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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d)
OF THE SECURITIES EXCHANGE ACT OF 1934

For the Quarterly Period Ended September 30, 2004

OR

[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d)
OF THE SECURITIES EXCHANGE ACT OF 1934

For the Transition Period from _____ to ______

Commission file number 0-24532
 
 

FLAG FINANCIAL CORPORATION
(Exact name of registrant as specified in its charter)
     
 
    
Georgia
  
58-2094179
(State of incorporation)
  
(I.R.S. Employer Identification No.)
     
     
3475 Piedmont Road N.E. Suite 550
    
Atlanta, Georgia
  
30305
(Address of principal executive offices)
  
(Zip Code)
     
(404) 760-7700
(Telephone Number)
 
Indicate by check mark whether the registrant has (1) filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

YES XX   NO

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).
 
YES XX   NO

Common stock, par value $1 per share: 8,259,663 shares
outstanding as of November 4, 2004


 
     
 
 

Flag Financial Corporation and Subsidiaries



Table of Contents
     
Page
PART I.
Financial Information
  
       
Item 1.
 
       
     
   
3
       
     
   
4
       
     
   
5
       
     
   
6
       
       
   
7
       
Item 2.
 
 
9
     
Item 3.
19
     
Item 4.
19
     
     
PART II.
Other Information
  
     
Item 1.
20
     
Item 2.
20
     
Item 3.
20
     
Item 4.
20
     
Item 5.
20
     
Item 6.
21
 

 
     
 

Part I. Financial Information
< FONT style="DISPLAY: inline; FONT-SIZE: 12pt; FONT-FAMILY: Times New Roman, serif">< STRONG>Item 1. Financial Statements
Flag Financial Corporation and Subsidiaries
 
             
(in thousands)
              
   
(UNAUDITED)
  
(AUDITED)
  
(UNAUDITED)
  
 
    
September 30, 
    
December 31,
    
September 30,
  
     
2004
    
2003
    
2003
  
ASSETS
                    
                     
Cash and due from banks
  
$
13,721
    
17,454
  
 
17,434
  
Interest-bearing deposits in banks
    
15,852
    
12,183
    
19,201
  
Federal funds sold
    
18,826
    
7,100
    
-
  
   Total cash and cash equivalents
    
48,399
    
36,737
    
36,635
 
Interest-bearing deposits
    
1,626
    
2,675
    
99
 
Investment securities available-for-sale
    
94,607
    
122,565
    
123,728
  
Other investments
    
13,211
    
14,944
    
15,265
 
Mortgage loans held-for-sale
    
6,666
    
4,234
    
4,829
 
Loans, net
    
582,046
    
477,095
    
428,292
 
Premises and equipment, net
    
14,284
    
16,497
    
16,766
 
Other assets
    
32,199
    
29,110
    
29,038
  
           Total assets
  
$
793,038
    
703,857
  
 
654,652
  
                 
 
LIABILITIES
                    
                     
Non interest-bearing deposits
  
$
42,679
    
51,087
  
 
41,475
  
Interest-bearing demand deposits
    
320,777
    
282,261
    
244,362
 
Savings
    
21,863
    
23,898
    
25,241
  
Time
   
277,998
    
213,324
    
200,514
  
   Total deposits
    
663,317
    
570,570
    
511,592
  
Advances from Federal Home Loan Bank
    
40,000
    
58,000
    
53,000
 
Federal funds purchased and other borrowings
    
4,144
    
5,197
    
19,715
  
Subordinated debt
    
14,433
    
-
    
-
  
Accrued interest payable and other liabilities
    
6,106
    
4,830
    
6,150
 
          Total liabilities
    
728,000
    
638,597
    
590,457
 
                     
STOCKHOLDERS' EQUITY
                    
                     
Preferred stock (10,000 shares authorized, none
                    
     issued and outstanding)
    
-
    
-
    
-
  
Common stock ($1 par value, 20,000 shares authorized,
                    
     9,811, 9,775 and 9,757 shares issued at     
                    
     September 30, 2004, December 31, 2003 and
                    
     September 30, 2003, respectively
  
$
9,811
    
9,775
    
9,757
 
Additional paid-in capital
    
24,799
    
24,557
    
24,433
 
Retained earnings
    
43,460
    
39,294
    
38,276
  
Accumulated other comprehensive income
    
472
    
1,211
    
1,306
 
Less: Treasury stock at cost; 1,551 shares at September 30, 2004, 1,247 shares at
                   
     December 31, 2003 and 1,247 shares at September 30, 2003, respectively
   
(13,504
)
  
(9,577
)
  
(9,577
)
 
                    
          Total stockholders' equity
    
65,038
    
65,260
    
64,195
 
          Total liabilities and stockholders' equity
  
$
793,038
    
703,857
    
654,652
 
                     
See Accompanying Notes to Unaudited Consolidated Financial Statements.
            
 

 
     
 


Consolidated Statements of Ea rnings

(in thousands, except per share data)
        
(UNAUDITED)
      
 
  
Three Months Ended 
Nine Months Ended
 
  
September 30, 
September 30,
     
2004
    
2003
    
2004
    
2003
  
Interest Income
                          
Interest and fees on loans
  
$
9,515
  
 
7,757
    
26,313
    
22,197
  
Interest on investment securities
    
1,177
    
1,383
   
3,925
    
4,371
  
Interest on federal funds sold and interest-bearing deposits
    
121
    
127
    
320
    
506
  
       Total interest income
    
10,813
    
9,267
    
30,558
    
27,074
  
Interest Expense
                          
Interest on deposits:
                          
  Demand
    
1,343
    
821
    
3,576
    
2,345
  
  Savings
    
32
    
37
    
99
    
112
  
  Time
    
1,436
    
1,413
    
3,857
    
4,848
  
Interest on other borrowings
    
354
    
219
    
887
    
634
  
       Total interest expense
    
3,165
    
2,490
   
8,419
    
7,939
  
       Net interest income before provision for loan losses
    
7,648
    
6,777
    
22,139
    
19,135
  
Provision for Loan Losses
    
375
    
375
    
1,470
   
946
  
       Net interest income after provision for loan losses
    
7,273
    
6,402
   
20,669
    
18,189
  
Other Income
                          
Fees and service charges on deposit accounts
    
946
    
850
    
2,796
    
2,572
  
Mortgage banking activities
    
744
    
1,144
    
1,869
    
3,487
  
Insurance commissions and brokerage fees
    
162
    
49
    
438
    
424
  
Gain on sale of branch
    
-
    
-
    
3,000
    
-
  
Gain on sale of investment securities
    
7
    
4
    
700
    
12
  
Other income
    
395
    
285
    
734
    
1,827
  
       Total other income
    
2,254
    
2,332
    
9,537
    
8,322
  
Other Expenses
                          
Salaries and employee benefits
    
4,480
    
3,939
    
13,347
    
12,018
  
Occupancy
    
974
    
825
    
2,747
    
2,522
  
Professional fees
   
235
    
123
    
817
    
564
  
Postage, printing and supplies
    
244
    
230
    
693
    
759
  
Amortization of intangibles
   
23
    
23
   
68
    
60
  
Communications and data
    
556
    
626
   
1,670
    
1,832
 
Other operating
    
785
    
737
    
2,676
    
2,121
  
       Total other expenses
    
7,297
    
6,503
    
22,018
    
19,876
  
       Earnings before provision for
                         
       income taxes
    
2,230
    
2,231
    
8,188
    
6,635
  
Provision for income taxes
    
571
    
685
   
2,512
    
2,060
  
       Net earnings
  
$
1,659
    
1,546
   
5,676
    
4,575
  
                           
                           
                           
                           
Basic earnings per share
  
$
0.20
    
0.18
    
0.67
    
0.54
  
                           
Diluted earnings per share
  
$
0.19
    
0.17
    
0.63
    
0.51
  
     
See Accompanying Notes to Unaudited Consolidated Financial Statements.
    

 
 
     
 
 

Consolidated Statements of Comprehensive Income
                                                                                                                                                        (UNAUDITED)    
   
Three Months Ended
  
Nine Months Ended
  
(in thousands)
  
September 30,
  
September 30,
  
   
2004
  
2003
  
2004
  
2003
  
                           
Net earnings
  
$
1,659
    
1,546
    
5,676
    
4,575
  
Other comprehensive loss, net of tax:
                          
   Unrealized gains (losses) on investment
                          
     securities available-for-sale:
                          
       Unrealized gains (losses) arising during the period,
                          
         net of tax of $271, $387, $187 and
                          
         $374, respectively
    
441
    
(631
)
  
(306
)
  
(611
)
   Reclassification adjustment for (gains) losses included in net earnings
                          
     net of tax of $3, $1, $266 and $5, respectively
    
(4
)
  
(3
)
  
(433
)
  
(7
)
   Unrealized gain on cash flow hedges, net of tax of $46
    
-
    
-
    
-
    
(75
)
                           
Other comprehensive income (loss)
    
437
   
(634
)
  
(739
)
  
(693
)
                           
Comprehensive income
  
$
2,096
    
912
    
4,937
    
3,882
  
                           
See Accompanying Notes to Unaudited Consolidated Financial Statements
 
 
     
 


Consolidated Statements of Cash Flow s

 
(UNAUDITED) 
(in thousands)
  
Nine Months Ended
 
  
September 30, 
     
2004
    
2003
  
CASH FLOWS FROM OPERATING ACTIVITIES:
              
Net earnings
  
$
5,676
  
 
4,575
  
Adjustment to reconcile net earnings to net
              
     cash provided by operating activities:        
              
          Depreciation, amortization and accretion
    
2,322
    
2,606
 
          Provision for loan losses
   
1,470
    
946
  
          Gain on sale of branch office
    
(3,000
)
  
-
  
          Gain on sale of available-for-sale securities
    
(700
)
  
(12
)
          Gain on sale of loans
   
(1,028
)
  
(1,899
)
          Loss (gain) on sale, write-down of fixed assets
    
56
    
(922
)
          Gain on sale of other real estate
   
(113
)
  
(113
)
               
          Change in:
              
               Mortgage loans held-for-sale
   
(1,404
)
  
7,777
  
               Other
   
(3,084
)
  
2,551
  
                  Net cash provided by operating activities
    
195
   
15,509
  
               
CASH FLOWS FROM INVESTING ACTIVITIES:
              
Cash paid in branch sale
    
(14,141
)
  
-
  
Net change in interest-bearing deposits
    
1,049
    
12,312
  
Proceeds from sales and maturities of investment
              
     securities available-for-sale
   
65,603
    
69,033
  
Purchases of investment securities available-for-sale
    
(39,649
)
  
(55,874
)
Purchases of other investments
   
(750
)
  
(8,920
)
Proceeds from sales of other investments
    
3,160
    
450
  
Net change in loans
   
(123,110
)
  
(54,454
)
Proceeds from sale of other real estate
    
1,650
    
1,933
  
Proceeds from sale of premises and equipment
    
183
    
4,345
  
Purchases of premises and equipment
   
(1,136
)
  
(691
)
Purchases of cash surrender value life insurance
   
(115
)
  
(123
)
               Net cash used in investing activities
   
(107,256
)
  
(31,989
)
               
CASH FLOWS FROM FINANCING ACTIVITIES:
              
Net change in deposits
   
128,502
    
1,860
  
Change in federal funds purchased
    
(2,453
)
  
17,030
  
Change in other borrowed funds
    
1,400
   
1,350
  
Proceeds from FHLB advances
   
15,000
        
Payments of FHLB advances
    
(33,000
)
  
(5,000
)
Proceeds from issuance of subordinated debt
    
14,433
    
-
  
Purchase of treasury stock
    
(3,927
)
  
-
  
Proceeds from exercise of stock options
    
278
    
939
  
Proceeds from issuance of stock
    
-
    
138
  
Proceeds from issuance of warrants
    
-
    
12
 
Cash dividends paid
    
(1,510
)
  
(1,524
)
                  Net cash provided by financing activities
   
118,723
    
14,805
  
               
                  Net change in cash and cash equivalents
    
11,662
    
(1,675
)
Cash and cash equivalents at beginning of period
   
36,737
    
38,310
  
               
Cash and cash equivalents at end of period
   $ 48,399       36,635   
 
  
 
 
  
 
  
See Accompanying Notes to Unaudited Consolidated Financial Statements

 
     
 


Notes to Consolidated Financial Statements                        


The accompanying consolidated financial statements have not been audited. The results of operations are not necessarily indicative of the results of operations for the full year or any other interim periods.

Note 1. Basis of Presentation
The consolidated financial statements include the accounts of Flag and its wholly owned subsidiaries, Flag Bank (Atlanta, Georgia) and Flag Financial Corporation Statutory Trust. All significant inter-company accounts and transactions have been eliminated in consolidation.

The consolidated financial information furnished herein represents all adjustments that are, in the opinion of management, necessary to present a fair statement of the results of operations, and financial position for the periods covered herein and are normal and recurring in nature. For further information, refer to the consolidated financial statements and footnotes included in Flag’s annual report on Form 10-K for the year ended December 31, 2003.

Note 2. Earnings Per Share
Net earnings per common share are based on the weighted average number of common shares outstanding during each period. The calculation of basic and diluted earnings per share is as follows:
        
      
 

    Three Months Ended 
    Nine Months Ended
(in thousands, except per share data)
  
    September 30,
    September 30,
     
2004
    
2003
    
2004
    
2003
  
Basic earnings per share:
Net earnings     
  
$
1,659
    
1,546
    
5,676
    
4,575
  
Weighted average common shares outstanding
    
8,263
   
8,500
    
8,416
    
8,456
  
Per share amount    
  
$
0.20
    
0.18
    
0.67
    
0.54
  
 
Diluted earnings per share:
Net earnings    
  
$
1,659
    
1,546
    
5,676
    
4,575
  
Effect of stock options and warrants     
    
593
    
665
    
562
    
586
  
Diluted earnings per share    
  
$
0.19
    
0.17
    
0.63
    
0.51
  
  

Note 3. Stock-based Compensation
Flag sponsors stock-based compensation plans. Flag accounts for these plans under the recognition and measurement principles of APB Opinion No. 25, “Accounting for Stock Issued to Employees,” and related Interpretations. No stock-based employee compensation cost is reflected in net earnings, as all options granted under those plans had an exercise price equal to the market value of the underlying common stock on the date of grant. The following table illustrates the effect on net earnings and earnings per share if Flag had applied the fair value recognition provisions of Statement of Financing Accounting Standards (“SFAS”) No. 123, “Accounting for Stock-Based Compensation,” to stock-based employee compensation.
       
 
  

    Three months ended 
    Nine months ended
(in thousands, except per share data)    
  
    September 30,
    September 30,
     
2004
    
2003
    
2004
    
2003
  
Net earnings as reported
  
$
1,659
    
1,546
    
5,676
    
4,575
  
Compensation expense determined by fair value method
  
$
(49
)
  
(76
)
  
(104
)
  
(229
)
Pro forma net earnings
  
$
1,610
    
1,470
    
5,572
    
4,346
  
                           
Basic earnings per share:
                          
As reported
  
$
0.20
    
0.18
    
0.67
    
0.54
  
Pro forma
  
$
0.19
    
0.17
    
0.66
    
0.51
  
                           
Diluted earnings per share:
                          
As reported
  
$
0.19
    
0.17
    
0.63
    
0.51
  
Pro forma
  
$
0.18
   
0.16
    
0.62
    
0.48
  
                           


 
     
 

Notes to Consolidated Financial Statements                        


During the first nine months of 2004, Flag issued 91,500 options with a weighted average estimated value of $3.48 each. The fair value of each option was estimated on the date of grant using the Black-Scholes options-pricing model with the following weighted average assumptions: dividend yield of 1.80%; volatility of .2865; risk free interest rate of 4.23%; and an expected life of five years.

Note 4. Loans
Flag engages in a full complement of lending activities, including real estate-related, commercial and financial loans and consumer installment loans. Flag generally concentrates lending efforts on real estate related loans. As of September 30, 2004, Flag’s loan portfolio consisted of 86.6% real estate-related loans, 10.9% commercial and financial loans, and 2.5% consumer installment loans. While risk of loss is primarily tied to the credit quality of the various borrowers, risk of loss may also increase due to factors beyond the Flag’s control, such as local, regional and/or national economic downturns. General conditions in the real estate market may also impact the relative risk in the real estate portfolio. Of the target areas of lending activities, commercial and financial loans are generally cons idered to have a greater risk of loss than real estate loans or consumer installment loans.

Loans are stated at unpaid balances, net of unearned income and deferred loan fees. Balances within the major loans receivable categories are represented in the following table:

 
     September 30,     
December 31,
    
September 30,
  
(in thousands)
    
2004
    
2003
    
2003
  
                     
Commercial/financial/agricultural
  
$
64,603
  
 
50,435
  
 
58,224
  
Real estate - Construction
    
159,308
    
100,108
    
81,111
 
Real estate - Mortgage
    
351,669
    
315,610
    
276,042
 
Installment loans to individuals
    
14,620
    
17,287
    
19,300
  
Lease financing
    
174
    
340
    
402
 
          Total loans
  
$
590,374
  
 
483,780
  
 
435,079
  
Less: Allowance for loan losses
    
8,328
    
6,685
    
6,787
 
          Total net loans
  
$
582,046
  
 
477,095
  
 
428,292
  


Note 5. Trust Preferred Securities
During the first quarter of 2004, the Company formed a wholly-owned Connecticut statutory business trust, Flag Financial Corporation Statutory Trust, a subsidiary whose sole purpose was to issue $14.4 million of Trust Preferred Securities through a pool sponsored by SunTrust Bank in Atlanta, Georgia. The Trust Preferred Securities have a maturity of 30 years and are redeemable after five years with certain exceptions. During the third quarter of 2004, the floating-rate securities had a 4.34% interest rate, which will reset quarterly at the three-month LIBOR rate plus 2.75%. The Trust Preferred Securities are recorded as subordinated debentures on the balance sheets, but subject to certain limitations, qualify as Tier 1 capital for regulatory capital purposes.
 

Note 6. Stock Repurchase Program
In March 2004, Flag’s board of directors authorized a stock repurchase program covering an amount equal to 10% of the outstanding shares of Flag’s common stock. Through September 30, 2004 the Company had purchased approximately 304,000 shares of the approximately 853,000 shares authorized to be purchased, at an average price of $12.91.


 
     
 

Item 2
Management’s Discussion and Analysis of
Financial Condition and Results of Operations

Overview
Growth in the balance sheet, primarily driven from efforts in Metro Atlanta, highlighted the Company’s performance in the third quarter. Total assets grew to approximately $793.0 million, an increase of 12.7% from December 31, 2003. Loans outstanding (excluding loans held for sale) increased 22.0% to $590.4 million at September 30, 2004 when compared to December 31, 2003. Total deposits grew to $663.3 million, an increase of $92.7 million or 16.3% from balances at December 31, 2003.

The growth in the balance sheet and earning assets contributed to solid growth in net interest income. Net interest income for the third quarter of 2004 increased 12.9% to $7.6 million from $6.8 million in the third quarter of 2003. For the nine-month period, net interest income increased 15.7% to $22.1 million from the $19.1 million recorded during the same time period in 2003. Total interest income for the nine-month period increased 12.9% to $30.6 million. This increase in interest income is the result of several factors, the most significant of which are the growth in loan balances and the growth in loan fees. Fees on loans for the nine-month period ended September 30, 2004 were $4.1 million, an increase of 36.6% when compared to the same period in 2003.
 
Return on average equity for the three months ended September 30, 2004 was 10.21% on average shareholders’ equity of $65.0 million. This compares to 9.70% on average equity of $63.8 million for the same period in 2003. Return on average assets for the three months ended September 30, 2004 was 0.87%. This compares to 0.98% for the same period in 2003. For the nine-month periods ended September 30, 2004 and 2003, Flag’s return on average shareholders’ equity was 11.50% and 9.72%, respectively. Flag’s return on average assets for the same periods was 1.04% and 0.97%, respectively.

Forward-Looking Statements
The following discussion and comments contain "forward-looking statements" relating to, without limitation, future economic performance, plans and objectives of management for future operations, and projections of revenues and other financial items that are based on the beliefs of our management, as well as assumptions made by and information currently available to our management. The words “expect”, “estimate”, “anticipate”, and “believe”, as well as similar expressions, are intended to identify forward-looking statements. Our actual results may differ materially from the results discussed in the forward-looking statements, and our operating performance each quarter is subject to various risks and uncertainties. Factors that could cause actual results to differ from those discussed in the forward-looking statements include, but are not limited to, (i) the strength of the U.S. economy as well as the strength of the local economies in which operations are conducted; (ii) the effects of changing interest rates which could lower margins; (iii) inflation, interest rate, market and monetary fluctuations; (iv) unanticipated regulatory proceedings or legal actions, or changes in accounting policies and practices as adopted by the Financial Accounting Standards Board; (v) issues involved in the integration of any acquisitions; and (vi) the timely development of products and services that position Flag to succeed in an increasi ngly competitive industry. If we are unsuccessful in managing the risks relating to these factors, together with other risks incident to the operation of our business, our financial condition, results of operations and cash flows could be adversely affected. Forward-looking statements speak only as of the date on which they are made. We undertake no obligation to update any forward-looking statement to reflect events or circumstances after the date on which the statement is made to reflect the occurrence of unanticipated events.

Critical Accounting Policies
The accounting principles we follow and our methods of applying these principles conform with accounting principles generally accepted in the United States and with general practices within the banking industry. In connection with the application of those principles, we have made judgments, estimates and assumptions which, in the case of the determining our allowance for loan losses (ALL), have been critical to the determination of our financial position and results of operations. Management assesses the adequacy of the ALL regularly during the year, and formally prior to the end of each calendar quarter. This assessment includes procedures to estimate the allowance and test the adequacy and appropriateness of the resulting balance.
 
This estimation process can affect our estimated loan loss expense for a given period. Generally, the allowance for loan losses increases as the outstanding balance of loans or the level of classified or impaired loans increases. Loans or portions of loans that are deemed uncollectible are charged against and reduce the allowance. The allowance is replenished by means of a provision for loan losses that is charged as an expense against income. As a result, our estimate of the allowance for loan losses affects our earnings directly.  


 
     
 

Item 2
Management’s Discussion and Analysis of
Financial Condition and Results of Operations

The ALL consists of two portions: (1) allocated amounts representing the potential exposures on specifically identified credits and other exposures readily predictable by historical or comparative experience; and (2) an unallocated amount
representative of inherent loss, which is not readily identifiable. Even though the ALL is composed of two components, the entire ALL is available to absorb any credit losses. Allocated amounts are used on loans where management has determined that there is an increased probability or severity of loss than on the loan portfolio as a whole. We base the allocation for these unique loans primarily on risk rating grades assigned to each of these loans as a result of our loan management and review processes. We then assign each risk-rating grade a loss ratio, which is determined based on the experience of management, discussions with banking regulators and our independent loan review process. We estimate losses on impaired loans based on estimated cash flows discounted at the loan's original effective interest rate or based on the underlying collateral value. To the extent that management does not believe that a certain loan's risk is appropriately represented by the risk rating grades, a specific review of the credit is performed which would result in a less subjective allocation for that particular loan.

 
Unallocated amounts are particularly subjective and do not lend themselves to exact mathematical calculation. The unallocated amount represents estimated inherent credit losses which may exist, but have not yet been identified, as of the balance sheet date. In estimating the unallocated amount, such matters as changes in the local or national economy, the depth or experience in the lending staff, any concentrations of credit in any particular industry group, and new banking laws or regulations. After we assess applicable factors, we evaluate the aggregate unallocated amount based on our management's experience. We then est the resulting ALL balance by comparing the balance in the ALL to historical trends and peer information. Our management then evaluates the result of the procedures performed, including the result of our tes ting, and concludes on the appropriateness of the balance of the ALL in its entirety.

The audit committee of our board of directors reviews the assessment prior to the filing of quarterly and annual financial information. In assessing the adequacy of the ALL, we also rely on an ongoing independent loan review process. We undertake this process both to ascertain whether there are loans in the portfolio whose credit quality has weakened over time and to assist in our overall evaluation of the risk characteristics of the entire loan portfolio. Our loan review process includes the judgment of management, the input from our independent loan reviewer, and reviews that may have been conducted by bank regulatory agencies as part of their usual examination process.


 
     
 
 
Summary Financial Data
The following table presents summary financial data for the previous five quarters
(in thousands, except per share data)
    
2004
  

2003 

(unaudited)
    
Third Quarter
    
Second Quarter
    
First Quarter
    
Fourth Quarter
    
Third Quarter
  
INCOME SUMMARY
                                
Interest income
  
$
10,813
  
 
10,071
    
9,674
    
9,461
    
9,267
  
Interest expense
    
3,165
    
2,712
    
2,541
    
2,608
    
2,490
  
Net interest income
   
7,648
    
7,359
    
7,133
    
6,853
    
6,777
  
Provision for loan losses
    
375
    
375
    
720
    
375
    
375
  
Other income
    
2,254
    
2,591
    
4,692
    
2,042
    
2,332
  
Other expenses
   
7,297
    
6,734
    
7,988
    
6,327
    
6,503
  
Earnings before taxes
    
2,230
    
2,841
    
3,117
    
2,193
    
2,231
  
Income taxes
    
571
    
920
    
1,021
    
664
    
685
  
Earnings
   $
1,659
    
1,921
  
 
2,096
    
1,530
    
1,546
  
PERFORMANCE RATIOS 
                                
Earnings per common share:
                                
    Basic
    $
0.20
    
0.23
    
0.25
    
0.18
    
0.18
  
    Diluted 
   
0.19
    
0.21
    
0.23
    
0.17
    
0.17
  
Return on average equity
   
10.21
%
  
11.59
%
  
12.68
%
  
9.30
%
  
9.70
%
Return on average assets
    
0.87
%
  
1.07
%
  
1.19
%
  
0.89
%
  
0.98
%
Net interest margin
    
4.28
%
  
4.46
%
  
4.40
%
  
4.31
%
  
4.67
%
Yield on Earning Assets
    
6.05
%
  
6.11
%
  
5.96
%
  
5.94
%
  
6.39
%
Cost of Funds
    
1.98
%
  
1.73
%
  
1.59
%
  
1.68
%
  
1.77
%
Efficiency ratio
    
74.00
%
  
67.39
%
  
67.33
%
  
71.13
%
  
71.82
%
Net overhead ratio
    
2.64
%
  
2.32
%
  
1.87
%
  
2.50
%
  
2.65
%
Dividend payout ratio 
   
29.90
%
  
26.63
%
  
24.42
%
  
33.45
%
  
33.02
%
ASSET QUALITY
                                
Allowance for loan losses
    $
8,328
    
7,489
    
7,052
    
6,685
    
6,787
  
Non-performing assets
   
5,907
    
5,853
    
6,785
    
7,426
    
7,658
  
Allowance for loan losses to loans
    
1.41
%
  
1.41
%
  
1.48
%
  
1.38
%
  
1.56
%
Non-performing assets to total assets
    
0.74
%
  
0.78
%
  
0.99
%
  
1.06
%
  
1.17
%
Net charge-offs to average loans
   
-0.04
%
  
-0.05
%
  
0.29
%
  
0.42
%
  
0.03
%
AVERAGE BALANCES
                                
  Loans
    $
566,691
    
503,045
    
485,528
    
459,405
    
406,258
  
  Earning assets
    
710,765
    
663,258
    
652,312
    
631,399
    
575,304
  
  Total assets
    
762,679
    
715,212
    
706,763
    
686,422
    
628,899
  
  Deposits
    
629,221
    
572,871
    
577,212
    
551,658
    
499,710
  
  Stockholders’ equity
    
65,003
    
66,311
    
66,093
    
65,005
    
63,798
  
  Common shares outstanding:
                                
    Basic
    
8,263,028
    
8,457,214
    
8,528,138
    
8,515,858
    
8,500,030
  
    Diluted
    
8,855,623
    
8,990,704
    
9,094,604
    
9,120,823
    
9,164,931
  
AT PERIOD END
                                
  Loans
    $
590,374
    
530,338
    
478,038
    
483,780
    
435,079
  
  Earning assets
    
741,162
    
693,613
    
633,450
    
647,482
    
598,201
  
  Total assets
    
793,038
    
749,371
    
684,823
    
703,857
    
654,652
  
  Deposits
    
663,317
    
610,636
    
548,467
    
570,570
    
511,591
  
  Stockholders’ equity
    
65,038
    
64,392
    
66,623
    
65,260
    
64,195
  
  Common shares outstanding
    
8,260
    
8,333
    
8,528
    
8,528
    
8,510
  
 

 
     
 

Management’s Discussion and Analysis of
Financial Condition and Results of Operations

Overview of Financial Condition
Total assets were $793.0 million at September 30, 2004, an increase of $89.2 million or 12.7% from December 31, 2003. Earning assets totaled $741.2 million or 93.5% of total assets at September 30, 2004 compared to $647.5 million or 92.0% of total assets at December 31, 2003. Total deposits increased 16.3% from $570.6 million at December 31, 2003 to $663.3 million at September 30, 2004. Stockholders’ equity decreased $222,000 or 0.3% to $65.0 million at September 30, 2004.

Loans
Gross loans outstanding (excluding mortgage loans held for sale) at September 30, 2004 totaled $590.4 million, an increase of $106.6 million over December 31, 2003 balances. Mortgage loans held-for-sale increased from $4.2 million at December 31, 2003 to $6.7 million at September 30, 2004. Flag’s consistently strong loan demand relates mostly to its continued expansion into Metro Atlanta. Loans in the Company’s Metro Atlanta region grew to $358.3 million at September 30, 2004 compared to $283.6 million at December 31, 2003. Loans, including mortgage loans held for sale, comprised 74.7% and 79.7% of earning assets at December 31, 2003 and September 30, 2004, respectively.

Investment Securities
Investment securities at September 30, 2004 totaled $107.8 million, a decrease of $29.7 million or 21.6% from December 31, 2003. During 2004, Flag has experienced calls and maturities in the investment portfolio that provided some of the funding for the strong growth in loans. Flag’s reallocation of earning assets during 2004 was planned and within the Company’s policy for maintaining adequate liquidity while maximizing yield on earning assets. Investment securities comprised 14.9% and 21.2% of earning assets at September 30, 2004 and December 31, 2003, respectively.

Federal Funds Sold and Interest Bearing Deposits
Short-term investments (federal funds sold and interest bearing deposits) totaled $36.3 million at September 30, 2004, an increase of $14.3 million from December 31, 2003. Historically, Flag has maintained lower levels of short-term investments, choosing instead to invest more heavily in loans and investment securities. Levels of short-term investments vary from quarter to quarter depending on anticipated liquidity needs. These liquidity needs include, but are not limited to the pace of anticipated loan demand, maturing amounts of time deposits, the Company’s interest rates on deposit accounts relative to the market in which it operates and anticipated investment opportunities. Seasonality also affects our level of liquidity in that Flag experiences more activity and higher account balances wit h various municipalities and their taxing divisions during the third and fourth quarters. Short-term investments amounted to 4.8% of earning assets at September 30, 2004 and 3.0% of earning assets at December 31, 2003.

Premises and Equipment
Premises and equipment at September 30, 2004 totaled $14.3 million compared to $16.5 million at December 31, 2003. The primary reason for the decrease in premises and equipment was the sale of approximately $1.8 million of premises and equipment related to the Thomaston, Georgia branch during the first quarter of 2004.

Deposits and Other Funding
Total deposits at September 30, 2004 were $663.3 million, an increase of $92.7 million or 16.3% over December 31, 2003. Included in the change since December 31, 2003 is the divestiture of approximately $36 million in deposits related to the sale of Flag’s Thomaston, Georgia branch in the first quarter. Demand deposits (interest-bearing and non-interest bearing) have increased 9.03% or $30.1 million over this period, due largely to sales efforts focused in the Metro Atlanta market. Total deposits in the Company’s Metro Atlanta region were $350.6 million at the end of September 30, 2004 compared to $201.3 million at December 31, 2003. Customer deposits represented 91.9% of total funding at September 30, 2004 compared to 90.0% at December 31, 2003.

Advances from the Federal Home Loan Bank
Advances from the Federal Home Loan Bank (FHLB) amounted to $40 million at September 30, 2004 compared to $58 million at December 31, 2003. Flag has been able to reduce the dependency on borrowings from the FHLB during the year due to successful efforts in the Company’s deposit sales programs.


  
     
 

Management’s Discussion and Analysis of
Financial Condition and Results of Operations

Liquidity
Liquidity management involves Flag’s ability to maintain adequate short-term assets to meet the cash flow expectations of depositors and other lending institutions and to provide funds for the growth in earning assets. Liquidity is managed daily by understanding the cash flow expectations of depositors and other lending institutions and maintaining enough liquid assets to meet these expectations. As of September 30, 2004, Flag had $385.3 million of deposits due on demand and $170.4 million of time deposits and other borrowings due within one year. Potential liquidity needs of these liabilities are met with liquid assets (assets that can be easily converted to cash). Liquid assets at September 30, 2004 totaled $88.1 million and included cash and due from banks, federal funds sold and interest bearing deposit s with other banks, unpledged investment securities available-for-sale, marketable other investments and mortgage loans held-for-sale. In addition to using liquid assets to meet potential liquidity needs, Flag maintains available lines of credit with other financial institutions. These include federal funds and other lines of credit totaling $46 million, a line of credit with the Federal Home Loan Bank totaling $95 million, and a line of credit with the Federal Reserve Bank of Atlanta totaling $125 million. At September 30, 2004, unadvanced portions of these lines amounted to $223.5 million.

Market Rate Sensitivity
Market rate sensitivity is the tendency for changes in the interest rate environment to be reflected in Flag’s net interest income and results of operations. Flag seeks to balance maturities and rates on earning assets and the corresponding funding such that interest rate fluctuations have a minimal impact on earnings and the value of Flag’s equity.

Historically, the average term to maturity or repricing (rate changes) of assets (primarily loans and investment securities) has exceeded the average repricing period of liabilities (primarily deposits and borrowings). Flag’s liabilities over the past year have shifted from mostly time deposits with longer maturities to demand deposits, which reprice daily. This shift in funding results from sales and pricing disciplines that in the long run will prove profitable, but currently shows Flag with more liabilities repricing in the early months of a rate change than do earning assets. The Company measures the impact of this mismatch using an interest rate simulation model that monitors and evaluates the impact of changing interest rates on net interest income and the market value of its investment portfolio. As of September 30, 2004, Flag’s simulation model shows that changing interest rates (rising or falling) will have minimal impacts on the Company’s net interest margin or net income. The market value of the Company’s investment portfolio shows more sensitivity to rising interest rates but is within tolerance specified by the Company’s ALCO policy.

Management carefully measures and monitors market rate sensitivity and believes that its operating strategies offer protection against interest rate risk. As required by various regulatory authorities, Flag’s Board of Directors established an interest rate risk policy, which sets specific limits on interest rate risk exposure. Adherence to this policy is reviewed by Flag's executive committee and presented at least annually to the Board of Directors.

Flag’s management from time to time uses certain derivative instruments in an effort to add stability to the Company’s net interest income and manage exposure to changing interest rates. Guidance for using these instruments is found in SFAS No. 149, “Amendment of Statement 133 on Derivative Instruments and Hedging Activities,” Under the terms of this statement, all derivatives are classified as either fair value hedges (those designed to hedge the fair market value of asset or liabilities affected by changing interest rates) or cash flow hedges (those designed to mitigate exposure to variability in expected future cash flows due to changing interest rates).

At September 30, 2004, the Company had three derivative instruments designated as cash flow hedges. No fair value hedges were outstanding. The following table summarizes the outstanding derivative instruments.

Type
Transaction
Date
Term
Date
Notional
Receive
Rate
Pay
Rate
Current
Spread
             
Receive Fixed, Pay LIBOR Swap
June 2004
Dec 2005
5,000,000
2.68%
1.84%
0.84%
Receive Fixed, Pay LIBOR Swap
June 2004
June 2006
15,000,000
3.00%
1.84%
1.16%
Receive Fixed, Pay LIBOR Swap
June 2004
Dec 2006
5,000,000
3.27%
1.84%
1.43%
Total Received Fixed Swaps
    
25,000,000
2.99%
1.84%
1.15%
 

 
     
 

Capital
At September 30, 2004, the capital ratios of Flag and Flag Bank (the “Bank”) were adequate compared to the minimum regulatory capital requirements.  Minimum regulatory capital levels for banks and holding companies require Tier one capital (core capital accounts less intangible assets) to risk-weighted assets of at least 4%, total capital (tier one capital plus a portion of the allowance for loan losses) to risk-weighted assets of 8%, and tier one capital to average assets of at least 4%. The following table reflects Flag’s capital position with respect to the regulatory minimums as of September 30, 2004:

Flag’s subordinated debt is supported by $14,433,000 of trust preferred securities, which were issued on April 15, 2004 in a private pooled transaction through an off balance sheet trust: Flag Financial Corporation Statutory Trust. The subordinated debt and associated trust preferred securities carry a variable rate and were priced during the third quarter at 4.34%, or LIBOR plus 2.75%. Interest payments and the resetting of rates both occur on a quarterly basis. The debt is scheduled to mature in April 2034 and cannot be redeemed by the trust for a minimum of five years after issuance. Flag Financial intends to use the proceeds as capital for continued growth in metro Atlanta, for the stock repurchase program, and for other general operating purposes.

In March 2004, Flag’s board of directors authorized a stock repurchase program covering an amount equal to 10% of outstanding shares. Through September 30, 2004 the Company had purchased approximately 304,000 shares at an average price of $12.91.


                           
   
Actual
     
Required
     
Excess
     
   
Amount
    %  
Amount
   %   
Amount
   %   
                           
Total Capital (to Risk Weighted Assets)
   $ 69,992    
11.34
%
 
59,715
    
8.00
%
 
0,277
    
3.34
%
Tier 1 Capital (to Risk Weighted Assets)
  
$
62,261
    
10.08
%
 
29,857
    
4.00
%
 
32,404
    
6.08
%
Tier 1 Capital (to Average Assets)
  
$
62,261
    
8.34
%
 
24,697
    
4.00
%
 
37,564
    
4.34
%
                                       
 
 
Provision and Allowance for Possible Loan and Lease Losses
The following table presents an analysis of the allowance for loan losses for the nine-month periods ended September 30, 2004 and 2003:
                                                                                
         2004         2003   
(in thousands)
              
Balance of allowance for loan losses at beginning of period
  
$
6,685
    
6,888
 
Provision charged to operating expense
    
1,470
    
946
 
Charge offs:
              
Commercial
    
90
    
222
 
Real estate - mortgage
    
21
    
32
 
Real estate - other
    
381
    
946
 
Consumer
    
155
    
151
 
Total charge-offs
    
647
    
1,351
 
Recoveries:
              
Commercial
    
202
    
75
 
Construction
     -     
-
  
Real estate - mortgage
    
38
    
17
 
Real estate - other
    
98
    
90
  
Consumer
    
82
    
122
  
Total recoveries
    
420
    
304
 
Net charge-offs
    
227
    
1,047
 
Allowance added for acquisition
    
400
    
-
  
Balance of allowance for loan losses at end of period
  
$
8,328
    
6,787
 
 
See “Critical Accounting Policies” for an explanation of our methodology for determining the appropriate level for the allowance and its effect on our results of operations.
 

 
     
 

Management’s Discussion and Analysis of
Financial Condition and Results of Operations


Non-Performing Assets
Non-performing assets (nonaccrual loans, real estate owned and repossessions) totaled approximately $5.9 million at September 30, 2004, compared to $7.4 million at December 31, 2003. These levels as a percentage of total assets represented 0.74% and 1.06% respectively.

Flag has a loan review function that continually monitors selected accruing loans for which general economic conditions or changes within a particular industry could cause the borrowers financial difficulties. The loan review function also identifies loans with high degrees of credit or other risks. The focus of loan review is to maintain a low level of non-performing assets and to return current non-performing assets to earning status.

Flag’s credit quality has improved significantly over the past few years. This is due to several factors including a stricter credit culture that focuses more heavily on the quality of the borrower’s financial condition and collateral values. In addition, Flag’s expansion into lending in Metro Atlanta presents more credit opportunities than in the Company’s past, allowing the company to be more selective in the credit approval process without hampering or slowing the growth in loans outstanding.


(in thousands)
  
September 30,
  
December 31,
  
September 30,
  
Non-performing assets
    
2004
    
2003
    
2003
  
                     
Loans on nonaccrual
  
$
4,557
    
4,685
    
5,190
  
Loans past due 90 days and still accruing
    
15
    
309
    
330
 
Other real estate owned and repossessions
    
1,335
    
2,432
    
2,138
  
Total non-performing assets
 
$
5,907
    
7,426
    
7,658
 
Total non-performing assets as a percentage of
                   
total assets
    
0.74
%
  
1.06
%
  
1.17
%
 

  
     
 

Management’s Discussion and Analysis of
Financial Condition and Results of Operations

Results of Operations for the Three Month Periods Ended September 30, 2004 and 2003

Net income - Net income for the quarter ended September 30, 2004 was $1.7 million or $0.19 per diluted share, compared to $1.5 million or $0.17 per diluted share for the quarter ended September 30, 2003. Flag’s return on average assets was 0.87% and 0.98% for the third quarter of 2004 and 2003, respectively, while return on equity was 10.21% and 9.70% on average equity of $65.0 million and $63.8 million for the same quarters.

Interest income - Interest income for the quarter ended September 30, 2004 was $10.8 million, an increase of $1.5 million or 16.7% compared to the same quarter in 2003. Interest income and fees on loans in the current quarter increased $1.8 million, or 22.7%, to $9.5 million compared to the same quarter in 2003. Average loans for the period increased $160.4 million or 39.5% while the average yield decreased to 6.66% from 7.07% during the third quarter of 2003. Fees on loans for the current quarter totaled $1.3 million compared to $1.1million for the same quarter in 2003. Interest income on investment securities declined by $206,000 during the third quarter of 2004 compared to the third quarter of 2003 as t he average balance of investment securities decreased from $127.4 million in 2003 to $110.0 million in the current period. Interest on federal funds sold and interest bearing deposits in other banks decreased by 4.7% during the third quarter of 2004 to $121,000 as Flag’s strong loan demand allowed the Company to maintain lower levels of short term liquidity than in the same period in 2003. Average balances for federal funds sold and interest-bearing deposits as of September 30, 2004 and September 30, 2003 were $27.8 million and $28.6 million, respectively, reflecting a 2.8% decrease during the twelve-month period.

Yields on earning assets declined by 34 basis points or 5.3% during the quarter ended September 30, 2004 when compared to the third quarter of 2003. Yields on earning assets for the current quarter were 6.05% compared to 6.39% for the same period in 2003.

Interest expense - Interest expense for the third quarter of 2004 was $3.2 million, an increase of $675,000 over the same quarter in 2003. Interest expense has moved in a relative fashion with total funding, which increased 23.5% from $584.3 million at September 30, 2003 to $721.9 million at September 30, 2004. Higher rates on deposit accounts due to sales efforts and an increasing rate environment also contributed to the increase in interest expense for the period. Demand deposits (interest-bearing and non-interest bearing) comprised 50.3% of total funding at September 30, 2004 compared to 48.9% at September 30, 2003. In addition to higher levels of funding and higher rates of interest, the current quarte r’s level of interest expense includes interest on the Company’s trust preferred debentures which were issued during the second quarter of 2004. Interest on the debentures during the third quarter was $159,900, accounting for 23.7% of the increase in interest expense for the current quarter.

Net interest income - Net interest income for the quarter ended September 30, 2004 was $7.6 million, an increase of 12.9% from the quarter ended September 30, 2003. Flag’s net interest margin (net interest income divided by average earning assets) decreased from 4.67% to 4.28% on average earning assets of $710.8 million and $575.3 million for the quarters ended September 30, 2004 and September 30, 2003, respectively. Assets per employee at September 30, 2004 was $3.14 million compared to $2.68 million at September 30, 2003. Deposits per branch office have increased from $33.6 million at September 30, 2003 to $41.5 million at September 30, 2004.

Provision for loan losses - Flag’s provision for loan losses for the third quarter of 2004 was $375,000, the same as the third quarter a year ago. Although loans have increased substantially during the past year, Flag’s overall credit quality has improved substantially as discussed in the credit quality sections titled “Provision and Allowance for Possible Loan and Lease Losses” and “Non-Performing Assets.” 

Non-interest income - Non-interest income for the quarter ended September 30, 2004 totaled $2.3 million, a decrease of $78,000 compared to the quarter ended September 30, 2003. Flag’s income from mortgage banking activities declined from $1.1 million in the third quarter of 2003 to $744,000 in the third quarter of 2004 as mortgage interest rates in the current period were not as favorable as in 2003. Decreases in mortgage banking revenue were almost completely offset by increases in service charges of $96,000, increases in insurance and brokerage commissions of $113,000 and increases in other miscellaneous income of $113,000.

Non-interest expense - Non-interest expense for the third quarter of 2004 totaled $7.3 million compared to $6.5 million in the same quarter of 2003. Most of the increase in non-interest expenses was in salaries and benefits, which increased 13.7% from $3.9 million in 2003 to $4.5 million in 2004. This increase in salaries and benefits relates mostly to Flag’s continued recruiting efforts for lending and treasury sales staff in the Metro Atlanta region. Occupancy expense increased $149,000 to $974,000 for the third quarter of 2004 as compared to the third quarter of 2003. During the third quarter of 2004, Flag opened a branch office in Newnan, Georgia and purchased three loan production offices (mortga ge and construction lending) in Duluth, Macon and Warner Robins, Georgia. Smaller increases during the quarter in professional fees and supplies expense were offset by savings in communications and data expenses.


 
     
 

Income taxes - Income tax expense for the quarter ended September 30, 2004 totaled $571,000 compared to $685,000 for the same quarter of 2003. Flag’s effective tax rate was 25.6% and 30.7% for the third quarters of 2004 and 2003, respectively. Flag’s lower effective tax rate during the current quarter relates to certain state income tax credits taken during the third quarter of 2004.


 
     
 

Management’s Discussion and Analysis of
Financial Condition and Results of Operations

Results of Operations for the Nine Month Periods Ended September 30, 2004 and 2003

Net income - Net income for the nine-month period ended September 30, 2004 was $5.7 million or $0.63 per diluted share compared to net income of $4.6 million or $0.51 per diluted share for the same period in 2003.

Interest Income - Total interest income for the nine-month period ending September 30, 2004 increased by 12.9% to $30.6 million.  Interest and fees on loans increased from $22.2 million during the first nine months of 2004 to $26.3 million for the same period in 2003, an increase of 18.5%.  Average earning assets for the first nine months of 2004 were $675.6 million compared to $572.8 million for the first nine months of 2003.  Loans (including loans held for sale) averaged 77.4% of average earnings assets for 2004 compared to 70.1% for 2003.  The positive effect of the growth in earning assets was offset partially by decreasing yields on earning assets. Yields on earning assets decreased 28 basis po ints or 4.4% from 6.32% through September 30, 2003 to 6.04% through September 30, 2004. 

Interest Expense - Interest expense increased $480,000 from September 30, 2003 to $8.4 million at September 30, 2004, an increase of 6.0%. Average total funding increased $93.9 million to $658.6 million at September 30, 2004. Flag’s total cost of funding for the nine-month period ending September 30, 2004 was 1.82% compared to 1.88% for the same period in 2003. Flag’s lower cost of funds during the first nine months of 2004 than for the same period in 2003 was due to lower wholesale funding costs as well as continued savings on customer CDs at renewal.

Net interest income - Net interest income for the nine-month period ended September 30, 2004 totaled $22.1 million, an increase of 15.7% over the same period in 2003. Flag’s net interest margin for the first nine months of 2004 was 4.38% compared to 4.47% for the same period in 2003.

Provision for loan losses - Flag’s provision for loan losses in the first nine months of 2004 amounted to $1,470,000, compared to $946,000 for the same period in 2003. Flag’s larger provision for the nine-month period is due mostly to a special charge for specific credits taken in the first quarter of 2004 of $345,000. See “Critical Accounting Policies” and “Allowance for Possible Loan and Lease Losses.”

Non-interest income - Non-interest income totaled $9.5 million for the nine-month period ending September 30, 2004. This increase of $1.2 million or 14.6% relates primarily to the $3.0 million gain recognized on the sale of Flag’s Thomaston, Georgia branch during the first quarter of 2004. Service charges on deposit accounts improved to $2.8 million in the first nine months of 2004, an increase of 8.7%. Revenues from mortgage banking activities during the quarter were $1.9 million, a decrease from $3.5 million during the same period in 2003. Flag anticipated a decline in this income as interest rates during most of 2003 were very favorable and provided many homeowners with refinance opportunities. Fla g’s other income decreased by $1.1 million in the first nine months of 2004 as compared to the same period in 2003, due primarily to the sale and leaseback of Flag’s Dunwoody, Georgia branch facility during the first half of 2003, which resulted in a one-time gain of $922,000.

Non-interest expense - Non-interest expense for the nine-month period ending September 30, 2004 totaled $22.0 million, an increase of $2.1 million from the same period in 2003. Included in the $22.0 million for 2004 are expenses totaling $635,000 directly related to the sale of Flag’s Thomaston, Georgia branch and $376,000 of benefit plan expense that related to director and officer plans under a recent accounting interpretation by various regulatory agencies. On a recurring basis, Flag’s operating expenses for the nine month period ended September 30, 2004 represent an increase of only 2.15% over the same period in 2003, despite continued success at improving the depth of bankers in Atlanta base d lending, treasury and deposit sales functions.

Provision for income taxes - Flag’s provision for income taxes during the first nine months of 2004 amounted to $2.5 million for an effective tax rate of 30.7%. During the first nine months of 2003, Flag recorded an income tax expense of approximately $2.1 million for an effective rate of 31.0%. The slight decrease in Flag’s effective tax rate relates to the use of certain state tax credits in 2004 that were not available to the Company in 2003.


 
     
 

Management’s Discussion and Analysis of
Financial Condition and Results of Operations

Item 3. Quantitative and Qualitative Disclosures about Market Risk

As of September 30, 2004, there were no substantial changes in the composition of Flag’s market-sensitive assets and liabilities or their related market values from that reported as of December 31, 2003. See, however, “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Market Rate Sensitivity” for information regarding three cash flow hedges that the Company acquired in 2004. The foregoing disclosures related to the market risk of Flag should be read in conjunction with Flag’s audited consolidated financial statements, related notes and management’s discussion and analysis of financial condition and results of operations for the year ended December 31, 2 003 included in Flag’s 2003 Annual Report on Form 10-K.

Item 4. Controls and Procedures

As of the end of the period covered by this report, Flag carried out an evaluation, under the supervision and with the participation of Flag’s management, including Flag’s Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of Flag’s disclosure controls and procedures pursuant to Exchange Act Rule 13a-15. Based upon that evaluation, Flag’s Chief Executive Officer and Chief Financial Officer concluded that Flag’s disclosure controls and procedures are effective in timely alerting them to material information relating to Flag (including its consolidated subsidiaries) that is required to be included in Flag’s periodic filings with the Securities and Exchange Commission. There have been no significant changes in Flag’s internal cont rols or, to Flag’s knowledge, in other factors that could significantly affect those internal controls subsequent to the date Flag carried out its evaluation, and there have been no corrective actions with respect to significant deficiencies or material weaknesses.

  
     
 

Part 2. Other Information
Flag Financial Corporation and Subsidiaries

PART II. Other Information

Item 1. Legal Proceedings - None

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


The following table sets forth information regarding the Company’s purchases of its common stock on a monthly basis during the third quarter of 2004.

     
Total Number of
Maximum Number (or
     
Shares (or Units)
Appropriate Dollar Value)
 
Total
Average
Purchased as Part
Of Shares (or Units) that
 
Number of
Price
Of Publicly
May Yet Be Purchased
 
Shares
Paid Per
Announced Plans or
Under the Plans or
Period
Purchased
Share
Programs
Programs
         
July 1 through
        
July 31, 2004
73,800
$13.01
1,551,186
548,589
         
August 1 through
        
August 31, 2004
0
0
1,551,186
548,589
         
September 1 through
        
September 30, 2004
0
0
1,551,186
548,589
         
Total
73,800
$13.01
1,551,186
548,589

Item 3. Defaults upon Senior Securities - None

Item 4. Submission of Matters to a Vote of Security Holders - None
 
Item 5. Other Information
 
Pursuant to Rule 14a-14(c)(1) promulgated under the Securities Exchange Act of 1934, as amended, shareholders desiring to present a proposal for consideration at the Company’s 2005 Annual Meeting of Shareholders must notify the Company in writing to the Secretary of the Company, at 3475 Piedmont Road, N.E., Suite 550, Atlanta, Georgia, 30305, of the contents of such proposal no later than November 11, 2004. If the Company does not receive such notice prior to that date, the proposal will not be included in the Company’s 2005 proxy statement.


 
     
 

Other Information
Flag Financial Corporation and Subsidiaries


  
Item 6. Exhibits
 

31.1
    Section 302 Certification by Chief Executive Officer
31.2
    Section 302 Certification by Chief Financial Officer

 32.1
    Section 906 Certification by Chief Executive Officer and Chief Financial Officer
   
 

 
     
 

 
Flag Financial Corporation and Subsidiaries













SIGNATURES

 Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned thereunto duly authorized.

     Flag Financial Corporation

        By:_/s/_Joseph W Evans___
      
                             Joseph W. Evans
                        (Chief Executive Officer)

                      Date:___11/5/04__________


                By:_/s/_J. Daniel Speight, Jr.
      
                   J. Daniel Speight, Jr.
                                  (Chief Financial Officer)

                                           Date:___11/5/04__________