LSB BANCSHARES INC /NC/ - 10-Q Quarterly Report

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549

FORM 10-Q


(Mark One)
x		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.

For the quarterly period ended June 30, 2003

OR

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

For the transition period from _______________ to _______________

Commission file number 0-11448

LSB BANCSHARES, INC.
(Exact Name of Registrant as Specified in Its Charter)


North Carolina		56-1348147
(State or Other Jurisdiction of		(I.R.S. Employer
Incorporation or Organization)		Identification No.)

LSB BANCSHARES, INC.
ONE LSB PLAZA
LEXINGTON, NORTH CAROLINA 27292
(Address of Principal Executive Offices)
(Zip Code)

(336) 248-6500
(Registrant’s Telephone Number, Including Area Code)

Indicate by check ü 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 þ No o

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

LSB Bancshares, Inc. has 8,533,255 shares of common stock outstanding as of July 31, 2003.

LSB BANCSHARES, INC.

FORM 10-Q

INDEX


Part I		Financial Information

Item 1.		Financial Statements

		Consolidated Balance Sheets June 30, 2003 and 2002, and December 31, 2002

		Consolidated Statements of Income Three Months Ended June 30, 2003 and 2002 Six Months Ended June 30, 2003 and 2002

		Consolidated Statements of Changes in Shareholders’ Equity Six Months Ended June 30, 2003 and 2002

		Consolidated Statements of Cash Flows Six Months Ended June 30, 2003 and 2002

		Notes to Consolidated Financial Statements Six Months Ended June 30, 2003 and 2002

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

Item 3.		Quantitative and Qualitative Disclosures about Market Risk

Part II		Other Information

Item 1.		Legal Proceedings

Item 2.		Changes in Securities and Use of Proceeds

Item 3.		Defaults Upon Senior Securities

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

Item 5.		Other Information

Item 6.		Exhibits and Reports on Form 8-K

Signatures

PART I. FINANCIAL INFORMATION
Item 1. Financial Statements

LSB Bancshares, Inc.
Consolidated Balance Sheets
(In Thousands)


			(Unaudited)						(Unaudited)
			June 30			December 31			June 30
			2003			2002			2002

Assets
Cash and Due From Banks			$	49,895		$	41,522		$	41,510
Interest-Bearing Bank Balances				4,430			5,550			4,046
Federal Funds Sold				15,050			13,384			11,735
Investment Securities:
	Held to Maturity, Market Value $42,807, $46,013 and $48,660			40,426			44,030			47,041
	Available for Sale, at Market Value			92,582			84,372			99,803
Loans				674,391			645,548			605,264
Less, Reserve for Loan Losses				(7,724	)		(7,284	)		(6,948	)

		Net Loans		666,667			638,264			598,316
Premises and Equipment				14,250			13,490			13,178
Other Assets				11,361			11,181			11,708

		Total Assets	$	894,661		$	851,793		$	827,337


Liabilities
Deposits
	Demand		$	101,798		$	94,612		$	83,802
	Savings, NOW and Money Market Accounts			401,573			385,981			365,493
	Certificates of Deposit of less than $100,000			136,711			145,669			169,227
	Certificates of Deposit of $100,000 or more			101,742			70,219			56,551

		Total Deposits		741,824			696,481			675,073
Securities Sold Under Agreements to Repurchase				1,068			1,529			1,342
Borrowings from the Federal Home Loan Bank				58,000			63,000			63,000
Other Liabilities				5,337			5,276			5,318

		Total Liabilities		806,229			766,286			744,733

Shareholders’ Equity
Preferred Stock, Par Value $.01 Per Share:
	Authorized 10,000,000 shares; none issued			0			0			0
Common Stock, Par Value $5 Per Share:
Authorized 50,000,000 Shares; Issued 8,522,590 Shares in 2003 and 8,472,518 and 8,483,095 shares in 2002				42,613			42,363			42,415
Paid-In Capital				9,974			9,729			9,983
Common Stock Acquired for Directors’ Deferred Plan				(1,085	)		(995	)		(968	)
Retained Earnings				35,109			32,578			30,075
Accumulated Other Comprehensive Income				1,821			1,832			1,099

		Total Shareholders’ Equity		88,432			85,507			82,604

		Total Liabilities and Shareholders’ Equity	$	894,661		$	851,793		$	827,337


Memorandum: Standby Letters of Credit			$	3,628		$	4,138		$	5,839

Notes to consolidated financial statements are an integral part hereof.

LSB Bancshares, Inc.
Consolidated Statements of Income
(In Thousands except Share Data)
(Unaudited)


			Three Months Ended				Six Months Ended
			June 30				June 30

			2003		2002		2003		2002

Interest Income
	Interest and Fees on Loans		$	11,522	$	10,927	$	22,833	$	22,155
	Interest on Investment Securities:
		Taxable		1,021		1,439		2,063		2,942
		Tax Exempt		398		404		803		837
	Interest-Bearing Bank Balances			44		74		98		152
	Federal Funds Sold			64		107		161		283

		Total Interest Income		13,049		12,951		25,958		26,369

Interest Expense
	Deposits			2,167		2,995		4,466		6,356
	Securities Sold Under Agreements to Repurchase			3		5		8		33
	Borrowings from the Federal Home Loan Bank			769		788		1,544		1,566

		Total Interest Expense		2,939		3,788		6,018		7,955

Net Interest Income				10,110		9,163		19,940		18,414
	Provision for Loan Losses			487		682		1,074		1,062

	Net Interest Income After Provision for Loan Losses			9,623		8,481		18,866		17,352

Noninterest Income
	Service Charges on Deposit Accounts			1,716		1,646		3,323		3,069
	Gains on Sales of Mortgages			379		145		737		329
	Other Operating Income			1,620		1,332		3,004		2,393

		Total Noninterest Income		3,715		3,123		7,064		5,791

Noninterest Expense
	Personnel Expense			5,299		4,347		10,315		8,529
	Occupancy Expense			394		354		778		710
	Equipment Depreciation and Maintenance			499		446		974		876
	Other Operating Expense			3,117		2,615		5,999		5,317

		Total Noninterest Expense		9,309		7,762		18,066		15,432

	Income Before Income Taxes			4,029		3,842		7,864		7,711
	Income Taxes			1,332		1,273		2,613		2,542

Net Income			$	2,697	$	2,569	$	5,251	$	5,169

Earnings Per Share:
	Basic		$	0.32	$	0.30	$	0.62	$	0.61
	Diluted			0.31		0.30		0.61		0.61

Weighted Average Shares Outstanding:
	Basic			8,510,088		8,471,507		8,492,709		8,456,677
	Diluted			8,571,002		8,564,855		8,556,098		8,530,096

Cash Dividends Declared per Share			$	0.16	$	0.15	$	0.32	$	0.30

Notes to consolidated financial statements are an integral part hereof.

LSB Bancshares, Inc.
Consolidated Statements of
Changes in Shareholders’ Equity
(In Thousands)
(Unaudited)


												Accumulated
						Directors'						Other			Total
		Common		Paid-In		Deferred			Retained			Comprehensive			Shareholders'
		Stock		Capital		Plan			Earnings			Income			Equity

Balances at December 31, 2001		$	42,209	$	9,860	$	(878	)	$	27,444		$	708		$	79,343
Net Income										5,169						5,169
Change in unrealized loss on securities available for sale, net of deferred income taxes													391			391

	Comprehensive income															5,560
Cash dividends declared on common stock										(2,538	)					(2,538	)
Common stock issued for stock options exercised			206		123											329
Common stock acquired							(90	)								(90	)

Balances at June 30, 2002		$	42,415	$	9,983	$	(968	)	$	30,075		$	1,099		$	82,604


Balances at December 31, 2002		$	42,363	$	9,729	$	(995	)	$	32,578		$	1,832		$	85,507
Net Income										5,251						5,251
Change in unrealized gain on securities available for sale, net of deferred income taxes													(11	)		(11	)

	Comprehensive income															5,240
Cash dividends declared on common stock										(2,720	)					(2,720	)
Common stock issued for stock options exercised			250		245											495
Common stock acquired							(90	)								(90	)

Balances at June 30, 2003		$	42,613	$	9,974	$	(1,085	)	$	35,109		$	1,821		$	88,432

Notes to consolidated financial statements are an integral part hereof.

LSB Bancshares, Inc.
Consolidated Statements of Cash Flows
(In Thousands)
(Unaudited)


				Six Months Ended June 30

				2003			2002

Cash Flow from Operating Activities
Net Income				$	5,251		$	5,169
Adjustments to reconcile net income to net cash:
	Depreciation and amortization				877			820
	Securities premium amortization and discount accretion, net				38			38
	(Increase) decrease in loans held for sale				(4,901	)		5,921
	Deferred income taxes				(13	)		(353	)
	Income taxes payable				196			124
	(Increase) decrease in income earned but not received				186			284
	Increase (decrease) in interest accrued but not paid				(18	)		(467	)
	Net (increase) decrease in other assets				(346	)		(1,487	)
	Net increase (decrease) in other liabilities				(117	)		318
	Provision for loan losses				1,074			1,062
	(Gain) loss on sale of investment securities				0			0
	(Gain) loss on sale of premise and equipment				(31	)		18

			Net Cash provided by operating activities		2,196			11,447

Cash Flow From Investing Activities
Purchases of securities held to maturity					0			(332	)
Proceeds from maturities of securities held to maturity					3,603			11,923
Proceeds from sales of securities held to maturity					0			0
Purchases of securities available for sale					(35,030	)		(16,700	)
Proceeds from maturities of securities available for sale					26,765			14,200
Proceeds from sales of securities available for sale					0			0
Net (increase) decrease in loans made to customers					(24,576	)		(23,376	)
Purchases of premises and equipment					(1,653	)		(1,976	)
Proceeds from sale of premises and equipment					47			0
Net (increase) decrease in federal funds sold and securities purchased under resale agreements					(1,666	)		25,975

	Net cash (used by) provided by investing activities				(32,510	)		9,714

Cash Flow from Financing Activities
Net increase (decrease) in demand deposits, NOW, money market and savings accounts					22,778			15,290
Net increase (decrease) in time deposits					22,565			(22,381	)
Net increase (decrease) in securities sold under agreements to repurchase					(461	)		(1,835	)
Proceeds from long term debt					0			0
Payments on long term debt					(5,000	)		(300	)
Dividends Paid					(2,720	)		(2,539	)
Proceeds from issuance of common stock					495			330
Common stock acquired					(90	)		(89	)

	Net cash provided by (used by) financing activities				37,567			(11,524	)


Increase (decrease) in cash and cash equivalents					7,253			9,637
Cash and cash equivalents at the beginning of the period					47,072			35,918

Cash and cash equivalents at the end of the period				$	54,325		$	45,555

Supplemental Disclosures of Cash Flow Information
	Cash paid during the years for:
		Interest		$	6,036		$	8,422
		Income Taxes			2,900			2,771

Supplemental Disclosures of Noncash Transactions
	Transfer of loans to other real estate owned			$	1,040		$	1,188
	Unrealized gains/(losses) on securities available for sale:
		Change in securities available for sale			(18	)		636
		Change in deferred income taxes			7			(245	)
		Change in shareholders’ equity			(11	)		391

Notes to consolidated financial statements are an integral part hereof.

LSB Bancshares, Inc.
Notes to Consolidated Financial Statements
Six Months Ended June 30, 2003 and 2002

Note 1. Basis of Presentation

The accompanying interim unaudited Consolidated Financial Statements have been prepared in accordance with generally accepted accounting principles in the United States for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles in the United States for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the six-month period ended June 30, 2003 are not necessarily indicative of the results that may be expected for the year ending December 31, 2003.

LSB Bancshares, Inc. is a bank holding company headquartered in Lexington, North Carolina. Bancshares principal business is providing banking and other financial services through its banking subsidiary, Lexington State Bank (“LSB”). LSB has two wholly owned subsidiaries, Peoples Finance Company of Lexington, Inc. and LSB Investment Services, Inc. LSB offers a complete array of services in commercial banking including accepting deposits, corporate cash management, discount brokerage, IRA plans, secured and unsecured loans and trust functions through twenty-six offices in sixteen communities located in Davidson, Forsyth, Stokes, Guilford and Randolph counties. LSB has two subsidiaries that operate within its market area. Peoples Finance offers secured and unsecured loans to individuals up to a maximum of $10,000 as well as dealer originated loans. LSB Investment Services offers products through UVEST Investment Services, an independent broker-dealer. Investments are neither deposits nor obligations of Lexington State Bank, nor are they guaranteed or insured by any depository institution, the FDIC, or any other government agency.

For further information, refer to the Consolidated Financial Statements and footnotes thereto included in the Corporation’s Annual Report on Form 10-K for the year ended December 31, 2002.

Note 2. Investment Securities

The valuations of investment securities as of June 30, 2003 and December 31, 2002 were as follows (in thousands):


		June 30, 2003

								Approximate
		Amortized		Unrealized		Unrealized		Market
		Cost		Gains		Losses		Value

Securities held to maturity:
U.S. Treasury and other U.S government agency obligations		$	8,999	$	209	$	0	$	9,208
State, county and municipal securities			31,427		2,172		0		33,599

	Total securities held to maturity	$	40,426	$	2,381	$	0	$	42,807


								Approximate
		Amortized		Unrealized		Unrealized		Market
		Cost		Gains		Losses		Value

Securities available for sale:
U.S. Treasury and other U.S government agency obligations		$	84,866	$	2,879	$	0	$	87,745
State, county and municipal securities			1,852		85				1,937
Federal Home Loan Bank stock			2,900		0		0		2,900

	Total securities available for sale	$	89,618	$	2,964	$	0	$	92,582


		December 31, 2002

								Approximate
		Amortized		Unrealized		Unrealized		Market
		Cost		Gains		Losses		Value

Securities held to maturity:
U.S. Treasury and other U.S government agency obligations		$	12,001	$	381	$	0	$	12,382
State, county and municipal securities			32,029		1,624		22		33,631

	Total securities held to maturity	$	44,030	$	2,005	$	22	$	46,013


								Approximate
		Amortized		Unrealized		Unrealized		Market
		Cost		Gains		Losses		Value

Securities available for sale:
U.S. Treasury and other U.S government agency obligations		$	76,373	$	2,926	$	0	$	79,299
State, county and municipal securities			1,853		56		1		1,908
Federal Home Loan Bank stock			3,165		0		0		3,165

	Total securities available for sale	$	81,391	$	2,982	$	1	$	84,372

No investment securities were sold during the period ending June 30, 2003.

Investment securities with amortized cost of $92,765,000 and $95,002,447, as of June 30, 2003 and December 31, 2002, respectively, were pledged to secure public deposits and for other purposes. The Bank also has a $20,000,000 irrevocable letter of credit with FHLB that is used in lieu of securities to pledge against public deposits.

Note 3. Loans (Table in thousands)

A summary of consolidated loans follows:


	June 30

	2003		2002

Commercial, financial, & agricultural	$	285,473	$	245,841
Real estate — construction		40,700		31,216
Real estate — mortgage		284,996		263,494
Installment loans to individuals		56,680		56,170
Lease financing		572		488
Other		5,970		8,055

Total loans, net of unearned income	$	674,391	$	605,264

As of January 1, 1995, the Corporation adopted SFAS 114 as amended by SFAS 118 for impaired loans. The statements subject all loans to impairment recognition except for large groups of smaller-balance homogeneous loans such as credit card, residential mortgage and consumer loans. The Corporation generally considers loans to be impaired when future payments of principal and interest are in doubt. Included in impaired loans are loans that are consistently past due, loans 90 days or more past due and nonaccrual loans. Interest income on impaired loans is recognized consistent with the Corporation’s income recognition policy of daily accrual of income until the loan is determined to be uncollectible and placed in a nonaccrual status. For all impaired

loans other than nonaccrual loans, interest income totaling $121,728 for the period was recorded on an accrual basis. Interest income on nonaccrual loans is recognized on a cash basis. No interest was collected during the period on nonaccrual loans since being placed in a nonaccrual status. Interest income on nonaccrual loans that would have been recorded in accordance with the original terms of the notes was $155,675. The adoption of SFAS 114 and SFAS 118 did not have a material effect on the Corporation’s financial position or results of operations and required no increase to the reserve for loan and lease losses. At June 30, 2003, the total investment in loans that are considered impaired under SFAS 114 was $10,000,000, including nonaccrual loans of $576,000. A related valuation allowance of $1,704,000 was determined for the total amount of impaired loans. The average recorded investment in impaired loans for the quarter ended June 30, 2003 was approximately $8,392,000.

At June 30, 2003, loans totaling $ 19,312,000 were held for sale stated at the lower of cost or market on an individual loan basis.

Note 4. Reserve for Loan Losses (in thousands)

The following sets forth the analysis of the consolidated reserve for loan losses:


	Six Months Ended
	June 30

	2003			2002

Balances at beginning of periods	$	7,284		$	6,440
Provision for loan losses		1,074			1,062
Recoveries of amounts previously charged off		127			157
Loan losses		(761	)		(711	)

Balances at end of periods	$	7,724		$	6,948

Note 5. Other Accounting Changes

In June 2001, the FASB issued SFAS 142, “Goodwill and Other Intangible Assets”. SFAS 142 requires that goodwill and other intangible assets that have indefinite lives are to no longer be amortized unless there is an impairment. SFAS 142 is effective for fiscal years beginning after December 15, 2001. At December 31, 2001, Bancshares had $490,330 in goodwill, which will no longer be amortized, but will be monitored for impairment annually.

In October 2001, the FASB issued statement of Financial Accounting Standards No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets” (SFAS 144). SFAS 144 provides updated guidance concerning the recognition and measurement of certain long-lived assets. SFAS 144 is effective for fiscal years beginning after December 15, 2001. Bancshares adopted SFAS 144 with no resulting material effects on its financial position or operating results.

In October 2002, the FASB issued statement of Financial Accounting Standards No. 147 “Acquisitions of Certain Financial Institutions” (SFAS 147). SFAS 147 requires that acquisitions of financial institutions be accounted for in accordance with SFAS 141, that under certain circumstances, previously recognized unidentifiable intangible assets be reclassified as goodwill, and amends SFAS 144 to include within its applicability long-term customer relationship intangible assets of financial institutions. SFAS is effective as of October 1, 2002. Bancshares adopted SFAS 147 with no resulting material effect on its financial position or operating results.

In December 2002, the FASB issued statement of Financial Accounting Standards No. 148 “Accounting for Stock-Based Compensation-Transition and Disclosure” (SFAS 148). SFAS 148 provides alternative methods of transition for an entity that voluntarily changes to the fair value method of accounting for stock-based employee compensation, and stipulates additional disclosure provisions related to stock-based employee compensation. SFAS 148 is effective for financial statements for fiscal years ending after December 15, 2002. Bancshares adopted the disclosure provisions of SFAS 148 with no resulting material effect on its financial position or operating results.

In July 2002, President Bush signed into law the Sarbanes-Oxley Act of 2002 (The Act). The purpose of the act is to increase the reliability of financial statements issued by public companies. The act does this by increasing the number of independent parties responsible for the issuance of the statements, by increasing the independence of those already involved in the process and by the imposition of sanctions for those in violation of accounting and reporting rules. Bancshares is in compliance with the Act, and does not expect for the act to have a material effect on its financial position or operating results.

Note 6. Stock Compensation Plans

Bancshares had three stock based compensation plans at June 30, 2003, accounted for under Accounting Principles Board Opinion Number 25, under which no compensation cost has been recognized. Had compensation cost for these plans been determined consistent with Statement of Financial Accounting Standards Numbers 123 and 148, Bancshares’ net income and earnings per share would have been reduced to the following pro forma amounts:


		3 Months Ended June 30				6 Months Ended June 30

		2003		2002		2003		2002

Net income, as reported		$	2,697	$	2,569	$	5,251	$	5,169
(In thousands)

Less, total stock-based employee compensation expense determined under the fair value based method for all awards, net of related tax effects (In thousands)			77		120		169		194


Pro Forma Net Income (In thousands)		$	2,620	$	2,449	$	5,082	$	4,975


Earnings Per Share:

	Basic — as reported	$	0.32	$	0.30	$	0.62	$	0.61


	Basic — pro forma	$	0.31	$	0.29	$	0.60	$	0.59


	Diluted — as reported	$	0.31	$	0.30	$	0.61	$	0.61


	Diluted — pro forma	$	0.31	$	0.29	$	0.59	$	0.58

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

The discussion presented herein is intended to provide an overview of the changes in financial condition and results of operation for LSB Bancshares, Inc. (“Bancshares”) and its wholly owned subsidiary, Lexington State Bank (“LSB”) for the six months ended June 30, 2003 and 2002. The consolidated financial statements also include the accounts and results of operation of LSB’s wholly owned subsidiaries, Peoples Finance Company of Lexington, Inc. (“Peoples Finance”) and LSB Investment Services, Inc. (“LSB Investment Services”). This discussion and analysis is intended to complement the unaudited financial statements, footnotes and supplemental financial data in this Form 10Q, and should be read in conjunction therewith.

This report contains certain forward-looking statements related to anticipated future operating and financial performance, and other similar statements of expectations. These forward-looking statements are based on estimates, beliefs and assumptions made by management and are not guarantees of future performance. Actual results may differ from those expressed or implied as the result of various factors,

including: (1) the strength of the United States economy generally and the strength of the local economies in which Bancshares conducts operations may be different than expected resulting in, among other things, a deterioration in credit quality or a reduced demand for credit, including the resultant effect on Bancshares’ loan portfolio and allowance for loan losses; (2) the effects of, and changes in, trade, monetary and fiscal policies and laws, including interest rate policies of the Board of Governors of the Federal Reserve System; (3) inflation, interest rate, market and monetary fluctuations; (4) adverse conditions in the stock market, the public debt market and other capital markets (including changes in interest rate conditions) and the impact of such conditions on Bancshares’ capital markets and capital management activities, including, without limitation, Bancshares’ private equity investment activities and brokerage activities; (5) the timely development of competitive new products and services by Bancshares and the acceptance of these products and services by new and existing customers; (6) the willingness of customers to accept third party products marketed by Bancshares; (7) the willingness of customers to substitute competitors’ products and services for Bancshares’ products and services and vice versa; (8) the impact of changes in financial services’ laws and regulations (including laws concerning taxes, banking and securities); (9) technological changes; (10) changes in consumer spending and saving habits; (11) the effect of corporate restructurings, acquisitions and/or disposition, and the failure to achieve the expected revenue growth and/or expense savings from such corporate restructurings, acquisitions and/or dispositions; (12) the growth and profitability of Bancshares’ noninterest or fee income being less than expected; (13) unanticipated regulatory or judicial proceedings; (14) the impact of changes in accounting policies by the Securities and Exchange Commission; (15) adverse changes in financial performance and/or condition of Bancshares’ borrowers which could impact repayment of such borrowers’ outstanding loans; and (16) Bancshares’ success at managing the risks involved in the foregoing. Bancshares cautions that the foregoing list of important factors is not exclusive. Bancshares does not undertake to update any forward-looking statement, whether written or oral, that may be made from time to time by or on behalf of Bancshares.

Critical Accounting Policies

The accounting and reporting policies of the bank and its subsidiaries comply with generally accepted accounting principles in the United States and conform to standards within the industry. The allowance for loan and lease losses policy is particularly critical, as it requires the most subjective and complex judgments from senior management. Management considers several factors in determining the allowance for loan and lease losses. These include economic conditions, advice of regulators, historical experience and factors affecting particular borrowers. Changes in the assumptions of these policies could result in a significant impact on the bank’s financial statements. For further information, see the Asset Quality and Provision for Loan Losses section.

Three Months Ended June 30, 2003 Compared to Three Months Ended June 30, 2002

Net Interest Income

The primary source of earnings for the Corporation is net interest income, which represents the dollar amount by which interest generated from earning assets exceeds the cost of funds. Earning assets consist primarily of loans and investment securities and cost of funds is the interest paid on interest-bearing deposits and borrowed funds.

Moderate loan growth during the second quarter of 2003 contributed to increased interest income for the period. Total interest income of $13.049 million for the second quarter of 2003 increased $98,000 or 0.8% compared to $12.951 million for the second quarter of 2002. Total interest expense of $2.939 million for the second quarter of 2003 was down $849,000 or 22.4% compared to $3.788 million for the comparable period in 2002. Net interest income of $10.110 million for the second quarter of 2003, increased $947,000 or 10.3% compared to $9.163 million for the second quarter of 2002. The bank’s net interest margin increased five basis points in the second quarter of 2003 to reach 5.00% from the 4.95% for the first quarter of 2003. On June 23, 2003 the Federal Reserve cut interest rates for the thirteenth consecutive time. The change was too late in the quarter to affect the bank’s net interest margin, but could have an impact on margins in the third quarter.

Noninterest Income and Expense

Second quarter 2003 noninterest income of $3.715 million increased $592,000 or 19.0% compared to second quarter 2002 noninterest income of $3.123 million. Fee income related to service charges on deposit accounts for the second quarter of 2003 increased $70,000 or 4.3% compared to the second quarter of 2002. As in the first quarter,

mortgage loan refinancing during the second quarter of 2003 resulted in substantial increases in noninterest income. Gains on sales of mortgages increased $234,000 or 161.4% for the second quarter of 2003 compared to the second quarter of 2002. Other operating income increased $288,000 or 21.6% for the second quarter of 2003 compared to the second quarter of 2002. Within the other operating income category, fee income from the bankcard division increased $146,000 or 33.0% compared to the corresponding period in 2002. Trust income for the second quarter of 2003 was down $17,000 or 13.3% compared to the second quarter of 2002. Commissions generated by LSB Investment Services increased $201,000 or 88.1% in the second quarter of 2003 compared to the corresponding quarter of 2002. LSB Investment Services generates commission income from the sale of noninsured investment funds.

Noninterest expense for the second quarter of 2003 increased $1.547 million or 19.9% compared to the second quarter of 2002. Personnel expense for the second quarter of 2003, comprised of salaries and fringe benefits increased $952,000 or 21.9% compared to the second quarter of 2002. The increase in personnel expense is attributable in part to normal increases in compensation and mortgage production incentives related to the high refinancing activity. The increases were also attributable in part to increased health care costs. Occupancy expense increased $40,000 or 11.3% during the second quarter of 2003 compared to the second quarter of 2002 and equipment depreciation and maintenance expense increased $53,000 or 11.9% for the period being compared. Other operating expense increased $502,000 or 19.2% for the second quarter of 2003 compared to the second quarter of 2002. Within the other operating expense category, automated processing expenses increased $84,000 or 18.9% for the second quarter of 2003 compared to the corresponding quarter of 2002. Expenses for the bankcard division increased $136,000 or 40.0% for the second quarter of 2003 compared to the second quarter of 2002. Legal and professional expense increased $108,000 or 33.9% for the second quarter of 2003 compared to the second quarter of 2002.

Six Months Ended June 30, 2003 Compared to Six Months Ended June 30, 2002

Net Interest Income

Lower interest rates year over year put both interest income and interest expense below last years level. Total interest income for the first six months of 2003 of $25.958 million was down $411,000 or 1.6% compared to $26.369 million for the first six months of 2002. Total interest expense for the first six months of 2003 of $6.018 million was down $1.937 million or 24.3% compared to $7.955 million for the first six months of 2002. Net interest margins for the first six months of 2003 remained strong resulting in gains in net interest income. Net interest income of $19.940 million for the first six months of 2003 increased $1.526 million or 8.3% compared to $18.414 million for the first six months of 2002.

In light of the weak economy, loan growth has remained relatively moderate during the first six months of 2003. Loan growth in the first half of 2003 was $28.843 million or 4.5% compared to December 31, 2002 and $69.127 million or 11.4% compared to June 30, 2002. For the period ended June 30, 2003 deposits increased $45.343 million or 6.5% compared to December 31, 2002 and $66.751 million or 9.9% compared to June 30, 2002. Demand deposits increased $7.186 million or 7.6% from December 31, 2002 and $17.996 million or 21.5% from June 30, 2002. Savings, NOW and money market deposits increased $15.592 million or 4.0% compared to December 31, 2002 and $36.080 or 9.9% compared to June 30, 2002. Certificate of deposit growth was mixed with CD’s under $100,000 declining and CD’s over $100,000 increasing compared with the year ago period. This is due in part to the banks emphasis on relationship banking and liability pricing.

Noninterest Income and Expense

Noninterest income for the first six months of 2003 was up $1.273 million or 22.0% compared to the first six months of 2002. Fee income from service charges on deposit accounts increased $254,000 or 8.3% for the first six months of 2003 compared to the first six months of 2002. Gains on the sale of mortgage loans of $737,000 for the first six months of 2003 increased $408,000 or 124.0% compared to $329,000 for the first six months of 2002. In the current low interest rate environment, fee income from mortgage refinancing and sales to the secondary market continues to be strong. For the first six months of 2003, other operating income increased $611,000 or 25.5% compared to the first six months of 2002. Fee income from the Bank’s bankcard division for the first six months of 2003 was up $295,000 or 34.8% compared to the same period of 2002. Commissions generated by LSB Investment Services increased $344,000 or 88.0% the first six months of 2003 compared to the first six months of 2002. The bank’s investment services subsidiary generates commission income from the sale of mutual funds, annuities and equities.

Noninterest expense of $18.066 million for the first six months of 2003 was up $2.634 million or 17.1% compared to $15.432 million for the first six months of 2002.

Personnel expense for the first six months of 2003, comprised of salaries and fringe benefits, increased $1.786 million or 20.9% compared to the first six months of 2002. The gain in personnel expense for the first half of 2003 is attributable in part to increased mortgage production incentives related to the high volume of refinance activity. Normal increases to compensation and additions to staff, primarily sales staff, accounted for some personnel expense increase. Occupancy expense was up $68,000 or 9.6% for the first six months of 2003 compared to the same period in 2002. Equipment depreciation and maintenance expense increased $98,000 or 11.2% for the first half of 2003 compared to the first half of 2002. Other operating expense for the first six months of 2003 of $5.999 million increased by $682,000 or 12.8% compared to $5.317 million for the first six months of 2002. Historically low interest rates contributed to growth in mortgage originations, on the one hand, but also produced higher prepayment speeds on the other. As the result of higher prepayment speed assumptions, the bank recognized write-downs totaling $104,000 in mortgage servicing rights for the first six months of 2003. Expense associated with the Bank’s bankcard division for the first six months of 2003 increased by $248,000 or 38.1% compared to the first six months of 2002. Automated processing expenses increased $93,000 or 10.2% for the first six months of 2003 compared to the first six months of 2002. Legal and professional expense increased $61,000 or 8.3% for the period being compared. Expenses associated with LSB Investment Services increased $60,000 or 92.3% for the first six months of 2003 compared to the first six months of 2002.

Asset Quality and Provision for Loan Losses

At June 30, 2003 loan loss reserves were $7.724 million or 1.15% of loans outstanding compared to $7.284 million or 1.13% of loans outstanding at December 31, 2002 and $6.948 million or 1.15% at June 30, 2002. Nonperforming assets (including loans over 90 days past due and still accruing) totaled $6.673 million or 0.75% of total assets at June 30, 2003 compared to $6.997 million or .82% of total assets at December 31, 2002 and $6.402 million or .77% of total assets at June 30, 2002. While there continues to be weakness in the economy, Bancshares nonperforming assets at June 30, 2003 were only slightly higher than June 30, 2002 and were down from the total at December 31, 2002. Nonperforming assets include nonaccrual loans, restructured loans, other real estate acquired through foreclosure and accruing loans ninety days or more past due. As of June 30, 2003, restructured loans had declined to $245,000 from $2.260 million at December 31, 2002 and $1.791 million at June 30, 2002. Properties held in the other real estate category at June 30, 2003 totaled $1.968 million compared to $2.111 million at December 31, 2002 and $1.878 million at June 30, 2002. Nonaccrual loans totaled $576,000 at June 30, 2003 compared to $272,000 at December 31, 2002 and $1.005 million at June 30, 2002. Accruing loans past due 90 days or more were $3.884 million at June 30, 2003 compared to $2.354 million at December 31, 2002 and $1.728 million at June 30, 2002. The accrual of interest is generally discontinued on any loan that becomes 90 days past due as to principal or interest unless collection of both principal and interest can be assured by way of collateralization, guarantees or other security and the loan is considered to be in the process of collection. At June 30, 2003, the reserve for loan losses was 1.16 times non-performing assets, compared to 1.04 times at December 31, 2002 and 1.09 at June 30, 2002.

Responsibility for market risk management resides with the Asset/Liability Management Committee (“ALCO”). The ALCO Committee monitors market conditions, interest rate trends and the economic environment in its decision-making process. Based upon its view of existing and expected market conditions, balance sheet strategies are adopted to optimize net interest income while minimizing the risks associated with unanticipated changes in interest rates.

The provision for loan losses that was charged to operations the first six months 2003 was $1.074 million compared to $1.062 million for the first six months of 2002. Net charge-offs for the six month period ended June 30, 2003 were $632,000, or .19% of average loans outstanding on an annualized basis compared to $554,000 or .19% for the first six months of 2002. Management continues to monitor the asset quality of the loan portfolio. Loans charged-off are recorded based upon the financial condition of the borrower and the likelihood of repayment.

Loans classified for regulatory purposes as loss, doubtful, substandard or special mention that have not been disclosed as nonperforming do not represent or result from trends or uncertainties which management reasonably expects will materially impact future operating results, liquidity, or capital resources, or represent material credits about which management is aware of any information which causes management to have serious doubts as to the ability of such borrowers to comply with the loan repayment terms.

In the opinion of management, all loans where serious doubts exist as to the ability of

borrowers to comply with the present repayment terms have been included in the schedule presented.

ASSET QUALITY ANALYSIS


		Period Ended			Year Ended			Period Ended
		6/30/2003			12/31/2002			6/30/2002

RESERVE FOR LOAN LOSSES
	Beginning Balance	$	7,284		$	6,440		$	6,440
	Provision for loan losses		1,074			2,480			1,062
	Net (charge-off) recoveries		(634	)		(1,636	)		(554	)

	Ending balance		7,724			7,284			6,948

RISK ASSETS
	Nonaccrual loans	$	576		$	272		$	1,005
	Foreclosed real estate		1,968			2,111			1,878
	Restructured loans		245			2,260			1,791
	Loans 90 days or more past due and still accruing		3,884			2,354			1,728

	Total risk assets		6,673			6,997			6,402

ASSET QUALITY RATIOS
Nonaccrual loans as a percentage of total loans			0.09	%		0.04	%		0.16	%
Nonperforming assets as a percentage of:
	Total assets		0.75			0.82			0.77
	Loans plus foreclosed property		0.99			1.08			1.05
Net charge-offs as a percentage of average loans			0.19	*		0.27			0.19	*
Reserve for loan losses as a percentage of loans			1.15			1.13			1.15
Ratio of reserve for loan losses to:
	Net charge-offs		6.11	*		4.45			6.27	*
	Nonaccrual loans		13.41			26.78			6.91

	* Denotes Annualized

Income Taxes

Accrued income taxes applicable to income for the six-month period ended June 30, 2003 were $2.613 million compared to $2.542 million for the six-month period ended June 30, 2002. Pretax income for the first six months of 2003 of $7.864 million was up compared to $7.711 million for the first six months of 2002. The increase in accrued taxes for the period ended June 30, 2003 is primarily due to higher taxable income.

Capital Resources and Shareholders’ Equity

Regulatory guidelines require minimum levels of capital based on a risk weighting of each asset category and off-balance sheet contingencies. Regulatory agencies divide capital into Tier 1 or core capital and total capital. Tier 1 capital, as defined by regulatory agencies, consists primarily of common shareholders’ equity less goodwill and certain other intangible assets. Total capital consists of Tier 1 capital plus the allowable portion of the reserve for loan losses and certain long-term debt. At June 30, 2003, based on these measures, Bancshares’ had a Tier 1 capital ratio of 13.10% compared to the regulatory requirement of 4% and total capital ratio of 14.28% compared to an 8% regulatory requirement.

Additional regulatory capital measures include the Tier 1 leverage ratio. The Tier 1 leverage ratio is defined as Tier 1 capital divided by average total assets less goodwill and certain other intangibles and has a regulatory minimum of 3.0%, with most institutions required to maintain a ratio of at least 4.0% to 5.0%, depending primarily upon risk profiles. At June 30, 2003, Bancshares’ Tier 1 leverage ratio was 9.77%.

In November of 1998, the Board of Directors of Bancshares (“Board”) approved a stock repurchase program for up to 300,000 shares of its common stock, or approximately 3.4% of its outstanding shares. The Board authorized the repurchase of shares of common stock in the open market or privately negotiated transactions on a time-to-time and ongoing basis, depending upon market conditions and subject to compliance with all applicable securities laws and regulations. The repurchase plan is intended to help Bancshares achieve its goal of building shareholder value and maintaining appropriate capital levels. On August 11, 1999, Bancshares approved an extension of its stock repurchase program for up to an additional 300,000 shares of its common stock, or approximately 3.5% of its then outstanding shares. No shares have been repurchased under this plan during 2003. During 2002, Bancshares purchased 20,000 shares under the plan at an average cost of $20.20.

Market Risk Management

Bancshares’ market risk arises primarily from the interest rate risk inherent in its lending and deposit-taking activities. The objectives of market risk management are to ensure long-range profitability performance and minimize risk, adhere to proper liquidity and maintain sound capital. To meet these goals, the Asset/Liability Management Committee (“ALCO”) monitors the exposure to interest rate risk, balance sheet trends, pricing policies and liquidity position. The objectives are to achieve relatively stable net interest margins and assure liquidity through coordinating the volumes, maturities or repricing opportunities of earning assets, deposits and borrowed funds. This is accomplished through strategic pricing of asset and liability accounts. As a result of this management, appropriate maturities and/or repricing opportunities are developed to produce consistent earnings during changing interest rate environments.

Based upon its view of existing and expected market conditions, ALCO adopts balance sheet strategies intended to optimize net interest income to the extent possible while minimizing the risk associated with unanticipated changes in interest rates. Core deposits have historically been the primary funding sources for asset growth. Correspondent relationships have been maintained with several large banks in order to have access to federal funds purchases when needed. The Bank also has available lines of credit maintained with the Federal Home Loan Bank (the “FHLB”) that can be used for funding and/or liquidity needs. The Bank has a $20 million irrevocable letter of credit with FHLB that is used in lieu of securities to pledge against public deposits. The Bank also has a retail CD brokerage agreement, which provides an additional source for liquidity or funding needs.

To minimize risk of interest rate movements, the asset/liability management process seeks to match maturities and repricing opportunities of interest-sensitive assets and interest-sensitive liabilities. The Bank uses an asset/liability simulation model to produce a gap analysis. The simulation model computes projected runoff of deposits that do not have contractual maturity dates. On June 30, 2003, the gap between interest-sensitive assets and interest-sensitive liabilities was a positive $145,508,000 or 1.52. Under current economic conditions, management believes that is an acceptable ratio.

Asset/liability management also addresses liquidity positioning. Liquidity management is required in order to fund current and future extensions of credit, meet deposit withdrawals, maintain reserve requirements and otherwise sustain operations. As such, it is related to interest rate sensitivity management, in that each is affected by maturing assets and liabilities. While interest sensitivity management is concerned with repricing intervals of assets and liabilities, liquidity management is concerned with the maturities of those respective balances. The Bank’s liquidity position is primarily accomplished through deposit growth, loan repayments and investment securities management. The Bank also has access to federal fund lines at correspondent banks and borrowings from the Federal Reserve discount window.

Item 3. Quantitative and Qualitative Disclosures about Market Risk

Market risk reflects the risk of economic loss resulting from adverse changes in market price and interest rates. This risk of loss can be reflected in diminished current market values and/or reduced potential net interest income in future periods.

Bancshares’ market risk arises primarily from the interest rate risk inherent in its lending and deposit-taking activities. The structure of Bancshares’ loan and deposit portfolios is such that a significant decline in interest rates may adversely impact net market values and net interest income. Bancshares’ does not maintain a trading account nor is it subject to currency exchange risk or commodity price risk. Responsibility for monitoring interest rate risk rests with the Asset/Liability Management Committee (“ALCO”), which is appointed by the Board. ALCO meets on a regular basis to review interest rate risk exposure and liquidity positions. Balance sheet management and funding strategies are reviewed to ensure that any potential impact on earnings and liquidity, resulting from a fluctuation in interest rates is within acceptable standards.

Item 4. Controls and Procedures.

Within the 90 days prior to the filing date of this report, Bancshares carried out an evaluation, under the supervision and with the participation of Bancshares’s management, including Bancshares’s Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of Bancshares’s disclosure controls and procedures pursuant to Rule 13a-14 under the Securities Exchange Act of 1934. Based upon that evaluation, Bancshares’s Chief Executive Officer and Chief Financial Officer concluded that Bancshares’s disclosure controls and procedures are effective in timely alerting them to material information relating to Bancshares (including its consolidated subsidiaries) required to be included in Bancshares’s periodic filings with the Securities and Exchange Commission.

Since the date of the evaluation, there have been no significant changes in Bancshares’s internal controls or in other factors that could significantly affect these controls.

PART II. OTHER INFORMATION


Item 1.		Legal Proceedings
		Not applicable.

Item 2.		Changes in Securities and Use of Proceeds
		Not applicable.

Item 3.		Defaults Upon Senior Securities
		Not applicable.

Item 4.		Submission of Matters to a Vote of Security Holders
		Not applicable.

Item 5.		Other Information
		Not Applicable.

Item 6.		Exhibits and Reports on Form 8-K
		A. Exhibits

		Exhibit 99.1 Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

		Exhibit 99.2 Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

		Exhibit 99.3 Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

		B. Reports on Form 8-K
		The Corporation filed an 8-K on April 21, 2003 to report an earnings release for the three months ended March 31, 2003.

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.


Date August 11, 2003	LSB BANCSHARES, INC. (Registrant)

	By:	/s/ Monty J. Oliver

		Name: Monty J. Oliver
		Title: Secretary and Chief Financial Officer
		(Authorized Officer and Chief Accounting Officer)

			The accompanying interim unaudited Consolidated Financial Statements have been prepared in accordance with generally accepted accounting principles in the United States for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles in the United States for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the six-month period ended June 30, 2003 are not necessarily indicative of the results that may be expected for the year ending December 31, 2003.

			LSB Bancshares, Inc. is a bank holding company headquartered in Lexington, North Carolina. Bancshares principal business is providing banking and other financial services through its banking subsidiary, Lexington State Bank (“LSB”). LSB has two wholly owned subsidiaries, Peoples Finance Company of Lexington, Inc. and LSB Investment Services, Inc. LSB offers a complete array of services in commercial banking including accepting deposits, corporate cash management, discount brokerage, IRA plans, secured and unsecured loans and trust functions through twenty-six offices in sixteen communities located in Davidson, Forsyth, Stokes, Guilford and Randolph counties. LSB has two subsidiaries that operate within its market area. Peoples Finance offers secured and unsecured loans to individuals up to a maximum of $10,000 as well as dealer originated loans. LSB Investment Services offers products through UVEST Investment Services, an independent broker-dealer. Investments are neither deposits nor obligations of Lexington State Bank, nor are they guaranteed or insured by any depository institution, the FDIC, or any other government agency.

			For further information, refer to the Consolidated Financial Statements and footnotes thereto included in the Corporation’s Annual Report on Form 10-K for the year ended December 31, 2002.

			No investment securities were sold during the period ending June 30, 2003.

			Investment securities with amortized cost of $92,765,000 and $95,002,447, as of June 30, 2003 and December 31, 2002, respectively, were pledged to secure public deposits and for other purposes. The Bank also has a $20,000,000 irrevocable letter of credit with FHLB that is used in lieu of securities to pledge against public deposits.

			loans other than nonaccrual loans, interest income totaling $121,728 for the period was recorded on an accrual basis. Interest income on nonaccrual loans is recognized on a cash basis. No interest was collected during the period on nonaccrual loans since being placed in a nonaccrual status. Interest income on nonaccrual loans that would have been recorded in accordance with the original terms of the notes was $155,675. The adoption of SFAS 114 and SFAS 118 did not have a material effect on the Corporation’s financial position or results of operations and required no increase to the reserve for loan and lease losses. At June 30, 2003, the total investment in loans that are considered impaired under SFAS 114 was $10,000,000, including nonaccrual loans of $576,000. A related valuation allowance of $1,704,000 was determined for the total amount of impaired loans. The average recorded investment in impaired loans for the quarter ended June 30, 2003 was approximately $8,392,000.

			At June 30, 2003, loans totaling $ 19,312,000 were held for sale stated at the lower of cost or market on an individual loan basis.

			In June 2001, the FASB issued SFAS 142, “Goodwill and Other Intangible Assets”. SFAS 142 requires that goodwill and other intangible assets that have indefinite lives are to no longer be amortized unless there is an impairment. SFAS 142 is effective for fiscal years beginning after December 15, 2001. At December 31, 2001, Bancshares had $490,330 in goodwill, which will no longer be amortized, but will be monitored for impairment annually.

			In October 2001, the FASB issued statement of Financial Accounting Standards No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets” (SFAS 144). SFAS 144 provides updated guidance concerning the recognition and measurement of certain long-lived assets. SFAS 144 is effective for fiscal years beginning after December 15, 2001. Bancshares adopted SFAS 144 with no resulting material effects on its financial position or operating results.

			In October 2002, the FASB issued statement of Financial Accounting Standards No. 147 “Acquisitions of Certain Financial Institutions” (SFAS 147). SFAS 147 requires that acquisitions of financial institutions be accounted for in accordance with SFAS 141, that under certain circumstances, previously recognized unidentifiable intangible assets be reclassified as goodwill, and amends SFAS 144 to include within its applicability long-term customer relationship intangible assets of financial institutions. SFAS is effective as of October 1, 2002. Bancshares adopted SFAS 147 with no resulting material effect on its financial position or operating results.

			In December 2002, the FASB issued statement of Financial Accounting Standards No. 148 “Accounting for Stock-Based Compensation-Transition and Disclosure” (SFAS 148). SFAS 148 provides alternative methods of transition for an entity that voluntarily changes to the fair value method of accounting for stock-based employee compensation, and stipulates additional disclosure provisions related to stock-based employee compensation. SFAS 148 is effective for financial statements for fiscal years ending after December 15, 2002. Bancshares adopted the disclosure provisions of SFAS 148 with no resulting material effect on its financial position or operating results.

			The discussion presented herein is intended to provide an overview of the changes in financial condition and results of operation for LSB Bancshares, Inc. (“Bancshares”) and its wholly owned subsidiary, Lexington State Bank (“LSB”) for the six months ended June 30, 2003 and 2002. The consolidated financial statements also include the accounts and results of operation of LSB’s wholly owned subsidiaries, Peoples Finance Company of Lexington, Inc. (“Peoples Finance”) and LSB Investment Services, Inc. (“LSB Investment Services”). This discussion and analysis is intended to complement the unaudited financial statements, footnotes and supplemental financial data in this Form 10Q, and should be read in conjunction therewith.

			This report contains certain forward-looking statements related to anticipated future operating and financial performance, and other similar statements of expectations. These forward-looking statements are based on estimates, beliefs and assumptions made by management and are not guarantees of future performance. Actual results may differ from those expressed or implied as the result of various factors,

			The primary source of earnings for the Corporation is net interest income, which represents the dollar amount by which interest generated from earning assets exceeds the cost of funds. Earning assets consist primarily of loans and investment securities and cost of funds is the interest paid on interest-bearing deposits and borrowed funds.

			Moderate loan growth during the second quarter of 2003 contributed to increased interest income for the period. Total interest income of $13.049 million for the second quarter of 2003 increased $98,000 or 0.8% compared to $12.951 million for the second quarter of 2002. Total interest expense of $2.939 million for the second quarter of 2003 was down $849,000 or 22.4% compared to $3.788 million for the comparable period in 2002. Net interest income of $10.110 million for the second quarter of 2003, increased $947,000 or 10.3% compared to $9.163 million for the second quarter of 2002. The bank’s net interest margin increased five basis points in the second quarter of 2003 to reach 5.00% from the 4.95% for the first quarter of 2003. On June 23, 2003 the Federal Reserve cut interest rates for the thirteenth consecutive time. The change was too late in the quarter to affect the bank’s net interest margin, but could have an impact on margins in the third quarter.

			mortgage loan refinancing during the second quarter of 2003 resulted in substantial increases in noninterest income. Gains on sales of mortgages increased $234,000 or 161.4% for the second quarter of 2003 compared to the second quarter of 2002. Other operating income increased $288,000 or 21.6% for the second quarter of 2003 compared to the second quarter of 2002. Within the other operating income category, fee income from the bankcard division increased $146,000 or 33.0% compared to the corresponding period in 2002. Trust income for the second quarter of 2003 was down $17,000 or 13.3% compared to the second quarter of 2002. Commissions generated by LSB Investment Services increased $201,000 or 88.1% in the second quarter of 2003 compared to the corresponding quarter of 2002. LSB Investment Services generates commission income from the sale of noninsured investment funds.

			Noninterest expense for the second quarter of 2003 increased $1.547 million or 19.9% compared to the second quarter of 2002. Personnel expense for the second quarter of 2003, comprised of salaries and fringe benefits increased $952,000 or 21.9% compared to the second quarter of 2002. The increase in personnel expense is attributable in part to normal increases in compensation and mortgage production incentives related to the high refinancing activity. The increases were also attributable in part to increased health care costs. Occupancy expense increased $40,000 or 11.3% during the second quarter of 2003 compared to the second quarter of 2002 and equipment depreciation and maintenance expense increased $53,000 or 11.9% for the period being compared. Other operating expense increased $502,000 or 19.2% for the second quarter of 2003 compared to the second quarter of 2002. Within the other operating expense category, automated processing expenses increased $84,000 or 18.9% for the second quarter of 2003 compared to the corresponding quarter of 2002. Expenses for the bankcard division increased $136,000 or 40.0% for the second quarter of 2003 compared to the second quarter of 2002. Legal and professional expense increased $108,000 or 33.9% for the second quarter of 2003 compared to the second quarter of 2002.

			Lower interest rates year over year put both interest income and interest expense below last years level. Total interest income for the first six months of 2003 of $25.958 million was down $411,000 or 1.6% compared to $26.369 million for the first six months of 2002. Total interest expense for the first six months of 2003 of $6.018 million was down $1.937 million or 24.3% compared to $7.955 million for the first six months of 2002. Net interest margins for the first six months of 2003 remained strong resulting in gains in net interest income. Net interest income of $19.940 million for the first six months of 2003 increased $1.526 million or 8.3% compared to $18.414 million for the first six months of 2002.

			In light of the weak economy, loan growth has remained relatively moderate during the first six months of 2003. Loan growth in the first half of 2003 was $28.843 million or 4.5% compared to December 31, 2002 and $69.127 million or 11.4% compared to June 30, 2002. For the period ended June 30, 2003 deposits increased $45.343 million or 6.5% compared to December 31, 2002 and $66.751 million or 9.9% compared to June 30, 2002. Demand deposits increased $7.186 million or 7.6% from December 31, 2002 and $17.996 million or 21.5% from June 30, 2002. Savings, NOW and money market deposits increased $15.592 million or 4.0% compared to December 31, 2002 and $36.080 or 9.9% compared to June 30, 2002. Certificate of deposit growth was mixed with CD’s under $100,000 declining and CD’s over $100,000 increasing compared with the year ago period. This is due in part to the banks emphasis on relationship banking and liability pricing.

			Noninterest income for the first six months of 2003 was up $1.273 million or 22.0% compared to the first six months of 2002. Fee income from service charges on deposit accounts increased $254,000 or 8.3% for the first six months of 2003 compared to the first six months of 2002. Gains on the sale of mortgage loans of $737,000 for the first six months of 2003 increased $408,000 or 124.0% compared to $329,000 for the first six months of 2002. In the current low interest rate environment, fee income from mortgage refinancing and sales to the secondary market continues to be strong. For the first six months of 2003, other operating income increased $611,000 or 25.5% compared to the first six months of 2002. Fee income from the Bank’s bankcard division for the first six months of 2003 was up $295,000 or 34.8% compared to the same period of 2002. Commissions generated by LSB Investment Services increased $344,000 or 88.0% the first six months of 2003 compared to the first six months of 2002. The bank’s investment services subsidiary generates commission income from the sale of mutual funds, annuities and equities.

			Noninterest expense of $18.066 million for the first six months of 2003 was up $2.634 million or 17.1% compared to $15.432 million for the first six months of 2002.

			At June 30, 2003 loan loss reserves were $7.724 million or 1.15% of loans outstanding compared to $7.284 million or 1.13% of loans outstanding at December 31, 2002 and $6.948 million or 1.15% at June 30, 2002. Nonperforming assets (including loans over 90 days past due and still accruing) totaled $6.673 million or 0.75% of total assets at June 30, 2003 compared to $6.997 million or .82% of total assets at December 31, 2002 and $6.402 million or .77% of total assets at June 30, 2002. While there continues to be weakness in the economy, Bancshares nonperforming assets at June 30, 2003 were only slightly higher than June 30, 2002 and were down from the total at December 31, 2002. Nonperforming assets include nonaccrual loans, restructured loans, other real estate acquired through foreclosure and accruing loans ninety days or more past due. As of June 30, 2003, restructured loans had declined to $245,000 from $2.260 million at December 31, 2002 and $1.791 million at June 30, 2002. Properties held in the other real estate category at June 30, 2003 totaled $1.968 million compared to $2.111 million at December 31, 2002 and $1.878 million at June 30, 2002. Nonaccrual loans totaled $576,000 at June 30, 2003 compared to $272,000 at December 31, 2002 and $1.005 million at June 30, 2002. Accruing loans past due 90 days or more were $3.884 million at June 30, 2003 compared to $2.354 million at December 31, 2002 and $1.728 million at June 30, 2002. The accrual of interest is generally discontinued on any loan that becomes 90 days past due as to principal or interest unless collection of both principal and interest can be assured by way of collateralization, guarantees or other security and the loan is considered to be in the process of collection. At June 30, 2003, the reserve for loan losses was 1.16 times non-performing assets, compared to 1.04 times at December 31, 2002 and 1.09 at June 30, 2002.

			Responsibility for market risk management resides with the Asset/Liability Management Committee (“ALCO”). The ALCO Committee monitors market conditions, interest rate trends and the economic environment in its decision-making process. Based upon its view of existing and expected market conditions, balance sheet strategies are adopted to optimize net interest income while minimizing the risks associated with unanticipated changes in interest rates.

			The provision for loan losses that was charged to operations the first six months 2003 was $1.074 million compared to $1.062 million for the first six months of 2002. Net charge-offs for the six month period ended June 30, 2003 were $632,000, or .19% of average loans outstanding on an annualized basis compared to $554,000 or .19% for the first six months of 2002. Management continues to monitor the asset quality of the loan portfolio. Loans charged-off are recorded based upon the financial condition of the borrower and the likelihood of repayment.

			Loans classified for regulatory purposes as loss, doubtful, substandard or special mention that have not been disclosed as nonperforming do not represent or result from trends or uncertainties which management reasonably expects will materially impact future operating results, liquidity, or capital resources, or represent material credits about which management is aware of any information which causes management to have serious doubts as to the ability of such borrowers to comply with the loan repayment terms.

			In the opinion of management, all loans where serious doubts exist as to the ability of

			Additional regulatory capital measures include the Tier 1 leverage ratio. The Tier 1 leverage ratio is defined as Tier 1 capital divided by average total assets less goodwill and certain other intangibles and has a regulatory minimum of 3.0%, with most institutions required to maintain a ratio of at least 4.0% to 5.0%, depending primarily upon risk profiles. At June 30, 2003, Bancshares’ Tier 1 leverage ratio was 9.77%.

			In November of 1998, the Board of Directors of Bancshares (“Board”) approved a stock repurchase program for up to 300,000 shares of its common stock, or approximately 3.4% of its outstanding shares. The Board authorized the repurchase of shares of common stock in the open market or privately negotiated transactions on a time-to-time and ongoing basis, depending upon market conditions and subject to compliance with all applicable securities laws and regulations. The repurchase plan is intended to help Bancshares achieve its goal of building shareholder value and maintaining appropriate capital levels. On August 11, 1999, Bancshares approved an extension of its stock repurchase program for up to an additional 300,000 shares of its common stock, or approximately 3.5% of its then outstanding shares. No shares have been repurchased under this plan during 2003. During 2002, Bancshares purchased 20,000 shares under the plan at an average cost of $20.20.

			Bancshares’ market risk arises primarily from the interest rate risk inherent in its lending and deposit-taking activities. The objectives of market risk management are to ensure long-range profitability performance and minimize risk, adhere to proper liquidity and maintain sound capital. To meet these goals, the Asset/Liability Management Committee (“ALCO”) monitors the exposure to interest rate risk, balance sheet trends, pricing policies and liquidity position. The objectives are to achieve relatively stable net interest margins and assure liquidity through coordinating the volumes, maturities or repricing opportunities of earning assets, deposits and borrowed funds. This is accomplished through strategic pricing of asset and liability accounts. As a result of this management, appropriate maturities and/or repricing opportunities are developed to produce consistent earnings during changing interest rate environments.

			Based upon its view of existing and expected market conditions, ALCO adopts balance sheet strategies intended to optimize net interest income to the extent possible while minimizing the risk associated with unanticipated changes in interest rates. Core deposits have historically been the primary funding sources for asset growth. Correspondent relationships have been maintained with several large banks in order to have access to federal funds purchases when needed. The Bank also has available lines of credit maintained with the Federal Home Loan Bank (the “FHLB”) that can be used for funding and/or liquidity needs. The Bank has a $20 million irrevocable letter of credit with FHLB that is used in lieu of securities to pledge against public deposits. The Bank also has a retail CD brokerage agreement, which provides an additional source for liquidity or funding needs.

			To minimize risk of interest rate movements, the asset/liability management process seeks to match maturities and repricing opportunities of interest-sensitive assets and interest-sensitive liabilities. The Bank uses an asset/liability simulation model to produce a gap analysis. The simulation model computes projected runoff of deposits that do not have contractual maturity dates. On June 30, 2003, the gap between interest-sensitive assets and interest-sensitive liabilities was a positive $145,508,000 or 1.52. Under current economic conditions, management believes that is an acceptable ratio.

			Asset/liability management also addresses liquidity positioning. Liquidity management is required in order to fund current and future extensions of credit, meet deposit withdrawals, maintain reserve requirements and otherwise sustain operations. As such, it is related to interest rate sensitivity management, in that each is affected by maturing assets and liabilities. While interest sensitivity management is concerned with repricing intervals of assets and liabilities, liquidity management is concerned with the maturities of those respective balances. The Bank’s liquidity position is primarily accomplished through deposit growth, loan repayments and investment securities management. The Bank also has access to federal fund lines at correspondent banks and borrowings from the Federal Reserve discount window.

			Within the 90 days prior to the filing date of this report, Bancshares carried out an evaluation, under the supervision and with the participation of Bancshares’s management, including Bancshares’s Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of Bancshares’s disclosure controls and procedures pursuant to Rule 13a-14 under the Securities Exchange Act of 1934. Based upon that evaluation, Bancshares’s Chief Executive Officer and Chief Financial Officer concluded that Bancshares’s disclosure controls and procedures are effective in timely alerting them to material information relating to Bancshares (including its consolidated subsidiaries) required to be included in Bancshares’s periodic filings with the Securities and Exchange Commission.

			Since the date of the evaluation, there have been no significant changes in Bancshares’s internal controls or in other factors that could significantly affect these controls.