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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

Commission file number 000-25141

METROCORP BANCSHARES, INC.

9600 Bellaire Boulevard, Suite 252
Houston, Texas 77036

(713) 776-3876

     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 whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes o     No x.

     As of October 31, 2003, the number of outstanding shares of Common Stock, par value $1.00 per share, was 7,155,689.

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PART I FINANCIAL INFORMATION

Item 1. Condensed Consolidated Financial Statements.

METROCORP BANCSHARES, INC.
CONDENSED CONSOLIDATED BALANCE SHEET
(In thousands, except share amounts)
(Unaudited)

See accompanying notes to condensed consolidated financial statements

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METROCORP BANCSHARES, INC.
CONDENSED CONSOLIDATED STATEMENT OF INCOME
(In thousands, except per share amounts)
(Unaudited)

See accompanying notes to condensed consolidated financial statements

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METROCORP BANCSHARES, INC.
CONDENSED CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME
(In thousands)
(Unaudited)

METROCORP BANCSHARES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY
For The Nine Months Ended September 30, 2003
(In thousands)
(Unaudited)

See accompanying notes to condensed consolidated financial statements

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METROCORP BANCSHARES, INC
CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS
(In thousands)
(Unaudited)

See accompanying notes to condensed consolidated financial statements

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METROCORP BANCSHARES, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation

     The unaudited condensed consolidated financial statements include the accounts of MetroCorp Bancshares, Inc. (the “Company”) and its wholly-owned subsidiary MetroBank, National Association (the “Bank”). The Bank was formed in 1987 and is engaged in commercial banking activities through its fourteen branches in Houston and Dallas, Texas. The Company considers itself one reporting segment. All material intercompany accounts and transactions have been eliminated in consolidation.

     The accompanying unaudited condensed consolidated financial statements were prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and with the instructions for Form 10-Q. In the opinion of management, the unaudited condensed consolidated financial statements reflect all adjustments, consisting only of normal and recurring adjustments, necessary for a fair presentation of the Company’s financial position at September 30, 2003, results of operations for the three and nine months ended September 30, 2003 and 2002, and cash flows for the nine months ended September 30, 2003 and 2002. Interim period results are not necessarily indicative of results for a full-year period.

     Certain amounts applicable to the prior periods have been reclassified to conform to the classifications currently used. Such reclassifications had no effect on net income or shareholders’ equity.

     These financial statements and the notes thereto should be read in conjunction with the Company’s annual report on Form 10-K for the year ended December 31, 2002.

Stock Compensation

     The Company grants stock options under several stock-based incentive compensation plans. The Company utilizes the intrinsic value method for its stock compensation plans. No compensation cost is recognized for fixed stock options in which the exercise price is equal to or greater than the estimated market price on the date of grant. Statement of Financial Accounting Standards (“SFAS”) No. 123, Accounting for Stock-Based Compensation, which, if fully adopted by the Company, would change the method the Company applies in recognizing the cost of the plans to the fair value method. Adoption of the cost recognition provisions of SFAS No. 123 is optional and the Company has decided to continue to follow the intrinsic value method. However, pro forma disclosures as if the Company adopted the fair value method are required. If the fair value based method of accounting under SFAS No. 123 had been applied, the Company’s net income available to common shareholders and earnings per common share would have been reduced to the pro forma amounts indicated below (assuming that the fair value of options granted during the year are amortized over the vesting period) (in thousands except per share amounts):

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     The effects of applying SFAS No. 123 in this pro forma disclosure are not indicative of future amounts. SFAS No. 123 does not apply to awards prior to 1995, and the Company anticipates making awards in the future under its stock-based compensation plans. The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options which have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions including the expected stock price volatility. Because the Company’s employee stock options have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, the existing models do not necessarily provide a reliable single measure of the fair value of its employee stock options.

2. EARNINGS PER COMMON SHARE

     Basic earnings per share (“EPS”) is computed by dividing net income available to common shareholders by the weighted-average number of common shares outstanding during the period. Diluted EPS is computed by dividing net income available to common shareholders by the weighted-average number of common shares and potentially dilutive common shares outstanding during the period. Potentially dilutive common shares are computed using the treasury stock method.

3. LITIGATION

     In September 2003 a subsidiary of the Company, Advantage Finance Corporation (“AFC”), was served in connection with a law suit based on alleged “malicious prosecution” and “conspiracy”. Also included in the law suit are BDO Seidman LLP and The CIT Group/Commercial Services, Inc. The Case is in its early stages and has been set for trial in August 2004. Management is unable to determine whether the outcome will have a material impact on the Company's financial statements. The lawsuit does not seek a specified amount.

4. NEW ACCOUNTING PRONOUNCEMENTS

     On April 30, 2003, the Financial Accounting Standards Board (“FASB”) approved Statement of Financial Accounting Standards (“SFAS”) No. 149, an amendment to SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities. This statement amends and clarifies financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts (collectively referred to as derivatives) and for hedging activities under SFAS No. 133. The provisions of this statement were effective for contracts entered into or modified after June 30, 2003 and for hedging relationships designated after June 30, 2003. The adoption of SFAS No. 149 did not have a material effect on the Company’s financial condition or results of operations.

      On May 15, 2003, the FASB approved SFAS No. 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity. This statement changes the accounting for certain financial instruments that, under previous guidance, could be classified as equity or “mezzanine” equity, but now is requiring those instruments to be classified as liabilities (or assets in some circumstances) in the statement of financial

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condition. Further, SFAS No. 150 requires disclosure regarding the terms of those instruments and settlement alternatives. This statement is generally effective for all such financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003, except for mandatorily redeemable financial instruments of non-public entities. It is not expected that this statement will have a material effect on the Company’s financial condition or results of operations. On October 29, 2003, the FASB deferred certain provisions of this statement.

     On November 25, 2002, the FASB issued FASB Interpretation (“FIN”) No. 45, Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others. FIN No. 45 considers standby letters of credit, excluding commercial letters of credit and other lines of credit, a guarantee of the Bank. The Bank enters into a standby letter of credit to guarantee performance of a customer to a third party. These guarantees are primarily issued to support public and private borrowing arrangements. The credit risk involved is represented by the contractual amounts of those instruments. Under the standby letters of credit, the Bank is required to make payments to the beneficiary of the letters of credit upon request by the beneficiary so long as all performance criteria have been met. Most guarantees extend up to one year. The maximum potential amount of future payments was approximately $7.1 million at September 30, 2003. The Company has recorded a liability of approximately $4,437 at September 30, 2003, for the fair value of the Company’s potential obligations, which represents the unamortized portion of the letter of credit fees.

     On January 17, 2003, the FASB issued FIN No. 46, Consolidation of Variable Interest Entities, which addresses consolidation by business enterprises of variable interest entities. FIN No. 46 clarifies the application of ARB No. 51, Consolidated Financial Statements, to certain entities in which equity investors do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. The adoption of this interpretation will not impact the Company’s financial condition or results of operations.

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

     Special Cautionary Notice Regarding Forward-looking Statements

     The Statements and financial discussion and analysis contained in this Quarterly Report on Form 10-Q are not historical facts are forward-looking statements made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Forward-looking statements, which describe the Company’s future plans, strategies and expectations, are based on assumptions and involve a number of risks and uncertainties, many of which are beyond the Company’s control. The important factors that could cause actual results to differ materially from the results, performance or achievements expressed or implied by the forward-looking statements include, without limitation:

•

Changes in interest rates and market prices, which could reduce the Company’s net interest margins, asset valuations and expense expectations;

•

Changes in the levels of loan prepayments and the resulting effects on the value of the Company’s loan portfolio;

•

Changes in local economic and business conditions which adversely affect the ability of the Company’s customers to transact profitable business with the Company, including the ability of borrowers to repay their loans according to their terms or a change in the value of the related collateral;

•

Increased competition for deposits and loans adversely affecting rates and terms;

•

The timing, impact and other uncertainties of the Company’s ability to enter new markets successfully and capitalize on growth opportunities;

•

Increased credit risk in the Company’s assets and increased operating risk caused by a material change in commercial, consumer and/or real estate loans as a percentage of the total loan portfolio;

•

The failure of assumptions underlying the establishment of and provisions made to the allowance for loan losses;

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•

Changes in the availability of funds resulting in increased costs or reduced liquidity;

•

Increased asset levels and changes in the composition of assets and the resulting impact on the Company’s capital levels and regulatory capital ratios;

•

The Company’s ability to acquire, operate and maintain cost effective and efficient systems without incurring unexpectedly difficult or expensive but necessary technological changes;

•

The loss of senior management or operating personnel and the potential inability to hire qualified personnel at reasonable compensation levels; and

•

Changes in statutes and government regulations or their interpretations applicable to bank holding companies and our present and future banking and other subsidiaries, including changes in tax requirements and tax rates.

     The Company undertakes no obligation to publicly update or otherwise revise any forward-looking statements, unless the securities laws require the Company to do so. All written or oral forward-looking statements attributable to the Company are expressly qualified in their entirety by these cautionary statements.

Overview

     For the three months ended September 30, 2003, the Company had net income of $1.3 million, down approximately $1.2 million from net income of $2.5 million for the same quarter in 2002. The Company’s diluted earnings per share (“EPS”) for the three months ended September 30, 2003 was $0.19, down $0.16 per diluted share from diluted EPS of $0.35 for the same quarter in 2002. This decrease was primarily the result of a lower of cost or market adjustment of $824,000 on loans that were classified as held-for-sale in June 2003, and continued pressure on the net interest margin.

     Net income for the nine months ended September 30, 2003 was $1.9 million, down approximately $4.9 million from $6.8 million for the same period in 2002. The Company’s diluted EPS for the nine months ended September 30, 2003 was $0.26, down $0.69 from $0.95 for the same period in 2002. The decrease was primarily the result of lower of cost or market adjustments of $2.1 million and an increase of $3.1 million in provision for loan losses.

     At September 30, 2003, total assets were $863.9 million, up approximately $23.8 million or 2.8% from $840.1 million at December 31, 2002. The increase was primarily the result of deposit growth during the period that contributed to new loan funding. Investment securities at September 30, 2003 were $256.2 million, down approximately $3.8 million or 1.5% from $260.0 million at December 31, 2002. Net loans, both held-for-investment and held-for-sale at September 30, 2003, were $544.4 million, up approximately $26.8 million or 5.2% from $517.6 million at December 31, 2002. Total deposits at September 30, 2003 were $726.9 million, up approximately $35.5 million or 5.1% from $691.4 million at December 31, 2002. Other borrowings at September 30, 2003 were $53.9 million, down approximately $11.9 million from other borrowings of $65.8 million at December 31, 2002. The Company’s return on average assets (“ROAA”) for the three months ended September 30, 2003 and 2002 was 0.62% and 1.24%, respectively. The Company’s ROAA for the nine months ended September 30, 2003 and 2002 was 0.30% and 1.18%, respectively.

     Shareholders’ equity at September 30, 2003 was $74.1 million compared to $74.5 million at December 31, 2002, a decrease of approximately $400,000. The decrease for the nine months ended September 30, 2003 was primarily the combined result of $1.9 million in net income and a net increase in common stock, additional paid-in capital, and treasury stock of approximately $1.3 million that was partially offset by a reduction in accumulated other comprehensive income (an unrealized loss in the market value of securities) of approximately $2.3 million and dividend payments of approximately $1.3 million. The Company’s return on average shareholders’ equity (“ROAE”) for the three months ended September 30, 2003 and 2002 was 7.16% and 13.86%, respectively. The Company’s ROAE for the nine months ended September 30, 2003 and 2002 was 3.37% and 13.13%, respectively.

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Results of Operations

     Net Interest Income and the Net Interest Margin. For the three months ended September 30, 2003, net interest income, before the provision for loan losses, was $7.8 million, down approximately $1.1 million or 12.1% from $8.9 million for the same quarter in 2002. The decrease was primarily due to lower interest income resulting from lower yields on higher interest-earning asset balances that was partially offset by lower interest expense as a result of lower rates paid on higher interest-bearing liability balances. Average interest-earning asset balances for the three months ended September 30, 2003 were $825.6 million, up approximately $53.0 million or 6.9% from $772.6 million for the same quarter in 2002. The weighted average yield on interest-earning assets for the three months ended September 30, 2003 was 5.17%, down 123 basis points from 6.40% for the same quarter in 2002. Average interest-bearing liability balances for the three months ended September 30, 2003 were $627.6 million, up approximately $34.6 million or 5.8% from $593.0 million for the same quarter in 2002. The weighted average rate paid on interest-bearing liabilities for the three months ended September 30, 2003 was 1.87%, down 55 basis points from 2.42% for the same quarter in 2002.

     For the nine months ended September 30, 2003, net interest income, before the provision for loan losses, was $23.4 million, down approximately $2.3 million or 9.1% from $25.7 million for the same period in 2002. The decrease was primarily due to lower interest income resulting from lower yields on higher interest-earning asset balances that was partially offset by lower interest expense as a result of lower rates paid on higher interest-bearing liability balances. Average interest-earning asset balances for the nine months ended September 30, 2003 were $814.8 million, up approximately $82.6 million or 11.3% from $732.2 million for the same period in 2002. The weighted average yield on interest-earning assets for the nine months ended September 30, 2003 was 5.38%, down 135 basis points from 6.73% for the same period in 2002. Average interest-bearing liability balances for the nine months ended September 30, 2003 were $619.9 million, up approximately $55.3 million or 9.8% from $564.6 million for the same period in 2002. The weighted average rate paid on interest-bearing liabilities for the nine months ended September 30, 2003 was 2.03%, down 60 basis points from 2.63% for the same period in 2002.

     The net interest margin for the three months ended September 30, 2003 was 3.74%, down 81 basis points from 4.55% for the same quarter in 2002 and was primarily the result of a decrease in the yield on interest-earning assets of 123 basis points that was partially offset by a decrease in the cost of earning-assets of 42 basis points. The net interest margin for the nine months ended September 30, 2003 was 3.84%, down 86 basis points from 4.70% for the same period in 2002 and was primarily the result of a decrease in the yield on earning-assets of 135 basis points that was partially offset by a decrease in the cost of earning-assets of 49 basis points. The Company’s net interest margin may experience further pressure depending on the future interest rate environment.

     Total Interest Income. Total interest income for the three months ended September 30, 2003 was $10.7 million, down approximately $1.8 million or 13.8% from $12.5 million for the same quarter in 2002. Total interest income for the nine months ended September 30, 2003 was $32.8 million, down approximately $4.0 million or 11.0% from $36.8 million for the same period in 2002. The lower interest income for both periods in 2003, compared to 2002, was primarily the result of lower yields on interest-earning assets that was partially offset by increases in average interest-earning assets.

     Interest Income from Loans. Interest income from loans for the three months ended September 30, 2003 was $8.8 million, down approximately $700,000 or 8.0% from $9.5 million for the same quarter in 2002 primarily due to lower loan yields as a result of the current interest rate environment that was partially offset by higher average total loan balances. Average total loans for the three months ended September 30, 2003 were $555.6 million compared to average total loans for the same quarter in 2002 of $509.8 million, an increase of approximately $45.8 million or 9.0%. For the three months ended September 30, 2003, the average yield on total loans was 6.27% compared to 7.43% for the same quarter in 2002, a decrease of 116 basis points.

     Approximately $459.0 million or 84.5% of the loans in the loan portfolio are variable rate loans that reprice as the prime rate moves and therefore, are sensitive to interest rate movement. At September 30, 2003, the average yield on the total loan portfolio was approximately 200 basis points above the prime rate, which was supported by variable rate loans with interest rate floors that consisted of approximately $340.0 million or 62.6% of the total loan portfolio. These loans carried a weighted average interest rate of 5.97% at September 30, 2003 compared to 59.8% of the total loan portfolio with a weighted average interest rate of 6.89% at September 30, 2002. Future increases in market interest rates, especially the prime rate, will not be realized on the loan portfolio as quickly as the declines in 2001, 2002, and 2003 because of the interest rate floors already achieved on more than half of the loan portfolio.

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Other factors that have impacted interest income from loans include refinancing pressures on existing loans, increased nonaccrual loans, and new loans being added to the portfolio at lower interest rates.

     Interest income from loans for the nine months ended September 30, 2003 was $26.6 million, down approximately $2.1 million or 7.5% from $28.7 million for the same period in 2002 primarily due to the lower loan yields as a result of the interest rate environment that was partially offset by higher average loan balances. Average total loans for the nine months ended September 30, 2003 were $549.2 million compared to average total loans for the same period in 2002 of $498.9 million, an increase of approximately $50.3 million or 10.1%. For the nine months ended September 30, 2003, the average yield on total loans was 6.47%, compared to 7.70% for the same period in 2002, a decrease of 123 basis points.

     Interest Income from Investments. Interest income from investments (which includes investment securities, Federal Funds sold, and other temporary investments) for the three months ended September 30, 2003 was $2.0 million, down approximately $900,000 or 32.7% compared to $2.9 million for the same quarter in 2002, primarily due to lower interest rate yields as a result of premium amortization, prepayments in mortgage-backed securities, and the reinvestment of funds at lower market interest rates that was partially offset by higher average investment balances. Average total investments for the three months ended September 30, 2003, were $270.1 million compared to average total investments for the same quarter in 2002 of $262.8 million, and increase of approximately $7.3 million or 2.8%. For the three months ended September 30, 2003, the average yield on investments was 2.89% compared to 4.41% for the same quarter in 2002, a decrease of 152 basis points.

     Interest income from investments for the nine months ended September 30, 2003 was $6.2 million, down approximately $1.9 million or 23.1% compared to $8.1 million for the same period in 2002, primarily due to a lower interest rate yield as a result of premium amortization, prepayments on mortgage-backed securities, and the reinvestment of funds at lower market interest rates that was partially offset by higher average investment balances. Average total investments for the nine months ended September 30, 2003, were $265.7 million compared to average total investments for the same period in 2002 of $233.3 million, an increase of approximately $32.4 million or 13.9%. For the nine months ended September 30, 2003, the average yield on investments was 3.13% compared to 4.65% for the same period in 2002, a decrease of 152 basis points.

     Total Interest Expense. Total interest expense for the three months ended September 30, 2003 was $3.0 million, down approximately $600,000 or 18.1% compared to $3.6 million for the same quarter in 2002. Total interest expense for the nine months ended September 30, 2003 was $9.4 million, down approximately $1.7 million or 15.3% from $11.1 million for the same period in 2002. The lower interest expense for both periods in 2003, compared to 2002, was primarily the result of lower interest rates paid on interest-bearing liabilities that was partially offset by increases in average interest-bearing liabilities.

     Interest Expense on Deposits. Interest paid on interest-bearing deposits for the three months ended September 30, 2003 was $2.5 million, down approximately $600,000 or 18.5% compared to $3.1 million for the same period in 2002 and was primarily due to lower interest rates paid for interest-bearing deposits as a result of the lower interest rate environment that was partially offset by higher interest-bearing deposit balances. Average interest-bearing deposits for the three months ended September 30, 2003 were $570.9 million compared to average interest-bearing deposits for the same quarter in 2002 of $527.9 million, an increase of $43 million or 8.1%. The average interest rate paid on interest-bearing deposits for the three months ended September 30, 2003 was 1.75% compared to 2.32% for the same quarter in 2002, a decrease of 57 basis points.

     Interest paid on interest-bearing deposits for the nine months ended September 30, 2003 was $8.0 million, down approximately $1.8 million or 18.7% compared to $9.8 million for the same period in 2002 and was primarily due to lower interest rates paid for interest-bearing deposits as a result of the lower interest rate environment that was partially offset by higher interest-bearing deposit balances. Average interest-bearing deposits for the nine months ended September 30, 2003 were $557.7 million compared to average interest-bearing deposits for the same period in 2002 of $516.5 million, an increase of $41.2 million or 8.0%. The average interest rate paid on interest-bearing deposits for the nine months ended September 30, 2003 was 1.91% compared to 2.54% for the same period in 2002, a decrease of 63 basis points.

     Interest Expense on Other Borrowed Funds. Interest paid on other borrowed funds for the three months ended September 30, 2003 was $438,000, down approximately $84,000 compared to $522,000 for the same period in 2002 and was primarily due to lower borrowed funds balances and lower interest rates paid for borrowed funds. Average borrowed funds for the three months ended September 30, 2003 were $56.7 million compared to average

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borrowed funds for the same quarter in 2002 of $65.1 million, a decrease of $8.4 million. The average interest rate paid on borrowed funds for the three months ended September 30, 2003 was 3.06%, compared to 3.18% for the same quarter in 2002, a decrease of 12 basis points.

     Interest paid on other borrowed funds for the nine months ended September 30, 2003 was $1.4 million, up approximately $130,000 compared to $1.3 million for the same period in 2002 and was primarily due to higher borrowed funds balances that were partially offset by lower interest rates paid for borrowed funds. Average borrowed funds for the nine months ended September 30, 2003 were $62.2 million compared to average borrowed funds for the same period in 2002 of $48.1 million, an increase of $14.1 million. The increase in borrowed funds reflected advances obtained from the Federal Home Loan Bank (“FHLB”) to fund loans and mortgage-related securities investments. The average interest rate paid on borrowed funds for the nine months ended September 30, 2003 was 3.05%, compared to 3.58% for the same period in 2002, a decrease of 53 basis points.

     The following tables present the total dollar amount of interest income from average interest-earning assets and the resultant yields, as well as the interest expense on average interest-bearing liabilities, expressed both in dollars and rates for the periods indicated. No tax-equivalent adjustments were made and all average balances are daily average balances. Nonaccruing loans have been included in the table as loans having a zero yield.