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FORM 10-K
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

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

For the fiscal year ended December 31, 2003

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 000-22461

O.A.K. FINANCIAL CORPORATION
(Exact name of registrant as specified in its charter)

2445 84th Street, S.W., Byron Center, Michigan 49315
(Address of principal executive offices) (Zip Code)

Registrant’s telephone number, including area code: (616) 878-1591

Securities registered pursuant to Section 12(b) of the Act: None

Securities registered pursuant to Section 12(g) of the Act: Common Stock, $1.00 par value

(Title of Class)

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Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (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 [X] No [___]

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendments to this Form 10-K. [X].

Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12-b-2). Yes [___] No [X].

State the aggregate market value of the voting and nonvoting common equity held by non-affiliates of the registrant computed by reference to the price at which the common equity was sold, or the average bid and asked prices of such common equity, as of the last business day of the registrant’s most recently completed second quarter.

Aggregate Market Value as of June 30, 2003: $67,295,036

As of February 26, 2004, there were outstanding 2,035,191 shares of the Company’s Common Stock ($1.00 par value).

Documents Incorporated by Reference:

Portions of the Company’s Proxy Statement for the Annual Meeting of Shareholders to be held April 15, 2004 are incorporated by reference into Part III of this report.

PART I

Item 1. Business.

The Company

        O.A.K. Financial Corporation (the “Company”), was incorporated under the laws of the State of Michigan on October 13, 1988, for the purpose of becoming a bank holding company. The Company is registered under the Bank Holding Company Act of 1956, as amended, and owns the outstanding stock of Byron Center State Bank (the “Bank”), which is organized under the laws of the State of Michigan. Aside from the Bank, the Company has no other substantial assets. The Company conducts no business except for the provision of certain management and operational services to the Bank, the collection of dividends from the Bank and the payment of dividends to the Company’s stockholders. The executive office of the Company is located at 2445 84th Street, S.W., Byron Center, Michigan 49315. While the Company’s chief decision makers monitor the revenue streams of various products and services, operations are managed and financial performance is evaluated on a company wide basis. Accordingly, all of the Company’s operations are considered by Management to be aggregated in one reportable operating segment.

        Beginning January 1, 2001 the Company and all its subsidiaries are provided staff resources through O.A.K. ELC, an employee leasing company. O.A.K. ELC provides staffing solely to the Company and its subsidiaries.

The Bank

        The Bank was organized in 1921 as a Michigan banking corporation. The executive office of the Bank is located at 2445 84th Street, S.W., Byron Center, Michigan 49315. The Bank’s main office is located in Byron Center and it serves other communities with a total of 12 branch offices and one mortgage operations center. The Bank’s offices are located in Kent County, Ottawa County and the northern portion of Allegan County. The area in which the Bank’s offices are located, which is basically south and west of the city of Grand Rapids, has historically been rural in character but now has a growing suburban population as the Grand Rapids Metropolitan Area expands.

        The Bank provides a broad range of financial products and services through its branch network in West Michigan. A typical branch includes a full service lobby, most with drive-thru service and automatic teller machines. The Bank provides a wide range of commercial and personal banking services, including but not limited to: real estate, consumer and commercial loans, checking accounts, savings accounts, certificates of deposit, safe deposit boxes, U.S. Savings Bonds, internet banking, electronic ATM banking, telephone banking and other electronic banking services. Currently, the Bank does not offer trust services.

        The Bank owns a subsidiary, O.A.K. Financial Services, which offers mutual fund products, securities brokerage services, retirement planning services, investment management and advisory services. O.A.K. Financial Services in turn owns Dornbush Insurance Agency, which offers property and casualty, life, disability and long-term care insurance products.

Effect of Government Monetary Policies

        Our earnings are affected by domestic economic conditions and the monetary and fiscal policies of the United States government, its agencies, and the Federal Reserve Board. The Federal Reserve Board’s monetary policies have had, and will likely continue to have, an important impact on the operating results of commercial banks through its power to implement national monetary policy in order to, among other things, curb inflation or avoid a recession. The policies of the Federal Reserve Board have a major effect upon the levels of bank loans, investments and deposits through its open market operations in United States government securities, and through its regulation of, among other things, the discount rate on borrowings of member banks and the reserve requirements against member bank deposits. It is not possible to predict the nature and impact of future changes in monetary and fiscal policies.

Bank Competition

        The Bank has twelve offices, one within each of the communities it serves. Within these communities, its principal competitors are Comerica Bank, Bank One, Fifth-Third Bank, Flagstar Bank, National City Bank,

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Huntington Bank, Macatawa Bank, Mercantile Bank, United Bank of Michigan , and various credit unions. Each of these financial institutions, which are headquartered in larger metropolitan areas, have significantly greater assets and financial resources than the Company, with the exception of Macatawa Bank, Mercantile Bank, United Bank of Michigan and the credit unions.

        The financial services industry continues to be increasingly competitive. Principal methods of competition include loan and deposit pricing and the quality of services provided. The deregulation of the financial service industry has led to increased competition among banks and other financial institutions for a significant portion of funds, which traditionally have been deposited with commercial banks. However, with the enactment of the Gramm-Leach-Bliley Act of 1999, which permits the combinations of banks, insurance companies, and securities firms, and the increased use of internet banking, it is expected that competition may become more intense. Management continues to evaluate the opportunities for the expansion of products and services and additional branching opportunities.

Source of Revenue

        The Bank’s principal source of revenue includes net interest income, fees from the sale of loans, and non-interest income. The net interest revenue is the difference between the interest the Bank earns on loans and investments and the interest the Bank pays on deposits and other interest bearing borrowed funds. Non-interest revenue includes deposit service charges, insurance premium income, brokerage fees and other fees collected for services provided. Loan sales revenue is a result of the origination and sale of mortgage loans. The sources of income for the three most recent years are as follows:

Employees

        As of December 31, 2003, the Registrant and subsidiaries employed 171 full-time and 50 part-time persons. Management believes that relations with employees are good.

SUPERVISION AND REGULATION

        The following is a summary of certain statutes and regulations affecting the Company and the Bank. This summary is qualified in its entirety by such statutes and regulations. A change in applicable laws or regulations may have a material effect on the Company, the Bank and the business of the Company and the Bank.

General

        On October 16, 2003, OAK Financial Corporation and Byron Center State Bank were released from the written agreement that was entered into on October 4, 2002 with the Federal Reserve Bank of Chicago and the Michigan Office of Financial and Insurance Services. Release from the written agreement followed management’s compliance with all of the provisions of the written agreement. The Written Agreement addressed issues including management and asset quality. While the Written Agreement was in effect, the Company and the Bank required prior regulatory approval to pay dividends, add new directors, employ new senior executive officers, and to pay certain severance or related compensation.

        Financial institutions and their holding companies are extensively regulated under federal and state law. Consequently, the growth and earnings performance of the Company and the Bank can be affected not only by management decisions and general economic conditions, but also by the statutes administered by, and the regulations and policies of, various governmental regulatory authorities. Those authorities include, but are not limited to, the Board of Governors of the Federal Reserve System (the “Federal Reserve Board”), the FDIC, the Michigan Office of Financial and Insurance Services (“OFIS”), the Internal Revenue Service, and state taxing

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authorities. The effect of such statutes, regulations and policies can be significant, and cannot be predicted with a high degree of certainty.

        Federal and state laws and regulations generally applicable to financial institutions and their holding companies regulate, among other things, the scope of business, investments, reserves against deposits, capital levels relative to operations, lending activities and practices, the nature and amount of collateral for loans, the establishment of branches, mergers, consolidations and dividends. The system of supervision and regulation applicable to the Company and the Bank establishes a comprehensive framework for their respective operations and is intended primarily for the protection of the FDIC’s deposit insurance funds, the depositors of the Bank, and the public, rather than stockholders of the Bank or the Company. Federal law and regulations establish supervisory standards applicable to the lending activities of the Bank, including internal controls, credit underwriting, loan documentation and loan-to-value ratios for loans secured by real property.

The Company

    General. The Company is a bank holding company and, as such, is registered with, and subject to regulation by, the Federal Reserve Board under the Bank Holding Company Act, as amended (the “BHCA”). Under the BHCA, the Company is subject to periodic examination by the Federal Reserve Board, and is required to file with the Federal Reserve Board periodic reports of its operations and such additional information as the Federal Reserve Board may require.

        In accordance with Federal Reserve Board policy, the Company is expected to act as a source of financial strength to the Bank and to commit resources to support the Bank in circumstances where the Company might not do so absent such policy. In addition, if the OFIS deems the Bank’s capital to be impaired, the OFIS may require the Bank to restore its capital by a special assessment upon the Company as the Bank’s sole shareholder. If the Company were to fail to pay any such assessment, the directors of the Bank would be required, under Michigan law, to sell the shares of the Bank’s stock owned by the Company to the highest bidder at either a public or private auction and use the proceeds of the sale to restore the Bank’s capital.

        Investments and Activities. In general, any direct or indirect acquisition by the Company of any voting shares of any bank which would result in the Company’s direct or indirect ownership or control of more than 5% of any class of voting shares of such bank, and any merger or consolidation of the Company with another bank company, will require the prior written approval of the Federal Reserve Board under the BHCA.

        The merger or consolidation of an existing bank subsidiary of the Company with another bank, or the acquisition by such a subsidiary of assets of another bank, or the assumption of liability by such a subsidiary to pay any deposits in another bank, will require the prior written approval of the responsible Federal depository institution regulatory agency under the Bank Merger Act. In addition, in certain such cases an application to, and the prior approval of, the Federal Reserve Board under the BHCA and/or the OFIS under the Michigan Banking Code, may be required.

        With certain limited exceptions, the BHCA prohibits any bank holding company from engaging, either directly or indirectly through a subsidiary, in any activity other than managing or controlling banks unless the proposed non-banking activity is one that the Federal Reserve Board has determined to be so closely related to banking or managing or controlling banks as to be a proper incident thereto. Under current Federal Reserve Board regulations, such permissible non-banking activities include such things as mortgage banking, equipment leasing, securities brokerage, and consumer and commercial finance company operations. Well-capitalized and well-managed bank holding companies may engage de novo in certain types of non-banking activities without prior notice to, or approval of, the Federal Reserve Board, provided that written notice of the new activity is given to the Federal Reserve Board within 10 business days after the activity is commenced. If a bank holding company wishes to engage in a non-banking activity by acquiring a going concern, prior notice and/or prior approval will be required, depending upon the activities in which the company to be acquired is engaged, the size of the company to be acquired and the financial and managerial condition of the acquiring bank holding company.

        Eligible bank holding companies that elect to operate as financial holding companies may engage in, or own shares in companies engaged in, a wider range of non-banking activities, including securities and insurance activities and any other activity that the Federal Reserve Board, in consultation with the Secretary of the Treasury, determines by regulation or order is financial in nature, incidental to any such financial activity or complementary to

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any such financial activity and does not pose a substantial risk to the safety or soundness of depository institutions or the financial system generally. The Bank Holding Company Act generally does not place territorial restrictions on the domestic activities of non-bank subsidiaries of bank or financial holding companies.

        The Company’s common stock is registered under the Securities Exchange Act of 1934, as amended (the “Exchange Act”). It is therefore subject to the information, proxy solicitation, insider trading and other restrictions and requirements of the SEC under the Exchange Act. On July 30, 2002, President Bush signed into law the Sarbanes-Oxley Act of 2002. The Sarbanes-Oxley Act provides for numerous changes to the reporting, accounting, corporate governance and business practices of companies as well as financial and other professionals who have involvement with the U.S. public markets. The SEC continues to issue new and proposed rules implementing various provisions of the Sarbanes-Oxley Act.

        Capital Requirements. The Federal Reserve Board uses capital adequacy guidelines in its examination and regulation of bank holding companies. If capital falls below minimum guidelines, a bank holding company may, among other things, be denied approval to acquire or establish additional banks or non-bank businesses.

        The Federal Reserve Board’s capital guidelines establish the following minimum regulatory capital requirements for bank holding companies: (i) a leverage capital requirement expressed as a percentage of total average assets, and (ii) a risk-based requirement expressed as a percentage of total risk-weighted assets. The leverage capital requirement consists of a minimum ratio of Tier 1 capital (which consists principally of stockholders’ equity) to total average assets of 3% for the most highly rated companies, with minimum requirements of 4% to 5% for all others. The risk-based requirement consists of a minimum ratio of total capital to total risk-weighted assets of 8%, of which at least one-half must be Tier 1 capital.

    Dividends. The Company is a corporation separate and distinct from the Bank. Most of the Company’s revenues are received by it in the form of dividends paid by the Bank. Thus, the Company’s ability to pay dividends to its stockholders is indirectly limited by statutory restrictions on the Bank’s ability to pay dividends described below. Further, in a policy statement, the Federal Reserve Board expressed its view that a bank holding company experiencing earnings weaknesses should not pay cash dividends exceeding its net income or which can only be funded in ways that weaken the bank holding company’s financial health, such as by borrowing. Additionally, the Federal Reserve Board possesses enforcement powers over bank holding companies and their non-bank subsidiaries to prevent or remedy actions that represent unsafe or unsound practices or violations of applicable statutes and regulations. Among these powers is the ability to proscribe the payment of dividends by banks and bank holding companies. Similar enforcement powers over the Bank are possessed by the FDIC. The “prompt corrective action” provisions of federal law and regulation authorizes the Federal Reserve Board to restrict the payment of dividends by the Company for an insured bank which fails to meet specified capital levels.

        In addition to the restrictions on dividends imposed by the Federal Reserve Board, the Michigan Business Corporation Act provides that dividends may be legally declared or paid only if after the distribution a corporation, such as the Company, can pay its debts as they come due in the usual course of business and its total assets equal or exceed the sum of its liabilities plus the amount that would be needed to satisfy the preferential rights upon dissolution of any holders of preferred stock whose preferential rights are superior to those receiving the distribution. The Company’s Articles of Incorporation do not authorize the issuance of preferred stock and there are no current plans to seek such authorization.

The Bank

    General. The Bank is a Michigan banking corporation, is a member of the Federal Reserve System and its deposit accounts are insured by the Bank Insurance Fund (the “BIF”) of the FDIC. As a Federal Reserve System member and a Michigan chartered bank, the Bank is subject to the examination, supervision, reporting and enforcement requirements of the Federal Reserve Board as its primary federal regulator and OFIS, as the chartering authority for Michigan banks. These agencies and the federal and state laws applicable to the Bank and its operations, extensively regulate various aspects of the banking business including, among other things, permissible types and amounts of loans, investments and other activities, capital adequacy, branching, interest rates on loans and on deposits, the maintenance of non-interest bearing reserves on deposit accounts, and the safety and soundness of banking practices.

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        Deposit Insurance. As an FDIC-insured institution, the Bank is required to pay deposit insurance premium assessments to the FDIC. The FDIC has adopted a risk-based assessment system under which all insured depository institutions are placed into one of nine categories and assessed insurance premiums, based upon their respective levels of capital and results of supervisory evaluation. Institutions classified as well-capitalized (as defined by the FDIC) and considered healthy pay the lowest premium while institutions that are less than adequately capitalized (as defined by the FDIC) and considered of substantial supervisory concern pay the highest premium. Risk classification of all insured institutions is made by the FDIC for each semi-annual assessment period.

        The Federal Deposit Insurance Act (“FDIA”) requires the FDIC to establish assessment rates at levels which will maintain the Deposit Insurance Fund at a mandated reserve ratio of not less than 1.25% of estimated insured deposits. For several years, the BIF reserve ratio has been at or above the mandated ratio and assessments have ranged from 0% of deposits for institutions in the lowest risk category to .27% of deposits in the highest risk category.

        FICO Assessments. The Bank, as a member of the BIF, is subject to assessments to cover the payments on outstanding obligations of the Financing Corporation (“FICO”). FICO was created to finance the recapitalization of the Federal Savings and Loan Insurance Corporation, the predecessor to the FDIC’s Savings Association Insurance Fund (the “SAIF”), which insures the deposits of thrift institutions. From now until the maturity of the outstanding FICO obligations in 2019, BIF members and SAIF members will share the cost of the interest on the FICO bonds on a pro rata basis. It is estimated that FICO assessments during this period will be less than 0.025% of deposits.

        OFIS Assessments. Michigan banks are required to pay supervisory fees to the OFIS to fund the operations of the OFIS. The amount of supervisory fees paid by a bank is based upon the bank’s total assets, as reported to the OFIS.

        Capital Requirements. The Federal Reserve has established the following minimum capital standards for state-chartered, member banks, such as the Bank: a leverage requirement consisting of a minimum ratio of Tier 1 capital to total average assets of 3% for the most highly-rated banks with minimum requirements of 4% to 5% for all others, and a risk-based capital requirement consisting of a minimum ratio of total capital to total risk-weighted assets of 8%, at least one-half of which must be Tier 1 capital. Tier 1 capital consists principally of stockholders’ equity. These capital requirements are minimum requirements. Higher capital levels will be required if warranted by the particular circumstances or risk profiles of individual institutions.

        Federal law provides the federal banking regulators with broad power to take prompt corrective action to resolve the problems of undercapitalized institutions. The extent of the regulators’ powers depends on whether the institution in question is “well capitalized,” “adequately capitalized,” “undercapitalized,” “significantly undercapitalized,” or “critically undercapitalized.” Federal regulations define these capital categories as follows:

        As of December 31, 2003, the Bank’s ratios exceeded minimum requirements for the well capitalized category. (See “Liquidity and Capital Resources.”)

        Depending upon the capital category to which an institution is assigned, the regulators’ corrective powers include: requiring the submission of a capital restoration plan; placing limits on asset growth and restrictions on activities; requiring the institution to issue additional capital stock (including additional voting stock) or to be acquired; restricting transactions with affiliates; restricting the interest rate the institution may pay on deposits; ordering a new election of directors of the institution; requiring that senior executive officers or directors be dismissed; prohibiting the institution from accepting deposits from correspondent banks; requiring the institution to

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divest certain subsidiaries; prohibiting the payment of principal or interest on subordinated debt; and ultimately, appointing a receiver for the institution.

        In general, a depository institution may be reclassified to a lower category than is indicated by its capital levels if the appropriate federal depository institution regulatory agency determines the institution to be otherwise in an unsafe or unsound condition or to be engaged in an unsafe or unsound practice. This could include a failure by the institution, following receipt of a less-than-satisfactory rating on its most recent examination report, to correct the deficiency.

    Dividends. Under Michigan law, the Bank is restricted as to the maximum amount of dividends it may pay on its common stock. The Bank may not pay dividends except out of net income after deducting its losses and bad debts. A Michigan state bank may not declare or pay a dividend unless the bank will have surplus amounting to at least 20% of its capital after the payment of the dividend.

        As a member of the Federal Reserve System, the Bank is required by federal law to obtain the prior approval of the Federal Reserve Board for the declaration or payment of a dividend, if the total of all dividends declared by the Bank’s Board of Directors in any year will exceed the total of (i) the Bank’s retained net income (as defined and interpreted by regulation) for that year plus (ii) the retained net income for the preceding two years, less any required transfers to surplus. Federal law generally prohibits a depository institution from making any capital distribution (including payment of a dividend) or paying any management fee to its holding company if the depository institution would thereafter be undercapitalized. Further, federal regulatory agencies can prohibit a banking institution or bank holding company from engaging in unsafe and unsound business practices and could prohibit payment of dividends if such payment could be deemed an unsafe and unsound business practice.

        Insider Transactions. The Bank is subject to certain restrictions imposed by the Federal Reserve Act on any extensions of credit to the Company or its subsidiaries, on investments in the stock or other securities of the Company or its subsidiaries and the acceptance of the stock or other securities of the Company or its subsidiaries as collateral for loans. Certain limitations and reporting requirements are also placed on extensions of credit by the Bank to its directors and officers, to directors and officers of the Company and its subsidiaries, to principal stockholders of the Company, and to “related interests” of such directors, officers and principal stockholders. In addition, federal law and regulations may affect the terms upon which any person becoming a director or officer of the Company or one of its subsidiaries or a principal shareholder of the Company may obtain credit from banks with which the Bank maintains a correspondent relationship.

        Safety and Soundness Standards. Pursuant to FDICIA, the FDIC adopted guidelines to establish operational and managerial standards to promote the safety and soundness of federally insured depository institutions. The guidelines establish standards for internal controls, information systems, internal audit systems, loan documentation, credit underwriting, interest rate exposure, asset growth, compensation, fees and benefits, asset quality and earnings.

        Investments and Other Activities. Under federal law and regulations, Federal Reserve System member banks and FDIC-insured state banks are prohibited, subject to certain exceptions, from making or retaining equity investments of a type, or in an amount, that are not permissible for a national bank. Federal law, as implemented by regulations, also prohibits state banks and their subsidiaries, subject to certain exceptions, from engaging as principal in any activity that is not permitted for a national bank or its subsidiary, respectively, unless the bank meets, and continues to meet, its minimum regulatory capital requirements and the bank’s primary federal regulator determines the activity would not pose a significant risk to the deposit insurance fund of which the bank is a member. Impermissible investments and activities must be divested or discontinued within certain time frames set by the bank’s primary federal regulator in accordance with federal law. These restrictions are not currently expected to have a material impact on the operations of the Bank.

        Consumer Protection Laws. The Bank’s business includes making a variety of types of loans to individuals. In making these loans, the Bank is subject to State usury and regulatory laws and to various federal statutes, including the privacy of consumer financial information provisions of the Gramm-Leach-Bliley Act and regulations under, the Equal Credit Opportunity Act, the Fair Credit Reporting Act, the Truth in Lending Act, the Real Estate Settlement Procedures Act, and the Home Mortgage Disclosure Act, and regulations which prohibit discrimination, specify disclosures to be made to borrowers regarding credit and settlement costs, and regulate the mortgage loan servicing activities of the Bank, including the maintenance and operation of escrow accounts and the

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transfer of mortgage loan servicing. In receiving deposits, the Bank is subject to extensive regulation under State and federal law and regulations, including the Truth in Savings Act, the Expedited Funds Availability Act, the Bank Secrecy Act, the Electronic Funds Transfer Act, and the Federal Deposit Insurance Act. Violation of these laws could result in the imposition of significant damages and fines upon the Bank and its directors and officers.

        Branching Authority. Michigan banks, such as the Bank, have the authority under Michigan law to establish branches anywhere in the State of Michigan, subject to receipt of all required regulatory approvals.

        Banks may establish interstate branch networks through acquisitions of other banks. The establishment of de novo interstate branches or the acquisition of individual branches of a bank in another state (rather than the acquisition of an out-of-state bank in its entirety) is allowed only if specifically authorized by state law.

        Michigan permits both U.S. and non-U.S. banks to establish branch offices in Michigan. The Michigan Banking Code permits, in appropriate circumstances and with the approval of the Michigan Office of Financial and Insurance Services, Division of Financial Institutions, (1) acquisition of Michigan banks by FDIC-insured banks, savings banks or savings and loan associations located in other states, (2) sale by a Michigan bank of branches to an FDIC-insured bank, savings bank or savings and loan association located in a state in which a Michigan bank could purchase branches of the purchasing entity, (3) consolidation of Michigan banks and FDIC-insured banks, savings banks or savings and loan associations located in other states having laws permitting such consolidation, (4) establishment of branches in Michigan by FDIC-insured banks located in other states, the District of Columbia or U.S. territories or protectorates having laws permitting a Michigan bank to establish a branch in such jurisdiction, and (5) establishment by foreign banks of branches located in Michigan.

        Our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and all amendments to those reports are available free of charge through a link on our website at www.bcsbank.com to the SEC website. The reports are also available through the SEC website.

Item 2. Properties.

        The Company and the Bank own and operate a total of 13 facilities in Michigan. The facilities are located in Kent, Ottawa, and Allegan Counties. The individual properties are not materially significant to the Company’s or the Bank’s business or to the consolidated financials.

        With the exception of the potential remodeling of certain facilities to provide for the efficient use of work space or to maintain an appropriate appearance, each property is considered adequate for current and anticipated needs.

        During 2002 the Bank moved its Grandville branch to a new location and also purchased an existing bank facility in Jenison, which was opened under the Byron Center State Bank name in 2003.

Item 3. Legal Proceedings.

        From time to time, we may be involved in various legal proceedings that are incidental to our business. In the opinion of management, we are not a party to any current legal proceedings that are material to our financial condition, either individually or in the aggregate.

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

        None.

Executive Officers of the Company

        The Board of Directors appoints the executive officers of the Bank. There are no family relationships among the officers and/or the directors of the Company, or any arrangement or understanding between any officer and any other person pursuant to which the officer was elected. The following table sets forth certain information with respect to the Company’s executive officers (included for information purposes only) as of December 31, 2003:

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Name		Age		Position with Company		Year Became an Executive Officer
Patrick K. Gill James A. Luyk Thomas L. Fitzgerald		52 41 58		President, Chief Executive Officer and Director of the Company and the Bank Executive Vice President and Chief Financial Officer of the Company and the Bank Executive Vice President and Chief Lending Officer of the Company and the Bank		2002 2000 2002

        Prior to being named President and Chief Executive Officer in 2002, Mr. Gill served as President and Chief Executive Officer of Pavilion Bancorp, Inc. for more than five (5) years.

        Prior to being named Executive Vice President and Chief Financial Officer in 2000, Mr. Luyk served as regional controller for Huntington National Bank.

        Prior to being named Executive Vice President and Chief Lending Officer in 2002, Mr. Fitzgerald served as Executive Vice President, in charge of business development, at National City Bank for more than five (5) years.

PART II

Item 5. Market Price and Dividends for Registrant's Common Equity and Related Stockholder Matters.

        There is no active market for the Company’s Common Stock, and there is limited published information with respect to its market price. There are occasional sales through brokers and direct sales by stockholders of which the Company’s management may, or may not be aware. It is the understanding of the management of the Company that over the last two years, the Company’s Common Stock has sold at prices in excess of book value.

        The following table sets forth the range of high and low sales prices of the Company’s common stock during 2003 and 2002, based on information made available to the Company, as well as per share cash dividends declared during those periods. Although management is not aware of any transactions at higher or lower prices, there may have been transactions at prices outside the ranges listed below:

        The Company has approximately 1,050 holders of record of its common stock. The common stock is traded as a “pink-sheet” company and quoted on the Over-the-Counter Bulletin Board under the symbol “OKFC”.

        We are a holding company and substantially all of our assets are held by our subsidiaries. Our ability to pay dividends to our shareholders depends primarily on our bank’s ability to pay dividends to us. Dividend payments and extensions of credit to us from our bank are subject to legal and regulatory limitations, generally based on capital levels and current and retained earnings imposed by law and regulatory agencies with authority over our bank. The ability of our

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bank to pay dividends is also subject to its profitability, financial condition, capital expenditures and other cash flow requirements.

Item 6. Selected Financial Data (dollars in thousands, except per share data).

SUMMARY OF SELECTED CONSOLIDATED FINANCIAL DATA

Year Ended December 31,

FORWARD LOOKING STATEMENTS

        This report includes “forward-looking statements” as that term is used in the securities laws. All statements regarding our expected financial position, business and strategies are forward-looking statements. In addition, the words “anticipates,” “believes,” “estimates,” “seeks,” “expects,” “plans,” “intends,” and similar expressions, as they relate to us or our management, are intended to identify forward-looking statements. The presentation and discussion of the provision and allowance for loan losses and statements concerning future profitability or future growth or increases, are examples of inherently forward looking statements in that they involve judgments and statements of belief as to the outcome of future events. Our ability to predict results or the actual effect of future plans or strategies is inherently uncertain. Factors which could have a material adverse affect on our operations and our future prospects include, but are not limited to, changes in: interest rates, general economic conditions, legislative/regulatory changes, monetary and fiscal policies of the U.S. Government, including policies of the U.S. Treasury and the Federal Reserve Board, the quality or composition of the loan or investment portfolios, demand for loan products, deposit flows, competition, demand for financial services in our market area and accounting principles, policies and guidelines. These risks and uncertainties should be considered in evaluating forward-looking statements and undue reliance should not be placed on such statements. Further information concerning us and our

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business, including additional factors that could materially affect our financial results, is included in our other filings with the Securities and Exchange Commission.

ITEM 7.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001

        The following financial review presents management’s discussion and analysis of consolidated financial condition and results of operations during the period of 2001 through 2003. The discussion should be read in conjunction with the Company’s consolidated financial statements and accompanying notes thereto.

Critical Accounting Policies

        As described under “Supervision and Regulation”, the financial services industry is highly regulated. Furthermore, the nature of the financial services industry is such that, other than described below, the use of estimates and management judgment are not likely to present a material risk to the financial statements. In cases where estimates or management judgment are required, internal controls and processes are established to provide assurance that such estimates and management judgments are materially correct to the best of management’s knowledge.

        Allowance for loan losses — Accounting for loan classifications, accrual status, and determination of the allowance for loan losses is based on regulatory guidance. This guidance includes, but is not limited to, generally accepted accounting principles, the uniform retail credit classification and account management policy issued by the Federal Financial Institutions Examination Council, and the joint policy statement on the allowance for loan losses methodologies, issued by the Federal Financial Institutions Examination Council, Federal Deposit Insurance Corporation, and various other regulatory agencies. Accordingly, the allowance for loan losses includes a reserve calculation based on an evaluation of loans determined to be impaired, risk ratings, historical losses, loans past due, general and local economic conditions, trends, portfolio concentrations, collateral value and other subjective factors.

        Commercial loan rating system and identification of impaired loans – The Company has a defined risk rating system that is designed to assess the risk of individual loans and overall risk of the commercial loan portfolio. The system assigns a risk weighting to factors such as cash flow, collateral, financial condition, operating performance, repayment history, management, and strength of the industry. An assessment of risk is performed as a part of the loan approval process as well as periodic updates based on the circumstances of the individual loan. The Company employs both internal and external loan review services to assess risk ratings.

        Originated mortgage-servicing rights (“OMSR”) — The Company records the original “OMSR” based on market data. The “OMSR” is amortized into non-interest income, in proportion to the period of the estimated future net servicing income of the underlying financial asset. Additionally, an independent third party valuation is performed to determine potential impairment of the “OMSR” as a result of changes in interest rates and expected future loan repayment speeds. Significant changes in interest rates or repayment speeds could have a significant impact on the carrying value of the mortgage servicing assets.

FINANCIAL CONDITION

Summary

        Total assets declined 5% during 2003 as a direct result of management’s effort to improve asset quality. Total loans declined 4% largely due to a decline in consumer indirect lending, which the bank has exited, and a decline in non performing commercial loans. Total loans represent 71% of the Bank’s total assets followed by investments and fed funds sold, which comprise approximately 22% of the Bank’s assets. The surplus funding that resulted from the decline in assets was redeployed from loans and fed funds sold to the investment portfolio. Total deposits also declined in 2003 as the Bank did not compete as aggressively for rate sensitive deposits and decreased the reliance on deposits outside its market area. A discussion of changes in balance sheet amounts by major categories follows:

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Securities (in thousands)

        The Bank maintains a diversified securities portfolio, which includes obligations of government sponsored agencies, securities issued by states and political subdivisions, corporate securities, and mortgage-backed securities. The primary objective of the Company’s investing activities is to provide for safety of the principal invested, as a source of liquidity and management of exposure to changes in interest rates. A relatively high percent of the Bank’s security portfolio is pledged. The majority of the securities pledged are to secure borrowing arrangements for Federal Home Loan Bank borrowings and securities sold under agreements to repurchase or for other purposes as required or permitted by law. For administrative purposes, the Bank generally pledges more securities than required. The Bank was required to have approximately $58 million pledged at December 31, 2003 compared to $64 million at December 31, 2002.

        All of the Company’s securities are classified as available-for-sale. As a result, changes in market value are recognized as adjustments to carrying amount on the balance sheet and gains or losses are reported, net of tax, as an adjustment to the Bank’s stockholders’ equity. The Company’s total holdings increased approximately $22 million in 2003. The increase is a result of the liquidity provided by exiting consumer indirect lending and the reduction in non-performing commercial loans combined with a redeployment of fed fund funds sold at December 31, 2002 to achieve a higher yield and reduce the Bank’s exposure to falling interest rates.

Schedule of Maturities of Investment Securities and Weighted Average Yields

        The following is a schedule of contractual maturities and their weighted average yield of each category of investment securities as of December 31, 2003. The weighted average interest rates have been computed on a fully taxable equivalent basis, based on amortized cost. The rates shown on securities issued by states and political subdivisions are stated on a taxable equivalent basis using a 34% tax rate.

The Loan Portfolio

        The Bank’s lending policy is intended to reduce credit risk, enhance earnings and guide the lending officers in making credit decisions. The Board of Directors of the Bank approves the loan authority for each lender and has appointed a Chief Lending Officer who is responsible for the supervision of the lending activities of the Bank. The Board has also appointed a loan review officer who monitors the credit quality of the loan portfolio independent of the loan approval process. The loan review officer submits periodic reviews to the Chief Lending Officer and these reviews are submitted to the Audit/Compliance Committee on a quarterly basis. Requests to the Bank for credit are considered on the basis of creditworthiness of each applicant, without consideration of race, color, religion, national origin, sex, marital status, physical handicap, age, or the receipt of income from public assistance programs. Consideration is given to the applicant’s capacity for repayment based on cashflow, collateral, capital and alternative sources of repayment. Loan applications are accepted at all the Bank’s offices and are approved within the limits of

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each lending officer’s authority. Secured loan requests in excess of $1,250,000 or unsecured loan requests in excess of $400,000, are required to be presented to the Board of Directors or the Director Loan Committee for review and approval.

        The Bank has no foreign loans and there were no concentrations greater than 10% of total loans that are not disclosed as a separate category. The Bank’s largest concentration of loans is to businesses in the form of commercial loans and real estate mortgages. Management reviews the concentration, and changes in concentrations of loans, using the method of coding the commercial loan portfolio by Standard Industrial Classification (S.I.C.) code. Total consumer loans continue to decline as a result of zero percent financing provided by the auto industry and the Bank’s substantial exit from the consumer indirect business. As of December 31, 2003, the Bank had indirect loans totaling approximately $18 million, down 42% from $31 million at December 31, 2002. Management expects the indirect consumer loan portfolio to continue to decline during 2004. During 2003, total residential real estate loans increased 26%, largely comprised of floating rate and fixed rate mortgages with maturities of 10 years or less. The historically low rates provided an opportunity to add some shorter-term mortgages to the loan portfolio and decrease the Bank’s sensitivity to declining interest rates.

        It is the Bank’s general practice to sell residential real estate loans with maturities over 10 years to Freddie Mac . The Bank retains servicing rights on substantially all such loans sold. At December 31, 2003 and 2002, the Bank was servicing loans for Freddie Mac totaling approximately $257 million and $258 million, respectively. During 2003, the Bank also established a relationship with Washington Mutual Inc. to sell residential real estate loans, with servicing released. During 2003, the Bank sold approximately $5 million in residential real estate loans with servicing released.

        In addition to the communities served by the Bank’s branches, principal lending markets include nearby communities and metropolitan areas. Subject to established underwriting criteria, the Bank participates with other financial institutions to fund certain large commercial loans, which would exceed the Bank’s legal lending limit if made solely by the Bank.

Loan Portfolio Composition (in thousands)

        Commercial and Commercial Real-Estate Loans: Business loans are originated for a variety of purposes including working capital financing, machinery and equipment acquisition and the financing of commercial real-estate. The loans are generally secured by all assets of the borrower and are underwritten based on an assessment of the industry in which the borrower operates, management, economic conditions, cash flow, owners equity and collateral. Commercial real-estate loans are secured by properties located in the Bank’s primary market area.

        Residential Real-Estate Loans: Residential single family real-estate loans are originated in the Bank’s primary market area. Generally, the Bank sells the loans in the secondary market. The loans are underwritten using the guidelines and standards in the Federal Home Loan Mortgage Corporation Sellers and Servicers Guide. On occasion single family real-estate loans will be retained in the Bank’s portfolio and such loans will generally have maturities less than fifteen years.

        Consumer Loans: Consumer loans are originated for a variety of purposes including the acquisition of new and used automobiles, boats and recreational vehicles. Personal loans secured by the equity on the borrower’s residence are also granted for a variety of needs. Consumer loans are underwritten based on the borrowers credit history, monthly income, stability of employment, the amount of the down payment and the type of collateral.

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        The low interest rate environment resulted in a significant amount of re-financing during 2002 and 2003. Consumers refinanced mortgage loans to lock in the lower interest rates. This activity increased net gains on sales of loans held for sale compared to previous years. The Company does not expect this abnormally high volume to continue. The Company also experienced a significant amount of fixed rate commercial loan re-financing. A significant number of these customers re-financed from higher fixed interest rates to lower variable interest rates. For discussion regarding interest rate risk exposure and management of this risk see the “Interest Rate Risk” and “Asset/Liability Gap Position” sections.

        Management has taken significant steps in the loan administration area to improve underwriting standards. These changes have improved asset quality, which management expects to continue. However, asset quality is also dependent on general and local economic conditions, which continue to show signs of weakness, although improving.

Non-performing Assets (in thousands)

        Non-performing assets are comprised of loans for which the accrual of interest has been discontinued, accruing loans 90 days or more past due in payments, collateral for loans and other real estate, which has been acquired primarily through foreclosure and is awaiting disposition. Loans, including loans considered impaired under SFAS No. 118 and SFAS No. 114, are generally placed on a non-accrual basis when principal or interest is past due 90 days or more and when, in the opinion of management, full collection of principal and interest is unlikely.

        The Bank’s ratio of non-performing loans to total loans at December 31, 2003 was significantly lower than at December 31, 2002, which reflects management’s aggressive approach to credit management. A significant portion of the improvement is the result of the customers finding alternative financing and repaying their loan to the Bank. In some instances, non-performing assets have been sold to a new borrower of the Bank. The non-performing assets listed in other real estate consist of two commercial properties, which the bank is currently in the process of marketing. As of December 31, 2003 there were no other interest bearing assets, which required classification.

        During 2002, management, with the assistance of outside consultants, conducted a complete and comprehensive review of the lending process. The outcomes include an improvement in workflow, improvement in processes and procedures, standardization of loan quality assessment, and improvement in the management of non-performing credits. These changes have improved asset quality and credit management.

        The table below presents the interest income that would have been earned on non-performing loans outstanding at December 31, 2003, 2002 and 2001 had those loans been accruing interest in accordance with the original terms of the loan agreements (pro forma interest) and the amount of interest income actually included in net interest income for those years.

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Foregone Interest on Non-Performing Loans (in thousands)

Allowance for Loan Losses (dollars in thousands)

        For the year ended December 31, 2003 versus 2002, net loans charged off decreased from .68% of average loans outstanding to .18%. During the year ended December 31, 2003, management added $625,000 to the loan loss provision and had net charge-offs of $633,000. The provision for loan losses charged against earnings decreased $3,445,000, or approximately 85% from a year ago. The allowance for loan losses as a percent of total loans increased from 2.22% at December 31, 2002 to 2.31% at December 31, 2003. This increase reflects the low level of charge-offs and decline in total loans outstanding. Consumer loan net charge-offs declined sharply in 2003, falling $828,000 from 2002. This improvement is the result of exiting indirect consumer lending and improved recovery of prior amounts charged-off. The improvement in the recovery of prior charge-offs is, in part, due to the addition of a collector that specializes in the collection of charged-off loans. Net charge-offs in the Real Estate portfolio continue to be very low.

Allocation of the Allowance for Loan Losses (dollars in thousands)

        The allowance for loan losses is analyzed quarterly by management. In so doing, management assigns a portion of the allowance to specific credits that have been identified as problem loans, reviews past loss experience, the local economy and a number of other factors. Management believes that the allowance for loan losses is adequate.

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			Year ended December 31,
			2003						2002						2001
			Allowance Amount			% of total allowance			Allowance Amount			% of total allowance			Allowance Amount			% of total allowance
Commercial and commercial
real estate			$	5,591			67	%	$	5,817			69	%	$	4,908			70	%
Real estate mortgages				303			4			382			5			100			2
Consumer				1,534			18			1,871			22			1,273			18
Subjective				962			11			328			4			702			10
Total			$	8,390			100	%	$	8,398			100	%	$	6,983			100	%

        In determining the adequacy of the allowance for loan losses, management determines (i) a specific allocation for loans when a loss is probable, (ii) allocation based on credit risk rating for individual commercial loans, (iii) allocation based principally on historical losses for various categories of loans, and (iv) subjective factors including local and general economic factors and trends. Management’s assessment of a slow down in economic activity, increase in unemployment, sustained decline in business spending, and increase in non-performing loans is reflected in the recent increase in the allowance for loan losses as a percent of total loans.

        The first element reflects our estimate of probable losses based upon our systematic review of specific loans. These estimates are based upon a number of objective factors, such as payment history, financial condition of the borrower, and discounted collateral exposure.

        The second element reflects the application of our loan rating system. This rating system is similar to those employed by state and federal banking regulators. Loans that are rated below a certain predetermined classification are assigned a loss allocation factor for each loan classification category.

        The third element is determined by assigning allocations based principally upon the three-year average of loss experience for each type of loan. Additionally, an allocation is provided based on the current delinquency rate for some loan categories. Loss analyses are conducted at least annually.

        The fourth element is based on factors that cannot be associated with a specific credit or loan category and reflects our attempt to ensure that the overall allowance for loan losses appropriately reflects a margin for the imprecision necessarily inherent in the estimates of expected credit losses. We consider a number of subjective factors when determining the unallocated portion, including local and general economic business factors and trends, portfolio concentrations and changes in the size, mix and the general terms of the loan portfolios.

        Actual losses experienced in the future could significantly vary from the estimated allocation of the loan loss reserve. Changes in local and national economic factors could significantly affect the adequacy of the allowance for loan losses. While amounts are allocated to various portfolios as directed by Statement of Financial Accounting Standards No. 114, the entire allowance for loan losses is available to absorb losses from any portfolio segment.

Sources of Funds

        The primary sources of funding for the Bank are deposits, which includes brokered deposits, securities sold under agreements to repurchase and Federal Home Loan Advances. Non deposit sources of funding decreased approximately 5% or $4 million from December 31, 2002 to December 31, 2003. Total deposits declined approximately $26 million or 7% from December 31, 2002 to December 31, 2003. The entire decline can be attributed to a decline in certificates of deposit, which declined by approximately $34 million, or 17%, from December 31, 2002 to December 31, 2003. The decline in certificates of deposit reflect a decreased reliance on certificates over $100,000, which declined 20%, or approximately $20 million and a decline in certificates of deposit under $100,000 totaling $14 million, or approximately 14% as the result of not offering as many premium priced certificates in 2003 as in the years leading up to 2003.

        Excluding certificates of deposit, total deposits increased approximately 4% from December 31, 2002 to December 31, 2003. The increase in 2003 approximates the overall growth of deposits in the Bank’s market area. Due to the decline in funding needs, the Bank was able to reduce its use of brokered time deposits from $53 million at December 31, 2002 to $47 million at December 31, 2003. The average cost of funds for brokered deposits is at least 30 basis points higher than local deposits. The Bank’s plan of decreasing dependence on brokered deposits

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will lower the average cost of funds. The Bank will continue to use of brokered deposits as part of its asset & liability management plan.

        Deposits are gathered from the communities the Bank serves. Increasing core deposits is a key element of the Bank’s strategic plan. The checking and savings product mix has also been realigned to reward customers with special values if they maintain at least two accounts with the Bank. This is designed to improve the level of core deposits. Improvement in the equity markets has resulted in some deposit outflow back into the equity market. The largest percentage of growth has been from acquiring more of existing customers relationships. The Bank expects this trend to continue. The Company is developing a more comprehensive sales focus, which includes the newly created personal banker positions at each of the company’s offices. Additional sales training and measurement tools are being implemented to better assess our strengths and weaknesses in the selling process. In addition to the traditional bank offices, the Company provides a wide array of alternative electronic methods to serve customers. New cash management products are expected to be offered in early 2004. During the third quarter of 2003 the Bank launched Mobile Banking, a courier service in West Michigan that provides convenient, safe, and reliable pick-up and delivery for a variety of items including cash, checks and important Bank documents. The Mobile Banking vans are staffed by experienced Bank employees and a professional armed guard. Deposits are kept secure within a vault inside the van.

Average Deposit Balances (dollars in thousands)

        The following table lists the total average deposit balances during 2003 and 2002 and the weighted average rates paid on the funds provided.

        The Bank operates in a very competitive environment. Management monitors rates at other financial institutions in the area to ascertain that its rates are competitive with the market. Management also attempts to offer a wide variety of products to meet the needs of its customers. The Bank offers business and consumer checking accounts, regular and money market savings accounts, and certificates of deposit having many options in their terms.

Repurchase Agreements, Federal Funds Purchased and Borrowed Funds (dollars in thousands)

(1)     Other borrowings included two separate loans that were paid off in 2002 at interest rates of 8.0% and 6.5%.

Repurchase agreements are a variable interest rate borrowing with a 1 day maturity, these borrowings are from local customers of the Bank. The FHLB borrowings have a substantial prepayment penalty that almost prohibits early replacement. These borrowings have a fixed term and fixed interest rate.

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RESULTS OF OPERATIONS

Summary

        The Company achieved net income of $4.16 million in 2003, an increase of 10.1% from $3.78 million in 2002. Diluted earnings per share increased 9.7%, from $1.86 per share in 2002 to $2.04 per share in 2003. The growth in net income for the year reflects the significant progress made in improving asset quality. Non-performing assets declined by $7.2 million, or 77%, from a year ago. Net loan losses charged against the allowance for loan losses declined from .68% of total loans in 2002 to .18% of total loans in 2003. As a result, the provision for loan losses was reduced from $4,070,000 in 2002 to $625,000 in 2003.

        Net interest income declined approximately 12% in 2003. The decrease was a result of declines in the net interest margin and earning assets. The net interest margin compression is a direct result of the significant commercial loan refinancing activity and the exceptionally low interest rate environment. The net interest margin was 3.59% in 2003 compared to 4.06% in 2002. The decline in earning assets is directly attributable to the improvement in asset quality, which is discussed below.

        Non-interest income declined 5% in 2003, which is the result of a 35% decline in mortgage banking related fees. As previously reported, this decline is due to a significant increase in the amortization of mortgage servicing rights due to the significant mortgage refinance activity in 2003.

        The growth of non-interest expenses was held to approximately 2% in 2003. The increase in salary expense includes the cost associated with building a highly qualified and experienced management team. Non-employment related expenses declined 4% in 2003. This decline represents the efforts to reduce operating expenses in 2003. The organization-wide effort to lower total operating expenses will continue in 2004 and is expected to enhance performance results.

Earnings Performance (in thousands, except per share data)

        Net income increased approximately 10% in 2003. A significant improvement in asset quality resulted in a lower provision for loans losses during 2003, offsetting a decline in net interest income resulting from a decline in earning assets and compression of the net interest margin as due to the low interest rate environment, a 5% decline in non-interest income, primarily due to a decline in mortgage fees and 2% increase in non-interest expense.

        Net income declined $2.2 million, or 37%, from 2001 to 2002. Loan sales continued to increase during 2002, but were offset by an increase in the loan loss provision, an increase in non-interest expense and a declining trend in net interest margin due to the low interest rate environment.

Net Interest Income

        The following schedule presents the average daily balances, interest income (on a fully taxable-equivalent basis) and interest expense and average rates earned and paid for the Company’s major categories of assets, liabilities, and stockholders’ equity for the periods indicated:

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Interest Yields and Costs (in thousands)

        Net interest income is the principal source of income for the Company. In the current year, tax equivalent net interest income declined approximately $2.2 million, to $17.3 million, an 11.3% decrease from 2002.

        In 2003, the yield on total earning assets decreased 115 basis points, compared to a 72 basis point decline in the total interest bearing liabilities cost of funds. Both the net interest spread and net interest margin decreased in 2003 due to lower interest rates and interest earning assets repricing faster than interest bearing liabilities. The compression is a result of significant commercial loan refinancing from long-term fixed rates to short-term variable rates combined with the lowest interest rates in 45 years, which reduces the spread and margin on the Bank’s non-interest bearing deposits and other funding sources, known as free funds.

        In 2002, the yield on total earning assets decreased 140 basis points, compared to a 129 basis point decline in the total interest bearing liabilities cost of funds. Both the net interest spread and net interest margin decreased in 2002 due to lower interest rates and interest earning assets repricing faster than interest bearing liabilities. The compression is a result of significant commercial loan refinancing from long-term fixed rates to short-term variable rates and an increase in the dollar amount of loans for which the Bank stopped accruing interest, combined with the lowest interest rates in 40 years, which compressed the Bank’s net interest margin.

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        Management expects the declining trend in the fully taxable-equivalent (FTE) net interest margin to moderate as the decline in general interest rates appears to have slowed with an improving economy. However, the net interest margin is expected to remain below past levels as a result of the continued low rate environment and continued fierce competition for deposits in its local market. Management does not expect the net interest margin to decline significantly from its current level, but also does not anticipate a substantial improvement during 2004. The net interest margin is significantly affected by the monetary policies of the U.S. government, local competition and level of economic activity. There is no assurance regarding rates and the Bank’s net interest margin.

Change in Tax Equivalent Net Interest Income (in thousands)

        Interest from loans continues to be the primary source of interest income, accounting for 84.7%, 87.5% and 86.0% of total interest income for 2003, 2002 and 2001, respectively. Net interest income is significantly influenced by results of the Bank’s lending activities. During the past two years interest income has declined $9.5 million while interest expense has declined $7.1 million over the same period. The primary reason interest income has declined faster than interest expense is due to the significant shift of long-term fixed rate commercial loans to floating rate commercial loans. Furthermore, many of the Bank’s customers paid prepayment penalties to refinance their long-term fixed rate commercial loans. Although the Bank collected prepayment penalties of approximately $170,000 and $467,000 in 2002 and 2003 respectively, the decline in interest income was significantly higher. The use of prepayment language in commercial loans is a competitive issue and is being further reviewed by Bank management. Interest income also declined in 2003 as a result of a decline in earning assets.

        Total interest expense decreased 24.9%, or $3.2 million from 2002 to 2003 and declined 23.2% or $3.9 million from 2001 to 2002. The $3.2 million decline in the cost of funds is largely due the low interest rate environment, and, to a lesser degree, the decline in total deposits. Cost of funds is influenced by economic conditions and activities of the Federal Reserve and local competition. The Bank’s asset/liability committee seeks to manage sources and uses of funds, and to monitor the gap in maturities of these funds to maintain a steady net interest margin in varying market conditions.

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Composition of Average Earning Assets and Interest Paying Liabilities

        The Bank’s earning asset ratio rebounded in 2003 due to the reduction in loans on non-accrual, which resulted in a decline in the earning asset ratio in 2002 compared to 2001.

        The free funds ratio, funds on which the bank does not pay interest, increased from 12% in 2002 to 16% in 2003. The improvement reflects an increase in the Bank’s stockholders’ equity percent to average earning assets

Provision and Allowance for Loan Loss

        The provision for loan losses charged to earnings was $625,000 in 2003, compared to $4.1 million for 2002 and $3.0 million for 2001. The decrease in the provision reflects a substantial improvement in asset quality and significant reduction in net loan losses during 2003. Although asset quality is substantially improved, loans originated prior to management’s adoption of new underwriting standards still present a higher level of risk than loans made after adoption of these standards. Based upon the most recent review of the loan portfolio, it is unlikely that a provision for loan losses will be required in the early part of 2004. However, conditions can change suddenly, and a provision for loan losses will be charged against earnings if, and when it becomes necessary.

        As previously reported, management has taken significant steps to improve underwriting standards, and loan administration and has exited the indirect consumer loan business. These changes have improved asset quality. Future changes in asset quality will be subject to continued adherence to established policies and the general economic conditions of the markets in which the Bank operates.

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Non-interest Income (in thousands)

        Non-interest income declined 5%, or approximately $0.4 million from 2002 to 2003, compared to an increase of 22%, or approximately $1.2 million from 2001 to 2002. Service charges on deposits increased 16% due to deposit account growth and changes in the Bank’s fee structure. The gain on sale of mortgages declined $0.7 million, or 20%, despite a 7% increase in the volume of mortgage loans sold during 2003. The decline in gains on sale of loans reflects a lower sales price on loans due to a more aggressive pricing strategy. Additionally, the decrease reflects the sale of some mortgages at a loss during the third quarter. It is the Bank’s practice to obtain rate locks on nearly all of the mortgage production that is sold, however, the overwhelming volume of mortgages in the third quarter prevented the Bank from closing all mortgage production within the rate lock time period. At December 31, 2003, the Bank had approximately $1.7 million of loans available for sale, which are reported at the lower of cost or market value of those loans. As a result of the low rates and record mortgage refinancing activity, the mortgage servicing asset of the Bank was reduced by an 87% increase in the amortization of the Banks mortgage servicing asset. Late in 2003, the level of amortization slowed substantially as the mortgage volume declined. The slower prepayments and upward movement in rates also resulted in a reduction of the valuation allowance attributed to the mortgage servicing asset. The Bank employs an independent third party to determine the fair value of the mortgage servicing asset.

Net Gains on the Sale of Real Estate Mortgage Loans (in thousands)

        The decrease in gains on sale of real estate loans is a result of a lower sales price on loans due to a more aggressive pricing strategy and the sale of some mortgages at a loss in the third quarter of 2003. Net gains on the sale of loans are generally a function of the volume of loans sold. The volume of loans sold is dependent upon the Bank’s ability to originate loans, which is particularly sensitive to the absolute level of interest rates. Net gains on the sale of real estate mortgage loans are also dependant upon economic and competitive factors as well as management’s ability to effectively manage the Bank’s exposure to changes in interest rates. The Bank intends to aggressively market its services in the real estate area.

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Realized Gains and Losses on the Sale of Securities (in thousands)

        Generally, securities are purchased with the anticipation that the Company would hold them to maturity. However, occasionally securities are sold for asset & liability management planning, or to take advantage of changes in the yield curve. Approximately $138,000 of the gain in 2003 is due to the sale of equity securities, predominately other bank stocks, held at the parent company.

Non-interest Expense

        Non-interest expense increased $391,000 or 2.4% in 2003, compared to 2002. The Company’s salary expense increased 9.5%, or $701,000 during 2003, compared to 2002. The increase includes the addition of several key management positions and significantly higher mortgage commissions due to the increased volume and change in compensation structure. The average number of employees declined by one, from 200 in 2002 to 199, including the new Jenison Office, in 2003. Employee benefits declined 1.6%, or $28,000 during 2003 compared to a year earlier. An increase in employment taxes was off-set by a slight decline in the employee health benefits and profit sharing plan. The Company’s medical plan is self-insured and medical claims and participation fluctuate from year to year. Management has implemented strategies to contain health benefit costs. In November, the Bank opened a new office in Jenison, Michigan. The new office is not expected to significantly increase non-interest expense. Data processing and software expense increased approximately 20% in 2003, following an increase of approximately 25% during 2002. The Bank has completed significant software and hardware upgrades over the past two years. Significant additional investments are not expected in the near-term, however, the Bank anticipates a continued investment in technology to remain competitive and to maintain existing systems. Professional and legal fees decreased 13% compared to 2002, as a result of a reduction in the remediation cost attributed to the prior Supervision and Regulation issues. Professional and legal fees are expected to continue to decline in 2004. Printing & Supplies, Marketing and Other non-interest expenses declined approximately 14% in aggregate. The decrease reflects management’s effort to reduce operating cost and decrease in remediation costs associated with loan collection cost and legal fees. The decrease includes the recapture of approximately $210,000 of director deferred compensation benefit plan expense due to the early retirement of a participating director. Management will continue to explore opportunities to become more efficient and reduce operating expenses that are not directly related to revenue production or necessary for the safe operation of the Bank. Management anticipates that total non-interest expense should be within a range of up 5% to down 5% in 2004.

        Non-interest expense increased $2,367,000 or 16.9% in 2002, compared to 2001. The Company’s salary expense increased 18.4%, or $1,141,000 during 2002, compared to 2001. The increase includes the addition of several key management positions and an increase in the number of employees due to the Bank’s past growth. Employee benefits increased 18.4%, or $278,000 during 2002 compared to a year earlier. The Company’s medical plan is self-insured and there were higher medical claims and more employees enrolled in the plan. Health benefits increased 44.0% over 2001. Data processing and software expense increased 25.3%, or $194,000 during 2002, compared to 2001. Professional and legal fees increased 56.1% or $244,000, compared to 2001. This increase was largely due to issues discussed under Supervision and Regulation. Other non-interest expenses increased 8.7%, or $196,000 in 2002, compared to a year earlier. This increase includes higher postage, lending costs due to growth as well as higher director fees and FDIC fees due to issues discussed under Supervision and Regulation.

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			Year ended December 31,
			2003			2002			2001
Salaries			$	8,044		$	7,343		$	6,202
Employee benefits				1,764			1,792			1,514
Occupancy				1,249			1,197			1,016
Equipment				1,100			1,062			1,064
Data processing and software				1,151			962			768
Professional and legal fees				591			679			435
Printing and supplies				380			523			394
Marketing				203			357			350
Other				2,284			2,460			2,265
Total non-interest expense			$	16,766		$	16,375		$	14,008