UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

Commission File Number: 000-50904

SNB Bancshares, Inc.

(Exact name of Registrant as specified in its charter)

14060 Southwest Freeway

Sugar Land, Texas 77478

(Address of principal executive office)

(Registrant’s telephone number)

(281) 269-7200

Securities registered pursuant to Section 12(b) of the Act:

None

Securities registered pursuant to section 12(g) of the Act:

Common Stock, $0.01 par value per share

(Title of Class)

     Indicate by check mark whether the Registrant (1) has filed all reports required 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 þ          No o

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

      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.     o

      The aggregate market value of the shares of Common Stock held by non-affiliates, based on the average of the bid and asked price of the Common Stock on the OTC Bulletin Board as of June 30, 2004 was approximately $34.1 million.

Number of shares of Common Stock outstanding as of March 18, 2005: 9,756,412

Number of shares of Class B Stock outstanding as of March 18, 2005: 2,678,541

DOCUMENTS INCORPORATED BY REFERENCE

      Portions of the Registrant’s definitive proxy statement relating to the 2005 Annual Meeting of Shareholders, which will be filed within 120 days after December 31, 2004, are incorporated into Part III, Items 10-14 of this Form 10-K.

SNB BANCSHARES, INC.

2004 ANNUAL REPORT ON FORM 10-K

TABLE OF CONTENTS

PART I.

General

      SNB Bancshares, Inc. is a bank holding company headquartered approximately 15 miles southwest of downtown Houston in Sugar Land, Texas, the largest city in fast growing Fort Bend County. As of December 31, 2004, we had total assets of $1.1 billion, total loans of $598.3 million, total deposits of $868.4 million and total shareholders’ equity of $86.4 million. We derive substantially all of our income from the operation of our wholly-owned bank subsidiary, Southern National Bank of Texas. As of June 30, 2004, the most recent date for which this information is available, we were the largest independent banking organization headquartered in Fort Bend County in terms of deposits, where we ranked second among all financial institutions in total deposits with a 16.1% market share.

      Southern National Bank of Texas was chartered in 1985 in southwest Houston. In 1995, we relocated our main banking facility to its current location in Sugar Land, where we serve our primary market of Fort Bend County. We opened our other three branches in what we believe are three of Houston’s most attractive market areas. In 1990, we opened a branch at Memorial Hermann Southwest Hospital, the largest not-for-profit multi-hospital system in Houston. The hospital attracts a large number of physicians and other medical professionals. In 2000, we established our Uptown-Post Oak location in Houston’s upscale Galleria commercial area, which also serves the Tanglewood, Memorial and River Oaks residential communities. In October 2004, we opened our Old Town Katy location in Katy, Texas.

Available Information

      Our website address is www.snbtx.com. We make available free of charge on or through our website our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and all amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended, as soon as reasonably practicable after such material is electronically filed with or furnished to the Securities and Exchange Commission. The information found on our website is not part of this or any other report.

Recent Developments

      During March 2005, the Board of Directors approved a plan to reposition our balance sheet by reducing the amount of low-yielding investment securities and using a portion of the proceeds to de-leverage our borrowing position. We have identified for sale from our available-for-sale securities portfolio approximately $169.0 million in U.S. Government callable agency bonds, with coupon rates of 3.07% or less and with a weighted average yield of 2.76%. We expect to incur a loss of approximately $4.1 million, net of tax, during the quarter ended March 31, 2005 as a result of the writedown of these investments. We plan to use the net proceeds to reduce short-term borrowings and reinvest in higher-yielding investments.

Our Community Banking Strategy

      In order to attract customers, we utilize a two-pronged strategy: (1) provide a level of customer service that other banks are unable or unwilling to provide and (2) support community and charitable organizations by encouraging our employees to volunteer their time and allowing the organizations to use our facilities for their meetings and events. We support over 200 charitable organizations, including those involved with healthcare and preventative medicine, education and social services involving children, domestic violence and people with special needs. Many of these organizations regularly use our facilities, providing our officers an opportunity to solicit business from leaders in the community as well as the organizations themselves. This strategy, coupled with our ongoing business development efforts, has been successful, as we have grown loans at a five-year average annual compounded growth rate of 24.4%. In addition, we have grown net earnings 75.7% to $6.0 million for the year ended December 31, 2004 when compared with $3.4 million for the year

ended December 31, 2003. All of this growth was achieved without any acquisitions and with a limited amount of advertising.

      The cornerstone of our community banking strategy is to provide what we believe to be an unparalleled level of personal service. We differentiate ourselves among the many financial institutions in our markets by forging relationships based on old-fashioned, person-to-person customer service. We believe that a community-oriented culture is most effective where our customers and our employees establish long-term, mutually beneficial, relationships. Our community banking approach focuses on readily accessible, centralized management and streamlined decision making procedures that allow us to respond quickly to the needs of our customers. In fact, we designed our branches to allow our customers access to our executives and employees through our “open lobby” layout. We believe that our personal service emphasis puts us at a competitive advantage relative to the other banks in our market and has been an instrumental contributing factor to the growth that we have experienced.

      The second part of our community banking strategy centers on making our organization and our officers and employees visible participants in, and supporters of, philanthropic activities and events. Our attractive, spacious facilities, which are replicas of buildings designed by Thomas Jefferson, provide a hospitable meeting venue for charitable organizations as well as our customers. Making our facilities available to the community and participating heavily in community activities enables us to meet and attract the type of customers we seek, including white collar professionals, doctors, middle market businesses and their owners and municipalities. We believe that the residents of our community have reciprocated our commitment to the community by giving us their business.

Banking Activities

      We offer a range of traditional loan and deposit products to our customers through our two-pronged community banking strategy. Our primary customer focus is small to medium sized owner-operated businesses in a certain market area. Contractual depository relationships are another focus and we were successful in the 4-year renewal of our largest contractual lockbox and deposit relationship. At December 31, 2004, we maintained 15,388 separate deposit accounts and 2,560 separate loan accounts.

      We have primarily focused our lending on real estate related customers, which includes construction and land development loans, residential mortgages and commercial mortgage loans. As of December 31, 2004, such loans comprised 86.5% of our total loans outstanding. Our target business customer is primarily those that require loans in the $250,000 to $2,000,000 range. We offer businesses a variety of loan products including equipment loans, working capital loans, and interim construction loans for builders, term loans, revolving lines of credit and letters of credit.

      In addition, we offer consumer loans, home equity loans, Visa debit cards, telebanking, personal computer banking and other cash management services for our consumer and commercial customers. By offering certificates of deposit, checking with interest accounts, savings accounts and overdraft protection at competitive rates, we give our depositors a full range of traditional deposit products.

Business Strategies

      The key components of our growth and operating strategies are as follows:

Officers and Employees

      Our business strategy relies heavily on the guidance of our senior management team. Our six executive officers have an aggregate of 117 years of banking experience, with 74 of those years having been spent with us. We believe that our low employee turnover rate provides customers with a beneficial continuity of the service that is rare in the banking industry.

      As of December 31, 2004, we had 164 full-time employees. We provide medical and hospitalization insurance to our full-time employees. We consider our relations with employees to be excellent. Neither we nor the Bank is a party to any collective bargaining agreement.

Competition

      The banking business is highly competitive. We experience substantial competition in attracting and retaining savings deposits and in lending funds. The primary factors we encounter in competing for savings deposits are convenient office locations and rates offered. Direct competition for savings deposits comes from other commercial banks, thrift institutions, money market mutual funds and corporate and government securities which may offer more attractive rates than insured depository institutions are willing to pay. The primary factors we encounter in competing for loans include, among others, interest rate and loan origination fees and the range of services offered. Competition for origination of real estate loans normally comes from other commercial banks, thrift institutions, mortgage bankers, mortgage brokers and insurance companies. We believe that we have been able to compete effectively with other financial institutions by emphasizing customer service and technology; by establishing long-term customer relationships and building customer loyalty; and by providing products and services designed to address the specific needs of our customers.

Supervision and Regulation

      The supervision and regulation of bank holding companies and their subsidiaries is intended primarily for the protection of depositors, the deposit insurance funds of the FDIC and the banking system as a whole, and not for the protection of the bank holding company shareholders or creditors. The banking agencies have broad enforcement power over bank holding companies and banks including the power to impose substantial fines and other penalties for violations of laws and regulations.

      The following description summarizes some of the laws to which we and the Bank are subject. References in the following description to applicable statutes and regulations are brief summaries of these statutes and regulations, do not purport to be complete, and are qualified in their entirety by reference to such statutes and regulations.

      Various legislation and proposals to overhaul the bank regulatory system and limit the investments that a depository institution may make with insured funds are from time to time introduced in Congress. Such legislation may change banking statutes and our operating environment and that of our banking subsidiary in substantial and unpredictable ways. We cannot determine the ultimate effect that any potential legislation, if enacted, or implemented regulations with respect thereto, would have, upon the financial condition or results of operations of us or our subsidiaries.

      We are a bank holding company registered under the Bank Holding Company Act of 1956, as amended (BHCA). Accordingly, we are subject to supervision, regulation and examination by the Board of Governors of the Federal Reserve System (Federal Reserve Board). The Gramm-Leach-Bliley Act, the BHCA and other federal laws subject financial and bank holding companies to particular restrictions on the types of activities in which they may engage, and to a range of supervisory requirements and activities, including regulatory enforcement actions for violations of laws and regulations.

      Regulatory Restrictions on Dividends; Source of Strength. We are regarded as a legal entity separate and distinct from the Bank. The principal source of our revenue is dividends received from the Bank. As described in more detail below, federal law places limitations on the amount that national banks may pay in dividends, which the Bank must adhere to when paying dividends to us. It is the policy of the Federal Reserve Board that bank holding companies should pay cash dividends on common stock only out of income available over the past year and only if prospective earnings retention is consistent with the organization’s expected future needs and financial condition. The policy provides that bank holding companies should not maintain a level of cash dividends that undermines the bank holding company’s ability to serve as a source of strength to its banking subsidiaries.

      Under Federal Reserve Board policy, a bank holding company is expected to act as a source of financial strength to each of its banking subsidiaries and commit resources to their support. Such support may be required at times when, absent this Federal Reserve Board policy, a holding company may not be inclined to provide it. As discussed below, a bank holding company in certain circumstances could be required to guarantee the capital plan of an undercapitalized banking subsidiary.

      In the event of a bank holding company’s bankruptcy under Chapter 11 of the U.S. Bankruptcy Code, the trustee will be deemed to have assumed and is required to cure immediately any deficit under any commitment by the debtor holding company to any of the federal banking agencies to maintain the capital of an insured depository institution. Any claim for breach of such obligation will generally have priority over most other unsecured claims.

      Scope of Permissible Activities. Under the BHCA, bank holding companies generally may not acquire a direct or indirect interest in or control of more than 5% of the voting shares of any company that is not a bank or bank holding company and may not engage in activities other than those of banking, managing or controlling banks or furnishing services to or performing services for its subsidiaries, except that it may engage in, directly or indirectly, certain activities that the Federal Reserve Board determined to be closely related to banking or managing and controlling banks as to be a proper incident thereto. These activities include, among other things, numerous services and functions performed in connection with lending, investing, and financial counseling and tax planning. In approving acquisitions or the addition of activities, the Federal Reserve considers, among other things, whether the acquisition or the additional activities can reasonably be expected to produce benefits to the public, such as greater convenience, increased competition, or gains in efficiency, that outweigh such possible adverse effects as undue concentration of resources, decreased or unfair competition, conflicts of interest or unsound banking practices.

      The Gramm-Leach-Bliley Act, effective March 11, 2000, eliminated many of the historical barriers to affiliations among banks, securities firms, insurance companies and other financial service providers and permits bank holding companies to become financial holding companies and thereby affiliate with securities firms and insurance companies and engage in other activities that are financial in nature.

      Safe and Sound Banking Practices. Bank holding companies are not permitted to engage in unsafe and unsound banking practices. The Federal Reserve Board’s Regulation Y, for example, generally requires a holding company to give the Federal Reserve Board prior notice of any redemption or repurchase of its own equity securities, if the consideration to be paid, together with the consideration paid for any repurchases or redemptions in the preceding year, is equal to 10% or more of the holding company’s consolidated net worth. The Federal Reserve Board may oppose the transaction if it believes that the transaction would constitute an unsafe or unsound practice or would violate any law or regulation. Depending upon the circumstances, the Federal Reserve Board could take the position that paying a dividend would constitute an unsafe or unsound banking practice.

      The Federal Reserve Board has broad authority to prohibit activities of bank holding companies and their nonbanking subsidiaries which represent unsafe and unsound banking practices or which constitute violations of laws or regulations, and can assess civil money penalties for certain activities conducted on a knowing and reckless basis, if those activities caused a substantial loss to a depository institution. The penalties can be as high as $1.0 million for each day the activity continues.

      Anti-Tying Restrictions. Bank holding companies and their affiliates are prohibited from tying the provision of certain services, such as extensions of credit, to other services offered by a holding company or its affiliates.

      Capital Adequacy Requirements. The Federal Reserve Board has adopted a system using risk-based capital guidelines to evaluate the capital adequacy of bank holding companies. Under the guidelines, specific categories of assets are assigned different risk weights, based generally on the perceived credit risk of the asset. These risk weights are multiplied by corresponding asset balances to determine a “risk-weighted” asset base. The guidelines require a minimum total risk-based capital ratio of 8.0% (of which at least 4.0% is required to consist of Tier 1 capital elements). Total capital is the sum of Tier 1 and Tier 2 capital. As of December 31, 2004, our ratio of Tier 1 capital to total risk-weighted assets was 17.72% and our ratio of total capital to total risk-weighted assets was 19.86%.

      In addition to the risk-based capital guidelines, the Federal Reserve Board uses a leverage ratio as an additional tool to evaluate the capital adequacy of bank holding companies. The leverage ratio is a company’s Tier 1 capital divided by its average total consolidated assets. Certain highly rated bank holding companies may maintain a minimum leverage ratio of 3.0%, but other bank holding companies are required to maintain a leverage ratio of 4.0%. As of December 31, 2004, our leverage ratio was 10.87%.

      The federal banking agencies’ risk-based and leverage ratios are minimum supervisory ratios generally applicable to banking organizations that meet certain specified criteria, assuming that they have the highest regulatory rating. Banking organizations not meeting these criteria are expected to operate with capital positions well above the minimum ratios. The federal bank regulatory agencies may set capital requirements for a particular banking organization that are higher than the minimum ratios when circumstances warrant. Federal Reserve Board guidelines also provide that banking organizations experiencing internal growth or making acquisitions will be expected to maintain strong capital positions substantially above the minimum supervisory levels, without significant reliance on intangible assets.

      Imposition of Liability for Undercapitalized Subsidiaries. Bank regulators are required to take “prompt corrective action” to resolve problems associated with insured depository institutions whose capital declines below certain levels. In the event an institution becomes “undercapitalized,” it must submit a capital restoration plan. The capital restoration plan will not be accepted by the regulators unless each company having control of the undercapitalized institution guarantees the subsidiary’s compliance with the capital restoration plan up to a certain specified amount. Any such guarantee from a depository institution’s holding company is entitled to a priority of payment in bankruptcy.

      The aggregate liability of the holding company of an undercapitalized bank is limited to the lesser of 5% of the institution’s assets at the time it became undercapitalized or the amount necessary to cause the institution to be “adequately capitalized.” The bank regulators have greater power in situations where an institution becomes “significantly” or “critically” undercapitalized or fails to submit a capital restoration plan.

For example, a bank holding company controlling such an institution can be required to obtain prior Federal Reserve Board approval of proposed dividends, or might be required to consent to a consolidation or to divest the troubled institution or other affiliates.

      Acquisitions by Bank Holding Companies. The BHCA requires every bank holding company to obtain the prior approval of the Federal Reserve Board before it may acquire all or substantially all of the assets of any bank, or ownership or control of any voting shares of any bank, if after such acquisition it would own or control, directly or indirectly, more than 5% of the voting shares of such bank. In approving bank acquisitions by bank holding companies, the Federal Reserve Board is required to consider, among other things, the financial and managerial resources and future prospects of the bank holding company and the banks concerned, the convenience and needs of the communities to be served, and various competitive factors.

      Control Acquisitions. The Change in Bank Control Act prohibits a person or group of persons from acquiring “control” of a bank holding company unless the Federal Reserve Board has been notified and has not objected to the transaction. Under a rebuttable presumption established by the Federal Reserve Board, the acquisition of 10% or more of a class of voting stock of a bank holding company with a class of securities registered under Section 12 of the Exchange Act, such as us, would, under the circumstances set forth in the presumption, constitute acquisition of control of our company.

      In addition, any entity is required to obtain the approval of the Federal Reserve Board under the BHCA before acquiring 25% (5% in the case of an acquirer that is a bank holding company) or more of our outstanding common stock, or otherwise obtaining control or a “controlling influence” over our company.

      Sarbanes-Oxley Act of 2002. The Sarbanes-Oxley Act generally applies to all companies, both U.S. and non-U.S., that file or are required to file periodic reports with the SEC under the Exchange Act.

      The Sarbanes-Oxley Act includes disclosure requirements and corporate governance rules, requires the SEC and securities exchanges to adopt extensive additional disclosure, corporate governance and other related rules and mandates further studies of certain issues by the SEC. The Sarbanes-Oxley Act represents significant federal involvement in matters traditionally left to state regulatory systems, such as the regulation of the accounting profession, and the state corporate law, such as the relationship between a board or directors and management and between a board of directors and its committees.

      The Sarbanes-Oxley Act addresses, among other matters:

      The Bank is a nationally chartered banking association, the deposits of which are insured by the Bank Insurance Fund of the FDIC. The Bank’s primary regulator is the Office of the Comptroller of the Currency (OCC). By virtue of the insurance of its deposits, however, the Bank is also subject to supervision and regulation by the FDIC. In addition, because the Bank is also a member of the Federal Reserve System, it is subject to regulation pursuant to the Federal Reserve Act. Such supervision and regulation subjects the Bank to special restrictions, requirements, potential enforcement actions, and periodic examination by the OCC. Because the Federal Reserve Board regulates us as a holding company parent of the Bank, the Federal Reserve Board also has supervisory authority, which directly affects the Bank.

      Financial Modernization. Under the Gramm-Leach-Bliley Act, a national bank may establish a financial subsidiary and engage, subject to limitations on investment, in activities that are financial in nature, other than insurance underwriting, insurance company portfolio investment, real estate development, real estate investment, annuity issuance and merchant banking activities. To do so, a bank must be well capitalized, well managed and have a CRA rating of satisfactory or better. National banks with financial subsidiaries must remain well capitalized and well managed in order to continue to engage in activities that are financial in nature without regulatory actions or restrictions, which could include divestiture of the financial in nature subsidiary or subsidiaries. In addition, a bank may not acquire a company that is engaged in activities that are financial in nature unless the bank has a CRA rating of satisfactory or better. Currently, the Bank has a CRA rating of “satisfactory.”

      Branching. The establishment of a branch must be approved by the OCC, which considers a number of factors, including financial history, capital adequacy, earnings prospects, character of management, needs of the community and consistency with corporate powers.

      Restrictions on Transactions with Affiliates and Insiders. Transactions between the Bank and its non-banking affiliates, including us, are subject to Section 23A of the Federal Reserve Act. An affiliate of a bank is any company or entity that controls, is controlled by, or is under common control with the bank. In general, Section 23A imposes limits on the amount of such transactions, and also requires certain levels of collateral for loans to affiliated parties. It also limits the amount of advances to third parties which are collateralized by our securities or obligations or our non-banking subsidiaries.

      Affiliate transactions are also subject to Section 23B of the Federal Reserve Act which generally requires that certain transactions between the bank and its affiliates be on terms substantially the same, or at least as favorable to the bank, as those prevailing at the time for comparable transactions with or involving other nonaffiliated persons. The Federal Reserve has also issued Regulation W which codifies prior regulations under Sections 23A and 23B of the Federal Reserve Act and interpretive guidance with respect to affiliate transactions.

      The restrictions on loans to directors, executive officers, principal shareholders and their related interests (collectively referred to herein as “insiders”) contained in the Federal Reserve Act and Regulation O apply to all insured depository institutions and their subsidiaries. These restrictions include limits on loans to one borrower and conditions that must be met before such a loan can be made. There is also an aggregate limitation on all loans to insiders and their related interests. These loans cannot exceed the institution’s total unimpaired capital and surplus, and the OCC may determine that a lesser amount is appropriate. Insiders are subject to enforcement actions for knowingly accepting loans in violation of applicable restrictions.

      Restrictions on Distribution of Subsidiary Bank Dividends and Assets. Dividends paid by the Bank have provided a substantial part of our operating funds and for the foreseeable future it is anticipated that dividends paid by the Bank to us will continue to be our principal source of operating funds. Capital adequacy requirements serve to limit the amount of dividends that may be paid by the Bank. Until capital surplus equals or exceeds capital stock, a national bank must transfer to surplus 10% of its net income for the preceding four quarters in the case of an annual dividend or 10% of its net income for the preceding two quarters in the case of a quarterly or semiannual dividend. At December 31, 2004, the Bank’s capital surplus exceeded its capital stock. Without prior approval, a national bank may not declare a dividend if the total amount of all dividends,

declared by the bank in any calendar year exceeds the total of the bank’s retained net income for the current year and retained net income for the preceding two years. Under federal law, the bank cannot pay a dividend if, after paying the dividend, the bank will be “undercapitalized.” The OCC may declare a dividend payment to be unsafe and unsound even though the bank would continue to meet its capital requirements after the dividend.

      Because we are a legal entity separate and distinct from our subsidiaries, our right to participate in the distribution of assets of any subsidiary upon the subsidiary’s liquidation or reorganization will be subject to the prior claims of the subsidiary’s creditors. In the event of a liquidation or other resolution of an insured depository institution, the claims of depositors and other general or subordinated creditors are entitled to a priority of payment over the claims of holders of any obligation of the institution to its shareholders, arising as a result of their status as shareholders, including any depository institution holding company (such as us) or any shareholder or creditor thereof.

      Examinations. The OCC periodically examines and evaluates insured banks. Based upon such an evaluation, the OCC may revalue the assets of the institution and require that it establish specific reserves to compensate for the difference between the OCC-determined value and the book value of such assets.

      Audit Reports. Insured institutions with total assets of $500 million or more must submit annual audit reports prepared by independent auditors to federal regulators. In some instances, the audit report of the institution’s holding company can be used to satisfy this requirement. Auditors must receive examination reports, supervisory agreements and reports of enforcement actions. In addition, financial statements prepared in accordance with accounting principles generally accepted in the U.S., management’s certifications concerning responsibility for the financial statements, internal controls and compliance with legal requirements designated by the OCC, and an attestation by the auditor regarding the statements of management relating to the internal controls must be submitted. For institutions with total assets of more than $3 billion, independent auditors may be required to review quarterly financial statements. The Federal Deposit Insurance Corporation Improvement Act of 1991 (FDICIA) requires that independent audit committees be formed, consisting of outside directors only. The committees of such institutions must include members with experience in banking or financial management, must have access to outside counsel, and must not include representatives of large customers.

      Capital Adequacy Requirements. Similar to the Federal Reserve Board’s requirements for bank holding companies, the OCC has adopted regulations establishing minimum requirements for the capital adequacy of national banks. The OCC may establish higher minimum requirements if, for example, a bank has previously received special attention or has a high susceptibility to interest rate risk.

      The OCC’s risk-based capital guidelines generally require national banks to have a minimum ratio of Tier 1 capital to total risk-weighted assets of 4.0% and a ratio of total capital to total risk-weighted assets of 8.0%. As of December 31, 2004, the Bank’s ratio of Tier 1 capital to total risk-weighted assets was 16.17% and its ratio of total capital to total risk-weighted assets was 17.35%.

      The OCC’s leverage guidelines require national banks to maintain Tier 1 capital of no less than 4.0% of average total assets, except in the case of certain highly rated banks for which the requirement is 3.0% of average total assets unless a higher leverage capital ratio is warranted by the particular circumstances or risk profile of the depository institution. As of December 31, 2004, the Bank’s ratio of Tier 1 capital to average total assets (leverage ratio) was 9.89%.

      Corrective Measures for Capital Deficiencies. The federal banking regulators are required to take “prompt corrective action” with respect to capital-deficient institutions. Agency regulations define, for each capital category, the levels at which institutions are “well-capitalized,” “adequately capitalized,” “under capitalized,” “significantly under capitalized” and “critically under capitalized.” A “well-capitalized” bank has a total risk-based capital ratio of 10.0% or higher; a Tier 1 risk-based capital ratio of 6.0% or higher; a leverage ratio of 5.0% or higher; and is not subject to any written agreement, order or directive requiring it to maintain a specific capital level for any capital measure. An “adequately capitalized” bank has a total risk-based capital ratio of 8.0% or higher; a Tier 1 risk-based capital ratio of 4.0% or higher; a leverage ratio of 4.0%

or higher (3.0% or higher if the bank was rated a composite 1 in its most recent examination report and is not experiencing significant growth); and does not meet the criteria for a well-capitalized bank. A bank is “under capitalized” if it fails to meet any one of the ratios required to be adequately capitalized.

      In addition to requiring undercapitalized institutions to submit a capital restoration plan, agency regulations authorize broad restrictions on certain activities of undercapitalized institutions including asset growth, acquisitions, branch establishment, and expansion into new lines of business. With certain exceptions, an insured depository institution is prohibited from making capital distributions, including dividends, and is prohibited from paying management fees to control persons if the institution would be undercapitalized after any such distribution or payment.

      As an institution’s capital decreases, the OCC’s enforcement powers increase. A significantly undercapitalized institution is subject to mandated capital raising activities, restrictions on interest rates paid and transactions with affiliates, removal of management, and other restrictions. The OCC has only limited discretion in dealing with a critically undercapitalized institution and is required to undertake stringent measures to protect the interests of deposits and the federal deposit insurance fund, which depending on the circumstances, could include the appointment of a receiver or conservator.

      Banks with risk-based capital and leverage ratios below the required minimums may also be subject to certain administrative actions, including the termination of deposit insurance upon notice and hearing, or a temporary suspension of insurance without a hearing in the event the institution has no tangible capital.

      Deposit Insurance Assessments. The Bank must pay assessments to the FDIC for federal deposit insurance protection. The FDIC has adopted a risk-based assessment system as required by FDICIA. Under this system, FDIC-insured depository institutions pay insurance premiums at rates based on their risk classification. Institutions assigned to higher-risk classifications (that is, institutions that pose a greater risk of loss to their respective deposit insurance funds) pay assessments at higher rates than institutions that pose a lower risk. An institution’s risk classification is assigned based on its capital levels and the level of supervisory concern the institution poses to the regulators. In addition, the FDIC can impose special assessments in certain instances.

      The FDIC established a process for raising or lowering all rates for insured institutions semi-annually if conditions warrant a change. Under this new system, the FDIC has the flexibility to adjust the assessment rate schedule twice a year without seeking prior public comment, but only within a range of five cents per $100 above or below the assessment schedule adopted. Changes in the rate schedule outside the five-cent range above or below the current schedule can be made by the FDIC only after a full rulemaking with opportunity for public comment.

      In 1996, Congress enacted a law that contained a comprehensive approach to recapitalizing the Savings Association Insurance Fund (SAIF) and to assure the payment of the Financing Corporation’s (FICO) bond obligations. Under this act, banks insured under the BIF are required to pay a portion of the interest due on bonds that were issued by FICO to help shore up the ailing Federal Savings and Loan Insurance Corporation in 1987. For the fourth quarter of 2004, the FICO assessment rate was 0.0148% of deposits.

      Enforcement Powers. The FDIC and the other federal banking agencies have broad enforcement powers, including the power to terminate deposit insurance, impose substantial fines and other civil and criminal penalties, and appoint a conservator or receiver. Failure to comply with applicable laws, regulations and supervisory agreements could subject us or our banking subsidiary, as well as officers, directors and other institution-affiliated parties of these organizations, to administrative sanctions and potentially substantial civil money penalties. The appropriate federal banking agency may appoint the FDIC as conservator or receiver for a banking institution (or the FDIC may appoint itself, under certain circumstances) if any one or more of a number of circumstances exist, including, without limitation, the fact that the banking institution is undercapitalized and has no reasonable prospect of becoming adequately capitalized; fails to become adequately capitalized when required to do so; fails to submit a timely and acceptable capital restoration plan; or materially fails to implement an accepted capital restoration plan.

      Brokered Deposit Restrictions. Adequately capitalized institutions (as defined for purposes of the prompt corrective action rules described above) cannot accept, renew or roll over brokered deposits except with a waiver from the FDIC, and are subject to restrictions on the interest rates that can be paid on such deposits. Undercapitalized institutions may not accept, renew, or roll over brokered deposits.

      Cross-Guarantee Provisions. The Financial Institutions Reform, Recovery and Enforcement Act of 1989 (FIRREA) contains a “cross-guarantee” provision which generally makes commonly controlled insured depository institutions liable to the FDIC for any losses incurred in connection with the failure of a commonly controlled depository institution.

      Community Reinvestment Act. The Community Reinvestment Act (CRA) and the regulations issued thereunder are intended to encourage banks to help meet the credit needs of their service area, including low and moderate-income neighborhoods, consistent with the safe and sound operations of the banks. These regulations also provide for regulatory assessment of a bank’s record in meeting the needs of its service area when considering applications to establish branches, merger applications and applications to acquire the assets and assume the liabilities of another bank. FIRREA requires federal banking agencies to make public a rating of a bank’s performance under the CRA. In the case of a bank holding company, the CRA performance record of the banks involved in the transaction are reviewed in connection with the filing of an application to acquire ownership or control of shares or assets of a bank or to merge with any other bank holding company. An unsatisfactory record can substantially delay or block the transaction.

      Consumer Laws and Regulations. In addition to the laws and regulations discussed herein, the Bank is also subject to certain consumer laws and regulations that are designed to protect consumers in transactions with banks. While the list set forth herein is not exhaustive, these laws and regulations include the Truth in Lending Act, the Truth in Savings Act, the Electronic Funds Transfer Act, the Expedited Funds Availability Act, the Equal Credit Opportunity Act, and the Fair Housing Act, among others. These laws and regulations mandate certain disclosure requirements and regulate the manner in which financial institutions must deal with customers when taking deposits or making loans to such customers. The bank must comply with all applicable provisions of these consumer protection laws and regulations as part of its ongoing compliance and customer relations programs.

      Privacy. In addition to expanding the activities in which banks and bank holding companies may engage, the Gramm-Leach-Bliley Act imposed new requirements on financial institutions with respect to customer privacy. The Gramm-Leach-Bliley Act generally prohibits disclosure of customer information to non-affiliated third parties unless the customer has been given the opportunity to object and has not objected to such disclosure. Financial institutions are further required to disclose their privacy policies to customers annually. Financial institutions, however, are required to comply with state law if it is more protective of customer privacy than the Gramm-Leach-Bliley Act. The privacy provisions became effective on July 1, 2002.

      USA PATRIOT Act of 2001. The Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism (USA PATRIOT) Act of 2001 was enacted in October 2001. The USA PATRIOT Act amended existing U.S. anti-money laundering laws to strengthen the ability of U.S. law enforcement and the intelligence communities to work cohesively to combat terrorism on a variety of fronts. The potential impact of the USA PATRIOT Act on financial institutions of all kinds is significant and wide ranging. The USA PATRIOT Act contains a broad range of anti-money laundering and financial transparency laws and requires various regulations, including: (i) due diligence requirements for financial institutions that administer, maintain, or manage private bank accounts or correspondent accounts for non-U.S. persons; (ii) standards for verifying customer identification at account opening as well as standards for institution and organization-wide anti-money laundering compliance programs; (iii) rules to promote cooperation among financial institutions, regulators and law enforcement entities in identifying parties that may be involved in terrorism or money laundering; (iv) reports by nonfinancial trades and business filed with the Treasury Department’s Financial Crimes Enforcement Network for transactions exceeding $10,000; and (v) filing of suspicious activities reports involving securities by brokers and dealers if they believe a customer may be violating U.S. laws and regulations.

      One of the major additional burdens imposed on the banking industry by FDICIA is the increased ability of banking regulators to monitor the activities of banks and their holding companies. In addition, the Federal Reserve Board and FDIC possess extensive authority to police unsafe or unsound practices and violations of applicable laws and regulations by depository institutions and their holding companies. For example, the FDIC may terminate the deposit insurance of any institution which it determines has engaged in an unsafe or unsound practice. The agencies can also assess civil money penalties, issue cease and desist or removal orders, seek injunctions, and publicly disclose such actions. FDICIA, FIRREA and other laws have expanded the agencies’ authority in recent years, and the agencies have not yet fully tested the limits of their powers.

      The policies of regulatory authorities, including the monetary policy of the Federal Reserve Board, have a significant effect on the operating results of bank holding companies and their subsidiaries. Among the means available to the Federal Reserve Board to affect the money supply are open market operations in U.S. government securities, changes in the discount rate on member bank borrowings, and changes in reserve requirements against member bank deposits. These means are used in varying combinations to influence overall growth and distribution of bank loans, investments and deposits, and their use may affect interest rates charged on loans or paid for deposits.

      Federal Reserve Board monetary policies have materially affected the operating results of commercial banks in the past and are expected to continue to do so in the future. The nature of future monetary policies and the effect of such policies on our business and earnings of us and those of our subsidiaries cannot be predicted.

Item 2.     Properties

      We conduct our business at four locations. Our headquarters are located at 14060 Southwest Freeway, Sugar Land, Texas in a one-story building we own. We also own the buildings in which our banking offices are located, except for the Memorial Hermann Southwest Hospital branch. The lease agreement for this location expires on October 8, 2010.

      The following table sets forth specific information regarding each of our banking locations:

      In addition, we lease two drive-through facilities, the Bellfort Motor Bank and Beechnut Motor Bank, which are not physically attached to our branch locations. The lease agreement for the Bellfort Motor Bank expires on January 31, 2006, not including two five-year renewal periods at our option. The lease agreement for the Beechnut Motor Bank expires on September 30, 2007.

      Our main office, located in Sugar Land, is the first of a “campus-style” series of facilities replicating buildings designed by Thomas Jefferson. Our headquarters building was inspired by Jefferson’s residence,

Monticello. In October 2002, adjacent to our main office building we completed construction of a building inspired by Jefferson’s retreat home, Poplar Forest. In 2004, we began construction on a series of buildings scheduled for completion in the summer of 2005, consisting of a long building made up of three connected pavilions modeled after buildings on the University of Virginia campus designed by Jefferson. This addition will be used for our operations center and will house our administrative and operational support departments. Our Uptown-Post Oak branch is based on Jefferson’s Farmington of Charlottesville, Virginia.

      We and the Bank from time to time will be party to or otherwise involved in legal proceedings arising in the normal course of business. Management does not believe that there are any material pending or threatened legal proceedings to which we or the Bank are a party which, upon resolution, would have a material adverse effect on our financial condition, results of operations or cash flows.

      No matters were submitted to a vote of security holders during the fourth quarter of 2004.

PART II.

      Our Common Stock began trading on the Nasdaq National Market on August 18, 2004 under the symbol “SNBT.” As of March 18, 2005, there were approximately 266 holders of record of our Common Stock. The number of beneficial owners is unknown to us at this time. From July 25, 2002 to August 17, 2004, our Common Stock was quoted on the OTC Bulletin Board under the same symbol. Although our Common Stock was quoted for trading on the OTC Bulletin Board, there was limited trading, at widely varying prices. Thus, the prices at which trades occurred may not have been representative of the actual value of our Common Stock. On a number of days during this period, there were no trades at all in our Common Stock.

      The following table sets forth the high and low sales prices for our Common Stock as reported by the Nasdaq National Market for each period since the Common Stock began trading on Nasdaq:

      The following table sets forth the high and low sales prices for our Common Stock as reported by the OTC Bulletin Board for each quarter in 2004 and 2003, prior to August 18, 2004:

Dividends

      Holders of our Common Stock and Class B stock are entitled to receive dividends when, as and if declared by our Board of Directors out of funds legally available for that purpose. We have not paid any dividends to our holders of Common Stock and Class B stock in the past and we currently do not intend to pay dividends on either class of stock in the foreseeable future. In the event that we decide to pay dividends, there are a number of restrictions on our ability to do so.

      Our principal source of cash revenues is dividends paid by the Bank with respect to its capital stock. There are certain restrictions on the payment of these dividends imposed by federal banking laws, regulations and authorities. See “Supervision and Regulation — Southern National Bank of Texas — Restrictions on Distribution of Subsidiary Bank Dividends and Assets.”

      The declaration and payment of dividends on our Common Stock and Class B stock will depend upon our earnings and financial condition, liquidity and capital requirements, the general economic and regulatory climate, our ability to service any equity or debt obligations senior to the Common Stock and Class B stock and other factors deemed relevant by our board of directors. As of December 31, 2004, an aggregate of approximately $16.8 million was available for payment of dividends by the Bank to us under applicable regulatory restrictions, without regulatory approval. Regulatory authorities could impose administratively stricter limitations on the ability of the Bank to pay dividends to us if such limits were deemed appropriate to preserve certain capital adequacy requirements. In addition, the terms of our junior subordinated debentures may limit our ability to pay dividends on our Common Stock and Class B stock.

Recent Sales of Unregistered Securities

      None.

Issuer Purchases of Equity Securities

      None.

      The following consolidated selected financial data is derived from our audited consolidated financial statements as of and for the five years ended December 31, 2004. The consolidated financial data should be read in conjunction with Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations and the consolidated financial statements and related notes included elsewhere in this report.

Special Cautionary Notice Regarding Forward-Looking Statements

      Statements and financial analysis contained in this annual report on Form 10K that 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 are based on assumptions and involve a number of risks and uncertainties that could cause actual results to differ materially from current expectations, future results, performance or achievements expressed or implied by such forward-looking statements. Such risks and uncertainties include, but are not limited to, the following:

      A forward-looking statement may include a statement of the assumptions or bases underlying the forward-looking statement. We believe we have chosen these assumptions or bases in good faith and that they are reasonable. However, we caution you that assumptions or bases almost always vary from actual results, and the differences between assumptions or bases and actual results can be material. We do not intend (and are not obligated) to publicly update or otherwise revise any forward-looking statement, unless the securities laws require us to do so.

For the Years Ended December 31, 2004, 2003 and 2002

      Management’s Discussion and Analysis of Financial Condition and Results of Operations analyzes the major elements of our balance sheets and statements of income. This section should be read in conjunction with our audited consolidated financial statements and related notes as of December 31, 2004 and 2003 and for each of the three years ended December 31, 2004, which are included in this report.

Overview

      We generate the majority of our revenue from interest on loans, service charges on customer accounts and income from investment securities. This revenue is offset by interest expense paid on deposits and other borrowings and noninterest expense such as administrative and occupancy expenses. Net interest income is the difference between interest income on interest-earning assets such as loans and securities and interest expense on interest-bearing liabilities such as customer deposits and other borrowings which are used to fund those assets. Net interest income is our largest source of net income. Interest rate fluctuations, as well as changes in the amount and type of earning assets and liabilities, combine to affect net interest income.

      Noninterest income is another source of income for us. We receive fees from our deposit customers in the form of service fees, check pay fees and other fees for services provided to the customer. Other services such as safe deposit, wire transfer and lock box fees provide additional fee income. We may also generate income from the sale of investment securities. The fees collected by us and any gains on sales of securities are found in our Consolidated Statements of Income under “noninterest income.” Offsetting these earnings are operating expenses referred to as “noninterest expense.” Because banking is a very people intensive industry, our largest operating expense is employee compensation and benefits.

Critical Accounting Policies

      Our accounting policies are integral to understanding the results reported. Our accounting policies are described in detail in Note 1 to the consolidated financial statements included in this report. The policies related to the allowance for loan losses and stock-based compensation require a significant amount of subjective and complex judgment and assumptions by our management. Because of the nature of judgments and assumptions made by our management, actual results could differ from these judgments and assumptions, which could have a material impact on our financial condition and results of operations.

      Allowance for Loan Losses — The allowance for loan losses is a valuation allowance for probable losses incurred on loans. Loans are charged to the allowance when the loss actually occurs or when a determination is made that a probable loss has occurred. Recoveries are credited to the allowance at the time of recovery. Throughout the year, management estimates the probable level of losses to determine whether the allowance for loan losses is adequate to absorb losses in the existing portfolio. Based on these estimates, an amount is charged to the provision for loan losses and credited to the allowance for loan losses in order to adjust the allowance to a level determined to be adequate to absorb losses. Management’s judgment as to the level of probable losses on existing loans involves the consideration of current economic conditions and their estimated effects on specific borrowers; an evaluation of the existing relationships among loans, potential loan losses and the present level of the allowance; results of examinations of the loan portfolio by regulatory agencies; and management’s internal review of the loan portfolio. In determining the collectability of certain loans, management also considers the fair value of any underlying collateral. The amount ultimately realized may differ from the carrying value of these assets because of economic, operating or other conditions beyond our control.

      Stock-based Compensation — We account for stock-based employee compensation plans based on the “intrinsic value method” provided in Accounting Principles Board Opinion (APB) No. 25, “Accounting for Stock Issued to Employees,” and related Interpretations. Because of the exercise price of our employee stock options equals the market price of the underlying stock on the date of grant, no compensation expense is recognized on options granted. Compensation expense for stock awards is based on the market price of the stock on the date of grant and is recognized ratably over the service period of the award. We make pro-forma disclosure of net earnings and earnings per share assuming the fair value-based accounting method discussed in Note 1 to our consolidated financial statements. The fair value of stock options granted is estimated at the date of grant using the Black-Scholes option-pricing model. This model requires the input of highly subjective assumptions.

      We expect to adopt the provisions of SFAS No. 123R “Share-Based Payment (Revised 2004),” on July 1, 2005. Among other things, SFAS No. 123R eliminates the ability to account for stock-based compensation using the intrinsic value based method of accounting and requires that such transactions be

recognized as compensation expense in the income statement based on their fair values on the date of the grant. SFAS No. 123R is effective on July 1, 2005. SFAS No. 123R will require that management make assumptions including stock price volatility and employee turnover that are utilized to measure compensation expense.

Results of Operations

      Net earnings for the year ended December 31, 2004 were $5.9 million, an increase of $2.5 million or 74.0%, compared with $3.4 million for the year ended December 31, 2003, primarily due to a $7.5 million increase in net interest income, partially offset by a $3.3 million increase in noninterest expense, and a $1.3 million increase in the provision for federal income taxes. Diluted earnings per share for the year ended December 31, 2004 were $0.65, compared with $0.48 per share for the same period in 2003. During the fourth quarter of 2004, we completed our initial public offering, adding 5,436,364 shares and $52.2 million to our capital. The weighted average shares of common stock and Class B stock outstanding during 2004 were 8,899,465 compared with 6,993,989 weighted average shares outstanding during 2003.

      Net earnings for the year ended December 31, 2003 were $3.4 million, an increase of $255 thousand or 8.1% compared with $3.2 million for the year ended December 31, 2002, primarily the result of a $3.3 million increase in our net interest income, partially offset by an increase of $2.1 million in noninterest expense. Diluted earnings per share were $0.48 compared with $0.56 for 2002. Earnings per share were affected by the increased average shares outstanding during 2003 versus 2002. During the second quarter of 2002, we completed a private offering of our common stock, adding 2,820,000 shares to the total shares outstanding, and $14.0 million to our capital. The weighted average shares of common stock and Class B stock outstanding during 2003 were 6,993,989 compared with 5,680,564 weighted average shares outstanding during 2002.

      Total assets as of December 31, 2004 were $1.1 billion, an increase of $246.2 million or 27.9% compared with total assets of $883.8 million as of December 31, 2003. The increase was primarily due to a $173.8 million increase in loans and a $75.9 million increase in investment securities. Both deposits and borrowings funded the loan growth. Total assets as of December 31, 2003 were $883.8 million, an increase of $309.2 million or 53.8% compared with total assets of $574.6 million as of December 31, 2002. We posted returns on average assets of 0.57%, 0.47% and 0.61% for the years ended December 31, 2004, 2003 and 2002, respectively. Returns on average equity were 11.86%, 11.13%, and 14.53% for the years ended December 31, 2004, 2003 and 2002, respectively.

      Our operating results depend on our net interest income, which represents the amount by which interest income on interest-earning assets, including securities and loans, exceeds interest expense incurred on interest-bearing liabilities, including deposits and other borrowed funds. Net interest income is the principal source of our earnings. Interest rate fluctuations, as well as changes in the amount and type of earning assets and liabilities, combine to affect net interest income. Our net interest income is affected by changes in the amount and mix of interest-earning assets and interest-bearing liabilities, referred to as “volume changes.” It is also affected by changes in yields earned on interest-earning assets and rates paid on interest-bearing deposits and other borrowed funds, referred to as “rate changes.”

      2004 versus 2003. For the year ended December 31, 2004, net interest income increased $7.4 million to $28.6 million compared with $21.2 million for the year ended December 31, 2003. This increase was primarily due to a $316.7 million increase in average earning assets, partially offset by a $282.0 million increase in interest-bearing liabilities. The average yield on interest-earning assets for the year ended December 31, 2004, decreased 0.19% to 4.56% compared with 4.75% for 2003. The average rate on interest-bearing liabilities for the year ended December 31, 2004, compared with the same period in 2003, increased 0.04% to 2.04% from 2.00%. Our net interest margin on a tax equivalent basis decreased 0.22% to 2.85% for the year ended December 31, 2004 compared with 3.07% for 2003.

      Our total interest income increased $13.4 million principally because of a $6.7 million increase in interest income on investment securities and a $6.6 million increase in interest income on loans. The $6.7 million

increase in interest income on investment securities was primarily the result of increases in volumes of securities, with increases in yield contributing to the revenue increase as well. The yield on investment securities increased 0.31% to 3.28% for 2004 compared with 2.97% for 2003. The $6.6 million increase in interest income on loans was primarily the result of increases in loan volumes which more than offset decreases in yields. The yield on loans decreased by 0.28% to 5.94% for 2004 compared with 6.22% for 2003.

      Our total interest expense increased $6.0 million primarily due to an increase in deposits. For the year ended December 31, 2004, average deposits increased $206.9 million compared with average deposits for the year ended December 31, 2003.

      2003 versus 2002. Net interest income was $21.2 million for the year ended December 31, 2003 compared with $17.9 million for the year ended December 31, 2002, an increase of $3.3 million or 18.6% primarily due to increases in the volume of loans and investment securities. This increase was partially offset by an increase in interest expense of $540,000. This resulted in net interest margins on a tax equivalent basis of 3.07% and 3.69% and net interest spreads of 2.75% and 3.13% for 2003 and 2002, respectively.

      Our total interest income increased $3.9 million primarily due to a $2.5 million increase in income on loans and a $1.6 million increase in income on investment securities. These increases in income were primarily due to the increases in volume of bank loans and investment securities that more than offset the decreases in interest rates earned on such assets during 2003.

      With average noninterest-bearing deposits remaining relatively flat during 2003, we funded the increase in average interest-earning assets with increases in interest-bearing liabilities. Accordingly, total interest expense was up $540 thousand to $12.1 million for the year ended December 31, 2003 compared with $11.5 million for the year ended December 31, 2002.

      The following table sets forth for the periods indicated an analysis of net interest income by each major category of interest-earning assets and interest-bearing liabilities, the average amounts outstanding, the interest earned or paid on such amounts, and the average rate earned or paid. The table also sets forth the average rate earned on total interest-earning assets, the average rate paid on total interest-bearing liabilities, and the net interest margin on average total interest-earning assets for the same periods. All balances are daily average balances and nonaccruing loans have been included in the table as loans carrying a zero yield.

      The following table presents information regarding changes in interest income and interest expense for the periods indicated for each major category of interest-earning assets and interest-bearing liabilities, which distinguishes between the changes attributable to changes in volume (changes in volume multiplied by old rate) and changes in rates (changes in rates multiplied by new volume). For purposes of this table, changes attributable to both rate and volume which cannot be segregated have been allocated to rate.

      Our provision for loan losses is a charge to earnings made in order to bring our allowance for loan losses to a level deemed appropriate by our management to absorb loan losses inherent in the loan portfolio based on our migration analysis. This analysis considers such factors as our historical loan loss experience, the diversification by industry of our commercial loan portfolio, the effect of changes in the local real estate market on collateral values, the results of recent regulatory examinations, the effects on the loan portfolio of current economic indicators and their probable impact on borrowers, the amount of charge-offs for the period, the amount of nonperforming loans and related collateral security, the evaluation of our loan portfolio by the semi-annual external loan reviews conducted by an independent loan review company and other relevant factors.

      The provision for loan losses for the year ended December 31, 2004 was $3.0 million compared with $2.8 million for the year ended December 31, 2003. We made the increased provision mainly due to the growth in our loans and management’s evaluation of our allowance for loan losses. We recorded a provision for loan losses of $1.6 million for the year ended December 31, 2002. For the years ended December 31, 2004, 2003 and 2002, net charge-offs were $479 thousand, $1.2 million and $955 thousand, respectively.

      The following table presents, for the periods indicated, the major categories of noninterest income:

      For the year ended December 31, 2004, noninterest income decreased to $2.1 million compared with $2.3 million for the year ended December 31, 2003, primarily due to a $180 thousand decrease in the net gains on sales of securities. The $88 thousand decrease in service charges can be attributed to a $58 thousand decrease in insufficient check charges due to more of our customers maintaining balances in transaction accounts and a $33 thousand decrease in demand and NOW account charges due to the elimination of the minimum balance requirement on our interest-free checking account in May 2004. The $78 thousand increase in other noninterest income was due to a $27 thousand increase in wire transfer fees, a $19 thousand increase in customer service fees, an $18 thousand interest payment from a franchise tax refund and a $14 thousand increase in check printing charges.

      Noninterest income for the year ended December 31, 2003 was $2.3 million, an increase of $416 thousand or 22.0% compared with $1.9 million in 2002. The increase was primarily due to an increase of $426 thousand in net gains on sales of securities, partially offset by an $11 thousand decrease in service charges on deposit accounts. The decrease in service charges can be attributed to a $32 thousand decrease in account analysis fees due to more of our customers keeping compensating balances in their accounts, a $16 thousand decrease in demand and NOW account charges due to an increase in waived fees and a $39 thousand increase in lockbox account fees due to an increase in volume.

      The following table presents, for the periods indicated, the major categories of noninterest expense:

      Noninterest expense for the year ended December 31, 2004 was $18.8 million compared with $15.5 million for the year ended December 31, 2003, an increase of $3.3 million or 21.5%, primarily due to an increase of $2.0 million in salaries and employee benefits and a $985 thousand increase in other noninterest expense. Employee compensation and benefits expense for the year ended December 31, 2004 was $11.4 million, an increase of $2.0 million or 21.8% compared with $9.3 million for the year ended December 31, 2003. The

increase was primarily due to a $1.1 million increase in salaries and a $383 thousand increase in employee benefits and payroll taxes, which were primarily the result of newly hired staff and $580 thousand in bonus and incentives, due to increased earnings. In 2002, management formulated a plan to provide what it believed to be the necessary platform for our growth, including hiring loan officers and additional personnel in loan operations, loan collections, deposit operations, audit, compliance, investments and information systems. In accordance with the plan, we added 15 employees in 2004 and 22 employees in 2003. The number of full-time equivalent employees was 164, 149 and 129 as of December 31, 2004, 2003 and 2002, respectively.

      Approximately $782 thousand of the $985 thousand increase in other noninterest expense was related to other real estate expenses, including $116 thousand in property taxes and a $535 thousand write-down of the carrying values of two properties.

      Noninterest expense totaled $15.5 million for the year ended December 31, 2003, an increase of $2.1 million or 16.0% compared with the year ended December 31, 2002. The increase was primarily the result of an increase in employee compensation and benefits expense of $1.6 million or 21.0% from $7.7 million for the year ended December 31, 2002 to $9.3 million for the year ended December 31, 2003. The increase was due primarily to increased salary expenses for new hires, promotions and annual merit increases and an increase in medical insurance premiums. In addition, net occupancy expense increased $299 thousand.

      The efficiency ratio is a supplemental financial measure utilized in management’s internal evaluation of the company and is not defined under generally accepted accounting principles. The efficiency ratio is calculated by dividing total noninterest expense by net interest income plus noninterest income, excluding securities gains and losses. Taxes are not part of this calculation. An increase in the efficiency ratio indicates that more resources are being utilized to generate the same volume of income, while a decrease would indicate a more efficient allocation of resources. Our efficiency ratio for the years ended December 31, 2004, 2003 and 2002 was 62.60%, 68.51% and 69.21%, respectively. The decreases reflect our continued success in managing operating expenses and growing revenues.

      The amount of federal income tax expense is influenced by the amount of taxable income, the amount of tax-exempt income, the amount of nondeductible interest expense and the amount of other nondeductible expenses. Income tax expense increased approximately $1.3 million to $3.0 million for the year ended December 31, 2004 compared with $1.8 million for the year ended December 31, 2003 and $1.6 million for the year ended December 31, 2002. The increases were primarily attributable to higher pretax net earnings which resulted from increases in net interest income partially offset by increases in noninterest expense. The effective tax rates in 2004, 2003 and 2002 were 33.9%, 34.0% and 34.2%, respectively.

Financial Condition

      The following table summarizes our loan portfolio by type of loan as of the dates indicated:

      Total loans were $598.3 million as of December 31, 2004, an increase of $173.8 million or 40.9% compared with loans of $424.5 million as of December 31, 2003. This loan growth occurred primarily in commercial mortgages, which increased $91.5 million or 52.1% and construction and land development loans, which increased $58.0 million or 88.4%.

      Total loans were $424.5 million as of December 31, 2003, an increase of $82.4 million or 24.1% compared with loans of $342.1 million as of December 31, 2002. Loan growth occurred primarily in commercial mortgage loans, which increased $49.4 million or 39.2% and residential loans, which increased $18.5 million or 18.7%.

      Our primary lending focus is on real estate related customers, which include construction and land development loans, residential mortgages and commercial mortgage loans, which accounted for 86.5% of our loan portfolio as of December 31, 2004. Business and industrial loans accounted for 11.7% of our portfolio as of December 31, 2004. The majority of our customers are small to medium-sized owner-operated businesses. In

addition to real estate and business and industrial loans, we offer equipment loans, working capital loans, term loans, revolving lines of credit and letters of credit. Most business and industrial loans are collateralized and on payment programs. The purpose of a particular loan generally determines its structure. In almost all cases, we require personal guarantees on business and industrial loans.

      Business and Industrial. Our business and industrial loans are primarily made within our market area and are underwritten on the basis of the borrower’s ability to service the debt from income. As a general practice, we take as collateral a lien on any available real estate, equipment, or other assets owned by the borrower and obtain the personal guaranty of the principal. In general, business and industrial loans involve more credit risk than residential mortgage loans and commercial mortgage loans and, therefore, usually yield a higher return. The increased risk in business and industrial loans is due to the type of assets collateralizing these loans. The increased risk also derives from the expectation that business and industrial loans generally will be serviced principally from the operations of the business, and those operations may not be successful. Historical trends have shown these types of loans to have higher delinquencies than mortgage loans. As a result of these additional complexities, variables and risks, business and industrial loans require more thorough underwriting and servicing than other types of loans. Further, our practices require us to visit with business and industrial customers annually. As of December 31, 2004, we had $70.1 million in business and industrial loans, which represented 11.7% of our total loans.

      Construction and Land Development. We also make loans to finance the construction of residential and, to a limited extent, nonresidential properties. We have long-standing relationships with approximately 40 homebuilders. Construction loans generally are secured by first liens on real estate and have floating interest rates. We employ our own construction inspector to make regular inspections prior to approval of periodic draws on these loans. Underwriting guidelines similar to those described above are also used in our construction lending activities. Construction loans involve additional risks attributable to the fact that loan funds are advanced upon the security of a project under construction, and the value of the project is dependent on its successful completion. As a result of these uncertainties, construction lending often involves the disbursement of substantial funds with repayment dependent, in part, on the success of the ultimate project rather than the ability of a borrower or guarantor to repay the loan. If we are forced to foreclose on a project prior to completion, there is no assurance that we will be able to recover the entire unpaid portion of the loan. In addition, we may be required to fund additional amounts to complete a project and may have to hold the property for an indeterminate period of time. While we have underwriting procedures designed to identify what we believe to be acceptable levels of risks in construction lending, no assurance can be given that these procedures will prevent losses from the risks described above. As of December 31, 2004, we had $123.7 million in construction and land development loans, which represented 20.7% of our total loans.

      Residential Mortgage. A portion of our lending activity has consisted of the origination of residential mortgage loans collateralized by owner-occupied properties located in our market areas. We offer a variety of mortgage loan products which generally are amortized over 15 to 30 years with balloon payments due in five to seven years. Loans collateralized by residential real estate generally have been originated in amounts of no more than 90% of appraised value. We have elected to keep all residential loans for our own account rather than selling these loans into the secondary market. As of December 31, 2004, our residential real estate loan portfolio was $126.2 million, which represented 21.1% of our total loans.

      We retain a valid lien on real estate and obtain a title insurance policy that insures that the property is free of encumbrances. We also require hazard insurance in the amount of the loan and, if the property is in a flood plain as designated by the Federal Emergency Management Agency, we require flood insurance. We offer the option to borrowers to advance funds on a monthly basis from which we make disbursements for items such as real estate taxes, private mortgage insurance and hazard insurance.

      Commercial Mortgage. In addition to business and industrial loans collateralized by real estate, we make commercial mortgage loans to finance the purchase of real property and the refinancing of such loans, which generally consists of real estate with completed structures. Commercial mortgage lending typically involves higher loan principal amounts and the repayment of loans is dependent, in large part, on sufficient income from the properties collateralizing the loans to cover operating expenses and debt service. As a general

practice, we require our commercial mortgage loans to be collateralized by well-managed income producing property with adequate margins and to be guaranteed by responsible parties. We look for opportunities where cash flow from the collateral provides adequate debt service coverage and the guarantor’s net worth is centered on assets other than the project we are financing.

      Our commercial mortgage loans are generally collateralized by first liens on real estate, have fixed or floating interest rates and amortize over a 15 to 25-year period with balloon payments due at the end of one to nine years. Payments on loans collateralized by such properties are often dependent on the successful operation or management of the properties. Accordingly, repayment of these loans may be subject to adverse conditions in the real estate market or the economy to a greater extent than other types of loans.

      In underwriting commercial mortgage loans, we seek to minimize the risks in a variety of ways, including giving careful consideration to the property’s operating history, future operating projections, current and projected occupancy, location and physical condition. Our underwriting analysis also includes credit checks, reviews of appraisals and environmental hazards or EPA reports and a review of the financial condition of the borrower. Our policies require us to inspect properties on an annual basis, but our practice is to have more frequent inspections of properties, if possible. At December 31, 2004, we had $267.2 million in commercial mortgage loans, which represented 44.7% of our total loans.

      Consumer. We provide a variety of consumer loans, including automobile loans, recreational vehicle loans, boat loans, home improvement loans, home equity loans, personal loans (collateralized and uncollateralized) and deposit account collateralized loans. The terms of these loans typically range from 12 to 120 months and vary based upon the nature of the collateral and size of the loan. Consumer loans entail greater risk than do residential mortgage loans, particularly in the case of consumer loans that are unsecured or secured by rapidly depreciating assets such as automobiles. In these cases, any repossessed collateral for a defaulted consumer loan may not provide an adequate source of repayment for the outstanding loan balance. The remaining deficiency often does not warrant further substantial collection efforts against the borrower beyond obtaining a deficiency judgment. In addition, consumer loan collections are dependent on the borrower’s continuing financial stability, and thus are more likely to be adversely affected by job loss, divorce, illness or personal bankruptcy. Furthermore, the application of various federal and state laws may limit the amount which can be recovered on such loans. As of December 31, 2004, we had $12.6 million in consumer loans, which represented 2.1% of our total loans.

      Underwriting Strategy. We maintain few lending relationships that approach our legal lending limit of approximately $17.8 million. Lending officers are assigned various levels of loan approval authority based upon their respective levels of experience and expertise. New and renewed loans, or modifications to loans, in which the loan relationship is $2.0 million or above are evaluated weekly by our Senior Loan Committee, which consists of non-employee directors. Our strategy for approving or disapproving loans is to follow conservative loan policies and underwriting practices which include:

      Our credit administration and compliance personnel interact regularly with commercial and consumer lenders to identify potential underwriting or technical exception variances. In addition, we have placed increased emphasis on the early identification of problem loans to aggressively seek resolution of the situations and thereby keep loan losses at a minimum.

      The contractual maturity ranges of our business and industrial, real estate and consumer loan portfolios and the amount of such loans with predetermined interest rates and floating interest rates in each maturity range as of December 31, 2004 are summarized in the following table:

      As of December 31, 2004, 47.3% of our total loan portfolio carries fixed rates of interest and 52.7% of our loan portfolio has floating or adjustable interest rates. Scheduled contractual principal repayments do not reflect the actual maturities of loans. The average maturity of loans is substantially less than their average contractual term because of prepayments. The average life of mortgage loans tends to increase when the current mortgage loan rates are substantially higher than rates on existing mortgage loans and, conversely, to decrease when current mortgage loan rates are substantially lower than rates on existing mortgages due primarily to the refinancing of adjustable rate and fixed rate loans at lower rates.

      We have several procedures in place to assist us in maintaining the overall quality of our loan portfolio. We have established underwriting guidelines to be followed by our officers and also monitor our delinquency levels for any negative or adverse trends, which are also monitored by our board of directors. There can be no assurance, however, that our loan portfolio will not become subject to increasing pressures from deteriorating borrower credit due to general economic conditions.

      We place a loan on nonaccrual status and cease to accrue interest when loan payment performance is deemed uncertain, generally when a loan is 90 days past due. Loans where the interest payments jeopardize the collection of principal are placed on nonaccrual status, unless the loan is both well secured and in the process of collection. Cash payments received while a loan is classified as nonaccrual are recorded as a reduction of principal as long as doubt exists as to collection. We are sometimes required to revise the interest rate or repayment terms in a troubled debt restructuring.

      We obtain appraisals on loans secured by real estate with principal amounts in excess of $250,000, as required by applicable regulatory guidelines, and may update such appraisals for loans categorized as nonperforming loans and potential problem loans. In instances where updated appraisals reflect reduced collateral values, an evaluation of the borrower’s overall financial condition is made to determine the need, if any, for possible write-down or appropriate additions to the allowance for loan losses. We record real estate acquired through foreclosure at fair value at the time of acquisition, less estimated costs to sell.

      The following table presents information regarding nonperforming assets as of the dates indicated:

      Nonperforming assets were $4.8 million and $4.6 million as of December 31, 2004 and 2003, respectively. Our ratio of nonperforming assets to total loans and other real estate was 0.80% and 1.07% as of December 31, 2004 and 2003, respectively. Interest on nonperforming loans that would have been accrued under the original loan agreements was $65 thousand and $258 thousand for the years ended December 31, 2004 and December 31, 2003, respectively.

      We had restructured loans as of December 31, 2004 of $1.9 million, down from $2.0 million as of December 31, 2003. This decrease was related to payments received on the restructured loans. As of December 31, 2004 and December 31, 2003, we had other real estate totaling $1.3 million and $40 thousand, respectively. Other real estate increased by $1.3 million as of December 31, 2004 compared with December 31, 2003 due to defaults on two loans collateralized by commercial real estate. Subsequent to December 31, 2004, one commercial real estate property in the amount of $825 thousand was sold realizing a $2 thousand loss.

      As of December 31, 2004, loans totaling $12.2 million were classified as potential problem loans that are not reported in the table above. These loans are subject to management attention and their classification is reviewed on a quarterly basis.

      Our allowance for loan losses is a reserve established through monthly charges to earnings in the form of a provision for loan losses. The allowance for loan losses is comprised of two components: specific reserves and unallocated reserves. Generally, all loans that have been identified as impaired are reviewed on a monthly basis in order to determine whether a specific allowance is required. A loan is considered impaired when, based on current information, it is probable that we will not receive all amounts due in accordance with the contractual terms of the loan agreement. Once a loan has been identified as impaired, management measures impairment in accordance with Statement of Financial Accounting Standards No. 114, Accounting by Creditors for Impairment of a Loan. When management’s measured value of the impaired loan is less than the recorded investment in the loan, the amount of the impairment is recorded as a specific reserve. These specific reserves are determined on an individual loan basis based on management’s current evaluation of our loss exposure for each credit, given the payment status, financial condition of the borrower, and value of any underlying collateral. Loans for which specific reserves are provided are excluded from the unallocated allowance calculations described below. Changes in specific reserves from period to period are the result of changes in the circumstances of individual loans such as charge-offs, pay-offs, changes in collateral values or other factors.

      The allowance for loan losses represents management’s estimate of the amount necessary to provide for known and inherent losses in the loan portfolio in the normal course of business. We make specific allocations for each impaired loan based on its type and classification as discussed above. However, there are additional risks of losses that cannot be quantified precisely or attributed to particular loans or categories of loans, including general economic and business conditions and credit quality trends. We have established an

unallocated portion of the allowance for loan losses based on our evaluation of these risks, which management believes is prudent and consistent with regulatory requirements.

      We evaluate the adequacy of the unallocated portion of our allowance for loan losses through our migration analysis, which allows management to consider factors such as our historical loan loss experience, the diversification by industry of our commercial loan portfolio, the effect of changes in the local real estate market on collateral values, the results of recent regulatory examinations, the effects on the loan portfolio of current economic indicators and their probable impact on borrowers, the amount of charge-offs for the period, the amount of nonperforming loans and related collateral security and other relevant factors. Each factor is designated an adjustment percentage. These adjustment percentages are determined by our historical experience, portfolio trends and economic and industry trends. These percentages are combined with the historical loss percentages for each of the following categories: watch, special mention and substandard (for which there is no specific allocation), and the uncriticized portion of the following categories: business and industrial, construction and land development, residential mortgages, commercial mortgages and consumer and other. These combined percentages are then applied to the amount of loans in the respective categories to determine the amount of the unallocated portion of the allowance for loan losses, the results of which are set forth in the following table: