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 September 30, 2003


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

LSB Bancshares, Inc. had 8,537,443 shares of common stock outstanding as of October 31, 2003.

LSB BANCSHARES, INC.

FORM 10-Q

INDEX


Part I.		Financial Information
Item 1.		Financial Statements.
		Consolidated Balance Sheets September 30, 2003 and 2002, and December 31, 2002
		Consolidated Statements of Income Three Months Ended September 30, 2003 and 2002 Nine Months Ended September 30, 2003 and 2002
		Consolidated Statements of Changes in Shareholders’ Equity Nine Months Ended September 30, 2003 and 2002
		Consolidated Statements of Cash Flows Nine Months Ended September 30, 2003 and 2002
		Notes to Consolidated Financial Statements Nine Months Ended September 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.
Item 4.		Controls and Procedures.
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)
			September 30			December 31			September 30
			2003			2002			2002

Assets
Cash and Due From Banks			$	42,265		$	41,522		$	44,244
Interest-Bearing Bank Balances				3,113			5,550			1,286
Federal Funds Sold				15,302			13,384			31,484
Investment Securities:
	Held to Maturity, Market Value $38,439, $46,013 and $48,562			36,798			44,030			46,039
	Available for Sale, at Market Value			97,132			84,372			95,026
Loans				673,719			645,548			631,689
Less, Reserve for Loan Losses				(7,795	)		(7,284	)		(7,155	)

		Net Loans		665,924			638,264			624,534
Premises and Equipment				14,548			13,490			13,428
Other Assets				11,441			11,181			12,523

		Total Assets	$	886,523		$	851,793		$	868,564

Liabilities
Deposits
	Demand		$	89,303		$	94,612		$	83,573
	Savings, NOW and Money Market Accounts			418,391			385,981			403,936
	Certificates of Deposit of less than $100,000			131,751			145,669			154,515
	Certificates of Deposit of $100,000 or more			82,409			70,219			72,316

		Total Deposits		721,854			696,481			714,340
Securities Sold Under Agreements to Repurchase				1,688			1,529			1,286
Borrowings from the Federal Home Loan Bank				68,000			63,000			63,000
Other Liabilities				5,791			5,276			5,416

		Total Liabilities		797,333			766,286			784,042

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 8,535,255 Shares in 2003 and 8,472,518 and 8,466,048 shares in 2002				42,676			42,363			42,330
Paid-In Capital				10,083			9,729			9,698
Common Stock Acquired for Directors’ Deferred Plan				(1,095	)		(995	)		(986	)
Retained Earnings				36,267			32,578			31,409
Accumulated Other Comprehensive Income				1,259			1,832			2,071

		Total Shareholders’ Equity		89,190			85,507			84,522

		Total Liabilities and Shareholders’ Equity	$	886,523		$	851,793		$	868,564

Memorandum: Standby Letters of Credit			$	4,141		$	4,138		$	5,012

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				Nine Months Ended
			September 30				September 30

			2003		2002		2003		2002

Interest Income
	Interest and Fees on Loans		$	11,318	$	11,398	$	34,151	$	33,553
	Interest on Investment Securities:
		Taxable		963		1,294		3,026		4,236
		Tax Exempt		426		409		1,229		1,246
	Interest-Bearing Bank Balances			35		50		133		202
	Federal Funds Sold			46		108		207		391

		Total Interest Income		12,788		13,259		38,746		39,628

Interest Expense
	Deposits			1,853		2,952		6,319		9,308
	Securities Sold Under Agreements to Repurchase			2		4		10		37
	Borrowings from the Federal Home Loan Bank			786		807		2,330		2,373

		Total Interest Expense		2,641		3,763		8,659		11,718

Net Interest Income				10,147		9,496		30,087		27,910
	Provision for Loan Losses			839		532		1,913		1,594

	Net Interest Income After Provision for Loan Losses			9,308		8,964		28,174		26,316

Noninterest Income
	Service Charges on Deposit Accounts			1,824		1,731		5,147		4,800
	Gains on Sales of Mortgages			403		132		1,140		461
	Other Operating Income			1,611		1,192		4,615		3,585

		Total Noninterest Income		3,838		3,055		10,902		8,846

Noninterest Expense
	Personnel Expense			5,376		4,595		15,691		13,124
	Occupancy Expense			440		370		1,218		1,080
	Equipment Depreciation and Maintenance			549		478		1,523		1,354
	Other Operating Expense			2,995		2,690		8,994		8,007

		Total Noninterest Expense		9,360		8,133		27,426		23,565

	Income Before Income Taxes			3,786		3,886		11,650		11,597
	Income Taxes			1,261		1,282		3,874		3,824

Net Income			$	2,525	$	2,604	$	7,776	$	7,773

Earnings Per Share:
	Basic		$	0.30	$	0.31	$	0.91	$	0.92
	Diluted			0.29		0.30		0.91		0.91
Weighted Average Shares Outstanding:
	Basic			8,534,255		8,465,715		8,506,558		8,459,689
	Diluted			8,613,409		8,572,018		8,575,203		8,544,877
Cash Dividends Declared per Share			$	0.16	$	0.15	$	0.48	$	0.45

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												7,773						7,773
Change in unrealized loss on securities available for sale, net of deferred income taxes															1,363			1,363

	Comprehensive income																	9,136
Cash dividends declared on common stock												(3,808	)					(3,808	)
Common stock issued for stock options exercised			221			142												363
Common stock acquired			(100	)		(304	)		(108	)								(512	)

Balances at September 30, 2002		$	42,330		$	9,698		$	(986	)	$	31,409		$	2,071		$	84,522

Balances at December 31, 2002		$	42,363		$	9,729		$	(995	)	$	32,578		$	1,832		$	85,507
Net Income												7,776						7,776
Change in unrealized gain on securities available for sale, net of deferred income taxes															(573	)		(573	)

	Comprehensive income																	7,203
Cash dividends declared on common stock												(4,087	)					(4,087	)
Common stock issued for stock options exercised			313			354												667
Common stock acquired									(100	)								(100	)

Balances at September 30, 2003		$	42,676		$	10,083		$	(1,095	)	$	36,267		$	1,259		$	89,190

Notes to consolidated financial statements are an integral part hereof.

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


			Nine Months Ended September 30

			2003			2002

Cash Flow from Operating Activities
Net Income			$	7,776		$	7,773
Adjustments to reconcile net income to net cash:
	Depreciation and amortization			1,333			1,244
	Securities premium amortization and discount accretion, net			56			50
	(Increase) decrease in loans held for sale			(10,892	)		4,961
	Deferred income taxes			(206	)		(353	)
	Income taxes payable			321			(137	)
	(Increase) decrease in income earned but not received			123			(79	)
	Increase (decrease) in interest accrued but not paid			(243	)		(610	)
	Net (increase) decrease in other assets			184			(2,549	)
	Net increase (decrease) in other liabilities			436			819
	Provision for loan losses			1,913			1,594
	(Gain) loss on sale of investment securities			0			0
	(Gain) loss on sale of premise and equipment			(31	)		(14	)

		Net Cash provided by operating activities		770			12,699

Cash Flow From Investing Activities
Purchases of securities held to maturity				0			(332	)
Proceeds from maturities of securities held to maturity				7,232			12,923
Proceeds from sales of securities held to maturity				0			0
Purchases of securities available for sale				(45,515	)		(18,950	)
Proceeds from maturities of securities available for sale				31,765			22,800
Proceeds from sales of securities available for sale				0			0
Net (increase) decrease in loans made to customers				(18,681	)		(49,165	)
Purchases of premises and equipment				(2,413	)		(2,665	)
Proceeds from sale of premises and equipment				53			48
Net (increase) decrease in federal funds sold and securities purchased under resale agreements				(1,918	)		6,226

	Net cash (used by) provided by investing activities			(29,477	)		(29,115	)

Cash Flow from Financing Activities
Net increase (decrease) in demand deposits, NOW, money market and savings accounts				27,101			53,504
Net increase (decrease) in time deposits				(1,727	)		(21,328	)
Net increase (decrease) in securities sold under agreements to repurchase				159			(1,891	)
Proceeds from long term debt				10,000			0
Payments on long term debt				(5,000	)		(300	)
Dividends Paid				(4,087	)		(3,808	)
Proceeds from issuance of common stock				667			363
Common stock acquired				(100	)		(512	)

	Net cash provided by (used by) financing activities			27,013			26,028

Increase (decrease) in cash and cash equivalents				(1,694	)		9,612
Cash and cash equivalents at the beginning of the period				47,072			35,918

Cash and cash equivalents at the end of the period			$	45,378		$	45,530


			Nine Months Ended September 30

			2003			2002

Supplemental Disclosures of Cash Flow Information
	Cash paid during the years for:
		Interest	$	8,902		$	12,328
		Income Taxes		4,227			4,314
Supplemental Disclosures of Noncash Transactions
	Transfer of loans to other real estate owned		$	1,542		$	2,456
	Unrealized gains/(losses) on securities available for sale:
		Change in securities available for sale		(933	)		2,218
		Change in deferred income taxes		360			(855	)
		Change in shareholders’ equity		(573	)		1,363

Notes to consolidated financial statements are an integral part hereof.

LSB Bancshares, Inc.
Notes to Consolidated Financial Statements
Nine Months Ended September 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 nine-month period ended September 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 September 30, 2003 and December 31, 2002 were as follows (in thousands):


		September 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	$	110	$	0	$	9,109
State, county and municipal securities			27,799		1,538		7		29,330

	Total securities held to maturity	$	36,798	$	1,648	$	7	$	38,439


								Approximate
		Amortized		Unrealized		Unrealized		Market
		Cost		Gains		Losses		Value

Securities available for sale:
U.S. Treasury and other U.S. government agency obligations		$	89,832	$	2,016	$	26	$	91,822
State, county and municipal securities			1,851		59				1,910
Federal Home Loan Bank stock			3,400		0		0		3,400

	Total securities available for sale	$	95,083	$	2,075	$	26	$	97,132


		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 September 30, 2003.

Investment securities with amortized cost of $95,915,000 and $95,002,447, as of September 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:


	September 30
	2003		2002

Commercial, financial, & agricultural	$	281,397	$	261,684
Real estate - construction		37,871		29,997
Real estate - mortgage		292,227		276,331
Installment loans to individuals		57,557		55,282
Lease financing		1,068		488
Other		3,599		7,907

Total loans, net of unearned income	$	673,719	$	631,689

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 $101,914 for the period was recorded on an accrual basis. Interest income on nonaccrual loans is recognized on a

cash basis. No interest has been 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 $152,657. 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 September 30, 2003, the total investment in loans that are considered impaired under SFAS 114 was $9,830,000, including nonaccrual loans of $2,170,000. A related valuation allowance of $1,640,000 was determined for the total amount of impaired loans. The average recorded investment in impaired loans for the quarter ended September 30, 2003 was approximately $9,855,000.

At September 30, 2003, loans totaling $25,303,000 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:


	Nine Months Ended
	September 30
	2003			2002

Balances at beginning of periods	$	7,284		$	6,440
Provision for loan losses		1,913			1,594
Recoveries of amounts previously charged off		313			190
Loan losses		(1,715	)		(1,069	)

Balances at end of periods	$	7,795		$	7,155

Note 5. Other Accounting Changes

In June 2001, the FASB issued Statement of Financial Accounting Standards No. 142, “Goodwill and Other Intangible Assets” (SFAS 142). 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 September 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 Mths Ended Sept. 30				9 Mths Ended Sept. 30
		2003		2002		2003		2002

Net income, as reported (In thousands)		$	2,525	$	2,604	$	7,776	$	7,773
Less, total stock-based employee compensation expense determined under the fair value based method for all awards, net of related tax effects (In thousands)			52		97		221		291

Pro Forma Net Income (In thousands)		$	2,473	$	2,507	$	7,555	$	7,482

Earnings Per Share:
	Basic - as reported	$	0.30	$	0.31	$	0.91	$	0.92

	Basic - pro forma	$	0.29	$	0.30	$	0.89	$	0.88

	Diluted - as reported	$	0.29	$	0.30	$	0.91	$	0.91

	Diluted - pro forma	$	0.29	$	0.29	$	0.88	$	0.88

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 nine months ended September 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 September 30, 2003 Compared to Three Months Ended September 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.

Relatively flat loan growth during the third quarter of 2003 coupled with a further drop in interest rates resulted in lower interest income for the period. Total interest income of $12.788 million for the third quarter of 2003, decreased $471,000 or 3.6% compared to $13.259 million for the third quarter of 2002. Total interest expense of $2.641 million for the third quarter of 2003 was down $1.122 million or 29.8% compared to $3.763 million for the comparable period in 2002. Net interest income of $10.147 million for the third quarter of 2003, increased $651,000 or 6.9% compared to $9.496 million for the third quarter of 2002. The bank’s net interest margin decreased five basis points in the third quarter of 2003 to 4.95% from 5.00% for the second quarter of 2003. On June 23, 2003 the Federal Reserve cut interest rates for the thirteenth consecutive time. The change, which was too late in the second quarter to affect the bank’s net interest margin, did have an impact on margins in the third quarter.

Noninterest Income and Expense

Third quarter 2003 noninterest income of $3.838 million increased $783,000 or 25.6% compared to third quarter 2002 noninterest income of $3.055 million. Fee income related to service charges on deposit accounts for the third quarter of 2003 increased $93,000 or 5.4% compared to the third quarter of 2002. As in the first two quarters of 2003, mortgage loan refinancing resulted in substantial increases in noninterest income during the third quarter. Gains on sales of mortgages increased $271,000 or 205.3% for

the third quarter of 2003 compared to the third quarter of 2002. Other operating income increased $419,000 or 35.2% in the third quarter of 2003 compared to the third quarter of 2002. Within the other operating income category, fee income from the bankcard division increased $124,000 or 26.6% compared to the corresponding period in 2002. Commissions generated by LSB Investment Services increased $161,000 or 72.5% in the third 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 third quarter of 2003 increased $1.227 million or 15.1% compared to the third quarter of 2002. Personnel expense for the third quarter of 2003, comprised of salaries and fringe benefits increased $781,000 or 17.0% compared to the third quarter of 2002. Increased health care costs contributed to the increase in personnel expense. The increase in personnel expense is also attributable to mortgage production incentives related to high refinancing activity and to normal increases in compensation. Occupancy expense increased $70,000 or 18.9% during the third quarter of 2003 compared to the third quarter of 2002 and equipment depreciation and maintenance expense increased $71,000 or 14.9% for the period being compared. Other operating expense increased $305,000 or 11.3% for the third quarter of 2003 compared to the third quarter of 2002. Within the other operating expense category, automated processing expenses increased $28,000 or 6.1% for the third quarter of 2003 compared to the corresponding quarter of 2002. Expenses for the bankcard division increased $61,000 or 15.3% for the third quarter of 2003 compared to the third quarter of 2002. Legal and professional expense increased $52,000 or 15.8% for the third quarter of 2003 compared to the third quarter of 2002.

Nine Months Ended September 30, 2003 Compared to Nine Months Ended September 30, 2002

Net Interest Income

Lower interest rates year over year and slower growth in loans and deposits put both interest income and interest expense below last years level. Total interest income for the first nine months of 2003 of $38.746 million was down $882,000 or 2.2% compared to $39.628 million for the first nine months of 2002. Total interest expense for the first nine months of 2003 of $8.659 million was down $3.059 million or 26.1% compared to $11.718 million for the first nine months of 2002. The net interest margin for the first nine months of 2003 remained strong resulting in increased net interest income. Net interest income of $30.087 million for the first nine months of 2003 increased $2.177 million or 7.8% compared to $27.910 million for the first nine months of 2002. For the first nine months of 2003 the net interest margin was 4.96% compared to 4.85% for the first nine months of 2002.

In light of the continued weak economy through the first nine months of 2003, loan growth has remained relatively moderate. For the nine-month period ended September 30, 2003, loan growth was $28.171 million or 4.4% compared to December 31, 2002 and $42.030 million or 6.7% compared to September 30, 2002. For the same period deposits increased $25.373 million or 3.6% compared to December 31, 2002 and $7.514 million or 1.1% compared to September 30, 2002. Demand deposits were down $5.309 million or 5.6% compared to December 31, 2002 and up $5.730 million or 6.9% compared to September 30, 2002. Savings, NOW and money market deposits increased $32.410 million or 8.4% from December 31, 2002 and $14.455 or 3.6% from September 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 nine months of 2003 was up $2.056 million or 23.2% compared to the first nine months of 2002. Fee income from service charges on deposit accounts increased $347,000 or 7.2% for the first nine months of 2003 compared to the first nine months of 2002. Gains on the sale of mortgage loans of $1.140 million for the first nine months of 2003 increased $679,000 or 147.3% compared to $461,000 for the first nine months of 2002. The low interest rate environment prevailing throughout the nine months of 2003 has resulted in increased gains from mortgage refinancing and sales to the secondary market. For the first nine months of 2003, other operating income increased $1.030 million or 28.7% compared to the first nine months of 2002. Fee income from the bank’s bankcard division for the first nine months of 2003 was up $419,000 or 31.9% compared to the same period of 2002. Commissions generated by LSB Investment Services increased $505,000 or 82.4% the first nine months of 2003 compared to the first nine months of 2002. The bank’s investment services subsidiary generates commission income from the sale of mutual funds, annuities and equities.

Noninterest expense of $27.426 million for the first nine months of 2003 was up $3.861 million or 16.4% compared to $23.565 million for the first nine months of 2002. For

the first nine months of 2003 personnel expense, comprised of salaries and fringe benefits, increased $2.567 million or 19.6% compared to the corresponding period of 2002. The increase in personnel expense for the first nine months of 2003 is attributable in part to increased mortgage production incentives related to the high volume of refinance activity and higher health care costs. Normal increases to compensation and additions to staff, primarily sales staff, accounted for some personnel expense increase. Occupancy expense was up $138,000 or 12.8% for the nine-month period ended September 30, 2003 compared to the corresponding nine-month period in 2002. Equipment depreciation and maintenance expense increased $169,000 or 12.5% for the period being compared. Other operating expense for the first nine months of 2003 of $8.994 million increased by $987,000 or 12.3% compared to $8.007 million for the first nine months of 2002. Expense associated with the Bank’s bankcard division for the first nine months of 2003 increased by $309,000 or 29.4% compared to the first nine months of 2002. Automated processing expenses increased $121,000 or 8.9% for the first nine months of 2003 compared to the first nine months of 2002. Legal and professional expense increased $113,000 or 10.7% for the period being compared. Expenses associated with LSB Investment Services increased $31,000 or 49.8% for the first nine months of 2003 compared to the first nine months of 2002.

Asset Quality and Provision for Loan Losses

At September 30, 2003 loan loss reserves were $7.795 million or 1.16% of loans outstanding compared to $7.284 million or 1.13% of loans outstanding at December 31, 2002 and $7.155 million or 1.13% at September 30, 2002. Nonperforming assets (including loans over 90 days past due and still accruing) totaled $6.232 million or 0.70% of total assets at September 30, 2003 compared to $6.997 million or 0.82% of total assets at December 31, 2002 and $6.794 million or 0.78% of total assets at September 30, 2002. While there is still weakness in the economy, nonperforming assets at September 30, 2003 declined compared to September 30, 2002 and 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 September 30, 2003, restructured loans had declined to $1.136 million from $2.260 million at December 31, 2002 and $2.265 million at September 30, 2002. Properties held in the other real estate category had also declined at September 30, 2003 to $1.550 million compared to $2.111 million at December 31, 2002 and $2.673 million at September 30, 2002. Nonaccrual loans increased to $2.171 million at September 30, 2003 compared to $272,000 at December 31, 2002 and $717,000 at September 30, 2002. Accruing loans past due 90 days or more were $1.375 million at September 30, 2003 compared to $2.354 million at December 31, 2002 and $1.139 million at September 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 September 30, 2003, the reserve for loan losses was 1.25 times non-performing assets, compared to 1.04 times at December 31, 2002 and 1.05 at September 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 nine months 2003 was $1.913 million compared to $1.594 million for the first nine months of 2002. Net charge-offs for the nine-month period ended September 30, 2003 were $1.402 million or .28% of average loans outstanding on an annualized basis compared to $879,000 or .20% for the first nine 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
		9/30/03			12/31/02			9/30/02

RESERVE FOR LOAN LOSSES
	Beginning Balance	$	7,284		$	6,440		$	6,440
	Provision for loan losses		1,913			2,480			1,594
	Net (charge-off) recoveries		(1,402	)		(1,636	)		(879	)

	Ending balance		7,795			7,284			7,155
RISK ASSETS
	Nonaccrual loans	$	2,171		$	272		$	717
	Foreclosed real estate		1,550			2,111			2,673
	Restructured loans		1,136			2,260			2,265
	Loans 90 days or more past due and still accruing		1,375			2,354			1,139

	Total risk assets		6,232			6,997			6,794
ASSET QUALITY RATIOS
Nonaccrual loans as a percentage of total loans			0.32	%		0.04	%		0.11	%
Nonperforming assets as a percentage of:
	Total assets		0.70			0.82			0.78
	Loans plus foreclosed property		0.92			1.08			1.07
Net charge-offs as a percentage of average loans			0.28	*		0.27			0.20	*
Reserve for loan losses as a percentage of loans			1.16			1.13			1.13
Ratio of reserve for loan losses to:
	Net charge-offs		4.17	*		4.45			6.10	*
	Nonaccrual loans		3.59			26.78			9.98

* Denotes Annualized

Income Taxes

Accrued income taxes applicable to income for the nine-month period ended September 30, 2003 were $3.874 million compared to $3.824 million for the nine-month period ended September 30, 2002. Pretax income for the first nine months of 2003 of $11.650 million was up compared to $11.597 million for the first nine months of 2002. The increase in accrued taxes for the period ended September 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 September 30, 2003, based on these measures, Bancshares’ had a Tier 1 capital ratio of 13.34% compared to the regulatory requirement of 4% and total capital ratio of 14.53% 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 September 30, 2003, Bancshares’ Tier 1 leverage ratio was 9.85%.

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 September 30, 2003, the gap between interest-sensitive assets and interest-sensitive liabilities was a positive $166,060,000 or 1.61. 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.

As of the end of the period covered by this report, Bancshares has evaluated, under the supervision and with the participation of Bancshares’s management, including Bancshares’s Chief Executive Officer and Chief Financial Officer, the effectiveness of Bancshares’s disclosure controls and procedures (as defined in Rule 13a-15(e) promulgated under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)). Based upon that evaluation, Bancshares’s Chief Executive Officer and Chief Financial Officer have concluded that Bancshares’s disclosure controls and procedures are effective to ensure that information required to be disclosed by Bancshares in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within time periods specified in the rules and forms of the Securities and Exchange Commission (the “Commission”).

During the quarterly period covered by this report, there has been no change in Bancshares’s internal control over financial reporting (as defined in Rule 13a-15(f) promulgated under the Exchange Act) that has materially affected, or is reasonably likely to materially affect, Bancshares’s internal control over financial reporting.

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

Exhibit 31.2 Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

Exhibit 32 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 October 30, 2003 to report an earnings release for the nine months ended September 30, 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 October 6, 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)

Exhibit Index


Exhibit 31.1		Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

Exhibit 31.2		Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

Exhibit 32		Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

		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 nine-month period ended September 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 September 30, 2003.

		Investment securities with amortized cost of $95,915,000 and $95,002,447, as of September 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.

		cash basis. No interest has been 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 $152,657. 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 September 30, 2003, the total investment in loans that are considered impaired under SFAS 114 was $9,830,000, including nonaccrual loans of $2,170,000. A related valuation allowance of $1,640,000 was determined for the total amount of impaired loans. The average recorded investment in impaired loans for the quarter ended September 30, 2003 was approximately $9,855,000.

		At September 30, 2003, loans totaling $25,303,000 were held for sale stated at the lower of cost or market on an individual loan basis.

		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 nine months ended September 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

		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.

		Relatively flat loan growth during the third quarter of 2003 coupled with a further drop in interest rates resulted in lower interest income for the period. Total interest income of $12.788 million for the third quarter of 2003, decreased $471,000 or 3.6% compared to $13.259 million for the third quarter of 2002. Total interest expense of $2.641 million for the third quarter of 2003 was down $1.122 million or 29.8% compared to $3.763 million for the comparable period in 2002. Net interest income of $10.147 million for the third quarter of 2003, increased $651,000 or 6.9% compared to $9.496 million for the third quarter of 2002. The bank’s net interest margin decreased five basis points in the third quarter of 2003 to 4.95% from 5.00% for the second quarter of 2003. On June 23, 2003 the Federal Reserve cut interest rates for the thirteenth consecutive time. The change, which was too late in the second quarter to affect the bank’s net interest margin, did have an impact on margins in the third quarter.

		the third quarter of 2003 compared to the third quarter of 2002. Other operating income increased $419,000 or 35.2% in the third quarter of 2003 compared to the third quarter of 2002. Within the other operating income category, fee income from the bankcard division increased $124,000 or 26.6% compared to the corresponding period in 2002. Commissions generated by LSB Investment Services increased $161,000 or 72.5% in the third 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 third quarter of 2003 increased $1.227 million or 15.1% compared to the third quarter of 2002. Personnel expense for the third quarter of 2003, comprised of salaries and fringe benefits increased $781,000 or 17.0% compared to the third quarter of 2002. Increased health care costs contributed to the increase in personnel expense. The increase in personnel expense is also attributable to mortgage production incentives related to high refinancing activity and to normal increases in compensation. Occupancy expense increased $70,000 or 18.9% during the third quarter of 2003 compared to the third quarter of 2002 and equipment depreciation and maintenance expense increased $71,000 or 14.9% for the period being compared. Other operating expense increased $305,000 or 11.3% for the third quarter of 2003 compared to the third quarter of 2002. Within the other operating expense category, automated processing expenses increased $28,000 or 6.1% for the third quarter of 2003 compared to the corresponding quarter of 2002. Expenses for the bankcard division increased $61,000 or 15.3% for the third quarter of 2003 compared to the third quarter of 2002. Legal and professional expense increased $52,000 or 15.8% for the third quarter of 2003 compared to the third quarter of 2002.

		Lower interest rates year over year and slower growth in loans and deposits put both interest income and interest expense below last years level. Total interest income for the first nine months of 2003 of $38.746 million was down $882,000 or 2.2% compared to $39.628 million for the first nine months of 2002. Total interest expense for the first nine months of 2003 of $8.659 million was down $3.059 million or 26.1% compared to $11.718 million for the first nine months of 2002. The net interest margin for the first nine months of 2003 remained strong resulting in increased net interest income. Net interest income of $30.087 million for the first nine months of 2003 increased $2.177 million or 7.8% compared to $27.910 million for the first nine months of 2002. For the first nine months of 2003 the net interest margin was 4.96% compared to 4.85% for the first nine months of 2002.

		In light of the continued weak economy through the first nine months of 2003, loan growth has remained relatively moderate. For the nine-month period ended September 30, 2003, loan growth was $28.171 million or 4.4% compared to December 31, 2002 and $42.030 million or 6.7% compared to September 30, 2002. For the same period deposits increased $25.373 million or 3.6% compared to December 31, 2002 and $7.514 million or 1.1% compared to September 30, 2002. Demand deposits were down $5.309 million or 5.6% compared to December 31, 2002 and up $5.730 million or 6.9% compared to September 30, 2002. Savings, NOW and money market deposits increased $32.410 million or 8.4% from December 31, 2002 and $14.455 or 3.6% from September 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 nine months of 2003 was up $2.056 million or 23.2% compared to the first nine months of 2002. Fee income from service charges on deposit accounts increased $347,000 or 7.2% for the first nine months of 2003 compared to the first nine months of 2002. Gains on the sale of mortgage loans of $1.140 million for the first nine months of 2003 increased $679,000 or 147.3% compared to $461,000 for the first nine months of 2002. The low interest rate environment prevailing throughout the nine months of 2003 has resulted in increased gains from mortgage refinancing and sales to the secondary market. For the first nine months of 2003, other operating income increased $1.030 million or 28.7% compared to the first nine months of 2002. Fee income from the bank’s bankcard division for the first nine months of 2003 was up $419,000 or 31.9% compared to the same period of 2002. Commissions generated by LSB Investment Services increased $505,000 or 82.4% the first nine months of 2003 compared to the first nine months of 2002. The bank’s investment services subsidiary generates commission income from the sale of mutual funds, annuities and equities.

		Noninterest expense of $27.426 million for the first nine months of 2003 was up $3.861 million or 16.4% compared to $23.565 million for the first nine months of 2002. For

		At September 30, 2003 loan loss reserves were $7.795 million or 1.16% of loans outstanding compared to $7.284 million or 1.13% of loans outstanding at December 31, 2002 and $7.155 million or 1.13% at September 30, 2002. Nonperforming assets (including loans over 90 days past due and still accruing) totaled $6.232 million or 0.70% of total assets at September 30, 2003 compared to $6.997 million or 0.82% of total assets at December 31, 2002 and $6.794 million or 0.78% of total assets at September 30, 2002. While there is still weakness in the economy, nonperforming assets at September 30, 2003 declined compared to September 30, 2002 and 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 September 30, 2003, restructured loans had declined to $1.136 million from $2.260 million at December 31, 2002 and $2.265 million at September 30, 2002. Properties held in the other real estate category had also declined at September 30, 2003 to $1.550 million compared to $2.111 million at December 31, 2002 and $2.673 million at September 30, 2002. Nonaccrual loans increased to $2.171 million at September 30, 2003 compared to $272,000 at December 31, 2002 and $717,000 at September 30, 2002. Accruing loans past due 90 days or more were $1.375 million at September 30, 2003 compared to $2.354 million at December 31, 2002 and $1.139 million at September 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 September 30, 2003, the reserve for loan losses was 1.25 times non-performing assets, compared to 1.04 times at December 31, 2002 and 1.05 at September 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 nine months 2003 was $1.913 million compared to $1.594 million for the first nine months of 2002. Net charge-offs for the nine-month period ended September 30, 2003 were $1.402 million or .28% of average loans outstanding on an annualized basis compared to $879,000 or .20% for the first nine 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.

		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 September 30, 2003, Bancshares’ Tier 1 leverage ratio was 9.85%.

		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 September 30, 2003, the gap between interest-sensitive assets and interest-sensitive liabilities was a positive $166,060,000 or 1.61. 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.

		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.

		As of the end of the period covered by this report, Bancshares has evaluated, under the supervision and with the participation of Bancshares’s management, including Bancshares’s Chief Executive Officer and Chief Financial Officer, the effectiveness of Bancshares’s disclosure controls and procedures (as defined in Rule 13a-15(e) promulgated under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)). Based upon that evaluation, Bancshares’s Chief Executive Officer and Chief Financial Officer have concluded that Bancshares’s disclosure controls and procedures are effective to ensure that information required to be disclosed by Bancshares in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within time periods specified in the rules and forms of the Securities and Exchange Commission (the “Commission”).

		During the quarterly period covered by this report, there has been no change in Bancshares’s internal control over financial reporting (as defined in Rule 13a-15(f) promulgated under the Exchange Act) that has materially affected, or is reasonably likely to materially affect, Bancshares’s internal control over financial reporting.

			Exhibit 31.1 Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

			Exhibit 31.2 Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

			Exhibit 32 Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002