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SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

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

(Mark One)

x            Annual report pursuant to section 13 or 15(d) of the Securities Exchange Act of 1934 (Fee Required)

for the fiscal year ended December 31, 2002

OR

o            Transition report pursuant to section 13 or 15(d) of the Securities Exchange Act of 1934 (No Fee Required)

for the transition period from ____________________ to ____________________.

Commission File Number 0-24172

GEORGIA BANK FINANCIAL CORPORATION

(Exact Name of Registrant as Specified in its Charter)

Registrant’s Telephone Number, Including Area Code: (706) 738-6990

Securities Registered Pursuant to Section 12(b) of the Act: None

Securities Registered Pursuant to Section 12(g) of the Act:
Common Stock, par value $3.00 per share

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 o

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 amendment to this Form 10-K. x

Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2):
Yes o No x

The number of shares outstanding of the Registrant’s Common Stock, as of March 17, 2003 was 2,385,280. The aggregate market value of the voting stock held by non-affiliates of the Registrant at March 17, 2003, based on the last sale price of $44.00 per share on such date was approximately $46,711,896.

Certain portions of the Company’s definitive Proxy Statement for the Annual Meeting of Shareholders to be held on April 16, 2003 (the “Proxy Statement”) filed pursuant to Rule 14a-6 of the Securities Exchange Act of 1934, as amended, are incorporated by reference into this Form 10-K. Other than those portions of the Proxy Statement specifically incorporated by reference pursuant to Items 10 through 13 of Part III hereof, no other portions of the Proxy Statement shall be deemed so incorporated.

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Item 1.            Description of Business

General

Georgia Bank Financial Corporation (the “Company”) is a Georgia corporation that is a bank holding company registered with the Board of Governors of the Federal Reserve System (the “Federal Reserve”) under the Bank Holding Company Act of 1956, as amended (the “BHCA”). The Company had total consolidated assets of $569.8 million, total deposits of $439.6 million and total stockholders’ equity of $46.7 million at December 31, 2002. Through its wholly-owned subsidiary, Georgia Bank & Trust Company of Augusta (the “Bank”), the Company operates a total of seven banking offices in the greater Augusta area in Richmond and Columbia Counties, Georgia. The Bank also has mortgage operations in Augusta, Georgia, Savannah, Georgia, and Nashville, Tennessee.

The Bank is community oriented and focuses primarily on offering real estate, commercial and consumer loans and various deposit and other services to individuals, small to medium sized businesses and professionals in its market area. The Bank is the only locally owned and managed commercial bank operating in Richmond and Columbia Counties. Each member of the Company’s management team is a banking professional with many years of experience in the Augusta market with this and other banking organizations. A large percentage of Bank management has worked together for many years. The Bank competes against the larger regional and super-regional banks operating in its market by emphasizing the stability and accessibility of its management, management’s long-term familiarity with the market, immediate local decision making and the pride of local ownership.

The Bank was organized by a group of local citizens from Richmond and Columbia Counties and commenced business from the main office location at 3530 Wheeler Road in Augusta on August 28, 1989. The Bank opened its first Augusta branch at 3111 Peach Orchard Road in December 1991 and its second Augusta branch at 1530 Walton Way in December 1992. The Bank became a subsidiary of the Company in February 1992 as a result of its holding company reorganization. The Company acquired FCS Financial Corporation and First Columbia Bank (“First Columbia”) on December 31, 1992. This allowed the Company to expand into neighboring Columbia County. In July 1993, First Columbia merged into the Bank, and the Bank now operates the former main office of First Columbia at 4105 Columbia Road, Martinez, Georgia as a branch. The Bank opened a second branch in Columbia County in November 1994 that is located in Evans, Georgia. In October 1995, the Bank opened its sixth banking office at 3133 Washington Road. The company opened a full service branch in May 2001 in Martinez, Georgia, the third Columbia County branch.

The Bank was founded with an experienced management team, and that team has continued to expand with the growth of the Bank. The Bank’s President and Chief Executive Officer, R. Daniel Blanton, was involved in the organization of the Bank in 1988 and previously served with a predecessor to First Union National Bank, Georgia State Bank, for over 13 years. With the acquisition of First Columbia, the Bank obtained its Executive Vice President and Chief

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Operating Officer, Ronald L. Thigpen, who had served as Chief Executive Officer of First Columbia since 1991, and before that served in various capacities with First Union National Bank and its predecessors. J. Pierce Blanchard, Jr., Executive Vice President-Business Development, joined the team in 1994. He previously served for six years as President of Citizens Bank & Trust Company in Evans, Georgia, and had prior experience with First Union National Bank and its predecessors. The Bank’s senior loan officer and Group Vice President, Tom C. McLaughlin, has been associated with the Bank for nine years, and worked together previously with Mr. Blanton at Georgia State Bank, a predecessor to First Union National Bank. Regina W. Mobley, Group Vice President, Bank Operations has been with the Bank since the acquisition of First Columbia Bank. With over 26 years of bank operations experience, she previously served First Columbia Bank and C&S National Bank, as predecessor of Bank of America.

Market Area

The Bank’s market area includes Richmond and Columbia Counties and is centered in West Augusta. This area represents a significant portion of the Augusta-Aiken metropolitan area. Augusta-Aiken is one of 318 metropolitan statistical areas (MSA) in the United States and its 2000 population of 478,200 ranked 107th in the nation. During the 1990 to 2000 period, the Augusta-Aiken metropolitan area had the fourth fastest growing population among Georgia’s metropolitan areas. The 2000 census shows the Augusta-Aiken area’s population at 477,441 at April 1, 2000. The Augusta market area has a diversified economy based principally on government, transportation, public utilities, health care, manufacturing, and wholesale and retail trade. Augusta is one of the leading medical centers in the Southeast. Significant medical facilities include the Medical College of Georgia, the University Hospital, Veteran’s Administration Hospital, Dwight D. Eisenhower Hospital, Gracewood State School and Hospital, Columbia/Augusta Regional Hospital and St. Joseph’s Hospital. Other major employers in the Augusta market area include the Fort Gordon military installation, E-Z Go (golf car manufacturer), International Paper Company (bleached paper board manufacturer), Thermal Ceramics (insulating material manufacturer), President Baking Company (cookie manufacturer), John Deere (tractor manufacturer) and Club Car (golf car manufacturer). The area is served by Interstate 20, which connects it to Atlanta, 140 miles to the west and Columbia, South Carolina, 70 miles to the east. Augusta is also served by a major commercial airport (Bush Field) and a commuter airport (Daniel Field). The average unemployment rate for the Augusta-Aiken MSA was 4.6% in 2000, and 5.0% in 2001. Between June 2001 and June 2002 (the latest date for which FDIC information is available), total commercial bank and thrift deposits in Richmond County increased 5.0% from $2.0 billion to $2.1 billion, and total commercial bank and thrift deposits in Columbia County increased 10.8% from $640.1 million to $709.2 million. At June 30, 2002, the Bank has 12.3% of all deposits in Richmond County and 19.8% in Columbia County. In both Richmond and Columbia Counties, the Bank has 14.2% of all deposits and is the second largest depository institution. The demographic information as presented above is based upon information and estimates provided by the Selig Center for Economic Growth at the University of Georgia, Georgia Department of Labor and the Federal Deposit Insurance Corporation.

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Lending Activities

General

The Bank offers a wide range of lending services, including real estate, commercial and consumer loans, to individuals, small to medium-sized businesses and professionals that are located in, or conduct a substantial portion of their business in, the Bank’s market area. The Bank’s total loans at December 31, 2002, were $396.7 million, or 73.3% of total interest-earning assets. An analysis of the composition of the Bank’s loan portfolio is set forth under “Management’s Discussion and Analysis of Financial Condition and Results of Operations - Composition of Loan Portfolio.”

Real Estate Loans. Loans secured by real estate are the primary component of the Bank’s loan portfolio, constituting $291.0 million, or 73.35% of the Bank’s total loans, at December 31, 2002. These loans consist of commercial real estate loans, construction and development loans, residential real estate loans, and home equity loans. See “-Consumer Loans.”

Commercial Real Estate Loans. At December 31, 2002, the Bank held $112.0 million of commercial real estate loans of various sizes secured by office buildings, retail establishments, and other types of property. These commercial real estate loans represented 28.23% of the Bank’s total loans at December 31, 2002. Loan terms are generally limited to five years and often do not exceed three years, although the installment payments may be structured on a 20-year amortization basis with a balloon payment at maturity. Interest rates may be fixed or adjustable. The Bank generally charges an origination fee. Management attempts to reduce credit risk in the commercial real estate portfolio by emphasizing loans on owner-occupied office and retail buildings where the loan-to-value ratio, established by independent appraisals, does not exceed 80%. In addition, the Bank requires personal guarantees from the principal owners of the property supported with an analysis by the Bank of the guarantors’ personal financial statements in connection with a substantial majority of such loans. A number of the loans classified as commercial real estate loans are, in fact, commercial loans for which a security interest in real estate has been taken as additional collateral. These loans are subject to underwriting as commercial loans as described below. The Bank experienced a $5,000 net loan recovery on commercial real estate loans during 2002.

Construction and Development Loans. Construction and development real estate loans comprise $79.5 million, or 20.04% of the Bank’s total loans at December 31, 2002.

A construction and development loan portfolio represents special problems and risks. The level of construction and development loans are representative of the character of the Bank’s market. Columbia County has been rated among the top five in the State of Georgia in population growth during each of the last four years. This growth has spawned a significant demand for residential housing in Columbia County. The Bank subjects this type of loan to

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underwriting criteria that include: certified appraisal and valuation of collateral; loan-to-value margins (typically not exceeding 75%); cash equity requirements; evaluations of borrowers’ cash flows and alternative sources of repayment; and a determination that the market is able to absorb the project on schedule.

To further reduce the risk related to construction and development loans, the Bank generally relies upon the long-standing relationships between its loan officers and the developer and contractor borrowers. In most cases these relationships exceed ten or more years. The Bank targets seasoned developers and contractors who have experience in the local market. Various members of the Bank’s Board of Directors have close contacts with the construction industry: Robert W. Pollard, Jr. owns and operates a lumber manufacturing company; E. G. Meybohm owns the largest local real estate brokerage firm; Larry S. Prather owns a utility and grading company and William J. Badger owns and operates a lumber company. Through these connections to the industry, the Bank attempts to monitor current economic conditions in the market place for residential real estate, and the financial standing and on-going reputation of its construction and development borrowers.

Infrastructure development loans are generally made with an initial maturity of one year, although the Bank may renew the loan for up to two additional one-year terms to allow the developer to complete the sale of the lots comprising the property before requiring the payment of the related loan. These loans typically bear interest at a floating rate and the Bank typically charges an origination fee. These loans are repaid, interest only, on a monthly or quarterly basis until sales of lots begin, and then principal payments are made as each lot is sold at a rate allowing the Bank to be repaid in full by the time 75% of the lots have been sold. In order to reduce the credit risk associated with these loans, the Bank requires the project’s loan to value ratio (on an as completed basis) to be not more than 70%. The Bank experienced $36,000 in net loan charge-offs on these loans during 2002.

Residential construction loans are typically made for homes with a completed value in the range of $110,000 to $300,000. Loans for the lower-value homes are typically made for a term of six months, while loans for the larger homes are typically made for a term of nine to twelve months. Typically, these loans bear interest at a floating rate and the Bank collects an origination fee. The Bank may renew these loans for one additional term (equal to the original term) to allow the contractor time to market the home. In order to reduce the credit risk with respect to these loans, the Bank restricts the loans that are made for homes being built on a speculative basis, carefully manages its aggregate lending relationship with each borrower, and requires approval of the Loan Committee of the Board of Directors to lend more than $500,000 in the aggregate to any borrower and its related interests.

Residential Loans.   The Bank originates, on a selective basis, residential loans for its portfolio on single-and multi-family properties, both owner-occupied and non-owner-occupied. At December 31, 2002, the Bank held $75.2 million of such loans, including home equity loans, representing 19.0% of the Bank’s loan portfolio, as compared to $63.9 million, or 18.8% of the Bank’s loan portfolio at December 31, 2001. There has been little growth in Residential Loans as most mortgage loans are sold in the secondary market. This portfolio includes, typically 15 or 30-year adjustable rate mortgage loans whose terms mirror those prevalent in the secondary

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market for mortgage loans or, less typically, floating rate non-amortized term loans for purposes other than acquisition of the underlying residential property. A limited number of fixed rate loans are maintained in the portfolio when there are compelling market reasons to do so. Generally, all fixed rate residential loans are sold into the secondary market. In the case of home equity loans and lines of credit, the underwriting criteria are the same as applied by the Bank when making a first mortgage loan, as described above. Home equity lines of credit typically expire ten years after their origination.

The Bank also originates residential loans for sale into the secondary market, an activity that began with the acquisition of First Columbia. Residential real estate lending for the purpose of sale of such loans was further expanded with the acquisition of Georgia Union Mortgage Company in May of 1997. The Bank further expanded its secondary market mortgage operations in June 2000 with the addition of experienced mortgage staff. The Bank moved its mortgage department from the Martinez Branch to its facilities located in the Operations Complex at 3515 Wheeler Road to accommodate this expansion. In September of 2000, the Bank acquired the mortgage origination offices of Prime Lending in Savannah, Georgia. In April of 2001, the Bank acquired the mortgage origination offices of Prime Lending in Nashville, Tennessee. The addition of experienced mortgage personnel well known to our management staff provides an opportunity to participate in that dynamic market. The Bank originates both fixed and variable rate residential mortgage loans for sale with servicing released. Loans originated for sale into the secondary market are approved for purchase by an investor prior to closing and the Bank takes no credit or interest rate risk with respect to these loans. The Bank generates loan origination fees, typically ranging from 1.0% to 1.5% of the loan balance, and servicing release fees, generally ranging from 0.25% to 0.75% of the loan balance, both of which are recognized as income when the loan is sold. The Bank limits interest rate and credit risk on these loans by locking the interest rate for each loan with the secondary investor and receiving the investor’s underwriting approval prior to originating the loan. The Bank had $24.3 million of such loans at December 31,2002, representing 6.1% of the Bank’s total loans.

Commercial Loans. The Bank makes loans for commercial purposes in various lines of businesses. At December 31, 2002, the Bank held $55.7 million of these loans, representing 14.04% of the total loan portfolio, excluding for these purposes commercial loans secured by real estate. See “-Real Estate Loans.” Equipment loans are made for a term of up to five years (more typically three years) at fixed or variable rates, with the loan being fully amortized over the term and secured by the financed equipment with a loan-to-value ratio of 80% or less. Working capital loans are made for a term typically not exceeding one year. These loans are usually secured by accounts receivable or inventory, and principal is either repaid as the assets securing the loan are converted into cash, or principal is due at maturity. The Bank experienced net loan charge-offs on commercial loans of $413,000 during 2002 and $282,000 during 2001.

Consumer Loans. The Bank makes a variety of loans to individuals for personal and household purposes, including secured and unsecured installment and term loans, and revolving lines of credit such as overdraft protection. During 1999, the Bank sold its credit card portfolio of $2.4 million. At December 31, 2002, the Bank held $49.9 million of consumer loans, representing 12.6% of total loans. These loans typically carry balances of less than $25,000 and

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earn interest at a fixed rate. Non-revolving loans are either amortized over a period not exceeding 60 months or are ninety-day term loans. Revolving loans require monthly payments of interest and a portion of the principal balance (typically 2 to 3% of the outstanding balance). The Bank entered the indirect lending business in 1997 and currently purchases sales finance contracts from dealers for new and used automobiles and home improvements. At December 31, 2002, indirect loans outstanding totaled $24.7 million. The Bank experienced net loan charge-offs on consumer loans of $547,000 during 2002 and $572,000 during 2001.

Loan Approval and Review. The Bank’s loan approval policies provide for various levels of officer lending authority. When the aggregate amount of outstanding loans to a single borrower exceeds that individual officer’s lending authority, the loan request must be considered and approved by an officer with a higher lending limit or by the Directors’ Loan Committee. Individual officers’ lending limits range from $10,000 to $400,000 depending on seniority and the type of loan. Any loan in excess of the lending limit of senior bank officers must be approved by the Directors’ Loan Committee.

The Bank has a loan review procedure involving multiple officers of the Bank which is designed to promote early identification of credit quality problems. All loan officers are charged with the responsibility of rating all their loans exceeding $25,000 and reviewing those loans on a periodic basis, the frequency of which increases as the quality of the loans decreases. The Bank’s Senior Credit Officer is charged with the responsibility of ensuring that all lending relationships of $300,000 and above are reviewed annually. In addition, the Credit Administration Department, under the direction of the Senior Credit Officer is involved in the analysis of all loans that require Directors Loan Committee approval.

Deposits

The Bank offers a variety of deposit programs to individuals and to small to medium-sized businesses and other organizations at interest rates generally consistent with local market conditions. The following table sets forth the mix of depository accounts at the Bank as a percentage of total deposits at the dates indicated.

Deposit Mix

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The Bank accepts deposits at its main office and six branch banking offices, each of which maintains an automated teller machine. The Bank is a member of the “HONOR” network of automated teller machines, which permits Bank customers to perform certain transactions in many cities throughout Georgia and other regions. The Bank controls deposit volumes primarily through the pricing of deposits and to a certain extent through promotional activities such as “free checking”. The Bank also utilizes other sources of funding, specifically repurchase agreements and Federal Home Loan Bank borrowings and occasionally brokered certificates of deposit. Deposit rates are set weekly by senior management of the Bank. Management believes that the rates it offers are competitive with, or in some cases, slightly above those offered by other institutions in the Bank’s market area. The Bank does not actively solicit deposits outside of its market area.

Competition

The banking business generally is highly competitive, and sources of competition are varied. The Bank competes as a financial intermediary with other commercial banks, savings and loan associations, credit unions, mortgage banking companies, consumer finance companies, securities brokerages, insurance companies, and money market mutual funds operating in Columbia and Richmond Counties and elsewhere. In addition, recent legislative and regulatory changes and technological advances have enabled customers to conduct banking activities without regard to geographic barriers through computer-based banking and similar services.

Many of the financial organizations in competition with the Company have much greater financial resources, more diversified markets and larger branch networks than the Company and are able to offer similar services at varying costs with higher lending limits. In addition, with the enactment of federal and state laws affecting interstate and bank holding company expansion, there have been major interstate acquisitions involving Augusta financial institutions which have offices in the Company’s market area but are headquartered in other states. The effect of such acquisitions (and the possible increase in size of the financial institutions in the Company’s market areas) may further increase the competition faced by the Company. The Company believes, however, that it will be able to use its local independent image to its advantage in competing for business from certain Augusta individuals and businesses.

Employees

The Company had approximately 233 full-time equivalent employees at December 31, 2002. The Company maintains training, educational and affirmative action programs designed to prepare employees for positions of increasing responsibility in both management and operations, and provides a variety of benefit programs, including group life, health, accident and other insurance and retirement plans. None of the Company’s employees are covered by a collective bargaining agreement, and the Company believes its employee relations are generally good.

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Supervision and Regulation

The Company and the Bank are subject to extensive state and federal banking laws and regulations which impose specific requirements or restrictions on, and provide for general regulatory oversight with respect to, virtually all aspects of their operations. These laws and regulations are generally intended to protect depositors or customers, not stockholders. The following summary of statutory or regulatory provisions is qualified in its entirety by reference to the particular statutory and regulatory provisions. Any change in applicable laws, or the policies or practices of the federal and state regulatory agencies, may have a material effect on the business and prospects of the Company. The Company is unable to predict the nature or the extent of the effect on its business and earnings that fiscal or monetary policies, or new federal or state legislation or regulation may have in the future.

Federal Bank Holding Company Regulation

The Company is a bank holding company within the meaning of the Bank Holding Company Act of 1956 (the “BHCA”). Under the BHCA, the Company is subject to periodic examination by the Federal Reserve and is required to file periodic reports of its operations and such additional information as the Federal Reserve may require. The Company’s activities are limited to banking, managing or controlling banks, furnishing services to or performing services for its subsidiaries, or engaging in any other activity that the Federal Reserve determines to be so closely related to banking or managing or controlling banks as to be a proper incident thereto.

Investments, Control, and Activities. The Company must generally obtain the prior approval of the Federal Reserve before acquiring or merging with another bank holding company or acquiring another bank. Similarly, prior approval or clearance is required before another person, group or company may acquire direct or indirect control of, or merge with, the Company.

Under the BHCA, the Company is generally prohibited from engaging in, or acquiring direct or indirect control of more than 5% of the voting shares of any company engaged in nonbanking activities, unless the Federal Reserve, by order or regulation, has found those activities to be so closely related to banking or managing or controlling banks as to be a proper incident thereto. Some of the activities that the Federal Reserve has determined by regulation to be proper incidents to the business of banking include making or servicing loans and certain types of leases, engaging in certain insurance agency and securities brokerage activities, engaging in limited insurance and securities underwriting, performing certain data processing services, acting in certain circumstances as a fiduciary or investment or financial advisor, owning savings associations, and making investments in certain corporations or projects designed primarily to promote community welfare. The Federal Reserve has adopted regulations governing the approval requirements associated with permissible non-banking activities.

Pursuant to the Gramm-Leach Bliley Act (“GLB”) enacted in 1999, bank holding companies that are well-capitalized and well-managed and meet certain other conditions can elect to become “financial holding companies.” As such, they and their subsidiaries are permitted to acquire or engage in previously impermissible activities such as insurance underwriting, securities

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underwriting and distribution, certain travel agency activities, broad insurance agency activities, merchant banking, and other activities that the Federal Reserve determines to be financial in nature or complementary thereto. While the Company does not currently intend to become a financial holding company in order to exercise the broader activity powers provided by GLB, it may elect to do so in the future.

Source of Strength; Cross-Guarantee. In accordance with Federal Reserve 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 in which the Company might not otherwise do so. Under the BHCA, the Federal Reserve may require a bank holding company to terminate any activity or relinquish control of a nonbank subsidiary (other than a nonbank subsidiary of a bank) upon the Federal Reserve’s determination that such activity or control constitutes a serious risk to the financial soundness or stability of any subsidiary depository institution of the bank holding company. Further, federal bank regulatory authorities have additional discretion to require a bank holding company to divest itself of any bank or nonbank subsidiary if the agency determines that divestiture may aid the depository institution’s financial condition. If the Company controlled two or more banks (which it does not), each bank may be required to indemnify, or cross-guarantee, the FDIC against losses it incurs were another of the bank subsidiaries to fail. Such arrangement would in effect make a bank holding company’s equity investments in healthy bank subsidiaries available to the FDIC to assist any failing or failed bank subsidiary of each holding company.

The Bank

General. The Bank is a Georgia-chartered bank, and its deposits are insured by the FDIC to the extent provided by law. It is not a member of the Federal Reserve System. The Georgia Department of Banking and Finance (the “Department”) and the FDIC are the primary regulators for the Bank. These regulatory authorities regulate or monitor all areas of the Bank’s operations, including security devices and procedures, adequacy of capitalization and loss reserves, loans, investments, borrowings, deposits, mergers, issuances of securities, payment of dividends, interest rates payable on deposits, interest rates or fees chargeable on loans, establishment of branches, corporate reorganizations, maintenance of books and records, and adequacy of staff training to carry on safe lending and deposit gathering practices. The Bank must maintain certain capital ratios and is subject to limitations on aggregate investments in real estate, bank premises, and furniture and fixtures.

All insured institutions must undergo regular on-site examination by their appropriate banking agency. The cost of examinations of insured depository institutions and any affiliates may be assessed by the appropriate agency against each institution or affiliate as it deems necessary or appropriate. Insured institutions are required to submit periodic reports to the FDIC and the appropriate state supervisor when applicable.

Transactions With Affiliates and Insiders. The Bank is subject to limitations on the amount of loans or extensions of credit to, or investments in, or certain other transactions with, affiliates and on the amount of advances to third parties collateralized by the securities or obligations of affiliates. The Bank may not engage in certain transactions with affiliates unless the transactions are on terms substantially the same, or at least as favorable to such institution or its subsidiaries, as those

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prevailing at the time for comparable transactions with non-affiliated companies. The Bank is subject to certain restrictions on extensions of credit to executive officers, directors, certain principal stockholders, and their related interests. Such extensions of credit (i) must be made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with third parties and (ii) must not involve more than the normal risk of repayment or present other unfavorable features.

Branching. In addition to the main office, the Bank currently has three branches in Richmond County and three branches in Columbia County. Under current Georgia law, banks may establish branches throughout the state. The Company, with prior regulatory approval, may also acquire an interest in and operate banks throughout the State of Georgia. There are currently no definitive plans for the Company to make any such acquisition, but the Company remains open to such acquisitions as part of its strategic growth plan.

The Company may also acquire banks or bank holding companies located in other states, subject to certain deposit-percentage, aging requirements and other restrictions. Subject to similar restrictions, the Bank may likewise merge with or acquire banks located in other states, and if permissible under state law, may enter other states through de novo branches. Out-of-state bank holding companies and banks may engage in similar transactions in Georgia, although Georgia law does not permit acquisitions or mergers involving banks less than five years old or the initial entry into Georgia through de novo branching or the acquisition of less than all of a bank. Once in the state, however, Georgia law permits out-of-state institutions to expand throughout the state on the same basis as the Company and the Bank.

Community Reinvestment Act. The Community Reinvestment Act requires that, each insured depository institution shall be evaluated by its primary federal regulator with respect to its record in meeting the credit needs of its local community, including low and moderate income neighborhoods, consistent with the safe and sound operation of those institutions. These factors are also considered in evaluating mergers, acquisitions, and applications to open a branch or facility. The Bank received a satisfactory rating in its most recent evaluation.

Other Statutes and Regulations. The operations of the Bank are subject to a myriad of federal and state statutes, many of which are specifically designed to protect individual customers of the Bank. These include statutes requiring accurate disclosure of interest rates, terms and conditions of loans and deposits, prohibiting discrimination in lending, the collection of indebtedness and other similar matters. The Bank is also required to make reports of certain large or suspicious transactions to state and federal regulators. GLB requires the Bank to safeguard personal information it obtains from its individual customers and to adopt and disclose policies regarding the sharing of personal information it obtains with third parties.

On October 26, 2001, the Uniting and Strengthening America by providing Appropriate Tools Required to Intercept and Obstruct Terrorism (USA PATRIOT) Act of 2001, was signed into law. Among the provisions applicable to financial institutions, the act calls for the issuance of new “know your customer” requirements that will obligate financial institutions to take actions to verify the identity of the account holders in connection with the opening of an account at any U.S. financial institution. Banking regulators may consider a financial institution’s

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compliance with the act’s money laundering provisions in making decisions regarding approval of acquisitions and mergers. In addition, the law gives the regulatory authorities the ability to impose sanctions for violations of the act.

Federal and state laws affect the ability of the Bank and the Company to establish and to close branch offices, to engage in new activities, to invest funds and, under certain circumstances, to accept brokered deposits. These restrictions may affect the ability of the Company and the Bank to respond to changes in market or economic conditions. There are numerous proposals pending for changes in state and federal laws and regulations that may substantially impact the business and operations of the Company and the Bank.

Enforcement Policies and Actions

The FDIC and other state and federal depository institution regulators monitor compliance with laws, rules and regulations. In the event the Company or the Bank violates a law, rule or regulation, or engages in unsafe or unsound practices, the regulators are authorized to impose fines or penalties, require that the institution cease and desist from certain activities or use other enforcement powers. Under certain circumstances, the agencies may enforce these remedies directly against officers, directors, employees or others participating in the affairs of a bank or bank holding company.

Deposit Insurance

The deposits of the Bank are currently insured to a maximum of $100,000 per depositor, subject to certain aggregation rules. The FDIC assesses premiums against federally insured banks and thrifts for deposit insurance. Separate insurance funds, the Bank Insurance Fund (BIF) and the Savings Association Insurance Fund (SAIF), are maintained for commercial banks and thrifts, respectively, with insurance premiums from the industry used to offset losses from insurance payouts when banks and thrifts fail. The Bank is a member of the BIF.

Because of the current level of reserves in the BIF, and as the Bank’s risk classification is the lowest allowable, the Bank was not required to pay an assessment for deposit insurance in 2001 and 2002. It is possible, given the recent number of bank failures and the growth of insured deposits among BIF-member banks, that deposit insurance assessments may be levied against the Bank in the near future. The Bank does pay an assessment to the FDIC for the Financing Corporation (FICO) bonds issued as a result of the thrift crisis of the late 1980’s and early 1990’s. This premium is adjusted quarterly, with the annual rate being set at $1.68 per $100 of insured deposits for the first quarter of 2003. This assessment is subject to change. Any increase in deposit insurance premiums (or related assessments such as the FICO obligation) for the Bank will increase its cost of funds, and there can be no assurance that such cost can be passed on to the Bank’s customers.

Dividends

The principal source of the Company’s cash revenues comes from dividends received from the Bank. The amount of dividends that may be paid by the Bank to the Company depends on the Bank’s earnings and capital position and is limited by federal and state law, regulations, and

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policies. In addition, the Federal Reserve has stated that bank holding companies should refrain from or limit dividend increases or reduce or eliminate dividends under circumstances in which the bank holding company fails to meet minimum capital requirements or in which its earnings are impaired.

Cash dividends on the Bank’s common stock may be declared and paid only out of its retained earnings, and dividends may not be declared at any time at which the Bank’s paid-in capital and appropriated retained earnings do not, in combination, equal at least 20% of its capital stock account. In addition, the Department’s current rules and regulations require prior Department approval before cash dividends may be declared and paid if: (i) the Bank’s ratio of equity capital to adjusted total assets is less than 6%; (ii) the aggregate amount of dividends declared or anticipated to be declared in that calendar year exceeds 50% of the Bank’s net profits, after taxes but before dividends, for the previous calendar year; or (iii) the percentage of the Bank’s assets classified as adverse as to repayment or recovery by the Department at the most recent examination of the Bank exceeds 80% of the Bank’s equity capital as reflected at such examination. The Bank is also prohibited from paying a cash dividend if, after paying the dividend, the Bank would be undercapitalized. See “Capital Regulations” below.

No cash dividends were declared in 2002 or 2001. The Company paid a 15% stock dividend on August 31, 2001.

Capital Regulations

The federal bank regulatory authorities have two sets of capital guidelines for banks and bank holding companies, a leverage test (measuring capital against assets) and a risk-based test (measuring capital against risk-weighted assets and off-balance sheet items). The guidelines are minimums, and the federal regulators have noted that banks and bank holding companies contemplating significant expansion programs should not allow expansion to diminish their capital ratios and should maintain ratios well in excess of the minimums. The current guidelines require all bank holding companies and federally regulated banks to maintain a ratio of total capital to risk-weighted assets of not less than 8%, of which at least 4% must be Tier 1 capital, and meet a minimum leverage ratio of Tier 1 capital to assets of not less than 3%. For the purposes of these tests, Tier 1 capital includes common stockholders equity, qualifying perpetual preferred stock, and minority interest in equity accounts of consolidated subsidiaries, but excludes goodwill and most other intangibles and excludes the allowance for loan and lease losses. Tier 2 capital includes the excess of any preferred stock not included in Tier 1 capital, mandatory convertible securities, hybrid capital instruments, subordinated debt and intermediate term preferred stock, and general allowances for loan and lease losses up to 1.25% of risk-weighted assets. Under the risk-based test, assets and off-balance sheet items are allocated certain percentages, reflecting perceived risks, ranging from 0% for U.S. government obligations, to 100% for most loans. Both the Company and the Bank exceeded their respective regulatory capital requirements at December 31, 2002. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations - Capital.”

Provisions of federal law set forth a capital-based regulatory scheme designed to promote early intervention for troubled banks and requires the FDIC to choose the least expensive resolution

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of bank failures. The capital-based regulatory framework contains five categories of compliance with regulatory capital requirements, including “well-capitalized,” “adequately capitalized,” “undercapitalized,” “significantly undercapitalized,” and “critically undercapitalized.” To qualify as a “well-capitalized” institution, a bank must have a leverage ratio of no less than 5%, a Tier 1 risk-based ratio of no less than 6%, and a total risk-based capital ratio of no less than 10%, and the bank must not be under any order or directive from the appropriate regulatory agency to meet and maintain a specific capital level. As of December 31, 2002, the Company and the Bank were qualified as “well-capitalized.”

Were the Company or the Bank to be less than well-capitalized, they would fall under a series of increasing regulatory restrictions. Institutions that fall into one of the three undercapitalized categories may be required to (i) submit a capital restoration plan; (ii) raise additional capital; (iii) restrict their growth, deposit interest rates, and other activities; (iv) improve their management; (v) eliminate management fees; or (vi) divest themselves of all or a part of their operations. Bank holding companies controlling financial institutions can be called upon to boost the institutions’ capital and to partially guarantee the institutions’ performance under their capital restoration plans. The Company believes it important to remain well-capitalized and avoid the imposition of such restrictions.

The federal banking regulators continue to refine the risk-based capital standards to take into consideration various risks that may not be adequately addressed in the current framework. It is uncertain what effect these regulations, when implemented, would have on the Company and the Bank.

Fiscal and Monetary Policy

The earnings of the Bank depend in significant part on the difference between the interest paid by the Bank on its deposits and its other borrowings and the interest received by the Bank on its loans, securities holdings, and the gain on sale of mortgage loans in the secondary market. Thus, the earnings and growth of the Company and the Bank are subject to the influence of economic conditions generally, both domestic and foreign, and also to the monetary and fiscal policies of the United States and its agencies, particularly the Federal Reserve. The Federal Reserve conducts open market dealings in U.S. government securities, and establishes certain interest rates and reserve requirements, all of which directly impact the operating results of the Bank. The conditions in the national and international economies and money markets, as well as the actions and changes in policy by monetary and fiscal authorities, and their effect on the Company and the Bank cannot be predicted.

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Item 2.            Description of Property

The Company currently operates a main office, six branches and an operations center housed in a series of buildings adjacent to the main office. The principal administrative offices of the Company are located at 3530 Wheeler Road, Augusta, Georgia. The main office and three branch offices are located in Augusta, Georgia, two branches are located in Martinez, Georgia and one branch is located in Evans, Georgia.

With the exception of the Washington Road branch, each banking office is a brick building of Georgian architecture with a teller line, customer service area, offices for the Bank’s lenders, drive-in teller lanes, a vault with safe deposit boxes, and a walk-up or drive-up automated teller machine. The banking offices are generally 3,000 to 5,000 square foot buildings except for the main office and the Washington Road branch. The main office contains approximately 14,000 square feet of space. The Washington Road branch contains 1,800 square feet and was converted into a drive through only bank in May 2001 when the new Furys Ferry branch located in close proximity was opened. The new Furys Ferry branch is a 3,500 square feet, full-service banking office on Furys Ferry Road in Columbia County.

In 1997, the Company acquired 24,000 square feet of commercial office space located at 3515 Wheeler Road, across the street from the main office. The Company renovated 17,000 square feet of this newly acquired space to be utilized for a consolidation of all operational functions, including data processing, deposit operations, human resources, loan operations, security, credit administration, audit and accounting. The objective of the Company in acquiring this property and planning the renovation was to provide adequate space for existing operations and to meet future requirements necessitated by growth of the Company. Renovations were completed in June 1998 and operational functions were relocated. In June 2000, the mortgage operations were moved to this Operations Complex, and occupied 4,500 square feet. In August 2001, with the expiration of a 3,000 square foot tenant lease, the mortgage department expanded operations and now occupies a total of 6,000 square feet. The remaining 1,500 square feet continue to be leased as commercial office space to an existing tenant.

In November 2002, the Bank purchased approximately 23,400 square feet of commercial office space on Walton Way Ext., located in close proximity to the Operations Complex and Main Office. Approximately 12,500 square feet will be renovated in 2003 to accommodate operational functions. Approximately 3,500 square feet of this property is leased until late 2003. All properties owned by the Company are adequately covered by the appropriate insurance for replacement value.

The Company’s automated teller machine network includes four drive-up machines located in major retail shopping areas in addition to those located in all branch offices.

See Note 5 to the Consolidated Financial Statements for additional information concerning the Bank’s premises and equipment and Note 7 to the Consolidated Financial Statements for additional information concerning the Bank’s commitments under various equipment leases.

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Item 3.            Legal Proceedings

In the ordinary course of business, the Company and the Bank are parties to various legal proceedings. Although the amount of any ultimate liability with respect to such matters cannot be determined, in the opinion of management, there is no proceeding pending or, to the knowledge of management, threatened in which an adverse decision would result in a material adverse change to the consolidated results of operations or financial condition of the Company and the Bank.

Item 4.            Submission of Matters to a Vote of Shareholders

There were no matters submitted to a vote of the shareholders of the Company during the fourth quarter of the Company’s fiscal year ended December 31, 2002.

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PART II

Item 5.            Market for the Company’s Common Equity and Related Stockholder Matters

As of March 17, 2003, there were approximately 742 holders of record of the Company’s common stock. As of March 17, 2003, there were 2,385,280 shares of the Company’s common stock issued and outstanding. Transactions in the Company’s common stock are generally negotiated through UBS PaineWebber and SunTrust Robinson-Humphrey Company, Inc. via the over-the-counter bulletin board both firms make a market in the common stock of the Company. The following table reflects the range of high and low bid quotations in the Company’s common stock for the past two years:

Georgia Bank Financial Corporation Stock Price

No cash dividends were paid on the common stock of the Company in 2002, and the Company does not presently plan to pay such dividends in 2003. The Company currently has no source of income other than dividends and other payments received from the Bank. The amount of dividends that may be paid by the Bank to the Company depends upon the Bank’s earnings and capital position and is limited by federal and state law, regulations and policies.

Cash dividends on the Bank’s common stock may be declared and paid only out of its retained earnings, and dividends may not be declared at any time when the Bank’s paid-in capital and appropriated earnings do not, in combination, equal at least 20% of its capital stock account. In addition, the Georgia Department of Banking and Finance’s current rules and regulations require prior approval before cash dividends may be declared and paid if: (1) the Bank’s ratio of equity capital to adjusted total assets is less than 6%; (ii) the aggregate amount of dividends declared or anticipated to be declared in that calendar year exceeds 50% of the Bank’s net profits, after taxes but before dividends, for the previous calendar year; or (iii) the percentage of the Bank’s loans classified as adverse as to repayment or recovery by the Georgia Department of Banking and Finance at the most recent examination of the Bank exceeds 80% of the Bank’s equity as reflected at such examination.

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The following table provides information regarding compensation plans under which equity securities of the Company are authorized for issuance. All data is presented as of December 31, 2002.

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Item 6.            Selected Consolidated Financial Data

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Item 7.            Management’s Discussion and Analysis of Financial Condition and Results of Operations

The purpose of this discussion is to focus on significant changes in the financial condition and results of operations of the Company and the Bank during the past three years. The discussion and analysis is intended to supplement and highlight information contained in the accompanying consolidated financial statements and related notes to the consolidated financial statements.

Critical Accounting Policies

The accounting and financial reporting policies of Georgia Bank Financial Corporation and subsidiary conform to generally accepted accounting principles and to general practices within the banking industry. Of these policies, management has identified the allowance for loan losses as a critical accounting policy that requires difficult subjective judgment and is important to the presentation of the financial condition and results of operations of the Company.

The allowance for loan losses is established through a provision for loan losses charged to expense. Loans are charged against the allowance for loan losses when management believes that the collectibility of the principal is unlikely. Subsequent recoveries are added to the allowance. The allowance is an amount that management believes will be adequate to absorb losses on existing loans that become uncollectible, based on evaluations of the collectibility of loans. The evaluations take into consideration such factors as changes in the nature and volume of the loan portfolio, historical loss rates, overall portfolio quality, review of specific problem loans, and current economic conditions and trends that may affect a borrower’s ability to repay.

The Company segments its allowance for loan losses into the following five major categories: 1) identified losses for impaired loans; 2) general reserves for Classified/Watch loans; 3) general reserves for loans with satisfactory ratings; 4) general reserves based on economic and market risk qualitative factors, and 5) an unallocated amount. Risk ratings are initially assigned in accordance with the Bank’s loan and collection policy. An organizationally independent department reviews grade assignments on an ongoing basis. Management reviews current information and events regarding a borrowers’ financial condition and strengths, cash flows available for debt repayment, the related collateral supporting the loan and the effects of known and expected economic conditions. When the evaluation reflects a greater than normal risk associated with the individual loan, management classifies the loan accordingly. If the loan is determined to be impaired, management allocates a portion of the allowance for loan losses for that loan based upon the present value of future cash flows discounted at the loan’s effective interest rate or the fair value of the collateral as the measure for the amount of the impairment. Impairment losses are included in the allowance for loan losses through a charge to the provision for losses on loans. Subsequent recoveries are added to the allowance for loan losses. Cash receipts for accruing loans are applied to principal and interest under the contractual terms of the loan agreement. Cash receipts on impaired loans for which the accrual of interest has been discontinued are applied first to principal and then to interest income. Impaired and Classified/Watch loans are aggressively monitored. The reserves for loans rated satisfactory are further subdivided into various types of loans as defined by call report codes. The unallocated

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component of the reserve decreased $648,000 in 2002 as the Company developed specific qualitative factors to apply to each individual component of the reserve. These qualitative factors are based upon economic, market and industry conditions that are specific to the Company’s local two county markets. These qualitative factors include, but are not limited to, national and local economic conditions, bankruptcy trends, unemployment trends, loan concentrations, dependency upon government installations and facilities, and competitive factors in the local market. These allocations for the qualitative factors are included in the various individual components of the allowance for loan losses. The qualitative factors are subjective in nature and require considerable judgment on the part of the Bank’s management. However, it is the Bank’s opinion that these factors do represent uncertainties in the Bank’s business environment that must be factored into the Bank’s analysis of the allowance for loan losses. The Bank is committed to developing more historical data in the future to reduce the dependence on these qualitative factors. The unallocated component of the allowance is established for losses that specifically exist in the remainder of the portfolio, but have yet to be identified.

Management believes that the allowance for loan losses is adequate. While the Company has 73.35% of its loan portfolio secured by real estate loans, this percentage is not significantly higher than in previous years. Commercial real estate comprises 28.23 % of the loan portfolio and is primarily owner occupied properties where the operations of the commercial entity provide the necessary cash flow to service the debt. For this portion of real estate loans, repayment is not dependent upon liquidation of the real estate. Construction and development (20.04%) has been an increasingly important portion of the real estate loan portfolio. The Company carefully monitors the loans in this category since the repayment of these loans is generally dependent upon the liquidation of the real estate and is impacted by national and local economic conditions. The residential category represents those loans that Company chooses to maintain in its portfolio rather than selling into the secondary market for marketing and competitive reasons. The residential held for sale comprises loans that are in the process of being sold into the secondary market. The credit has been approved by the investor and the interest rate locked so the Company takes no credit or interest rate risk with respect to these loans. The Company has no large loan concentrations to individual borrowers or industries. Only 12.58% of the Company’s portfolio consists of consumer loans. Unsecured loans at December 31, 2002 were $8.5 million. While management uses available information to recognize losses on loans, future additions to the allowance may be necessary based on changes in economic conditions. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Bank’s allowance for loan losses. Such agencies may require the Bank to recognize additions to the allowance based on their judgments about information available to them at the time of their examination.

Please see “Provision for Loan Losses, Net Charge-offs, Non-Performing Assets and Allowance for Loan Losses” for a further discussion of the Company’s loans, loss experience, and methodology in determining the allowance.

Overview

As a result of the mortgage operations expansion in 2000 and 2001 and the decrease in the interest rates during 2002, the Company experienced an increase in the volume of loans

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originated for sale and the resulting gain on sale of mortgage loans in the secondary market of $2.0 million over 2001. The Company continued conversion of its core computer system through implementation of additional modules and continued to place special emphasis on quality asset growth and expense control to drive the improved earnings performance. Asset growth was achieved as total assets increased $88.3 million (or 18.3%) in 2002 compared to 2001. Despite the expenses associated with the new branch and the continued expansion of the mortgage and trust operations, the Company continues to make improvements in expense controls. In 2002, the Company implemented responsibility center budgeting to monitor expenses. The operating efficiency ratio of 64.02% in 2002 is a decrease of 2.4% from 2001, which is a reflection of the established mortgage, trust, and Furys Ferry branch operations, as well as additional monitoring of expenses.

Results of Operations

The Company had record net income of $6,010,000 in 2002, compared to $4,561,000 in 2001, an increase of $1.4 million or 31.8%.

The increase in net income during 2002 compared to 2001 resulted from an increased level of noninterest income and a decrease in interest expense somewhat offset by a decrease in interest income and an increase in noninterest expense. Net interest income increased $2.9 million (16.7%) in 2002 on a net interest margin of 4.04%, a decrease from 4.13% in 2001. The increase in net interest income was the result of higher levels of interest earning assets somewhat offset by decreases in the prime rate. Noninterest income increased $3.6 million (46.1%) in 2002 to $11.4 million compared to $7.8 million in 2001. The increase for 2002 resulted primarily from an increase in the gain on sale of mortgage loans in the secondary market of $2.0 million, due primarily to the declining interest rate environment and the expanded mortgage department, as well as an increase in service charges and fees on deposits of $1.4 million, due to the Bounce Overdraft Protection program that started in October 2001.

The earnings performance of the Company is reflected in a return on average assets and average equity of 1.14% and 13.95%, respectively, during 2002 compared to 1.02% and 12.19%, respectively, during 2001. The return on average assets and average equity was 1.08% and 12.58%, respectively, in 2000. Basic net income per share on weighted average common shares outstanding improved to $2.52 in 2002 compared to $1.91 in 2001 and $1.67 in 2000. Diluted net income per share on weighted average common and common equivalent shares outstanding improved to $2.51 in 2002 compared to $1.91 in 2001 and $1.67 in 2000. The Company’s average equity to average asset ratio decreased to 8.19% in 2002 compared to 8.32% in 2001. The average equity to average asset ratio was 8.56% in 2000. A 15% stock dividend was paid by the Company on August 31, 2001.

The improvement in the earnings of the Company represents the continued leveraging of its investment in additional branch offices in prior and current years. The offices are continuing to generate higher levels of interest earning assets and deposits. Also, the Company has continued to add services and products, such as Trust services, expanded mortgage operations, and the Bounce Overdraft Protection product.

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Net Interest Income

The primary source of earnings for the Company is net interest income, which is the difference between income on interest-earning assets, such as loans and investment securities, and interest expense incurred on interest-bearing sources of funds, such as deposits and borrowings. The following table shows the average balances of interest-earning assets and interest-bearing liabilities, average yields earned and rates paid on those respective balances, and the resulting interest income and interest expense for the periods indicated:

Average Balances, Income and Expenses, Yields and Rates

Average total assets for 2002 were $526.3 million, a 17.1% increase over 2001. Average interest earning assets for 2002 were $499.3 million which was 94.9% of average total assets. The increase in average loans of $48.6 million and the increase in average investments of $31.1

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million were funded by increases in average deposits of $55.3 million, securities sold under repurchase agreements of $13.1 million, and Federal Home Loan Bank borrowings of $2.5 million. For 2001, average total assets were $449.3 million, a 20.9% increase over 2000. Average interest earning assets for 2001 were $419.6 million, or 93.4% of average total assets.

Interest income is the largest contributor to income. Interest income on loans decreased $1.8 million from 2001 to $24.5 million. The decrease in loan interest income resulted from the lower interest rate environment despite the higher loan volume. This decrease in loan interest income was somewhat offset by an increase in investment income due to the large increase in investment volume although investment yields were lower in 2002 as compared to 2001. Interest expense decreased $4.1 million from 2001 to $11.2 million in 2002. Despite higher volumes of interest-bearing liabilities, interest expense decreased due to lower interest rates. The result was an increase in net interest income of $2.9 million or 16.7% in 2002 from 2001. Average yields on interest-earning assets decreased to 6.28% in 2002, compared to 7.76% in 2001.

Net interest income increased $2.1 million in 2001 compared to 2000 as a result of the growth in the volume of average earning assets somewhat offset by a decrease in interest rates. Interest earning assets averaged $419.6 million in 2001, an increase of 20.3%, from the $348.8 million averaged in 2000. Average yields on earning assets decreased to 7.76% in 2001, compared to 8.56% in 2000.

A key performance measure for net interest income is the “net interest margin”, or net interest income divided by average interest-earning assets. Unlike the “net interest spread”, the net interest margin is affected by the level of non-interest sources of funding used to support interest-earning assets. The Company’s net interest margin decreased to 4.04% in 2002 from 4.13% in 2001. In 2000, the net interest margin was 4.36%. The net interest margin deteriorated in 2002, as the average rate earned on interest earning assets decreased quicker than the average rate on interest-bearing deposits. In 2001, the net margin deteriorated as certificates of deposits repriced at a slower rate than variable rate loans and deposits. The high level of competition in the local market for both loans and deposits continues to influence the net interest margin. The net interest margin continues to be supported by an increasing amount of demand deposits which provide a noninterest bearing source of funds and helps prevent further deterioration in the net interest margin. The net interest spread measures the difference between the average yield on interest-earning assets and the average rate paid on interest-bearing sources of funds. The net interest spread eliminates the impact of noninterest bearing funds and gives a direct perspective on the effect of market interest rate movements. As a result of changes in interest rates in 2002, the net interest spread increased 14 basis points to 3.61% in 2002. The 2001 net interest spread of 3.47% represented a decrease from 2000’s 3.48%.

Changes in the net interest income from period to period result from increases or decreases in the volume of interest-earning assets and interest-bearing liabilities, increases in the average rates earned and paid on such assets and liabilities, the ability to manage the earning asset portfolio, and the availability of particular sources of funds, such as noninterest bearing deposits. The following table: “Analysis of Changes in Net Interest Income” indicates the changes in the Company’s net interest income as a result of changes in volume and rate from 2002 to 2001, and 2001 to 2000. The analysis of changes in net interest income included in the

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following table indicates that on an overall basis in 2002, the increase in the balances or volumes created a positive impact in net income while the decreases in interest rates of interest-earning assets created a negative impact on net interest income. The increases in the balances or volume of the interest-bearing liabilities were somewhat offset by the decrease in interest rates. Prime savings and money market accounts are tied to the prime rate. Also in 2001 and 2000, the volume of interest-earning assets had a positive impact on the net interest income while decreases in interest rates had a negative impact on interest income.

Analysis of Changes in Net Interest Income