectively.

 

*Noninterest expenses*

 

The following tables set forth information related toour noninterest expenses.

 
| ** **                         | ** ** | **Three months ended  September 30,** | ** ** | **Nine months ended  September 30,** | ** ** |
|------------------------------------|------------|---------------------------------------|------------|--------------------------------------|------------|
| ** **                         | ** ** | **2004**                              | ** ** | **2003**                             | ** ** | **2004** | ** ** | **2003** | ** ** |
|                               |       |                                  |       |                                 |       |   |   |   |   |
| Compensation and  benefits         |       | $                                     | 612,118    |                                 | 494,979    |   | 1,811,640 |   | 1,462,821 |   |
| Professional  fees                 |       | 41,711                                |       | 56,947                               |       | 141,526 |   | 131,506 |   |
| Marketing                          |       | 61,985                                |       | 44,128                               |       | 187,943 |   | 122,873 |   |
| Insurance.                         |       | 33,006                                |       | 28,171                               |       | 94,668 |   | 81,436 |   |
| Occupancy                          |       | 153,580                               |       | 141,899                              |       | 443,479 |   | 441,261 |   |
| Data processing  and related costs |       | 208,452                               |       | 169,240                              |       | 605,227 |   | 456,770 |   |
| Telephone                          |       | 6,454                                 |       | 5,517                                |       | 19,760 |   | 16,704 |   |
| Other.                             |       | 65,464                                |       | 55,733                               |       | 191,623 |   | 140,688 |   |
| Total  noninterest expense         |       | $                                     | 1,182,770  |                                 | 996,614    |   | 3,495,866 |   | 2,854,059 |   |

 

22

----

 

*Three months ended September 30, 2004 and 2003*

 

We incurred noninterest expenses of $1.2 million forthe three months ended September 30, 2004 compared to $996,614 for the threemonths ended September 30, 2003.  Averageinterest-earning assets increased 41.1% during this period, while general andadministrative expense increased only 18.7%.

 

The $117,139 increase in compensation and benefits and$39,212 in additional data processing and related costs accounted for 84.0% ofthe $186,156 increase in noninterest expense for the three months endedSeptember 30, 2004 compared to the same period in 2003.  The remaining $29,805 increase resultedprimarily from increases of $17,857 in marketing costs, and $9,731 in otherexpenses.   The increase in marketingexpenses related to expanding our market awareness in the Greenville market,while a significant portion of the increase in other expenses was due toincreased costs of postage and office supplies, additional staff education andtraining, and higher dues and subscription costs.

 

Occupancy expense, which represented 13.0% and 14.2%of total noninterest expense for the three months ended September 30, 2004 and2003, respectively, increased $11,681. Occupancy expense was $153,580 and $141,899 for the three months endedSeptember 30, 2004 and 2003, respectively.

 

*Nine months ended September 30, 2004 and 2003*

 

We incurred noninterest expenses of $3.5 million forthe nine months ended September 30, 2004 compared to $2.9 million for the ninemonths ended September 30, 2003.  Averageinterest-earning assets increased 43.1% during this period, while general andadministrative expense increased only 22.5%.

 

The $348,819 increase in compensation and benefits and$148,457 in additional data processing and related costs accounted for 77.5% ofthe $641,807 increase in noninterest expense for the nine months endedSeptember 30, 2004 compared to the same period in 2003.  The remaining $144,531 increase resultedprimarily from increases of $10,020 in professional fees, $65,070 in marketingcosts, and $50,935 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 12.7% and 15.5%of total noninterest expense for the nine months ended September 30, 2004 and2003, respectively, remained virtually unchanged.  Occupancy expense was $443,479 and $441,261for the nine months ended September 30, 2004 and 2003, respectively.

 

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

 
| ** **                          | ** ** | **Three months ended  September 30,** | ** ** | **Nine months ended  September 30,** | ** ** |
|-------------------------------------|------------|---------------------------------------|------------|--------------------------------------|------------|
| ** **                          | ** ** | **2004**                              | ** ** | **2003**                             | ** ** | **2004** | ** ** | **2003** | ** ** |
|                                |       |                                  |       |                                 |       |   |   |   |   |
| Base  compensation                  |       | $                                     | 415,303    |                                 | 347,435    |   | 1,226,390 |   | 1,034,748 |   |
| Incentive  compensation             |       | 159,000                               |       | 120,000                              |       | 429,000 |   | 302,000 |   |
| Total  compensation                 |       | 574,303                               |       | 467,435                              |       | 1,655,390 |   | 1,336,748 |   |
| Benefits                            |       | 72,645                                |       | 59,674                               |       | 251,740 |   | 215,778 |   |
| Capitalized loan  origination costs |       | (34,830                               | )          | (32,130                              | )          | (95,490 | ) | (89,705 | ) |
| Total  compensation and benefits    |       | $                                     | 612,118    |                                 | 494,979    |   | 1,811,640 |   | 1,462,821 |   |

 

23

----

 

*Three months ended September 30, 2004 and 2003*

 

Compensation and benefits expense was $612,118 and$494,979 for the three months ended September 30, 2004 and 2003,respectively.   Compensation and benefitsrepresented 51.8% and 50.0% of our total noninterest expense for the threemonths ended September 30, 2004 and 2003, respectively.  The $117,139 increase in compensation andbenefits in the third quarter of 2004 compared to the same period in 2003resulted from increases of $67,868 in base compensation,  $39,000 in additional incentive compensation,and $12,971 higher benefits expense. These amounts were partly offset by an increase of $2,700 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 $67,868 increase in base compensation expenserelated to the cost of two additional employees as well as annual salaryincreases.  Incentive compensationrepresented 26.0% and 24.2% of total compensation and benefits for the threemonths ended September 30, 2004 and 2003, respectively.  The incentive compensation expense recordedfor the third quarter of 2004 and 2003 represented an accrual of the portion ofthe estimated incentive compensation earned during the third quarter of therespective year.  Benefits expense increased$12,971 in the third quarter of 2004 compared to the same period in 2003.  Benefits expense represented 11.9% and 12.1%of the total compensation for the three months ended September 30, 2004 and2003, respectively.

 

*Nine months ended September 30, 2004 and*2003

 

Compensation and benefits expense was $1.8 million and$1.5 million for the nine months ended September 30, 2004 and 2003,respectively.   Compensation and benefitsrepresented 51.8% and 51.3% of our total noninterest expense for the nine monthsended September 30, 2004 and 2003, respectively.  The $348,819 increase in compensation andbenefits in the first nine months of 2004 compared to the same period in 2003resulted from increases of $191,642 in base compensation, $127,000 in additionalincentive compensation, and $35,962 in higher benefit costs, offset by anincrease of $5,785 in loan origination compensation expense, which is requiredto be capitalized and amortized over the life of the loan as a reduction ofloan interest income.

 

The $191,642 increase in base compensation expenserelated to the cost of two additional employees as well as annual salaryincreases.  Incentive compensationrepresented 23.7% and 20.6% of total compensation and benefits for the ninemonths ended September 30, 2004 and 2003, respectively.  The incentive compensation expense recordedfor the first nine months of 2004 and 2003 represented an accrual of theportion of the estimated incentive compensation earned during the first ninemonths of the respective year.  Benefitsexpenses increased $35,962 in the first nine months of 2004 compared to thesame period in 2003.  Benefits expenserepresented 13.9% and 14.8% of the total compensation for the nine months endedSeptember 30, 2004 and 2003, respectively.

 

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

 
| ** **                               | ** ** | **Three months ended  September 30,** | ** ** | **Nine months ended  September 30,** | ** ** |
|------------------------------------------|------------|---------------------------------------|------------|--------------------------------------|------------|
| ** **                               | ** ** | **2004**                              | ** ** | **2003**                             | ** ** | **2004** | ** ** | **2003** | ** ** |
|                                     |       |                                  |       |                                 |       |   |   |   |   |
| Data processing  costs                   |       | $                                     | 108,909    |                                 | 79,726     |   | 313,257 |   | 213,819 |   |
| ATM transaction  expense                 |       | 65,219                                |       | 56,496                               |       | 189,079 |   | 146,773 |   |
| Courier expense                          |       | 19,494                                |       | 14,234                               |       | 55,517 |   | 45,041 |   |
| Other expenses                           |       | 14,830                                |       | 18,784                               |       | 47,374 |   | 51,137 |   |
| Total data  processing and related costs |       | $                                     | 208,452    |                                 | 169,240    |   | 605,227 |   | 456,770 |   |

 

Data processing and related costs were $208,452 and$169,240 for the three months ended September 30, 2004 and 2003,respectively.  During the first ninemonths of 2004 and the same period of 2003, our data processing and relatedcosts were $605,227 and $456,770, respectively.

 

During the three months ended September 30, 2004, ourdata processing costs for our core processing system were $108,909 compared to$79,726 for the three months ended September 30, 2004.   We have contracted with an outside computer****service company to provide our core data processingservices.  During the nine months endedSeptember 30, 2004 and****2003, the dataprocessing costs were $313,257 and $213,819, respectively.

 

24

----

 

Data processing costs increased $29,183, or 36.6%, forthe three months ended September 30, 2004 compared to the same period in2003.  For the nine months endedSeptember 30, 2004, data processing costs increased $99,438, or 46.5%, 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 $65,219 and $56,496 for the three months ended September 30, 2004and 2003, respectively.  During the firstnine months of 2004 and the same period of 2003, the ATM transaction expensewas $189,079 and $146,773, respectively. The increases in each period related to the higher transaction volumeduring the respective periods.

 

Income tax expense was $310,876 for the three monthsended September 30, 2004 compared to $163,941 during the same period in2003.  For the nine months endedSeptember 30, 2004, income tax expense was $802,309 compared to $406,882 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 $230.8million, consisting principally of $206.1 million in loans, $15.8 million ininvestments, $2.8 million in federal funds sold, and $4.1 million in cash anddue from banks.  Our liabilities atDecember 31, 2003 totaled $219.7 million, consisting principally of $169.0million in deposits, $32.5 million in FHLB advances, $9.3 million of short-termborrowings, and $6.2 million of junior subordinated debentures.  At December 31, 2003, our shareholders’equity was $11.2 million.

 

At September 30,2004, we had total assets of $292.9 million, consisting principally of $264.3million in loans, $20.5 million in investments, $473,819 in federal funds sold,and $3.1 million in cash and due from banks. Our liabilities at September 30, 2004 totaled $267.5 million, whichconsisted principally of $183.2 million in deposits, $60.6 million in FHLBadvances, $13.8 million in short-term borrowings, and $6.2 million in juniorsubordinated debentures.  At September30, 2004, our shareholders’ equity was $25.5 million.

 

*Federal Funds Sold*

 

At December 31, 2003, our $2.8 million in short-terminvestments in federal funds sold on an overnight basis comprised 1.2% of totalassets.  At September 30, 2004, ourfederal funds sold were $473,819, or 0.2% of total assets.  As a result of the historically low yieldspaid for federal funds sold during the last two years, we have maintained alower than normal level of federal funds.

 

25

----

 

*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 $13.4 million and an amortizedcost of $13.3 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 in thefollowing table.  Expected maturities maydiffer from contractual maturities because issuers may have the right to callor prepay obligations with or without call or prepayment penalties.  At December 31, 2003, 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 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 |   | 4.70 | % | $ | 9,834 |   | 4.70 | % |

 

AtDecember 31, 2003, 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, $354,067, and $12.0million, respectively.

 

Otherinvestments at December 31, 2003 consisted of Federal Reserve Bank stock with acost 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.

 

AtSeptember 30, 2004, the $20.5 million in our investment securities portfoliorepresented approximately 7.0% of our total assets.  We held U.S. Government agency securities andmortgage-backed securities with a fair value of $16.6 million and an amortizedcost of $16.6 million for an unrealized gain of $42,506.

 

26

----

 

Contractualmaturities and yields on our investments that are available for sale and areheld to maturity at September 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 September 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 |       | $                     | 1,069      |                  | 5.43       | %          | $          | — |   | — |   | $ | 1,069 |   | 5.43 | % |
| Mortgage-backed  securities                     |       | —                |       | —                | %          | 1,881      |       | 4.40 | % | 1,881 |   | 4.40 | % |
| Total                                           |       | $                     | 1,069      |                  | 5.43       | %          | $          | 1,881 |   | 4.40 | % | $ | 2,950 |   | 4.78 | % |
| **Held to  Maturity**                           |       |                  |       |                  |       |       |       |   |   |   |   |   |   |
| Mortgage-backed  securities                     |       | $                     | —     |                  | —     | %          | $          | 13,697 |   | 4.45 | % | $ | 13,697 |   | 4.45 | % |

 

At September 30, 2004, our investments includedsecurities issued by Federal Home Loan Bank, Federal Home Loan MortgageCorporation, and Federal National Mortgage Association with carrying values of$1.1 million, $5.2 million, and $10.4 million, respectively.

 

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

 
| ** **                                       | ** ** | **September 30, 2004** | ** ** | **December 31, 2003** | ** ** |
|--------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                       | ** ** | **Amortized   Cost**   | ** ** | **Fair Value**        | ** ** | **Amortized   Cost** | ** ** | **Fair Value** | ** ** |
| ** **                                       | ** ** | **(In thousands)**     | ** ** |
| **Available  for Sale**                          | ** ** | ** **             | ** ** | ** **            | ** ** | ** ** | ** ** | ** ** | ** ** |
| U.S. Government  / government sponsored agencies |       | $                      | 1,016      |                  | $          | 1,069 |   | $ | 1,022 |   | $ | 1,098 |   |
| Mortgage-backed  Securities                      |       | 1,843                  |       | 1,881                 |       | 2,460 |   | 2,531 |   |
| Total                                            |       | 2,859                  |       | 2,950                 |       | 3,482 |   | 3,629 |   |
| **Held to  Maturity**                            |       |                   |       |                  |       |   |   |   |   |
| Mortgage-backed  Securities                      |       | $                      | 13,697     |                  | $          | 13,648 |   | $ | 9,834 |   | $ | 9,761 |   |

 

Other investments totaled $3.9 million and $2.3million, and $905,000 at September 30, 2004 and December 31, 2003,respectively.  Other investments atSeptember 30, 2004 consisted of Federal Reserve Bank stock with a cost of$485,150, an investment in Greenville First Statutory Trust I of $186,000, andFederal Home Loan Bank stock with a cost of $2.8 million.

 

27

----

 

*Loans*

 

Since loans typically provide higher interest yieldsthan other types of interest earning assets, a substantial percentage of ourearning assets are invested in our loan portfolio.  Average loans for the years ended December31, were $174.3 million.  Beforeallowance for loan losses, total loans outstanding at December 31, 2003 were$208.8 million.  For the nine monthsended September 30, 2004 and 2003, average loans were $235.0 million and $167.0million, respectively.  Before allowancefor loan losses, total loans outstanding at September 30, 2004 were $267.8million.

 

The principal component of our loan portfolio is loanssecured by real estate mortgages.    Mostof our real estate loans are secured by residential or commercialproperty.  We do not generally originatetraditional long term residential mortgages, but we do issue traditional secondmortgage residential real estate loans and home equity lines of credit.  We obtain a security interest in real estatewhenever possible, in addition to any other available collateral.  This collateral is taken to increase thelikelihood 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 at September30, 2004 and December 31, 2003.

** **
| ** **                               | ** ** | **September 30, 2004** | ** ** | **December 31, 2003** | ** ** |
|------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                               | ** ** | **Amount**             | ** ** | **% of Total**        | ** ** | **Amount** | ** ** | **% of Total** | ** ** |
| Real estate:                             |       |                   |       |                  |       |   |   |   |   |
| Commercial                               |       |                   |       |                  |       |   |   |   |   |
| Owner occupied                           |       | $                      | 41,456     |                  | 15.48      | % | $ | 39,301 |   | 18.82 | % |
| Non-owner  occupied                      |       | 72,363                 |       | 27.02                 | %          | 53,898 |   | 25.82 | % |
| Construction                             |       | 18,890                 |       | 7.05                  | %          | 10,878 |   | 5.21 | % |
| Total commercial  real estate            |       | 132,709                |       | 49.55                 | %          | 104,077 |   | 49.85 | % |
| Consumer                                 |       |                   |       |                  |       |   |   |   |   |
| Residential                              |       | 48,697                 |       | 18.18                 | %          | 35,823 |   | 17.16 | % |
| Home equity                              |       | 32,465                 |       | 12.12                 | %          | 24,278 |   | 11.63 | % |
| Construction                             |       | 6,445                  |       | 2.41                  | %          | 4,365 |   | 2.09 | % |
| Total consumer  real estate              |       | 87,607                 |       | 32.71                 | %          | 64,466 |   | 30.88 | % |
| Total real  estate                       |       | 220,316                |       | 82.26                 | %          | 168,543 |   | 80.73 | % |
| Commercial  business                     |       | 42,738                 |       | 15.96                 | %          | 36,107 |   | 17.29 | % |
| Consumer-other                           |       | 5,444                  |       | 2.03                  | %          | 4,662 |   | 2.23 | % |
| Deferred  origination fees, net          |       | (666                   | )          | (0.25                 | )%         | (530 | ) | (0.25 | )% |
| Total gross  loans, net of deferred fees |       | 267,832                |       | 100.00                | %          | 208,782 |   | 100.00 | % |
| Less—allowance  for loan losses     |       | (3,573                 | )          |                  |       | (2,705 | ) |   |   |
| Total loans, net                         |       | $                      | 264,259    |                  |       |   | $ | 206,077 |   |   |   |

 

28

----

 

*Maturities andSensitivity of Loans to Changes in Interest Rates*

 

The information in the following tables is based onthe contractual 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.

 

Thefollowing table summarizes the loan maturity distribution by type and relatedinterest rate characteristics at September 30, 2004.

 
| ** **                               | ** ** | **One year   or less** | ** ** | **After one   but within   five years** | ** ** | **After five   years** | ** ** | **Total** | ** ** |
|------------------------------------------|------------|------------------------|------------|-----------------------------------------|------------|------------------------|------------|-----------|------------|
| ** **                               | ** ** | **(In thousands)**     | ** ** |
| Real estate –  mortgage             |       | $                      | 33,578     |                                    | 136,820    |                   | 24,578     |      | 194,976    |   |
| Real estate –  construction         |       | 6,988                  |       | 11,351                                  |       | 7,000                  |       | 25,339    |       |
| Total real  estate                       |       | 40,566                 |       | 148,171                                 |       | 31,578                 |       | 220,315   |       |
|                                     |       |                   |       |                                    |       |                   |       |      |       |
| Commercial  business                     |       | 23,755                 |       | 18,891                                  |       | 92                     |       | 42,738    |       |
| Consumer-other                           |       | 2,740                  |       | 2,381                                   |       | 323                    |       | 5,444     |       |
| Deferred  origination fees, net          |       | (133                   | )          | (440                                    | )          | (92                    | )          | (666      | )          |
| Total gross  loans, net of deferred fees |       | $                      | 66,928     |                                    | 169,003    |                   | 31,901     |      | 267,832    |   |
| Loans maturing  after one year with:     |       |                   |       |                                    |       |                   |       |      |       |
| Fixed interest  rates                    |       |                   |       |                                    |       |                   |       | $         | 64,289     |   |
| Floating  interest rates                 |       |                   |       |                                    |       |                   |       | $         | 136,615    |   |

 

Thefollowing table summarizes the loan maturity distribution by type and relatedinterest rate characteristics at December 31, 2003.

 
| ** **                               | ** ** | **One year   or less** | ** ** | **After one   but within   five years** | ** ** | **After five   years** | ** ** | **Total** | ** ** |
|------------------------------------------|------------|------------------------|------------|-----------------------------------------|------------|------------------------|------------|-----------|------------|
| ** **                               | ** ** | **(In thousands)**     | ** ** |
| 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    |   |

 

29

----

 

*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.  Due to the rapid growth of our bank over thepast several years and our short operating history, a large portion of theloans in our loan portfolio and of our lending relationships are of relativelyrecent origin.  In general, loans do notbegin to show signs of credit deterioration or default until they have beenoutstanding for some period of time, a process we refer to as “seasoning.”  As a result, a portfolio of older loans willusually behave more predictably than a newer portfolio.  Because our loan portfolio is relatively new,the current level of delinquencies and defaults may not be representative ofthe level that will prevail when the portfolio becomes more seasoned, which maybe higher than current levels.  Ifdelinquencies and defaults increase, we may be required to increase ourprovision for loan losses, which would adversely affect our results ofoperations and financial condition. Periodically, we adjust the amount of the allowance based on changingcircumstances.  We charge recognizedlosses to the allowance and add subsequent recoveries back to the allowance forloan losses.  There can be no assurancethat charge-offs of loans in future periods will not exceed the allowance forloan losses as estimated at any point in time or that provisions for loanlosses will not be significant to a particular accounting period.

 

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

 
| ** **                                  | ** ** | **September 30,**  | ** ** |
|---------------------------------------------|------------|--------------------|------------|
| ** **                                  | ** ** | **2004**           | ** ** | **2003** | ** ** |
| ** **                                  | ** ** | **(In thousands)** | ** ** |
|                                        |       |               |       |   |   |
| Balance,  beginning of period               |       | $                  | 2,705      |   | 1,824 |   |
|                                        |       |               |       |   |   |
| Loans  charged-off                          |       | (192               | )          | (116 | ) |
|                                        |       |               |       |   |   |
| Recoveries of loans  previously charged-off |       | 35                 |       | 3 |   |
|                                        |       |               |       |   |   |
| Net loans  charged-off                      |       | $                  | (157       | ) | (113 | ) |
|                                        |       |               |       |   |   |
| Provision for  loan losses                  |       | 1,135              |       | 750 |   |
|                                        |       |               |       |   |   |
| Balance, end of  period                     |       | $                  | 3,683      |   | 2,461 |   |
|                                        |       |               |       |   |   |
| Allowance for  loan losses to gross loans   |       | 1.33               | %          | 1.31 | % |
|                                        |       |               |       |   |   |
| Net charge-offs  to average loans           |       | 0.07               | %          | 0.05 | % |

 

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 our creditgrading system which we apply to each loan. We have retained an independent consultant to review the loan files on atest basis to confirm the grading of each loan.

 

30

----

 

*NonperformingAssets*

 

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

 
| ** **                                                   | ** ** | **September 30,  2004**    | ** ** | **December 31,  2003** | ** ** |
|--------------------------------------------------------------|------------|----------------------------|------------|------------------------|------------|
| ** **                                                   | ** ** | **(Dollars in thousands)** | ** ** |
|                                                         |       |                       |       |                   |       |
| Loans over 90  days past due                                 |       | $                          | 178        |                   | 396        |   |
|                                                         |       |                       |       |                   |       |
| Loans on  nonaccrual:                                        |       |                       |       |                   |       |
| Mortgage                                                     |       | 74                         |       | 150                    |       |
| Commercial                                                   |       | 104                        |       | 224                    |       |
| Consumer                                                     |       | 2                          |       | 70                     |       |
| Total nonaccrual  loans                                      |       | 180                        |       | 444                    |       |
|                                                         |       |                       |       |                   |       |
| Troubled debt  restructuring                                 |       | —                     |       | —                 |       |
|                                                         |       |                       |       |                   |       |
| Total of  nonperforming loans                                |       | 180                        |       | 444                    |       |
|                                                         |       |                       |       |                   |       |
| Other  nonperforming assets                                  |       | 306                        |       | —                 |       |
|                                                         |       |                       |       |                   |       |
| Total  nonperforming assets                                  |       | $                          | 486        |                   | 444        |   |
|                                                         |       |                       |       |                   |       |
| Percentage of  total assets                                  |       | 0.17                       | %          | 0.19                   | %          |
|                                                         |       |                       |       |                   |       |
| Percentage of  nonperforming loans and assets to gross loans |       | 0.18                       | %          | 0.21                   | %          |
|                                                         |       |                       |       |                   |       |
| Allowance for  loan losses to gross loans                    |       | 1.33                       | %          | 1.30                   | %          |
|                                                         |       |                       |       |                   |       |
| Net charge-offs  to average loans                            |       | 0.07                       | %          | 0.10                   | %          |

 

At September 30, 2004 and December 31, 2003, theallowance for loan losses was $3.6 million and $2.7 million, respectively, or1.33% and 1.30% respectively, of outstanding loans.  During the year ended December 31, 2003, wecharged off loans of $172,646.  Duringthe nine months ended September 30, 2004 and 2003, our net charged-off loans were$157,057 and $112,839, respectively.

 

At September 30, 2004 and December 31, 2003,nonaccrual loans represented 0.07% and 0.21% of total loans, respectively.  At September 30, 2004 and December 31, 2003,we had $180,432 and $443,939 of loans, respectively, on nonaccrual status.   Generally, a loan is placed on nonaccrualstatus when it becomes 90 days past due as to principal or interest, or when webelieve, after considering economic and business conditions and collectionefforts, that the borrower’s financial condition is such that collection of theloan is doubtful.  A payment of intereston a loan that is classified as nonaccrual is recognized as income whenreceived**.**

 

Theamount of foregone interest income on the nonaccrual loans in the first nine monthsof 2004 was approximately $13,400.   Theamount of interest income recorded in the first nine months of 2004 for loansthat were on nonaccrual at September 30, 2004 was $2,800.

 

31

----

 

*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 $69.0 at September 30,2004.  The decrease in the first ninemonths 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 144% and 124%, at September 30, 2004 and December 31,2003, respectively.

 

 

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

** **
| ** **                           | ** ** | **2004**                   | ** ** | **2003** | ** ** |
|--------------------------------------|------------|----------------------------|------------|----------|------------|
| ** **                           | ** ** | **Amount**                 | ** ** | **Rate** | ** ** | **Amount** | ** ** | **Rate** | ** ** |
| ** **                           | ** ** | **(Dollars in thousands)** | ** ** |
| Noninterest  bearing demand deposits |       | $                          | 14,862     |     | —     | % | $ | 14,346 |   | — | % |
| Interest bearing  demand deposits    |       | 22,800                     |       | 1.28     | %          | 14,834 |   | 0.83 | % |
| Money market  accounts               |       | 37,340                     |       | 1.40     | %          | 19,826 |   | 0.62 | % |
| Saving accounts                      |       | 1,345                      |       | 0.34     | %          | 1,862 |   | 0.43 | % |
| Time deposits  less than $100,000    |       | 26,401                     |       | 2.36     | %          | 31,364 |   | 3.21 | % |
| Time deposits  greater than $100,000 |       | 73,321                     |       | 2.61     | %          | 57,090 |   | 2.70 | % |
| Total deposits                       |       | $                          | 176,069    |     | 1.91       | % | $ | 139,322 |   | 2.01 | % |

 

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 $108.4 million and$89.9 million, at September 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 September 30, 2004 and December 31, 2003 is asfollows:

 
| ** **                      | ** ** | **September 30,  2004** | ** ** | **December 31,  2003** | ** ** |
|---------------------------------|------------|-------------------------|------------|------------------------|------------|
| ** **                      | ** ** | **(In thousands)**      | ** ** |
|                            |       |                    |       |                   |       |
| Three months or  less           |       | $                       | 26,821     |                   | $          | 19,272 |   |
| Over three  through six months  |       | 16,387                  |       | 16,416                 |       |
| Over six through  twelve months |       | 1,938                   |       | 24,983                 |       |
| Over twelve  months             |       | 29,647                  |       | 18,437                 |       |
| Total                           |       | $                       | 74,793     |                   | $          | 79,108 |   |

 

Thedecrease in time deposits of $100,000 or more for the nine months endedSeptember 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

----

 

 

*Capital Resources*

 

Total shareholders’ equity was $11.2 million atDecember 31, 2003.  At September 30,2004, total shareholders’ equity was $25.5 million.  The increase during the first nine months of2004 resulted from the $1.3 million of net income earned during the first ninemonths, $13.0 million from proceeds from sale of common stock, and theadditional capital of $20,010 obtained from the exercise of warrants that wereoutstanding.  The additions to capitalwere partly offset by a $36,999 reduction in unrealized gain on investmentsecurities, net of tax.

 

The following table shows the return on average assets(net income divided by average total assets), return on average equity (netincome divided by average equity), and equity to assets ratio (average equitydivided by average total assets) for the nine months ended September 30, 2004and the year ended December 31, 2003. Since our inception, we have not paid cash dividends.

 
| ** **                | ** ** | **September 30, 2004** | ** ** | **December 31, 2003** | ** ** |
|---------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                | ** ** | ** **             | ** ** | ** **            | ** ** |
| Return on  average assets |       | 0.66                   | %          | 0.52                  | %          |
|                      |       |                   |       |                  |       |
| Return on  average equity |       | 14.15                  | %          | 9.28                  | %          |
|                      |       |                   |       |                  |       |
| Equity to assets  ratio   |       | 4.67                   | %          | 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%.

 

Under the capital adequacy guidelines, regulatorycapital is classified into two tiers. These guidelines require an institution to maintain a certain level ofTier 1 and Tier 2 capital to risk-weighted assets.  Tier 1 capital consists of commonshareholders’ equity, excluding the unrealized gain or loss on securitiesavailable 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.

 

At both the holding company and bank level, we aresubject to various regulatory capital requirements administered by the federalbanking agencies.  To be considered“adequately capitalized” under these capital guidelines, we must maintain aminimum total risk-based capital of 8%, with at least 4% being Tier 1capital.  In addition, we must maintain aminimum Tier 1 leverage ratio of at least 4%. To be considered “well-capitalized,” we must maintain total risk-basedcapital of at least 10%, Tier 1 capital of at least 6%, and a leverage ratio ofat least 5%.

 

Thefollowing table sets forth the holding company’s and the bank’s various capitalratios at September 30, 2004 and at December 31, 2003.  For all periods, the bank was considered“well capitalized” and the holding company met or exceeded its applicableregulatory capital requirements.

 
| ** **                 | ** ** | **September 30, 2004** | ** ** | **December 31, 2003** | ** ** |
|----------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                 | ** ** | **Holding   Company**  | ** ** | **Bank**              | ** ** | **Holding   Company** | ** ** | **Bank** | ** ** |
|                       |       |                   |       |                  |       |   |   |   |   |
| Total risk-based  capital  |       | 14.3                   | %          | 14.1                  | %          | 10.2 | % | 10.1 | % |
| Tier 1 risk-based  capital |       | 13.0                   | %          | 12.8                  | %          | 7.8 | % | 8.8 | % |
| Leverage capital           |       | 11.0                   | %          | 10.9                  | %          | 6.1 | % | 7.7 | % |

 

33

----

 

*Borrowings*

 

Thefollowing table outlines our various sources of borrowed funds during the ninemonths ended September 30, 2004 and the year ended December 31, 2003, theamounts outstanding at the end of each period, at the maximum point for eachcomponent during the periods and on average for each period, and the averageinterest rate 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 Nine Months Ended September 30, 2004** |       |                |       |                  |        |                            |       |                       |       |   |   |
| Federal Home  Loan Bank advances                       |       | $                   | 60,610     |                  | 2.42        | %                               | $          | 67,400                     |       | $ | 52,388 |   | 2.02 | % |
| Securities sold  under agreement to repurchase         |       | 13,632              |       | 1.71                  | %           | 14,637                          |       | 13,668                     |       | 1.24 | % |
| Federal funds  purchased                               |       | 173                 |       | 2.25                  | %           | —                          |       | 346                        |       | 1.70 | % |
| Correspondent  bank line of credit                     |       | —              |       | 4.02                  | %           | 3,000                           |       | 1,617                      |       | 3.39 | % |
| Junior  subordinated debentures                        |       | 6,186               |       | 5.05                  | %           | 6,186                           |       | 6,186                      |       | 4.71 | % |
|                                                   |       |                |       |                  |        |                            |       |                       |       |   |   |
| **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*

 

The effect of relative purchasing power over time dueto inflation has not been taken into account in our consolidated financialstatements.  Rather, our financialstatements have been prepared on an historical cost basis in accordance withgenerally accepted accounting principles.

 

Unlike most industrial companies, our assets andliabilities are primarily monetary in nature. Therefore, the effect of changes in interest rates will have a moresignificant impact on our performance than will the effect of changing pricesand inflation in general.  In addition,interest rates may generally increase as the rate of inflation increases,although not necessarily in the same magnitude. As discussed previously, we seek to manage the relationships betweeninterest sensitive assets and liabilities in order to protect against wide ratefluctuations, including those resulting from inflation.

 

34

----

 

*Off-Balance Sheet Risk*

 

Commitments to extend credit are agreements to lend toa client as long as the client has not violated any material condition establishedin the contract.  Commitments generallyhave fixed expiration dates or other termination clauses and may require thepayment of 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 September 30, 2004, unfunded commitmentsto extend credit were $48.6 million, of which $6.5 million was at fixed ratesand $42.1 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 millioncommitment under a letter of credit.  AtSeptember 30, 2004, there was a $2.7 million commitment under a letter ofcredit.  The credit risk and collateralinvolved in issuing letters of credit is essentially the same as that involvedin extending loan facilities to customers. Since most of the letters of credit are expected to expire without beingdrawn upon, they do not necessarily represent future cash requirements.

 

Except as disclosed inthis document, we are not involved in off-balance sheet contractualrelationships, unconsolidated related entities that have off-balance sheetarrangements or transactions that could result in liquidity needs or othercommitments that significantly impact earnings.

 

*Market Risk*

 

Market risk is the riskof loss from adverse changes in market prices and rates, which principallyarises from interest rate risk inherent in our lending, investing, depositgathering, and borrowing activities. Other types of market risks, such as foreign currency exchange rate riskand commodity price risk, do not generally arise in the normal course of ourbusiness.

 

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 anasset-sensitive gap position and generally would benefit from decreasing marketrates of interest when we are liability-sensitive.

 

Approximately68% of our loans were variable rate loans at December 31, 2003 and September30, 2004, and we were asset sensitive during most of the year ended December31, 2003 and the nine months ended September 30, 2004.  As of September 30, 2004, we expect to beasset sensitive for the next three months. After December 31, 2004, we expect to be liability sensitive for thenext nine months because substantially all of our variable rate loans repricedwithin the first three months of the year but a majority of our deposits willreprice over a 12-month period.  Theratio of cumulative gap to total earning assets after 12 months was (.7%)because $2.0 million more liabilities will reprice in a 12 month period thanassets.  However, our gap analysis is nota precise indicator of our interest sensitivity position.  The analysis presents only a static view ofthe timing of maturities and repricing opportunities, without taking intoconsideration that changes in interest rates do not affect all assets andliabilities equally.  For example, ratespaid on a substantial portion of core deposits may change contractually withina relatively short time frame, but those rates are viewed by us assignificantly less interest-sensitive than market-based rates such as thosepaid on noncore deposits.  Net interestincome may be affected by other significant factors in a given interest rateenvironment, including changes in the volume and mix of interest-earning assetsand interest-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

----

 

management control.  For example,the timing of maturities of our investment portfolio is fairly predictable andsubject to a high degree of control at the time investment decisions aremade.  However, net deposit inflows andoutflows are far less predictable and are not subject to the same degree ofcontrol.

 

AtSeptember 30, 2004, our liquid assets, consisting of cash and due from banksand federal funds sold, amounted to $3.6 million, or 1.2% of total assets.  Our investment securities at September 30,2004 amounted to $21.6 million, or 7.2% of total assets.  At December 31, 2003, our liquid assetsamounted to $6.9 million, or 3.0% of total assets.  Our investment securities at December 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 capabilities servesas our primary source of liquidity.  Weplan to meet our future cash needs through the liquidation of temporaryinvestments, the generation of deposits, and the net proceeds from future stockofferings.  In addition, we will receivecash upon the maturity and sale of loans and the maturity of investmentsecurities.  During most of 2003 and2004, as a result of historically low rates that were being earned onshort-term liquidity investments, we chose to maintain a lower than normallevel of short-term liquidity securities. In addition, we maintain three lines of credit with correspondent bankstotaling $14.5 million.  We are also amember of the Federal Home Loan Bank of Atlanta, from which applications forborrowings 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 September 30, 2004 was$15.1 million, assuming that the bank’s $3.2 million investment in FHLB stock,as well as qualifying mortgages, would be available to secure any futureborrowings.

 

Priorto September 30, 2004, the company entered into a commitment to construct twonew offices for approximately $2.3 million.

 

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 varioustimes during 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

----

 

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 the earningassets and interest-bearing liabilities presented due to consideration ofprepayment 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

----

 

Thefollowing table sets forth information regarding our rate sensitivity as ofSeptember 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                              |       | $                           | 474        |                                          | $          | —                                  |       | $                        | —     |      | $          | — |   | $ | 474 |   |
| Investment  securities                           |       | 672                         |       | 2,016                                         |       | 10,342                                  |       | 3,617                    |       | 16,647    |       |
| Loans                                            |       | 182,647                     |       | 11,813                                        |       | 55,023                                  |       | 18,842                   |       | 268,324   |       |
|                                             |       |                        |       |                                          |       |                                    |       |                     |       |      |       |
| Total earning  assets                            |       | $                           | 183,793    |                                          | $          | 13,829                                  |       | $                        | 65,365     |      | $          | 22,459 |   | $ | 285,445 |   |
|                                             |       |                        |       |                                          |       |                                    |       |                     |       |      |       |
| Interest-bearing  liabilities:                   |       |                        |       |                                          |       |                                    |       |                     |       |      |       |
| Money market and  NOW                            |       | $                           | 77,531     |                                          | $          | —                                  |       | $                        | —     |      | $          | — |   | $ | 77,531 |   |
| Regular savings                                  |       | 1,132                       |       | —                                        |       | —                                  |       | —                   |       | 1,132     |       |
| Time deposits                                    |       | 30,606                      |       | 24,789                                        |       | 29,278                                  |       | 5,824                    |       | 90,497    |       |
| Federal funds  purchased                         |       | 173                         |       |                                          |       |                                    |       |                     |       |      |       |
| Repurchase  agreements                           |       | 13,632                      |       | —                                        |       | —                                  |       | —                   |       | 13,632    |       |
| FHLB advances                                    |       | 40,610                      |       | 5,000                                         |       | 5,000                                   |       | 10,000                   |       | 60,610    |       |
| Junior  subordinated debentures                  |       | 6,186                       |       | —                                        |       | —                                  |       | —                   |       | 6,186     |       |
|                                             |       |                        |       |                                          |       |                                    |       |                     |       |      |       |
| Total  interest-bearing liabilities              |       | $                           | 169,870    |                                          | $          | 29,789                                  |       | $                        | 34,278     |      | $          | 15,824 |   | $ | 249,588 |   |
|                                             |       |                        |       |                                          |       |                                    |       |                     |       |      |       |
| Period gap                                       |       | $                           | 13,923     |                                          | $          | (15,960                                 | )          | $                        | 31,087     |      | $          | 6,635 |   |   |   |
| Cumulative gap                                   |       | 13,923                      |       | (2,037                                        | )          | 29,050                                  |       | 35,685                   |       |      |       |
|                                             |       |                        |       |                                          |       |                                    |       |                     |       |      |       |
| Ratio of  cumulative gap to total earning assets |       | 4.9                         | %          | (0.7                                          | )%         | 10.2                                    | %          | 12.5                     | %          |      |       |
|                                                  |            |                             |            |                                               |            |                                         |            |                          |            |           |            |  |  |  |  |  |  |  |  |  |  |  |  |

 

38

----

 

*Accounting,Reporting, and Regulatory Matters*

 

Recently IssuedAccounting Standards

 

The following is asummary of recent authoritative pronouncements that affect accounting,reporting, and disclosure of financial information by the Company:

 

In March 2004, the FASBissued an exposure draft on “Share-Based Payment.”  The proposed Statement addresses theaccounting for transactions in which an enterprise receives employee servicesin exchange for a) equity instruments of the enterprise or b) liabilities thatare based on the fair value of the enterprise’s equity instruments or that maybe settled by the issuance of such equity instruments.  This proposed Statement would eliminate theability to account for share-based compensation transactions using APB OpinionNo. 25, “Accounting for Stock Issued to Employees”, and generally would requireinstead that such transactions be accounted for using a fair-value-basedmethod.  This Statement, if approved,will be effective for awards that are granted, modified, or settled in fiscalyears beginning after a) December 15, 2004 for public entities and nonpublicentities that used the fair-value-based method of accounting under the originalprovisions of Statement 123 for recognition or pro forma disclosure purposesand 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 ofthis Statement is not permitted.  Theadoption of this Statement, if approved, will not have any impact on ourfinancial position or results of operations.

 

Other accountingstandards that have been issued or proposed by the FASB or other standards-settingbodies that do not require adoption until a future date are not expected tohave a material impact on the consolidated financial statements upon adoption.

 

**Item 3. Controls and Procedures**

 

As of the end ofthe period covered by this report, we carried out an evaluation, under thesupervision and with the participation of our management, including our ChiefExecutive Officer and Chief Financial Officer, of the effectiveness of ourdisclosure controls and procedures as defined in Exchange Act Rule 13a-15(e).  Based upon that evaluation, our ChiefExecutive Officer and Chief Financial Officer have concluded that our currentdisclosure controls and procedures are effective as of September 30, 2004.  There have been no significant changes in our internalcontrols over financial reporting during the fiscal quarter ended September 30,2004 that have materially affected, or are reasonably likely to materiallyaffect, our internal controls over 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.

 

 

**PART II.  OTHERINFORMATION**

 

**Item 1.       Legal Proceedings**

 

There are no material pending legal proceedings towhich the company is a party or of which any of its property is the subject.

 

**Item 2.       Unregistered Sales of Equity Securities and Use of Proceeds**

 

Notapplicable

 

**Item 3.       Defaults Upon Senior Securities**

 

Not applicable

 

39

----

 

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

 

None

 

**Item 5.       Other Information**

 

None

** **

**Item 6.****                    ****Exhibits**

 

31.1             Rule 13a-14(a) Certificationof the Chief Executive Officer.

 

31.2             Rule 13a-14(a)Certification of the Chief Financial Officer.

 

32                      Section 1350Certifications.

 

40

----

 

**SIGNATURES**

 

In accordance with the requirements of the Exchange Act, the registrantcaused this report to be signed on its behalf by the undersigned, thereuntoduly authorized.

 

 
|                     |   |   | GREENVILLE FIRST BANCSHARES, INC. |   |
|--------------------------|--------|--------|-----------------------------------|--------|
|                     |   |   |                              |   |
|                     |   |   |                              |   |
| Date:  November 11, 2004 |   |   |                              |   |
|                     |   |   | /s/ R.  Arthur Seaver, Jr.        |   |   |
|                     |   |   | R.  Arthur Seaver, Jr.            |   |
|                     |   |   | Chief  Executive Officer          |   |
|                     |   |   |                              |   |
|                     |   |   |                              |   |
| Date:  November 11, 2004 |   |   | /s/  James M. Austin, III         |   |   |
|                     |   |   | James M. Austin, III              |   |
|                     |   |   | Chief Financial Officer           |   |

 

41

----

 

**INDEX TO EXHIBITS**

 
| **Exhibit  Number** | ** ** | **Description**                                               |
|---------------------|------------|---------------------------------------------------------------|
|                |       |                                                          |
| 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.                                 |

 

42

----