WGNB CORP.

2003 Form 10-K Annual Report

TABLE OF CONTENTS

PART I

Item 1. Business

General

     WGNB Corp. is a $393 million asset bank holding company headquartered in Carrollton, Georgia. The Company was organized as a business corporation under the laws of the State of Georgia in 1984 and is a registered bank holding company under the federal Bank Holding Company Act of 1956, as amended, and under the bank holding company laws of the State of Georgia. The Company conducts operations in western Georgia through its wholly-owned subsidiary, West Georgia National Bank (the “Bank”). The Bank was organized in 1946 as a national banking association under the federal banking laws of the United States. As of February 27, 2004, the Company had 3,307,123 issued and outstanding shares of common stock, $1.25 par value per share (the “Common Stock”), held by approximately 1,000 shareholders of record.

     The Company conducts all of its business through the Bank. The executive offices of the Company and the main office of the Bank are located at 201 Maple Street, Carrollton, Georgia 30117. Access to the Company’s annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and all amendments to those reports is available at the Company’s website, www.wgnb.com.

The Bank

     The Bank is a full service commercial bank offering a variety of services customary for community banks of similar size which are designed to meet the banking needs of individuals and small to medium-sized businesses. The Bank attracts most of its deposits and conducts most of its lending transactions from and within its primary service area encompassing Carroll County, Georgia and the western portion of Douglas County, Georgia.

     The Bank’s main office is located in Carrollton, Georgia. The Bank operates a total of seven branches and six additional 24-hour ATM sites, located in Carroll and Douglas Counties in Georgia. The Bank operates two additional branches in the city of Carrollton, two branches in Villa Rica, one branch in Bowdon and one branch in Douglasville, Georgia.

     As a convenience to its customers, the Bank offers at most of its branch locations Saturday banking hours, drive-thru teller windows and 24-hour automated teller machines. The Bank is a member of Honor, Cirrus and several other ATM networks of automated teller machines that permit Bank customers to perform monetary transactions in most cities throughout the southeast and other regions. The Bank also offers Internet banking services through its web site located at www.wgnb.com. Information included on the Bank’s web site is not a part of this Report.

     Deposit Services. The Bank offers a full range of deposit services including checking accounts, NOW accounts, savings accounts and other time deposits of various types, ranging from money market accounts to longer-term certificates of deposit. The accounts are all offered to the Bank’s market area at rates competitive to those offered in the area. All deposits are insured by the Federal Deposit Insurance Corporation (the “FDIC”) up to the maximum allowed by law. In addition, the Bank has implemented service charge fee schedules competitive with other financial institutions in its market area covering such matters as maintenance fees on checking accounts, per item processing fees on checking accounts, returned check charges and the like.

     As of December 31, 2003, the Bank had deposits of approximately $303 million, and approximately 27 thousand deposit accounts. No material portion of the Bank’s deposits relates to one or a few persons or entities (including federal, state and local governments and agencies). The loss of any one or a few principal deposit customers would not be likely to have a material adverse effect on the operations or earnings of the Bank.

     The following table sets forth the mix of depository accounts at the Bank as a percentage of total deposits as of December 31, 2003.

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Deposit Mix

     Lending Services. The Bank’s lending business consists principally of making consumer loans to individuals and commercial loans to small and medium-sized businesses and professional concerns. In addition, the Bank makes secured real estate loans, including residential and commercial construction loans, and first and second mortgage loans for the acquisition or improvement of personal residences. As of December 31, 2003, the Bank had approximately $296 million in total loans outstanding, representing 75% of its total assets of approximately $393 million. The loan portfolio is made up of both fixed and adjustable rate loans. Approximately 66% of the Company’s total loan portfolio is fixed rate and 33% is adjustable rate as of December 31, 2003. No material portion of the Bank’s loans is concentrated within a single industry or group of related industries. The Bank is not dependent to any material degree upon any single borrower or a few principal borrowers. The loss of any individual borrower or of a few principal borrowers would not be likely to have a material adverse effect on the operations or earnings of the Bank.

     Real Estate Loans. Loans secured by real estate make up the primary component of the Bank’s loan portfolio, constituting approximately $249 million, or 84%, of the Bank’s total loans as of December 31, 2003. Approximately 64% of the real estate loans are fixed rate and 36% are adjustable rate. Approximately 51% of the fixed rate real estate loans mature in one year or less and approximately 94% of the fixed rate real estate loans mature in five years or less. These loans consist of commercial real estate loans, construction and development loans, residential real estate loans and home equity loans. Real estate loans are collateralized by commercial and residential real estate in the Company’s primary and secondary market areas. The types of real estate that typically constitute collateral include primary and secondary residences for individuals, including multi-family projects, places of business, real estate for agricultural uses and undeveloped land.

     Commercial Loans, Other Than Commercial Loans Secured by Real Estate. The Bank makes loans for commercial purposes in various industries resident to its market area. As of December 31, 2003, commercial loans constituted approximately $31 million, or 11% of the Bank’s total loans. Approximately 68% of commercial loans are fixed rate while 32% are adjustable. The typical commercial loan has a maturity of three years or less. The typical commercial loan has collateral such as equipment for business use and inventory and may include unsecured working capital lines.

     Consumer Loans. The Bank makes a variety of loans to individuals for personal and household purposes, including secured and unsecured installment and term loans and lines of credit. As of December 31, 2003, the Bank held approximately $16 million of consumer loans, representing 6% of its total loans. Consumer loans are primarily fixed rate in nature with 97% of this loan category carrying fixed rates. These loans are typically collateralized by personal automobiles, recreational vehicles or household items and may include unsecured loans to individuals.

     Other Lending Activities. The Bank also engages in secondary-market mortgage activities whereby the Bank originates mortgage loans on behalf of investor correspondent banks who fund the loans. The investor correspondent banks underwrite and price the loans and the Bank receives a fee for originating and packaging the loans. Periodically, the Bank receives discount points depending on the pricing of the loan. No mortgage loans are held by the Bank for resale nor does the Bank service third party loans.

     Risks Associated with Lending Activities. Consumer and non-mortgage loans to individuals entail greater risk than do residential mortgage loans, particularly in the case of loans that are unsecured or secured by rapidly depreciating assets such as automobiles. In such cases, any repossessed collateral for a defaulted consumer loan may not provide an adequate source of repayment of the outstanding loan balance as a result of the greater likelihood of

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damage, loss or depreciation. In addition, consumer loan collections are dependent on the borrower’s continuing financial stability, and thus are more likely to be adversely affected by job loss, divorce, illness or personal bankruptcy. Furthermore, the application of various federal and state laws, including federal and state bankruptcy and insolvency laws, may limit the amount that can be recovered on such loans.

     Commercial loans and loans secured by commercial and multi-family real estate properties are generally larger and involve greater degree of credit risk than one- to four-family residential mortgage loans. Because payments on these loans are often dependent on the successful operation of the business or management of the property, repayment of such loans may be subject to adverse conditions in the economy or real estate markets. It has been the Bank’s practice to underwrite such loans based on its analysis of the amount of cash flow generated by the business and the resulting ability of the borrower to meet its payment obligations. In addition, the Bank, in general, seeks to obtain a personal guarantee of the loan by the owner of the business and, under certain circumstances, seeks additional collateral.

     Construction loans are generally considered to involve a higher degree of credit risk than residential mortgage loans. Risk of loss on a construction loan is dependent largely upon the accuracy of the initial estimate of the security property’s value upon completion of construction as compared to the estimated costs of construction, including interest and fees. In addition, the Bank assumes certain risks associated with the borrower’s ability to complete construction in a timely and workmanlike manner. If the estimate of value proves to be inaccurate, or if construction is not performed timely or in a quality manner, the Bank may be confronted with a project which, when completed, has a value insufficient to assure full repayment or to advance funds beyond the amount originally committed to permit completion of the project.

     Target Concentrations & Loan Portfolio Mix. The Bank has target concentration and portfolio mix limits written in its loan policy. The goal of the policy is to avoid concentrations that would result in particular loan or collateral type, industry or geographic area comprising a large part of the whole portfolio. The portfolio should be varied enough to obtain a balance of maximum yield and minimum risk. The loan portfolio mix is reported and reviewed quarterly by the Board of Directors. Concentration targets are evaluated periodically to determine changes in risk profiles and market need. The following represents maximum target concentrations of loans by category as a percentage of total loans:

     While the loan policy includes a provision generally limiting all types of real estate loans to 85% of the total loan portfolio, the executive loan committee can approve loans that exceed the policy limits on a case by case basis where warranted. Although, in aggregate, it accounts for a large portion of the loan portfolio, real estate lending has historically been the Company’s lowest loan loss category.

     Legal Lending Limit. The Bank is subject to loans to one borrower limitations prescribed for national banks by the Office of the Comptroller of the Currency (see Supervision and Regulation). The legal lending limit to a single borrower by regulation is 15% of a bank’s total capital plus reserves, plus an additional 10% of a bank’s capital and reserves if the amount exceeding the 15% general limit is secured by readily marketable securities. The Bank, however, has adopted an internal policy requiring all exposure above 15% of capital and reserves to be approved by the entire Board of Directors unless certain conditions are met including one or more of the following:

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the amounts exceeding the limit are sold on a non-recourse basis;

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	•		the amounts exceeding the limit are secured by readily marketable securities, up to a limit of 25% of capital and reserves;
	•		the amounts exceeding the limit are secured by a perfected first lien security interest in one-to-four family real estate in an amount that does not exceed 80% of the appraised value of the property and the outstanding indebtedness to the borrower does not exceed the lesser of 20% (or 25% with the approval of a majority of the Board of Directors subject to certain additional restrictions) of capital and reserves, or $10 million; or
	•		the amounts exceeding the limit are for small business purposes and secured by non-farm nonresidential properties or are commercial or industrial loans but in no event can the outstanding indebtedness exceed the lesser of 20% (or 25% with the approval of a majority of the Board of Directors subject to certain additional restrictions) of capital and reserves, or $10 million.

     Loan Underwriting Standards. Management recognizes the importance of character and past performance as consideration in the lending decision process. In analyzing a credit relationship, primary emphasis is placed on adequacy of cash flow and the ability of the borrower to service the debt. Secondary emphasis is placed on the past performance of the borrower, the type or value of the collateral, the amount of net worth present or any performance of endorsers or guarantors that has not been proven.

     Collateral is not considered a substitute for the borrower’s ability to repay. Collateral serves as a way to control the borrower and provide additional sources of repayment in the event of default. The quality and liquidity of the collateral are of paramount importance and must be confirmed before the loan is made. The Bank has loan to value and margin guidelines that are varied depending on the type of collateral offered. Loans secured by liquid assets and securities carry margins of 75% to 100% depending on the liquidity and price volatility of the asset. Loans to value on various types of real estate credits generally do not exceed 85% with most below 80%. Installment loans, in general, allow for a maximum loan to collateral value of 85%. In addition, there are limits on terms of repayment of loans for automobiles and related collateral which are dependent on the age of the asset. There are certain exceptions to the loan to value guidelines that are dependent on the overall creditworthiness of the borrower.

     Loan Approval. The Bank’s loan approval policies provide for various levels of officer lending authority. When the aggregate outstanding loans to a single borrower exceeds an individual officer’s lending authority, the loan request must be considered and approved by an officer with a higher lending limit or an officers’ loan committee (the “OLC”). Individual officer’s secured and unsecured lending limits range from $5,000 to $100,000, depending on seniority. The OLC, which consists of the president, two executive vice presidents, one senior vice president and other lenders, has a lending limit of $300,000 for secured and $100,000 for unsecured loans. Loans between $300,000 and the Bank’s legal lending limit must be approved by an executive loan committee, which is made up of the CEO of the Company, the President of the Bank and six outside directors.

     Loan Review. The Bank has a comprehensive loan review process involving an independent loan review officer and lending officers. The loan review process is designed to promote early identification of credit quality problems. All loan officers are charged with the responsibility of rating their loans. According to the current bank loan policy, the scope of loan review activity is to include a minimum of 90% of all commercial and business purpose loan relationships greater than $500,000, with random sample checks on consumer loans and other loans less than $500,000. Additionally, the loan review officer monitors the loan rating system to ensure proper risk identification. The Bank’s risk identification process is also reviewed by its regulators and its independent auditors. Upgrades and credit risk grades require the approval of the loan review officer. In the event of disagreement, the executive loan committee makes the final decision.

Market Area

     The following statistical data is based on information contained in a report published by the State University of West Georgia Department of Economics dated November 6, 2003 and information published by the FDIC on its web site.

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     The Bank’s primary market area includes all of Carroll County, Georgia and the western portion of Douglas County, Georgia. Approximately 98% of the Bank’s deposit customers reside in Carroll County, although it attracts some loan business from neighboring Douglas and Paulding Counties. The Bank’s secondary market area includes the Georgia counties of Paulding, Douglas, Heard, Haralson and Coweta, and the Alabama counties of Clebourne and Randolph. Carroll County is located approximately 45 miles southwest of Atlanta and 90 miles east of Birmingham, Alabama. Carroll County ranks 29th among Georgia’s 159 counties in land area with 499 square miles and 21st (up from 23rd in 2000) in population with a 2002 population of 94,907. Carroll County’s major industries include manufacturing, wholesale trade, food processing, paper and lumber products, construction and health services. The Bank’s main office is located in Carrollton, which is the county seat for Carroll County. The State University of West Georgia, which serves more than 9,000 students, and Tanner Medical Center are also located in Carrollton.

     During the 1990’s the Carroll County grew at an average annual rate of 2%, down slightly from the 2.5% annual rate in the 1980’s and slower than the State of Georgia annual growth rate of 2.4%. Net migration accounted for 60% of the 1990 population growth, while 40% was due to natural increase. Carroll County’s population growth has accelerated in recent years, growing at an annual average rate of 3.8% from 2000-2002. This is almost double the County’s growth rate in the 1990’s. From April 2000 to July 2002, Carroll’s population grew 7,500 with net migration accounting for 83% of the change and most of the growth occurring on the I-20 corridor near Villa Rica and Temple, Georgia.

     Carroll County continues to be the largest deposit base county in the Bank’s market area with Douglas County, to its east, and Paulding County, to its north, emerging as deposit growth areas. The compound annual growth rate for deposits at financial institutions in Carroll County for the years 1993-2003 was 5.3%. The amount of total deposits in Carroll County was approximately $1.19 billion as of June 30, 2003, compared to total deposits of approximately $710 million as of June 30, 1993. Douglas County had the second largest deposit base in our market area with $862 million in total deposits, and Paulding County had the third largest base with $608 million in total deposits, as of June 30, 2003. The Bank held a market share of 24.0% of total deposits in Carroll County as of June 30, 2003, representing the largest deposit market share for any financial institution located in Carroll County.

     The Bank established two branches in the Douglas County market over the past four years. One branch is located on Highway 5 just south of I-20 and the other is located in a developing are known as Mirror Lake located on Mirror Lake Boulevard just north of I-20. The Bank is presently upgrading its Mirror Lake temporary branch facility to a permanent facility located in front of The Village at Mirror Lake Shopping Center. The Bank intends to serve the western Douglas County market with these two locations.

     Douglas County ranks 139th out of 159 counties in land area, but 16th in population in Georgia in 2002 with a population of 98,650. During the 90’s, Douglas grew at an annual rate of 2.6% with migration accounting for 65% of that growth. From 2000 to 2002 that growth rate increased to an average annual rate of 3.2% per year. Based on building permit activity, Douglas appears poised to join Carroll, Coweta, and Paulding as one of the 100 fastest-growing counties in the U.S. when the 2003 county population estimates are released in March 2004. From April 2000 to July 2002, Douglas County’s population grew 6,344 with net migration accounting for almost 70% of that growth.

     All of the Company’s market area has been affected by the downturn in both the local and national economies. Even before terrorism became a continued threat and foreign affairs impacted the national economy, evidence suggested a rise in unemployment in all counties in the Company’s market area. Retail trade and business expansion is likely to be effected by the downturn. Inventories of single-family homes are increasing with the upscale home market experiencing particularly hard times. Retail sales were down in 2001 as evidenced by a 15% reduction in sales tax collections in Georgia. All of these factors may have an impact on the Company’s business growth.

Competition

     The Bank operates in a competitive environment, competing for deposits and/or loans with commercial banks, thrifts and other financial entities. Principal competitors include other small community commercial banks

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(such as McIntosh Commercial Bank, First Georgia Community Bank, Community Bank of West Georgia and Gainesville Bank & Trust) and larger institutions with branches in the Bank’s market area such as CB&T of West Georgia (a division of Synovus Bank), BB&T, Regions Bank, United Community Bank, Bank of America, SunTrust Bank and SouthTrust Bank. Numerous mergers and consolidations involving banks in the Bank’s market area have occurred, requiring the Bank to compete with banks with greater resources. However, West Georgia National Bank is the largest and oldest independent bank in Carroll County. McIntosh Commercial Bank commenced operations in the fourth quarter of 2002, Community Bank of West Georgia commenced operations in the second quarter of 2003, and First Georgia Community Bank commenced operations in the third quarter of 2003 and a fourth de novo bank is in formation in Bremen, Georgia in north Carroll County. The de novo banks are limited in their funding strategies because they typically do not have access to wholesale funding. This has the effect of running up deposit rates as the new banks compete for funds in the market area.

     The primary factors in competing for deposits are interest rates, personalized services, the quality and range of financial services, convenience of office locations and office hours. Competition for deposits comes primarily from other commercial banks, savings associations, credit unions, money market funds and other investment alternatives. The primary factors in competing for loans are interest rates, loan origination fees, the quality and range of lending services and personalized services. Competition for loans comes primarily from other commercial banks, savings associations, mortgage banking firms, credit unions and other financial intermediaries. Many of the financial institutions operating in the Bank’s market area offer services such as trust, investment and international banking, which the Bank does not offer, and have greater financial resources or have substantially higher lending limits than do the Bank.

     To compete with other financial services providers, the Bank principally relies upon local promotional activities, personal relationships established by officers, directors and employees with its customers, and specialized services tailored to meet its customers’ needs. Management believes that the Bank has an opportunity to establish business ties with customers who have been displaced by the consolidations and desire to forge banking relationships with locally owned and managed institutions.

     The Bank offers many personalized services and attracts customers by being responsive and sensitive to the needs of the community. The Bank relies not only on the goodwill and referrals of satisfied customers, as well as traditional media advertising to attract new customers, but also on individuals who develop new relationships to build the customer base of the Bank. To enhance the Bank’s image in the community, the Bank supports and participates in many events. Employees, officers and directors represent the Bank on many boards and local civic and charitable organizations.

Employees

     As of December 31, 2003, the Bank had 145 full time equivalent employees none of whom is a party to a collective bargaining agreement. Certain executive officers of the Bank also serve as the officers of the Company (which does not have compensated employees). The Company believes that the Bank enjoys satisfactory relations with its employees.

Supervision and Regulation

     The Company and the Bank are regulated under federal and state law. These laws and regulations generally are intended to protect depositors, not shareholders. The following is a summary description of certain provisions of certain laws which affect the regulation of bank holding companies and banks. To the extent that the following summary describes statutory or regulatory provisions, it is qualified in its entirety by reference to the particular statutory and regulatory provisions. Any change in applicable laws or regulations may have a material effect on the business and prospects of the Company and its bank subsidiary.

The Company

     The Company is a bank holding company within the meaning of the Bank Holding Company Act of 1956, as amended (the “BHCA”). Under the BHCA, the Company is subject to periodic examination by the Federal Reserve and is required to file periodic reports of its operations and such additional information as the Federal

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Reserve may require. The Company’s and the Bank’s activities are limited to banking, managing or controlling banks, furnishing services to or performing services for its subsidiaries or engaging in any other activity that the Federal Reserve determines to be so closely related to banking or managing or controlling banks as to be a proper incident thereto.

     Investments, Control and Activities. With certain limited exceptions, the BHCA requires every bank holding company to obtain prior approval of the Federal Reserve:

	•		to acquire the ownership or control of more than 5% of any class of voting stock of any bank not already controlled by it;
	•		for it or any subsidiary (other than a bank) to acquire all or substantially all of the assets of a bank; and
	•		to merge or consolidate with any other bank holding company.

     In addition, and subject to certain exceptions, the BHCA and the Change in Bank Control Act, together with regulations thereunder, require Federal Reserve approval (or, depending on the circumstances, no notice of disapproval) prior to any person or company acquiring “control” of a bank holding company, such as the Company. Control is conclusively presumed to exist if an individual or company acquires 25% or more of any class of voting securities of the bank holding company. Control is rebuttably presumed to exist if a person acquires 10% or more but less than 25% of any class of voting securities and either the Company has registered securities under Section 12 of the Exchange Act or no other person will own a greater percentage of that class of voting securities immediately after the transaction. The regulations provide a procedure for challenge of the rebuttable control presumption.

     The BHCA further provides that the Federal Reserve may not approve any transaction that would result in a monopoly, or the effect of which may be substantially to lessen competition in any section of the country, or that in any other manner would be in restraint of trade, unless the transaction’s anticompetitive effects are clearly outweighed by the public interest. The Federal Reserve is also required to consider the financial and managerial resources and future prospects of the bank holding companies and banks concerned and the convenience and needs of the community to be served.

     Bank holding companies generally are also prohibited under the BHCA from engaging in non-banking activities or from acquiring direct or indirect control of any company engaged in non-banking activities. However, the Federal Reserve may permit bank holding companies to engage in certain types of non-banking activities determined by the Federal Reserve to be closely related to banking or managing or controlling banks. Activities determined by the Federal Reserve to fall under this category include:

	•		making or servicing loans and certain leases;
	•		providing certain data processing services;
	•		acting as a fiduciary or investment or financial advisor;
	•		providing discount brokerage services;
	•		underwriting bank eligible securities; and
	•		making investments designed to promote community welfare.

     Subsidiary banks of a bank holding company are subject to certain restrictions on extensions of credit to the bank holding company or its subsidiaries, on investments in their securities and on the use of their securities as collateral for loans to any borrower. These regulations and restrictions may limit the Company’s ability to obtain funds from the Bank for its cash needs, including funds for the payment of dividends, interest and operating expenses. Further, federal law prohibits a bank holding company and its subsidiaries from engaging in certain tie-in arrangements in connection with any extension of credit, lease or sale of property, or the furnishing of services. For

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example, the Bank may not generally require a customer to obtain other services from it or the Company, and may not require that a customer promise not to obtain other services from a competitor as a condition to an extension of credit to the customer.

     The Bank is also subject to certain restrictions imposed by the Federal Reserve on extensions of credit to executive officers, directors, principal shareholders, or any related interest of such persons. Extensions of credit (i) must be made on substantially the same terms, including interest rates and collateral, and following credit underwriting procedures that are at least as stringent as those prevailing at the time for comparable transactions with persons not covered above and who are not employees, and (ii) must not involve more than the normal risk of repayment or present other unfavorable features. The Bank is also subject to certain lending limits and restrictions on overdrafts to such persons.

     Financial Services Modernization Act. On November 12, 1999, the President signed into law the Gramm-Leach-Bliley Act of 1999, known as the Financial Services Modernization Act of 1999, which repeals many of the restrictions on the activities of banks and bank holding companies. The law establishes two new structures — “financial holding companies” and “financial subsidiaries” - that enable qualifying bank holding companies and banks to provide a wide variety of financial services that formerly could be performed only by insurance companies and securities firms. The law also permits bank affiliations with insurance and securities firms. At this time, the Company does not intend to seek qualification to enter into these additional financial services areas.

     Source of Strength; Cross-Guarantee. Under Federal Reserve policy, a bank holding company is expected to act as a source of financial strength to its bank subsidiaries and to commit resources to support these subsidiaries. This support may be required at times when, absent such policy, the bank holding company might not otherwise provide such support. Under these provisions, a bank holding company may be required to loan money to its subsidiary banks in the form of capital notes or other instruments which qualify for capital under regulatory rules. Under the BHCA, the Federal Reserve may require a bank holding company to terminate any activity or relinquish control of a nonbank subsidiary (other than a nonbank subsidiary of a bank) upon the Federal Reserve’s determination that such activity or control constitutes a serious risk to the financial soundness or stability of any subsidiary depository institution of the bank holding company. Further, federal bank regulatory authorities have additional discretion to require a bank holding company to divest itself of any bank or nonbank subsidiary if the agency determines that divestiture may aid the depository institution’s financial condition. The Bank may be required to indemnify, or cross-guarantee, the FDIC against losses it incurs with respect to any other bank controlled by the Company, which in effect makes the Company’s equity investments in healthy bank subsidiaries available to the FDIC to assist any failing or failed bank subsidiary of the Company.

     State Regulation. Activities of the Company are subject to certain provisions of The Financial Institutions Code of Georgia and regulations issued pursuant to such code. These provisions are administered by The Georgia Department of Banking & Finance, which has concurrent jurisdiction with the Federal Reserve over the activities of the Company. The laws and regulations administered by The Georgia Department of Banking & Finance are generally consistent with, or supplemental to, those federal laws and regulations discussed herein.

The Bank

     As a national bank, the Bank is subject to the supervision and examination by the Office of the Comptroller of the Currency (the “OCC”). Deposits in the Bank are insured by the FDIC up to a maximum amount of $100,000 per depositor, subject to aggregation rules. The OCC and the FDIC regulate or monitor all areas of the Bank’s commercial banking operations, including security devices and procedures, adequacy of capitalization and loan loss reserves, loans, investments, borrowings, deposits, mergers, consolidations, reorganizations, issuance of securities, payment of dividends, interest rates, establishment of branches, and other aspects of its operations. The OCC requires the Bank to maintain certain capital ratios and imposes limitations on the Bank’s aggregate investment in real estate, bank premises and furniture and fixtures. The Bank is currently required by the OCC to prepare quarterly reports on the Bank’s financial condition and to conduct an annual audit of its financial affairs in compliance with minimum standards and procedures prescribed by the OCC.

     Under FDICIA, all insured institutions must undergo periodic on-site examination by their appropriate banking agency. The cost of examinations of insured depository institutions and any affiliates may be assessed by

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the appropriate agency against each institution or affiliate as it deems necessary or appropriate. Insured institutions are required to submit annual reports to the FDIC and the appropriate agency (and state supervisor when applicable). FDICIA also directs the FDIC to develop with other appropriate agencies a method for insured depository institutions to provide supplemental disclosure of the estimated fair market value of assets and liabilities, to the extent feasible and practicable, in any balance sheet, financial statement, report of condition or other report of any insured depository institution. FDICIA also requires the federal banking regulatory agencies to prescribe, by regulation, standards for all insured depository institutions and depository institution holding companies relating, among other things, to: (i) internal controls, information systems and audit systems; (ii) loan documentation; (iii) credit underwriting; (iv) interest rate risk exposure; and (v) asset quality.

     Community Reinvestment Act. The Community Reinvestment Act requires that, in connection with examinations of financial institutions within their respective jurisdictions, the Federal Reserve, the FDIC or any other appropriate federal agency, shall evaluate the record of each financial institution in meeting the credit needs of its local community, including low and moderate income neighborhoods. These factors are also considered in evaluating mergers, acquisitions and applications to open a branch or facility. Failure to adequately meet these criteria could pose additional requirements and limitations on the bank. The Bank was examined for CRA compliance in March 1997 and received a CRA rating of “outstanding.”

     Other Regulations. Interest and certain other charges collected or contracted for by the Bank are subject to Georgia usury laws and certain federal laws concerning interest rates. The Bank’s loan operations are also subject to certain federal laws applicable to credit transactions, such as the federal Truth-In-Lending Act governing disclosures of credit terms to consumer borrowers, the Home Mortgage Disclosure Act of 1975 requiring financial institutions to provide information to enable the public and public officials to determine whether a financial institution is fulfilling its obligation to help meet the housing needs of the community it serves, the Equal Credit Opportunity Act prohibiting discrimination on the basis of race, creed or other prohibited factors in extending credit, the Fair Credit Reporting Act of 1978 governing the use and provision of information to credit reporting agencies, the Fair Debt Collection Act governing the manner in which consumer debts may be collected by collection agencies, the Soldiers’ and Sailors’ Civil Relieft Act of 1940 governing the repayment terms of, and property rights underlying, secured obligations of persons in military service, and the rules and regulations of the various federal agencies charged with the responsibility of implementing such federal laws. The deposit operations of the Bank also are subject to the Right to Financial Privacy Act, which imposes a duty to maintain confidentiality of consumer financial records and prescribes procedures for complying with administrative subpoenas of financial records, and the Electronic Funds Transfer Act and Regulation E issued by the Federal Reserve to implement that act, which governs automatic deposits to and withdrawals from deposit accounts and customers’ rights and liabilities arising from the use of automated teller machines and other electronic banking services. The Bank’s commercial transactions are also subject to the provisions of the Uniform Commercial Code and other provisions of The Georgia Code Annotated.

Deposit Insurance

     The deposits of the Bank are currently insured to a maximum of $100,000 per depositor, subject to aggregation rules. The FDIC establishes rates for the payment of premiums by federally insured banks and thrifts for deposit insurance. Since 1993, insured depository institutions like the Bank have paid for deposit insurance under a risk-based premium system. Insurance of deposits may be terminated by the FDIC upon a finding that the institution has engaged in unsafe and unsound practices, is in an unsafe or unsound condition to continue operations, or has violated any applicable law, regulation, rule, order, or condition imposed by the FDIC. Due to its severe consequences, the FDIC historically uses insurance termination as an enforcement action of last resort and the termination process itself involves substantial notice, a formal adjudicative hearing and federal appellate review. In instances where insurance deposit is terminated, the financial institution is required to notify its depositors and insured funds on the date of termination that they will continue to be insured for at least six months and up to two years, at the discretion of the FDIC. After the date of termination, no new deposits accepted by the financial institution will be federally insured.

Dividends

     The Company is a legal entity separate and distinct from the Bank. The principal source of cash flow for the Company is dividends from the Bank. The amount of dividends that may be paid by the Bank to the Company

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depends on the Bank’s earnings and capital position and is limited by various statutory and regulatory limitations. In addition, the Federal Reserve has stated that bank holding companies should refrain from or limit dividend increases or reduce or eliminate dividends under circumstances in which the bank holding company fails to meet minimum capital requirements or in which its earnings are impaired.

     As a national bank, the Bank may not pay dividends from its paid-in-capital. All dividends must be paid out of retained earnings, after deducting expenses, including reserves for losses and bad debts. In addition, a national bank is prohibited from declaring a dividend on its shares of common stock until its surplus equals its stated capital, unless there has been transferred to surplus no less than one-tenth of the bank’s net profits of the preceding two consecutive half-year periods (in the case of an annual dividend). The approval of the OCC is required if the total of all dividends declared by a national bank in any calendar year exceeds the total of its net profits for that year combined with its retained net profits for the preceding two years, less any required transfers to surplus. Under FDICIA, the Bank may not pay a dividend if, after paying the dividend, the Bank would be undercapitalized. See Capital Adequacy.

     As discussed below, additional capital requirements imposed by the OCC may limit the Bank’s ability to pay dividends to the Company. The Bank declared dividends in the amount of $2,216,818 to the Company during 2003. Under the OCC guidelines, as of December 31, 2003, the Bank was permitted to pay the Company dividends of up to $7,168,000 in addition to current earnings without obtaining prior regulatory approval.

     In addition to the availability of funds from the Bank, the future dividend policy of the Company is subject to the discretion of the Board of Directors and will depend upon a number of factors, including future earnings, financial condition, cash needs and general business conditions. If dividends should be declared in the future, the amount of such dividends presently cannot be estimated and it cannot be known whether such dividends would continue for future periods.

Capital Adequacy

     Federal bank regulatory authorities have adopted risk-based capital guidelines for banks and bank holding companies that are designed to:

	•		make regulatory capital requirements more sensitive to differences in risk profiles among banks and bank holding companies;
	•		account for off-balance sheet exposure; and
	•		minimize disincentives for holding liquid assets.

     The resulting capital ratios represent qualifying capital as a percentage of total risk-weighted assets and off-balance sheet items. The guidelines are minimums, and the federal regulators have noted that banks and bank holding companies contemplating significant expansion programs should not allow expansion to diminish their capital ratios and should maintain ratios well in excess of the minimums.

     The current guidelines require all bank holding companies and federally-regulated banks to maintain a minimum risk-based Total Capital ratio equal to 8%, of which at least 4% must be Tier 1 capital. The degree of regulatory scrutiny of a financial institution will increase, and the permissible activities of the institution will decrease, as it moves downward through the capital categories. Bank holding companies controlling financial institutions can be called upon to boost the institution’s capital and to partially guarantee the institution’s performance under their capital restoration plans. Tier 1 capital includes shareholders’ equity, qualifying perpetual preferred stock and minority interests in equity accounts of consolidated subsidiaries, but excludes goodwill and most other intangible assets and excludes the allowance for loan and lease losses. Tier 2 capital includes the excess of any preferred stock not included in Tier 1 capital, mandatory convertible securities, hybrid capital instruments, subordinated debt and intermediate-term preferred stock and general reserves for loan and lease losses up to 1.25% of risk-weighted assets.

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     Under the guidelines, banks’ and bank holding companies’ assets are given risk-weights of 0%, 20%, 50% and 100%. In addition, certain off-balance sheet items are given credit conversion factors to convert them to asset equivalent amounts to which an appropriate risk-weight will apply. These computations result in the total risk-weighted assets. Most loans are assigned to the 100% risk category, except for first mortgage loans fully secured by residential property and, under certain circumstances, residential construction loans, both of which carry a 50% rating. Most investment securities are assigned to the 20% category, except for municipal or state revenue bonds, which have a 50% rating, and direct obligations of or obligations guaranteed by the United States Treasury or United States Government agencies, which have a 0% rating.

     Failure to meet capital guidelines could subject a bank to a variety of enforcement remedies, including the termination of deposit insurance by the FDIC, and to certain restrictions on its business.

     The Federal Reserve also has implemented a leverage ratio, which is Tier 1 capital as a percentage of average total assets less intangible assets, to be used as a supplement to the risk-based guidelines. The principal objective of the leverage ratio is to place a constraint on the maximum degree to which a bank holding company may leverage its equity capital base. The Federal Reserve has established a minimum 3% leverage ratio of Tier 1 capital to total assets for the most highly rated bank holding companies and insured banks. All other bank holding companies and insured banks will be required to maintain a leverage ratio of 3% plus an additional cushion of at least 100 to 200 basis points. The tangible Tier 1 Leverage ratio is the ratio of a banking organization’s Tier 1 capital, less all intangibles, to total assets, less all intangibles.

     FDICIA established a capital-based regulatory plan designed to promote early intervention for troubled banks and requires the FDIC to choose the least expensive resolution of bank failures. The capital-based regulatory framework contains five categories of compliance with regulatory capital requirements, including well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized. To qualify as a well capitalized institution, a bank must have a leverage ratio of no less than 5%, a Tier 1 risk-based ratio of no less than 6%, and a total risk-based capital ratio of no less than 10%. The bank must also not be under any order or directive from the appropriate regulatory agency to meet and maintain a specific capital level.

     Under FDICIA, regulators must take prompt corrective action against depository institutions that do not meet minimum capital requirements. FDICIA and the related regulations establish five capital categories as shown in the following table:

     A depository institution may be deemed to be in a capitalization category that is lower than is indicated by its actual capital position if it receives a less than satisfactory examination rating in any one of four categories. As a depository institution moves downward through the capitalization categories, the degree of regulatory scrutiny will

11

increase and the permitted activities of the institution will decrease. Action may be taken by a depository institution’s primary federal regulator against an institution that falls into one of the three undercapitalized categories, including the requirement of filing a capital plan with the institution’s primary federal regulator, prohibition on the payment of dividends and management fees, restrictions on executive compensation, and increased supervisory monitoring. Other restrictions may be imposed on the institution either by its primary federal regulator or by the FDIC, including requirements to raise additional capital, sell assets, or sell the institution.

     As of the date of this Report, the Company and the Bank are both considered to be well capitalized according to their regulatory capital requirements. See Footnote 9 of the Notes to Financial Statements for additional details.

Interstate Banking and Branching Restrictions

     Pursuant to the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 (the “Riegle-Neal Act”), effective September 29, 1995, an adequately capitalized and adequately managed bank holding company may acquire a bank across state lines, without regard to whether such acquisition is permissible under state law. A bank holding company is considered to be “adequately capitalized” if it meets all applicable federal regulatory capital standards.

     While the Riegle-Neal Act precludes a state from entirely insulating its banks from acquisition by an out-of-state holding company, a state may still provide that a bank may not be acquired by an out-of-state company unless the bank has been in existence for a specified number of years, not to exceed five years. Additionally, the Federal Reserve may not approve an interstate acquisition which would result in the acquirer’s controlling more than 10% of the total amount of deposits of insured depository institutions in the United States with 30% or more of the deposits in the home state of the target bank. A state may waive the 30% limit based on criteria that does not discriminate against out-of-state institutions. The limitations do not apply to the initial entry into a state by a bank holding company unless the state has a deposit concentration cap that applies on a nondiscriminatory basis to in-state or out-of-state bank holding companies making an initial acquisition.

     The Riegle-Neal Act also provides that, beginning on June 1, 1997, banks with different home states may merge, unless a particular state opts out of the statute. Consistent with the Riegle-Neal Act, Georgia adopted legislation in 1996 which has permitted interstate bank mergers since June 1, 1997.

     In addition, beginning June 1, 1997, the Riegle-Neal Act has permitted national and state banks to establish de novo branches in another state if there is a law in that state which applies equally to all banks and expressly permits all out-of-state banks to establish de novo branches. However, in 1996, Georgia adopted legislation which opts out of this provision. The Georgia legislation provides that, with the prior approval of the Georgia Department of Banking and Finance, after July 1, 1996, a bank may establish three new or additional de novo branch banks anywhere in Georgia and, beginning July 1, 1998, a bank may establish new or additional branch banks anywhere in the state with prior regulatory approval.

Privacy

     Financial institutions are required to disclose their policies for collecting and protecting confidential information. Customers generally may prevent financial institutions from sharing nonpublic personal financial information with nonaffiliated third parties except under narrow circumstances, such as the processing of transactions requested by the consumer. Additionally, financial institutions generally may not disclose consumer account numbers to any nonaffiliated third party for use in telemarketing, direct mail marketing or other marketing to consumers.

Anti-Terrorism Legislation

     In the wake of the tragic events of September 11th, on October 26, 2001, the President signed the Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism (USA PATRIOT) Act of 2001. Under the USA PATRIOT Act, financial institutions are subject to prohibitions against specified financial transactions and account relationships as well as enhanced due diligence and “know your

12

customer” standards in their dealings with foreign financial institutions and foreign customers. For example, the enhanced due diligence policies, procedures, and controls generally require financial institutions to take reasonable steps —

	•		to conduct enhanced scrutiny of account relationships to guard against money laundering and report any suspicious transaction;
	•		to ascertain the identity of the nominal and beneficial owners of, and the source of funds deposited into, each account as needed to guard against money laundering and report any suspicious transactions;
	•		to ascertain for any foreign bank, the shares of which are not publicly traded, the identity of the owners of the foreign bank, and the nature and extent of the ownership interest of each such owner; and
	•		to ascertain whether any foreign bank provides correspondent accounts to other foreign banks and, if so, the identity of those foreign banks and related due diligence information.

     Under the USA PATRIOT Act, financial institutions are required to establish anti-money laundering programs. The USA PATRIOT Act sets forth minimum standards for these programs, including:

	•		the development of internal policies, procedures, and controls;
	•		the designation of a compliance officer;
	•		an ongoing employee training program; and
	•		an independent audit function to test the programs.

     In addition, the USA PATRIOT Act authorizes the Secretary of the Treasury to adopt rules increasing the cooperation and information sharing between financial institutions, regulators, and law enforcement authorities regarding individuals, entities and organizations engaged in, or reasonably suspected based on credible evidence of engaging in, terrorist acts or money laundering activities. Any financial institution complying with these rules will not be deemed to have violated the privacy provisions of the Gramm-Leach-Bliley Act, as discussed above. The Bank currently has policies and procedures in place designed to comply with the USA PATRIOT Act.

Proposed Legislation and Regulatory Action

     New regulations and statutes are regularly proposed that contain wide-ranging proposals for altering the structures, regulations and competitive relationships of the nation’s financial institutions operating in the United States. The Company cannot predict whether or in what form any proposed regulation or statute will be adopted or the extent to which its business may be affected by any new regulation or statute.

Effect of Governmental Monetary Policies

     The earnings of the Company are affected by domestic economic conditions and the monetary and fiscal policies of the United States government and its agencies. The Federal Reserve’s monetary policies have had, and are likely to continue to have, an important impact on the operating results of commercial banks through its power to implement national monetary policy in order to curb inflation or combat a recession. The monetary policies of the Federal Reserve have major effects upon the levels of bank loans, investments and deposits through its open market operations in United States government securities and through its regulation of the discount rate on borrowings of member banks and the reserve requirements against member bank deposits. It is not possible to predict the nature or impact of future changes in monetary and fiscal policies.

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Business Risks

     Like all other banking and financial services companies, the Company’s business and results of operations are subject to a number of risks, many of which are outside of the Company’s control. In addition to the other information in this report, readers should carefully consider that the following important factors, among others, could materially impact the Company’s business and future results of operations.

     The Company’s success depends on its ability to compete effectively in the competitive financial services industry - The Company and the Bank encounter strong competition for deposits, loans, and other financial services in all of their lines of business. The Company’s principal competitors include other commercial banks, savings banks, credit unions and savings and loan associations. Many of the Company’s competitors are significantly larger and have greater access to capital and other resources. In recent years there has been substantial consolidation among companies in the financial services industry. Such consolidation may increase competition because consolidation creates larger entities who may be able to offer additional services that the Company is unable to offer, have greater financial resources or have substantially higher lending limits to compete with. Further, the Company’s ability to compete effectively is dependent on its ability to adapt successfully to technological and other changes within the banking and financial services industry.

     The Company’s business may be adversely affected by the highly regulated environment in which it operates - The Company is highly regulated by state and federal agencies. Recently enacted and future legislation and regulations may have significant impact on the banking and financial services industries. Regulatory or legislative changes could increase the Company’s costs of doing business, restrict its access to new products or markets, or otherwise adversely affect its operations or the manner in which it conducts its business and, on the whole, adversely affect the profitability of its business.

     The Company may be adversely affected by a general deterioration in economic conditions - The risks associated with the Company’s business are greater in periods of a slowing economy or recession. Economic declines may be accompanied by a decrease in demand for consumer or commercial credit and declining real estate and other asset values. Declining real estate and other asset values may reduce the ability of borrowers to use such equity to support borrowings. Delinquencies, foreclosures and losses generally increase during economic slow downs or recessions. Additionally, the Company’s servicing costs, collection costs and credit losses may also increase in periods of economic slow down or recessions.

     The Company is subject to credit risk inherent in the Bank’s loan portfolios - In the financial services industry, there is always a risk that certain borrowers may not repay borrowings. The Bank maintains a reserve for loan losses to absorb the level of losses that it estimates to be probable in its portfolios. However, its reserve for loan losses may not be sufficient to cover the loan losses that it may actually incur. If the Bank experiences defaults by borrowers in any of its businesses, the Company’s earnings could be negatively affected. Changes in local economic conditions could adversely affect credit quality in its loan portfolio. In addition, federal and state regulators periodically review the Bank’s loan portfolio and may require it to increase the provision for loan losses or recognize loan charge-offs. Their conclusions about the quality of the loan portfolio may be different from the Bank. Any increase in the allowance for loan losses or charge-offs as required by these regulatory agencies could have a negative effect on the Company’s operating results.

     The Company may be adversely affected by interest rate changes - The Bank realizes income primarily from the difference between interest earned on loans and investments and interest paid on deposits and other borrowings. Interest rate fluctuations are caused by many factors which, for the most part, are not under the Company’s direct control. For example, national monetary policy plays a significant role in the determination of interest rates. Additionally, competitor pricing and the resulting negotiations that occur with the Bank’s customers also impact the rates it collects on loans and the rates it pays on deposits. As interest rates change, the Company expects that it will periodically experience “gaps” in the interest rate sensitivities of the Bank’s assets and liabilities, meaning that either its interest-bearing liabilities will be more sensitive to changes in market interest rates than its interest-earning assets, or vice versa. In either event, if market interest rates should move contrary to the Bank’s position, this “gap” may work against it, and the Company’s earnings may be negatively affected. Although the Bank actively manages its interest rate sensitivity, such management is not an exact science. Rapid increases or decreases in interest rates could adversely affect its net interest margin if changes in its cost of funds do not

14

correspond to changes in income yields. An increase in interest rates that adversely affects the ability of borrowers to pay the principal or interest on loans may lead to an increase in nonperforming assets and a reduction of interest accrued into income, which could have a material adverse affect on the Company’s results of operations.

     The Company could be held responsible for environmental liabilities of properties acquired through foreclosure - Environmentally related hazards have become a source of high risk and potentially unlimited liability for financial institutions relative to their loans. Environmentally contaminated properties owned by an institution’s borrowers may result in a drastic reduction in the value of the collateral securing the institution’s loans to such borrowers, high environmental clean up costs to the borrower affecting its ability to repay the loans, the subordination of any lien in favor of the institution to a state or federal lien securing clean up costs, and liability to the institution for clean up costs if it forecloses on the contaminated property or becomes involved in the management of the borrower. To minimize this risk, the Company may require an environmental examination of, and report with respect to, the property of any borrower or prospective borrower if circumstances affecting the property indicate a potential for contamination, taking into consideration the potential loss to the institution in relation to the burdens to the borrower. Such examination must be performed by an engineering firm experienced in environmental risk studies and acceptable to the institution, and the costs of such examinations and reports are the responsibility of the borrower. These costs may be substantial and may deter a prospective borrower from entering into a loan transaction with the Company. The Company is not aware of any borrower who is currently subject to any environmental investigation or clean up proceeding which is likely to have a material adverse affect on the financial condition or results of operation of the Company.

     Loss of the Company’s senior executive officers or other key employees could impair its relationship with customers and adversely affect its business - - The Company has assembled a senior management team which has a substantial background and experience in banking and financial services in the western Georgia market. Loss of these key personnel could negatively impact the Company’s earnings because of their skills, customer relationships and/or the potential difficulty of promptly replacing them.

Item 2. Properties

     The Company and the Bank’s main office is located at 201 Maple Street in Carrollton, Georgia near the city’s downtown square at the intersection of Georgia Highway 16 and U.S. Highway 27. The Bank has two other locations within the city limits of Carrollton. The First Tuesday Mall office is located at 1004 Bankhead Highway and the Motor office is located at 314 Newnan Street. In addition, the Bank has two other locations in Carroll County, one located at 725 Bankhead Highway, Villa Rica, Georgia and another located at 205 East College Street, Bowdon, Georgia. All locations are typical of branch banking facilities located throughout the United States and all locations, except the Motor office, are full service locations. The Motor office provides primarily teller and ATM transactions and does not originate loans. As to its Douglas County locations, the Mirror Lake office is currently a modular branch which will serve as a temporary site until a permanent structure is built. The Bank owns a 1.5 acre parcel on the Corner of Mirror Lake Boulevard and Conner Road in front of the Village at Mirror Lake shopping center on which it plans to construct a permanent facility in 2004. A second Douglas County branch is located at 9557 Georgia Highway 5 in Douglasville.

     The Bank’s main office, operations center and related parking are located on approximately 2.5 acres. The main office is a two-story building with a total of approximately 19,100 square feet housing its lobby, retail offices, administrative and executive offices. The operations center is a two-story building with a total of approximately 12,200 square feet housing a computer room, administrative offices and storage facilities. The branch offices (with the exception of the Motor office and the Mirror Lake office which are approximately 700 and 1200 square feet, respectively) are typical of other banking facilities and are approximately 5,000 square feet in size. Each branch location has an ATM machine that is either walk-up or drive-up. The Motor office, Mirror Lake, and Douglasville offices are leased facilities. All of the other office facilities are owned. The Bank also operates six additional ATM machines on leased properties located throughout the Carrollton and Villa Rica area.

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Item 3. Legal Proceedings

     While the Company and its subsidiaries are from time to time party to various legal proceedings arising from the ordinary course of business, management believes that there are no proceedings of material risk threatened or pending.

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

     No matters were submitted to a vote of shareholders of the Company during the fourth quarter of the fiscal year covered by this Report.

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PART II

Item 5. Market for the Common Equity and Related Shareholder Matters

Market Information

     The Company’s Common Stock is traded on the NASDAQ SmallCap Market System under trading symbol “WGNB”. Approximately 1000 shareholders of record held the Common Stock as of February 27, 2004. Set forth below are the high and low bid prices for each full quarterly period during 2002 and 2003 and the dividends declared and paid per share of Common Stock for those periods.

Dividends

     The declaration of future dividends is within the discretion of the Board of Directors and will depend, among other things, upon business conditions, earnings, the financial condition of the Bank and the Company, and regulatory requirements. See “Supervision and Regulation — Dividends.”

Recent Sales of Unregistered Securities

     The Company issued the following securities during the year ended December 31, 2003 without registering the securities under the Securities Act: Directors may elect to receive compensation for their services to the Company and the Bank in shares of Common Stock or cash. During 2003, a director of the Bank received 915 shares in payment of deferred director compensation for an aggregate consideration owed to them by the Bank of $28,915. The sale of the shares was exempt from registration under the Securities Act, pursuant to Section 4(2) thereof, as a transaction not involving a public offering.

Uses of Proceeds from Registered Securities

     The Company has previously reported the completion of a registered public offering pursuant to which it sold 200,000 shares of its Common Stock at a purchase price of $24.00 per share. The net proceeds from the offering (which was completed in April 2002) of $4,766,454 have not yet been used by the Company but continue to remain invested in corporate bonds and federal funds.

Item 6. Selected Financial Data

     The selected consolidated financial data of the Company for and as of the end of each of the periods indicated in the five-year period ended December 31, 2003 have been derived from the audited consolidated financial statements of the Company. The selected consolidated financial data should be read in conjunction with the consolidated financial statements of the Company, including the notes to those consolidated financial statements contained elsewhere in this report.

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18

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

     The purpose of the following discussion is to address information relating to the financial condition and results of operations of the Company that may not be readily apparent from a review of the consolidated financial statements and notes thereto, which begin on page F-1 of this Report. This discussion should be read in conjunction with information provided in the Company’s consolidated financial statements and accompanying footnotes.

CAUTIONARY NOTICE REGARDING FORWARD-LOOKING STATEMENTS

     Certain of the statements made in this Report and in documents incorporated by reference herein, including matters discussed under the caption “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” as well as oral statements made by WGNB Corp. (the “Company”) or its officers, directors or employees, may constitute forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Such forward-looking statements are based on Management’s beliefs, current expectations, estimates and projections about the financial services industry, the economy and about the Company and the Bank in general. The words “expect,” “anticipate,” “intend,” “plan,” “believe,” “seek,” “estimate” and similar expressions are intended to identify such forward-looking statements. Such forward-looking statements are not guarantees of future performance and are subject to risks, uncertainties and other factors that may cause the actual results, performance or achievements of the Company to differ materially from historical results or from any results expressed or implied by such forward-looking statements. The Company cautions readers that the following important factors, among others, could cause the Company’s actual results to differ materially from the forward-looking statements contained in this Report:

     •    the effect of changes in laws and regulations, including federal and state banking laws and regulations, with which the Company or the Bank must comply, and the associated costs of compliance with such laws and regulations either currently or in the future as applicable;

     •    the effect of changes in accounting policies, standards, guidelines or principles, as may be adopted by the regulatory agencies as well as by the Financial Accounting Standards Board;

     •    the effect of changes in the Company’s organization, compensation and benefit plans;

     •    the effect on the Company’s competitive position within its market area of the increasing consolidation within the banking and financial services industries, including the increased competition from larger regional and out-of-state banking organizations as well as non-bank providers of various financial services;

     •    the effect of changes in interest rates;

     •    the effect of changes in the business cycle and downturns in local, regional or national economies;

     •    the matters described under Part I, Item 1, Business - Business Risks.

The Company cautions that the foregoing list of important factors is not exclusive. The Company undertakes no obligation to publicly update or revise any forward-looking statements.

CRITICAL ACCOUNTING POLICIES

     The Company has established various accounting policies which govern the application of accounting principles generally accepted in the United States in the preparation of its financial statements. These significant accounting policies are described in the Notes to the consolidated financial statements. Certain accounting policies involve significant judgments and assumptions by management which have a material impact on the carrying value of certain assets and liabilities; management considers these accounting policies to be critical accounting policies. The judgments and assumptions used by management are based on historical experience and other factors, which are believed to be reasonable under the circumstances. Because of the nature of the judgments and assumptions made by management, actual results could differ from these judgments and estimates which could have a material impact on the carrying value of assets and liabilities and the results of operations of the Company. All accounting policies are

19

important, and all policies described in Notes to the consolidated financial statements should be reviewed for a greater understanding of how the Company’s financial performance is recorded and reported.

     The Company believes the allowance for loan losses is a critical accounting policy that requires the most significant judgments and estimates used in the preparation of the Company’s consolidated financial statements. The allowance for loan losses represents management’s estimate of probable loan losses inherent in the loan portfolio. Calculation of the allowance for loan losses is a critical accounting estimate due to the significant judgment, assumptions and estimates related to the amount and timing of estimated losses, consideration of current and historical trends and the amount and timing of cash flows related to impaired loans. Please refer to the section of this Report entitled “Balance Sheet Review — Provision and Allowance for Possible Loan and Lease Losses” and Note 1 and Note 3 to the Company’s consolidated financial statements for a detailed description of the Company’s estimation processes and methodology related to the allowance for loan losses.

EARNINGS OVERVIEW

For the Years Ended December 31, 2003, 2002 and 2001

     The Company reported net earnings of $5.8 million in 2003, $5.5 million in 2002 and $4.8 million in 2001, representing an increase of 4.4% between fiscal years 2002 and 2003 and an increase of 15.8% between fiscal years 2001 and 2002. The increases over the three fiscal years are primarily attributable to the Bank’s continued loan growth, higher non-interest income and lower increases in non-interest expense. Net earnings per share on a fully diluted basis were $1.72 for 2003, $1.69 for 2002 and $1.52 for 2001, representing an increase of 1.8% between fiscal years 2003 and 2002 and 11.2% between fiscal years 2002 and 2001. The net earnings per share for 2003 for the entire year and 2002 for a partial year were affected by the previously described Common Stock offering completed in April, 2002 which increased the weighted average number of shares outstanding. Return on average assets and return on average shareholders’ equity for 2003 was 1.51% and 14.22%, respectively, compared with 1.55% and 15.56%, respectively, for 2002, and 1.47% and 17.11%, respectively, for 2001. The reduction of return on average equity was primarily due to a large increase in equity in 2003 and 2002. The increases over the past two years were comprised of the Common Stock offering ($4.8 million), an increase in retained earnings ($7.2 million) and an increase in other comprehensive income ($1.0 million). These items had the effect of increasing the average balance of shareholders’ equity by $12.7 million in the last two years.

Net Interest Income

     The Company’s operational results primarily depend on the earnings of the Bank. The Bank’s earnings depend, to a large degree, on net interest income. Net interest income is defined as the difference between the interest income received from its investments (such as loans, investment securities, federal funds sold, etc.) and the interest expense on deposits and other borrowings. The following discussion and analysis of net interest margin assumes and is stated on a tax equivalent basis. That is, non-taxable interest is restated at its taxable equivalent rate.

     The banking industry uses two key ratios to measure the relative profitability of net interest income. The net interest rate spread measures the difference between the average yield on interest earning assets and the average rate paid on interest bearing liabilities. The interest rate spread eliminates the impact of non-interest bearing deposits and gives a direct perspective on the effect of market interest rate movements. The other commonly used measure is net interest margin. The net interest margin is defined as net interest income as a percent of average total interest earning assets and takes into account the positive impact of investing non-interest-bearing deposits.

     Net interest income for the Company increased by $442 thousand (2.8%) in 2003 from 2002, and by $1.1 million (or 7.6%) in 2002 from 2001. Net interest income at December 31, 2003, was $16.0 million compared to $15.6 million at December 31, 2002 and $14.5 million at December 31, 2001. The net interest margin on interest earning assets was 4.65% in 2003, 4.76% in 2002 and 4.84% in 2001. Beginning in early 2001 through the end of 2003, short term interest rates have dropped 550 basis points. Comparing the interest margin in 2003 to that in 2002, the Bank’s interest margin has declined by 11 basis points. Measuring the last three years, the Bank’s interest margin has decreased 19 basis points. Management’s interest rate risk strategies helped to mitigate the effects of rapidly declining interest rates. The average yield on assets in 2003 on a tax equivalent basis was 6.75% down 60 basis points from 2002 while the cost of funds was 2.52%, down 60 basis points from 2002. Likewise, during 2002,

20

the Bank’s yield on earning assets declined 139 points while its cost of funds was reduced by 147 basis points . The asset repricing point has “caught up” with the immediate repricing of the interest-bearing transaction account liabilities in each of the past three years of rapid rate decline.

     Those benchmark rates declined 475 basis points in ten months during a ten month period ending in 2002. The Bank’s balance sheet has traditionally been slightly liability sensitive, but as 2003 progressed, management sought to become more evenly matched and perhaps slightly asset sensitive. That is, its assets re-price faster than its liabilities because of its high percentage of transaction accounts and increasing amounts of adjustable rate assets. Therefore, in a rising rate environment the Bank’s interest margin will tend to widen whereas in a falling rate environment the Bank’s interest margin tends to narrow. However, when rates fall rapidly (as in the past three years), the Bank’s cost of funds hit an economic floor while its asset yields flatten out and become slightly more variable. The net result is that management has been attempting to poise the Bank’s interest margin to increase as interest rates rise.

     The cost of interest-bearing liabilities was 2.52% for 2003, 3.12% for 2002 and 4.59% for 2001, representing a decrease of 60 basis points between fiscal 2003 and 2002 and a decrease of 147 basis points between fiscal 2002 and 2001. The borrowings from the Federal Home Loan Bank (FHLB) which are fixed rate have kept the Bank’s cost of funds from decreasing more rapidly in 2003. Management anticipates that the Bank’s cost of funds will be positively impacted over the next eighteen months as $20 million of FHLB borrowings mature and those borrowings can be replaced with lower cost funds.

     If one considers the yield on interest-bearing assets of 6.75% for 2003, 7.35% for 2002 and 8.74% for 2001, the impact of decreasing rates on asset yields was more pronounced in 2002 than in 2003 suggesting that the Bank may have reached a range bound plateau in its net interest margin. However, the longer market interest rates remain low the more solidified asset yields will become and in an increasing rate environment, the margin will be slower to react positively. This trend supports management’s strategy of increasing asset sensitivity and adding interest rate floors to adjustable rate loans in order to create upside with increasing market rates. Prolonged low rates will have the impact of lowering the Company’s net interest margin.

     The following table shows, for the past three years, the relationship between interest income and interest expense and the average daily balances of interest-earning assets and interest-bearing liabilities on a tax equivalent basis assuming a rate of 34%:

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Table 1
Average Consolidated Balance Sheets and Net Interest Analysis
(in thousands)

     Non-accrual loans and the interest income that was recorded on these loans are included in the yield calculation for loans in all periods reported. Tax-exempt interest income is calculated on a tax equivalent basis.

     The following table shows the relative impact on net interest income of changes in the annual average daily outstanding balances (volume) of interest-earning assets and interest-bearing liabilities and the rates earned (rate) by the Bank on such assets and liabilities. Variances resulting from a combination of changes in rate and volume are allocated in proportion to the absolute dollar amounts of the change in each category.

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Table 2
Changes in Interest Income and Expense on a Tax Equivalent Basis
(in thousands)

Other Income and Expense

     Other income in 2003 was $5.6 million, compared to $5.3 million in 2002 and $4.6 million in 2001. This represents an increase of $302 thousand, or 5.8%, from fiscal 2002 to fiscal 2003 and an increase of $701 thousand, or 15.4%, from fiscal 2001 to fiscal 2002. These increases are primarily due to an increase in the volume of service charges on deposit accounts. Service charges on deposit accounts have increased an average of 12.6% over the last two years and most of that increase is due to insufficient funds charges and service charges on increased new account activity. Mortgage origination fees have decreased a little less than 1% from 2002 to 2003 after an increase of 14% from 2001 to 2002 primarily because during the last half of 2003 the Bank experienced a slow down in mortgage refinance activity. It appears that the refinance boom, which took place the last three years, may be subsiding. However, continued low rates and increased housing have maintained new home financing in the Bank’s market area. Miscellaneous income between 2003 and 2002 decreased $149 thousand or 13.4% and increased by $326 thousand or 41.6% between 2002 and 2001. The primary reason for the spike of miscellaneous income in 2002 was that the Bank settled its interest rate swap position accounted for as a fair value hedge in August 2002, recognizing a gain of $252,950 which is included in miscellaneous income for 2002. This income is non-recurring in nature as the Bank has no other hedge positions currently in place.

     Other expenses increased by $625 thousand, or 5.2%, in 2003 over 2002 and by $1.3 million, or 11.7%, in 2002 over 2001. The increase between 2003 and 2002 was due primarily to an increase in salaries and employee benefits of $439 thousand, or 6.1%, and an increase in occupancy expense of $163 thousand, or 9.9%. The increase between 2002 and 2001 was due to an increase in salaries and employee benefits of $682, or 10.5%, an increase in occupancy expense of $91 thousand and an increase in other operating expense of $495, or 17.7%.

     The increase in salaries and employee benefits for the years ended 2003 and 2002 is attributable to the following factors: (i) increased number of full time equivalent employees; (ii) increased costs of health insurance; and (iii) annual raises and increased profit sharing bonuses due to higher profitability. The Company had only two more full time equivalent employees at the end of 2003 than it did at the end of 2002. The increase in salaries and benefits between 2002 and 2001 was more pronounced amounting to an increase of $682 thousand, or 10.5%. The increase in salaries and employee benefits for the years ended 2002 and 2001 is attributable to the following factors (i) increased number of full time equivalent employees; (ii) increase commission on mortgage origination, (iii) increased costs of health insurance; and (iv) annual raises and increased profit sharing bonuses due to higher profitability. The Company had ten more full time equivalent employees at the end of 2002 than it did in 2001 which was primarily due to branch expansion in 2002.

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     The increase in occupancy expense in 2003 over 2002 was primarily attributable to the increase in depreciation expense of $118 thousand, or 15.8%, attributable to capital expenditures for updated bank technology, and a refurbishment of our main office and selective branches to update their appearance. The increase in occupancy expense in 2002 as compared to 2001 was primarily attributable to a full year of operations in our Douglasville branch in addition to increased depreciation expense due to additional office space and investment in bank technology.

     The increase in other operating expense between 2003 and 2002 was not significant. However the increase in other operating expense between 2002 and 2001 of $495 thousand, or 17.7%, is due to increases in legal, accounting, and annual fees associated with compliance with SEC regulations and listing requirements for NASDAQ. Additionally, the Bank paid increased software fees associated with its bounce protection program which was commensurate with the increased fee income.

     Income taxes, expressed as a percentage of earnings before income taxes, declined to 31.7% in 2003, from 32.5% in 2002 and 34.0% in 2001. The decline in marginal tax rate over the past three years is primarily attributable to tax credits purchased by the Bank in 2001 having a full effect in 2002 and 2003. In addition, in October 2002 the Bank formed WGNB Investments, Inc., a Nevada corporation, to manage, hold and trade cash, securities and loans of the Bank which had the effect of reducing its state income tax liability slightly in 2002 and more significantly in 2003.

BALANCE SHEET OVERVIEW

For the Years Ended December 31, 2003 and 2002

General

     Loan and deposit growth in 2003 was slightly more than 2002. During 2003, average total assets increased $27.0 million (7.5%), average deposits increased $17.2 million (6.2%) and average loans increased $25.1 million (9.5%) from amounts recorded in 2002. During 2002, average total assets increased $30.8 million (9.4%), average deposits increased $15.8 million (6.0%) and average loans increased $13.9 million (5.6%) from amounts recorded in 2001. The Bank’s growth rate in 2003 increased slightly when compared to 2002 but did not reach the levels experienced in 2001 and 2000. Loan demand rebounded in the later half of 2003 after a decline in the early part of the year. As in past years, management allows loan growth to drive balance sheet growth and, thus, a slowdown in loan growth is typically reflected on the balance sheet.

     Total assets at December 31, 2003, were $393 million, representing an $8.1 million (2.1%) increase from December 31, 2002. Total deposits increased $4.6 million (1.5%) from 2002 to 2003 while total loans increased $23.0 million (8.4%) during 2003 as management attempted to employ excess liquidity into loans. During 2003, Federal funds sold decreased $19.0 million while total loans increased $23.0 million and investments available for sale and held to maturity increased $3.9 million. The Federal funds sold decrease and the deposit increase basically funded the loan and investment portfolio growth.

     The increase in deposits in 2003 is attributable to an increase in non-interest bearing demand accounts of $2.1 million (5.6%), an increase in interest-bearing demand accounts of $14.5 million (11.7%) and a decrease in time deposit accounts of $14.2 million (11.1%). Interest-bearing demand accounts accounted for the vast majority of deposit increases in 2003. We attribute both the interest-bearing and non-interest-bearing demand deposit growth to three events that occurred in 2003. First, the only three independent competing community banks that remained in Carroll County merged with regional banks in 2002. This displacement has led to new checking account customers for the Bank. Second, because the time deposit rates continue to be low, some customers have moved their funds to money market accounts and NOW accounts in hopes that longer term CD rates will increase in the immediate future or that the stock market would be a viable investment alternative. Third, the Bank has deposit relationships with numerous county and municipal authorities. These deposit relationships in the banking industry are known as public funds. At the end of 2003, certain public entities had collected tax revenue in the amount of $7 million, subsequently deposited with the Bank, causing the Bank’s liquidity to increase. This amount was on deposit with the Bank at year end 2003, but typically is disbursed in the first quarter of the following year.

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     As the local and regional economy softened beginning in 2001, loan demand fell off in the last half of 2001 and that trend continued throughout 2002 and through the first half of 2003. The Bank had grown its loan portfolio by $43.7 million (23.6%) in 2000, by $25.3 million (11.1%) in 2001, by $19.7 million (7.7%) in 2002, and by 23.0 (8.4%) in 2003. The loans during those periods were funded principally with increased demand deposit accounts, a lower cost funding source and FHLB borrowings, typically lower than comparable certificates of deposit rates and terms.

     Total assets at December 31, 2002, were $385 million, representing a $34.9 million (10.0%) increase from December 31, 2001. Total deposits increased $18.2 million (6.5%) from 2001 to 2002 while total loans increased $19.7 million (7.7%) during 2002. Demand deposit accounts accounted for the vast majority of deposit increases in 2002. The loan production in 2002 was funded principally with deposit growth. Liquidity in 2003 and 2002 was abundant as the local competition was acquired by regional banks and the stock market languished.

Investments

     The Company’s available-for-sale investment portfolio of $55.3 million as of December 31, 2003 consisted primarily of debt securities, which provide the Company with a source of liquidity, a stable source of income and serve as a vehicle to implement asset and liability management strategies. This represented an increase of $3.1 million (6.0%) over the $52.1 million held at December 31, 2002. The Company believes the investment portfolio provides a balance to interest rate and credit risk in other categories of the balance sheet while providing a vehicle for the investment of available funds and supplying securities to pledge as required collateral for certain public deposits. Investment securities in the available-for-sale category are stated at fair value. These securities may be sold, retained until maturity, or pledged as collateral for liquidity and borrowing in response to changing interest rates, changes in prepayment risk and other factors as part of the Company’s overall asset liability management strategy.

     Investment securities held-to-maturity are stated at amortized cost and totaled $4.25 million at December 31, 2003, an increase of $750 thousand (21.4%) when compared to the prior year. The increase is attributable to the purchase of banking industry issued trust preferred securities from various issuers across the United States and particularly the Southeast. The Company has the intent and ability to hold these securities until maturity.

     The following table shows the carrying value of the Company’s securities, by security type, as of December 31, 2003, 2002 and 2001:

Table 3
Investment Portfolio
(in thousands)

     The following table presents the expected maturity of the amortized cost of securities by maturity date and average yields based on amortized cost (for all obligations on a fully taxable basis, assuming a 34% marginal tax rate) at December 31, 2003. The composition and maturity/re-pricing distribution of the securities portfolio is subject to change depending on rate sensitivity, capital and liquidity needs.

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Table 4
Expected Maturity of Securities
(in thousands)

     Mortgage backed securities are included in the maturities categories in which they are anticipated to be repaid based on scheduled maturities. The actual cash flow of mortgage backed securities differs with this assumption. Additionally, some agency securities in the portfolio have call features. The above analysis assumes that callable agencies will mature on their final maturity date. The actual cash flow of agency securities may differ from this assumption. Yields on tax-exempt securities are calculated on a tax equivalent basis.

Loans

     Loan concentrations are defined as aggregate credits extended to a number of borrowers engaged in similar activities or resident in the same geographic region, which would cause them to be similarly affected by economic or other conditions. The Bank, on a routine basis, evaluates these concentrations for purposes of policing its concentrations and making necessary adjustments in its lending practices to reflect current economic conditions, loan to deposit ratios, and industry trends.

     The primary types of loans in the Bank’s portfolio are residential mortgages and home equity loans, commercial real estate loans, commercial loans, and consumer installment loans. Generally, the Bank underwrites loans based upon the borrower’s debt service capacity or cash flow, a consideration of past performance on loans from other creditors as well as an evaluation of the collateral securing the loan. With some exceptions, the Bank’s general policy is to require conservative underwriting policies, primarily in the analysis of borrowers’ debt service coverage capabilities for commercial and commercial real estate loans, while emphasizing lower gross debt ratios for consumer loans and lower loan-to-value ratios for all types of real estate loans. Given the localized nature of the Bank’s lending activities, the primary risk factor affecting the portfolio as a whole is the health of the local economy in the west Georgia area and its effects on the value of local real estate and the incomes of local professionals and business firms.

     Loans to directors, executive officers and principal shareholders of the Company and to directors and officers of the Bank are subject to limitations of the Federal Reserve, the principal effect of which is to require that extensions of credit by the Bank to executive officers, directors, and ten percent shareholders satisfy certain standards. The Bank routinely makes loans in the ordinary course of business to certain directors and executive officers of the Company and the Bank, their associates, and members of their immediate families. In accordance with Federal Reserve guidelines, these loans are made on substantially the same terms, including interest rates and collateral, as those prevailing for comparable transactions with others and do not involve more than normal risk of collectibility or present other unfavorable features. As of December 31, 2003, loans and commitments outstanding to directors and executive officers of the Company and the Bank, their associates and members of their immediate families totaled $4.7 million (net of participations sold to other banks on a non-recourse basis), which represented approximately 1.6% of total loans as of that date. As of December 31, 2003, none of these loans outstanding from

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the Bank to related parties were on non-accrual, past due, restructured or considered by management to be a potential problem loan.

     The following table presents loans by type on the dates indicated:

Table 5
Loan Portfolio
(in thousands)

     The following table sets forth the maturity distribution (based upon contractual dates) and interest rate sensitivity of commercial, financial and agricultural loans, real estate construction and mortgage loans and consumer loans as of December 31, 2003:

Table 6
Loan Portfolio Maturity
(in thousands)

Variable/Fixed Rate Mix

Provision and Allowance for Possible Loan and Lease Losses

     The provision for loan losses for the Company in 2003 was $350 thousand compared to $483 thousand in 2002 and $911 thousand in 2001. The decrease in the provision for loan losses reflects the slower loan growth and lower level of nonperforming and adversely rated loans in 2003, expressed as a percentage of total loans, as compared to 2001 and 2002. The Company’s methodology described below for measuring the adequacy of the allowance for loan loss continues to indicate sufficient reserve for expected losses in the portfolio.

     The allowance for loan losses represented 1.17%, 1.38% and 1.47% of total loans outstanding at December 31, 2003, 2002 and 2001, respectively. Total charge-offs were $790 thousand, $695 thousand and $200 thousand

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compared to recoveries of $147 thousand, $263 thousand and $90 thousand during 2003, 2002 and 2001, respectively.

     The Company has an independent loan review function. All loans are placed in loan grade categories, which are consistent with those used by the Bank’s regulators. All loans are constantly monitored by the loan officer and the loan review function for credit quality, consistency and accuracy. Through this grading process, the Bank assures the timely recognition of credit risks. In general, as credit risk increases, the level of the allowance for loan loss will also increase.

     A formal allowance for loan loss adequacy test is performed at each month end. Specific amounts of loss are estimated on problem loans and historical loss percentages are applied to the balance of the portfolio using certain portfolio stratifications. Additionally, the evaluation takes into consideration such factors as changes in the nature and volume of the loan portfolio, current economic conditions, regulatory examination results, and the existence of loan concentrations.

     Management’s judgment in determining the adequacy of the allowance is based on evaluations of the collectability of loans. These evaluations take into consideration such factors as changes in the nature and volume of the loan portfolio, current economic conditions that may affect the borrower’s ability to pay, overall portfolio quality, and review of specific problem loans. In determining the adequacy of the allowance for loan losses, management uses a loan grading system that rates loans in eight different categories. Grades five though eight, which represent criticized or classified loans, are assigned allocations of loss based on management’s estimate of potential loss that is generally based on historical losses and/or collateral deficiencies. Loans graded one through four are stratified by type and allocated loss ranges based on historical loss experience for the strata. The combination of these results is compared monthly to the recorded allowance for loan losses and material differences are adjusted by increasing or decreasing the provision for loan losses. Loans deemed to be impaired are evaluated individually to measure the probable loss, if any, in the credit. Management uses an internal loan reviewer who is independent of the lending function to challenge and corroborate the loan grading system and provide additional analysis in determining the adequacy of the allowance for loan losses and the future provisions for estimated loan losses.

     Management believes that the allowance for loan losses is adequate. However, management uses available information to recognize losses on loans, future additions to the allowance may be necessary based on changes in economic conditions and a change in the borrowers’ ability to repay. In addition, regulators, as an integral part of their examination process, periodically review the Company’s allowance for loan losses. Such regulators may require the Company to recognize additions to the allowance based on their judgments of information available to them at the time of their examination. Management of the Company realizes the importance of maintaining an adequate allowance for loan losses. Through a professional loan review function and effective loan officer identification program, management is recognizing weaknesses in the loan portfolio in a timely manner. Early identification of deteriorating credit attributes allows management to take a proactive role in documenting an established plan to enhance the Company’s position and minimize the potential for loss.

     Through the problem loan identification program outlined above, management is able to identify those loans that exhibit weakness and classify them on a classified and criticized loan list. The Company’s migration analysis assigns historical loss amounts to pools of loans according to classifications of risk ratings to calculate a general allowance to the overall portfolio. In cases where significant weaknesses exist in a specific loan, a specific reserve is assigned to such loans in addition to the general allowance. The Company also evaluates the risks associated with concentrations in credit. If it is necessary to assign an allowance related to concentrations of credit, the Company adds a specific reserve related to such risks.

     During the first quarter of 2003, the Bank accepted cash in the work-out of nine classified loans that amounted to $3.3 million and recorded a charge-off in the amount of $337 thousand.

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     The following table presents a summary of changes in the allowance for loan losses for the years indicated:

Table 7
Allowance for Loan Losses
(in thousands)

Non-Performing Assets and Past Due Loans

     Non-performing assets at December 31, 2003, were $2.2 million, or .75%, of total loans and other real estate owned compared to $2.8 million, or 1.03%, of total loans and other real estate owned at December 31, 2002 and $3.9 million, or 1.55%, of total loans and other real estate owned at December 31, 2001. The levels of non-performing loans remain relatively low compared to the Bank’s peer group and its historical level. The percentage of non-performing assets to total loans has decreased from its peak in 2001. The decrease of non-performing loans from 2002 to 2003 was attributable to repayment of loans on non-accrual or the removal of loans from non-accrual status in the amount of $444 thousand and a reduction of loans ninety days past due in the amount of $590 thousand. The Bank sold $171 thousand of other real estate owned at a loss of $16 thousand during 2003. However, the Bank also settled loans in foreclosure in 2003 in the amount of $660 thousand.

     The following table summarizes loans 90 days or greater past due, non-accrual loans and real estate taken in settlement of foreclosure for the years indicated.

Table 8
Non-Performing Assets
(in thousands)

     While there may be additional loans in the portfolio that may become classified as conditions indicate, management is not aware of any potential problem loans that are not disclosed in the table above. As a result of management’s ongoing review of the loan portfolio, loans are classified as non-accrual generally when they are past due in principal or interest payments for more than 90 days or it is otherwise not reasonable to expect collection of principal

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and interest under the original terms. Exceptions are allowed for 90 day past due loans when such loans are well secured and in process of collection. Generally, payments received on non-accrual loans are applied directly to principal.

     The Bank’s loan review function continually monitors selected accruing loans for which general economic conditions or changes within a particular industry that could cause the borrowers financial difficulties. The loan review function also identifies loans with high degrees of credit or other risks. The focus of loan review and management is to maintain a low level of non-performing assets and return current non-performing assets to earning status. Management is unaware of any known trends, events or uncertainties that will have or that are reasonably likely to have a material effect on the Company’s liquidity, capital resources or operations.

Deposits

     Time deposits of $100 thousand and greater totaled $31.0 million at December 31, 2003, compared with $41.1 million at year-end 2002 and $41.5 million at year-end 2001. The following table sets forth the scheduled maturities of time deposits of $100 thousand and greater at December 31, 2003.

Table 9
Deposits
(in thousands)

Liquidity

     The Bank must maintain, on a daily basis, sufficient funds to cover the withdrawals from depositors’ accounts and to supply potential borrowers with funds. To meet these obligations, the Bank keeps cash on hand, maintains account balances with its correspondent banks, and purchases and sells federal funds and other short-term investments. Asset and liability maturities are monitored in an attempt to match these variables to meet liquidity needs. It is the policy of the Bank to monitor its liquidity to meet regulatory requirements and their local funding requirements. Management believes that the Bank’s current level of liquidity is adequate to meet its needs.

     The Bank maintains relationships with correspondent banks including the Federal Home Loan Bank (the “FHLB”) that can provide funds to it on short notice, if needed. The Bank has arrangements with correspondent and commercial banks for short term unsecured advances up to $11.0 million. As of December 31, 2003, the Bank had not drawn on the available facilities. In addition, the Bank has a line of credit with the FHLB in the amount of $56.7 million of which the Bank had drawn $45 million at December 31, 2003. The lines of credit have varying terms and maturities that are disclosed in detail in the notes to the financial statements.

     The Company’s cash flows are composed of three classifications: cash flows from operating activities, cash flows from investing activities, and cash flows from financing activities. Cash and cash equivalents decreased $20.4 million for a total $27.2 million at December 31, 2003, compared with $47.7 million at December 31, 2002. The decrease was primarily attributable to net cash used by investing activities of $30.0 million made up of $24.5 million of increased loans and a $4.0 million net increase in investment securities. These cash flow uses were offset by net cash provided by financing activities which was primarily attributable to a net increase in deposits of $4.6 million. Cash inflows from operations totaled $7.3 million in 2003.

     Cash inflows from operations totaled $5.1 million in 2002, while inflows from financing activities totaled $30.0 million, most of which was net deposit increases during 2002 of $18.2 million and FHLB advances of $10 million. Investing activities used $18.4 million of cash and cash equivalents, principally composed of net changes in loans of $20.5 million during 2002. The Company also completed a common stock offering in April 2002 that generated net cash proceeds of $4.8 million.

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Capital Resources

     Total shareholders’ equity as of December 31, 2003 was $42.1 million, an increase of $3.6 million over 2002. The increase in equity was due to $5.8 million in net income less $2.2 million in dividends and an increase in unrealized holding gain on securities available for sale of $79 thousand net of tax.

     The OCC has established certain minimum risk-based capital standards that apply to national banks, and the Company is subject to certain capital requirements imposed by the Federal Reserve. At December 31, 2003, the Bank exceeded all applicable regulatory capital requirements for classification as a “well capitalized” bank, and the Company satisfied all applicable regulatory requirements imposed on it by the Federal Reserve. The following tables present the Company’s regulatory capital position at December 31, 2002:

Table 10
Capital Ratio

Leverage Ratio