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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

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FORM 10-K

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

For the fiscal year ended December 31, 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 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)

_________________

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 [X].   No [__].

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, 2004: $79,925,982

As of February 25, 2005, there were outstanding 2,034,691 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 21, 2005 are incorporated by reference into Part III of this report.

PART I

Item 1. Business.

The Company

        OAK 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 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.

        The Company and all its subsidiaries are provided staff resources through OAK ELC, an employee leasing company. OAK 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 offices. 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.

        On February 17, 2005 the Bank changed its name from Byron Center State Bank to Byron Bank. Along with the new name, a new logo and new colors were introduced. The name change reflects the Bank’s heritage of over 80 years in the banking business and offers a dynamic new look for the future. The name of the Bank’s subsidiaries, OAK Financial Services and Dornbush Insurance Agency were also changed to Byron Investment Services and Byron Insurance, respectively.

        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, Byron Investment Services, Inc., which offers mutual fund products, securities brokerage services, retirement planning services, investment management and advisory services. During 2004, Byron Investment Services, Inc. added tax preparation to its list of available services. This service will allow Byron Investment Services to prepare customers’ tax returns and advise them on investment strategies for future tax savings. Byron Investment Services owns Byron Insurance Agency, Inc., which offers property and casualty, life, disability and long-term care insurance. On January 24, 2005, Byron Investment Services, Inc. formed a joint venture between OAK Title Insurance Agency, Inc. and First Metropolitan Title Co. as members of the new OAK Title Agency, LLC. OAK Title Insurance Agency, Inc. is a wholly owned subsidiary of Byron Investment Services, Inc.

Effect of Government Monetary Policies

        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

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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, Huntington Bank, Macatawa Bank, Mercantile Bank of West Michigan, United Bank of Michigan , and various credit unions. Generally the bank’s products, services, and pricing are competitive within the markets served. However, credit unions, due to favorable tax treatment, frequently offer higher rates on some deposit products.

        The financial services industry is very 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 funds, which traditionally have been deposited with commercial banks. The enactment of the Gramm-Leach-Bliley Act of 1999, which permits the combination of banks, insurance companies, and securities firms, has also increased competition in the financial services industry. Management continues to evaluate the opportunities for the expansion of products and services and additional branching opportunities. Management also believes the Bank is well positioned to compete effectively with other providers of financial serves in West Michigan.

Source of Revenue

        The Bank’s principal sources of revenue include net interest income 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 fees from the sale of loans, deposit service charges, insurance premium income, brokerage fees, mortgage banking and other fees collected for services provided. Mortgage banking revenue includes the gains resulting from the origination and sale of mortgage loans and fees received for servicing mortgage loans for others. The sources of income for the three most recent years are as follows:

Employees

        As of December 31, 2004, the Registrant and subsidiaries employed 153 full-time and 56 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 the 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.

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        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 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 OFIS deems the Bank’s capital to be impaired, 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 percent 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.

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        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 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. During 2004, the Company became an accelerated filer based on its aggregate market value as of June 30, 2004. As such, the Company is required to file regulatory reports on an accelerated basis and is also required to issue a report regarding the company’s system of internal controls.

        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 for bank holding companies are essentially the same as those described below for the Bank.

        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. 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 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 percent 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 percent of deposits for institutions in the lowest risk category to .27 percent 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 percent of deposits.

        OFIS Assessments. Michigan banks are required to pay supervisory fees to OFIS to fund the operations of OFIS. The amount of supervisory fees paid by a bank is based upon the bank’s total assets, as reported to 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 percent for the most highly-rated banks with minimum requirements of 4 percent to 5 percent for all others, and a risk-based capital requirement consisting of a minimum ratio of total capital to total risk-weighted assets of 8 percent, 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, 2004, 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 divest certain subsidiaries; prohibiting the payment of principal or interest on subordinated debt; and ultimately, appointing a receiver for the institution.

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        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 percent 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 Fair and Accurate Credit Transactions 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 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.

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        The USA Patriot Act. The Patriot Act contains sweeping anti-money laundering and financial transparency laws. Under the Act and implementing regulations, among other requirements financial institutions must establish anti-money laundering programs that include (i) internal policies, procedures, and controls, (ii) specific designation of an anti-money laundering compliance officer, (iii) ongoing employee training programs, and (iv) an independent audit function to test the anti-money laundering program. Financial institutions must also implement a risk-based customer identification program in connection with opening new accounts. The program must contain requirements for identity verification, record-keeping, comparison of information to government-maintained lists, and notice to customers. Bank regulators are directed to consider a holding company’s effectiveness in combating money laundering when ruling on Federal Reserve Act and Bank Merger Act applications.

        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.BankAtByron.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 12 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.

        At the end of 2004, the mortgage center, which was located in a separate facility, was in the process of being consolidated into the main office in Byron Center. The Company does not anticipate a continuing need for the facility and plans to list it for sale in 2005.

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.

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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, 2004:

        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.

        The following table sets forth the range of high and low sales prices of the Company’s common stock during 2004 and 2003, based on information available to the Company, as well as per share cash dividends declared during those periods.

At February 18, 2005, the Company has 873 record holders of our common stock. In addition, we estimate that there were approximately 300 beneficial owners of our common stock who own their shares through brokers or banks. The common stock is traded and quoted on the Over-the-Counter Bulletin Board under the symbol “OKFC”.

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        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 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

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

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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. The Company’s 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 its operations and its 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 the Company, including additional factors that could materially affect financial results, is included in the Company’s 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, 2004, 2003 AND 2002

        The following financial review presents management’s discussion and analysis of consolidated financial condition and results of operations during the period of 2002 through 2004. The discussion should be read in conjunction with the Company’s consolidated financial statements and accompanying notes.

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 values 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. Also, in addition to routine examinations by bank regulators, the Company employs 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. Changes in interest rates or repayment speeds could have a significant impact on the carrying value of the mortgage servicing assets.

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FINANCIAL CONDITION

Summary

        Total assets increased 6 percent during 2004 as a result of the Bank making a concentrated effort to grow loans and deposits during the year. Total loans increased 12 percent for the year, due in large part to a 20 percent increase in commercial loans and commercial real estate loans, which was somewhat offset by a 41 percent decline in consumer indirect loans, which the Bank has exited. Total deposits also increased 12 percent for the year. This was mainly the result of a 93 percent increase in NOW accounts, due to a new pricing strategy for the high-interest checking product. This was somewhat offset by a 13 percent decline in MMDA and savings accounts and an 8 percent decline in time deposits as the Bank did not compete aggressively for rate sensitive deposits and decreased its reliance upon deposits from outside its market area. A discussion of changes in balance sheet amounts by major categories follows:

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 a source of liquidity, provide for safety of the principal invested and manage the Bank’s exposure to changes in interest rates.

        A relatively high percentage of the Bank’s security portfolio is pledged. The majority of the securities pledged are to secure 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 $33 million pledged at December 31, 2004 compared to $58 million at December 31, 2003.

        All of the Company’s securities are classified as available-for-sale. As a result, changes in market value are recognized as adjustments to the 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 declined approximately $4 million in 2004. The slight decline is the result of the asset liability management of the Bank in relation to the loan and deposit growth the Bank experienced in 2004.

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, 2004. The weighted average interest rates have been computed on a fully taxable equivalent basis, using a 34 percent tax rate, based on amortized cost.

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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. In previous years the Bank appointed an internal loan review officer to monitor the credit quality of the loan portfolio. During 2005, the Bank will be using the services of an independent third party to periodically review the credit quality of the loan portfolio, separate from the loan approval process. These reviews will be submitted to the Risk Management Officer and to the Audit Committee.

        Requests to the Bank for credit are considered on the basis of the 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 cash flow, collateral, capital and alternative sources of repayment. Loan applications are accepted at all the Bank’s offices and are approved within the limits of 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’s Loan Committee for review and approval.

        The Bank does not have any foreign loans and there were no concentrations greater than 10 percent 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 the low interest financing provided by the auto industry and the Bank’s substantial exit from the consumer indirect business. As of December 31, 2004, the Bank had indirect loans totaling approximately $10 million, down 41 percent from $18 million at December 31, 2003. Management expects the indirect consumer loan portfolio to continue to decline during 2005. During 2004, total loans secured by residential real estate increased 7 percent. The increase was largely comprised of floating rate home equity loans, which increased 60 percent from $20 million at December 31, 2003 to $32 million at December 31, 2004.

        It is the Bank’s general practice to sell residential real estate loans with maturities over 15 years. During 2004, the Bank sold loans totaling $43 million with the servicing rights retained and $25 million with the servicing rights released. At December 31, 2004 and 2003, the Bank was servicing loans totaling approximately $240 million and $257 million, respectively.

        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 otherwise exceed the Bank’s legal lending limit if made solely by the Bank.

        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.

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        Residential Real-Estate Loans: Residential real-estate loans are originated in the Bank’s primary market area. Generally, the Bank sells all salable loans in the secondary market. Loans are underwritten to the Secondary Market Investors Guidelines using the automated underwriting system designed by the investor that will be purchasing a particular loan. On occasion, residential real-estate loans will be retained in the Bank’s portfolio. Personal loans secured by the equity in the borrower’s residence are also granted for a variety of needs.

        Consumer Loans: Consumer loans are originated for a variety of purposes including the acquisition of new and used automobiles, boats and recreational vehicles. 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.

        The Bank experienced significant growth during 2004 in the commercial real estate and commercial loan portfolios. Commercial real estate loans increased $22 million, or 11 percent and commercial loans increased $27 million, or 55 percent. This is the result of a concentrated effort by the Bank to grow business loans. Loans secured by residential real estate increased $6 million or 7 percent during the year. This was mainly the result of a 60 percent increase in home equity lines of credit. Consumer loans declined $10 million, or 29 percent from December 31, 2003 to December 31, 2004. This is primarily the result of an $8 million, or 41 percent, intentional decline, in indirect consumer loans.

        Management has taken significant steps over the past two years 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 upon general and local economic conditions.

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 and 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 total non-performing assets as of December 31, 2004 declined 29 percent, compared to December 31, 2003, which reflects the sale of two commercial properties that were held as other real estate at the end of 2003 and were sold during 2004. The Bank’s management has an aggressive approach to credit management and expects that a significant portion of the customers, with loans in non-accrual status, will secure alternative financing and repay their loans to the Bank. In some instances, non-performing assets are sold to a new borrower of the Bank. As of December 31, 2004 there were no other interest bearing assets, which required classification.

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Foregone Interest on Non-Performing Loans (in thousands)

        The table below presents the interest income that would have been earned on non-performing loans outstanding at December 31, 2004, 2003 and 2002 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.

        As discussed under “Critical Accounting Policies” the Bank establishes an allowance for loan losses including 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. During the fourth quarter of 2004, the Bank was able to reverse $1.1 million of the allowance for loan losses. This is due to the significant improvement in the Bank’s asset quality. The allowance for loan losses as a percent of total loans decreased from 2.31 percent at December 31, 2003 to 1.67 percent at December 31, 2004.

        Net loans charged off for the year, as a percentage of average loans outstanding, decreased from .18 percent in 2003 to .12 percent in 2004. This is primarily the result of the reduction of the amount of commercial real estate loans charged off during the year, which was partially offset by a reduction in the amount of funds recovered on consumer loans. Net charge-offs in the Real Estate portfolio continue to be very low.

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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.

        In determining the adequacy of the allowance for loan losses, management determines (i) a specific allocation for loans when a loss is probable, (ii) an allocation based on credit risk rating for other adversely rated loans, (iii) an allocation based on historical losses for various categories of loans, and (iv) subjective factors including local and general economic factors and trends. The allowance for loan losses as a percent of total loans reflects management’s assessment of the improved quality of the Bank’s assets, the decline in non-performing assets and the improving general economic conditions and labor market.

        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.

        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 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, Federal Home Loan Bank advances, federal funds purchased and other borrowed funds. Non-deposit sources of funding decreased 19 percent or $15 million from December 31, 2003 to December 31, 2004. The decline is the result of a net reduction of $10 million in Federal Home Loan Bank advances during 2004 as well as a significant decline in securities sold under agreements to repurchase, as many of these funds were shifted into NOW and money market accounts. This shift of funds, along with a concentrated effort to grow deposits and the new pricing strategy for the Bank’s high interest checking product, helped to grow the Bank’s total deposits during 2004. Total deposits increased $45 million, or 12 percent, from December 31, 2003 to December 31, 2004. The growth in total deposits includes a decline in certificates of deposit. Certificates of deposit declined $14 million, or 8 percent, during 2004. The decline in certificates of deposit mainly reflects a decrease in time deposits of less than $100,000. Time deposits less than $100,000 declined $19 million, or 20 percent, during 2004. This was partially due to the Bank not being as aggressive in retaining rate sensitive deposits by not offering as many premium priced certificates in 2004 as in prior years. Time deposits over $100,000 increased $4 million, or 6 percent, during 2004. This was the result of the Bank’s loan growth and a need for additional funding that was obtained through brokered deposits. Brokered deposits increased $4 million, or 8 percent, during 2004. The Bank will continue to use brokered deposits as part of its asset & liability management plan.

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        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 is also aligned 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 those markets. The Bank expects this trend to continue. In addition to the traditional bank offices, the Company provides a wide array of alternative electronic methods to serve customers. New cash management products as well as a new business sweep product were introduced in 2004. The Bank expects these new products to be excellent tools in marketing to potential business customers. During 2003, the Bank launched Mobile Banking, a business banking 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. From December 31, 2003 to December 31, 2004 the number of customers using the Mobile Banking courier service has increased more than 150 percent. Management expects this service to continue to be a key factor in attracting new business customers to the Bank.

Average Deposit Balances (dollars in thousands)

        The following table lists the total average deposit balances during 2004 and 2003 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 with many term options.

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

        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 fixed term and fixed interest rate.

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RESULTS OF OPERATIONS

Summary

        As a result of improvements in the Bank’s asset quality, the Bank was able to reverse $1.1 million from the allowance loan losses in 2004 compared to a provision of $625,000 in 2003. This reversal resulted in 2004 net income exceeding 2003 by 8 percent. The Company achieved net income of $4.5 million in 2004 compared to $4.2 million in 2003. Diluted earnings per share increased 8 percent, from $2.04 per share in 2003 to $2.21 per share in 2004. Net loan losses charged against the allowance for loan losses declined from .18 percent of total loans in 2003 to .12 percent of total loans in 2004.

        Net interest income declined approximately 4 percent in 2004. The decrease was a result of declines in the net interest margin. The net interest margin compression is a direct result of the significant commercial loan refinancing activity that occurred during 2002 and 2003, the exceptionally low interest rate environment and competitive pressures. The net interest margin was 3.42 percent in 2004 compared to 3.59 percent in 2003. Although the net interest margin for 2004 was lower than 2003, it showed significant signs of improvement throughout the year. The net interest margin increased 30 basis points from the first quarter of 2004 to the fourth quarter of 2004, from 3.32% to 3.62%, respectively.

        Non-interest income declined 8 percent in 2004, which is the result of a 32 percent decline in mortgage banking related fees and a 9 percent decline in insurance premiums and brokerage fees. The decline in mortgage banking related fees is due to a significant reduction in mortgage refinancing activity. The decline in insurance premiums and brokerage fees, from 2003 to 2004, was mainly due to a significant decline in the annual profit sharing revenue that was received from insurance carriers.

        Total non-interest expenses remained relatively flat from 2003 to 2004, increasing less than 1 percent. Salaries and benefits expenses increased 4 percent in 2004, compared to 2003. This was mainly the result of the increasing cost of providing employee health care. Employee health care expenses increased 42 percent in 2004, compared to 2003. Non-employment related expenses declined 5 percent in 2004. This decline was the result of an organization-wide effort to reduce operating expenses that began in 2003 and continued throughout 2004. As part of the effort to control costs, the Company was also able to reduce its total number of full time equivalent employees by 9 percent during 2004.

Earnings Performance (in thousands, except per share data)

        Net income increased approximately 8 percent from 2003 to 2004. The asset quality improvements that the Bank has made over the past two years resulted in the reversal of $1.1 million of the allowance for loans losses during 2004. This reversal offset a decline in net interest income due to the low interest rate environment and the compression of the net interest margin. It also compensated for an 8 percent decline in non-interest income that was mainly the result of a decline in mortgage related fees.

        Net income increased approximately 10 percent from 2002 to 2003. A significant improvement in asset quality resulted in a lower provision for loans losses during 2003. This offset a decline in net interest income that resulted from a decline in earning assets and compression of the net interest margin. This compression was primarily due to the low interest rate environment. Net income was also affected by a 5 percent decline in non-interest income, primarily due to a decline in mortgage fees and a 2 percent increase in non-interest expense.

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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:

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 $613,000 to $16.7 million in 2004, a 3.5 percent decrease from 2003. This resulted in a net interest margin, as a percentage of average earning assets, on a fully taxable equivalent basis, of 3.42 percent.

        In 2004, the yield on total earning assets declined 42 basis points, compared to a 28 basis point decline in the total interest-bearing liabilities cost of funds. The decline in both the interest yield and the cost of funds was a direct result of the low interest rate environment that occurred over the past few years. During 2004, the interest rate environment stabilized and during the second half of the year short-term rates began to rise. As a result, the Company’s net interest margin showed signs of improvement, rising steadily from 3.27 percent in the first quarter of 2004 to 3.62 percent in the fourth quarter of 2004.

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        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 was 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 reduced the spread and margin on the Bank’s non-interest bearing deposits and other funding sources, known as free funds.

        With the improving economy, management expects the increasing trend in the fully taxable-equivalent (FTE) net interest margin that was experienced during 2004 to continue during 2005. However, the rate of increase is expected to moderate based on the rising cost of funds. 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 is the primary source of interest income for the Bank, accounting for 84 percent, 85 percent, and 88 percent of total interest income for 2004, 2003 and 2002, respectively. Net interest income is significantly influenced by results of the Bank’s lending activities. During the past two years interest income declined $7.2 million, while interest expense declined only $4.4 million over the same period. The primary reason interest income declined faster than interest expense was the significant shift of long-term fixed rate commercial loans to floating rate commercial loans that occurred in 2002 and 2003.

        Total interest expense decreased 12.7 percent, or $1.2 million, from 2003 to 2004 and declined 24.9 percent, or $3.2 million, from 2002 to 2003. The $1.2 million decline in the cost of funds was largely due to the low interest rates that were paid on time deposits, which were slightly offset by the higher rate that was paid on the Bank’s new high interest checking product and the additional volume that this product created. 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 increased to 94 percent in 2004, compared to 93 percent in 2003, due mainly to the increase in the Bank’s loan portfolios. The Bank’s earning asset ratio increased to 93 percent in 2003 from 92 percent in 2002, due to the reduction in loans on non-accrual, which had reduced the earning asset ratio in 2002.

        The free funds ratio, funds on which the Bank does not pay interest, increased from 16 percent in 2003 to 18 percent in 2004. The increase is mainly the result of the increase in the loan portfolios combined with an increase in non-interest bearing deposits. The free funds ratio increased from 12 percent in 2002 to 16 percent in 2003. The improvement reflects an increase in the Bank’s ratio of stockholders’ equity as a percentage of average earning assets.

Provision and Allowance for Loan Loss

        The provision for loan losses charged to earnings was a credit to income of $1,100,000 in 2004, compared to an expense of $625,000 in 2003 and an expense of $4,070,000 in 2002. The credit to income is the result of the improving asset quality of the Bank, combined with improving general economic conditions. 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. Management is projecting that a provision of approximately $500,000 will be necessary during 2005 to support the Bank’s anticipated loan growth, net charge-offs and change in credit quality. The actual provision charged to income may vary from the projected amount based on changes in these factors.

        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)			Year ended December 31,
			2004			2003			2002
Service charges on deposit accounts			$	2,432		$	2,163		$	1,866
Net gains on asset sales:
Loans				1,090			2,780			3,474
Securities				282			236			80
Amortization of mortgage servicing rights				(621	)		(1,754	)		(940	)
Impairment of (recovery of impairment on)
mortgage servicing rights				86			146			(233	)
Loan servicing fees				673			627			488
Insurance premium revenue				1,112			1,227			1,150
Brokerage revenue				278			307			254
Other				404			503			449
Total non-interest income			$	5,736		$	6,235		$	6,588