UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

(Mark One)

For the quarterly period ended September 30, 2004

OR

For the transition period from                     to                    

Commission file number 0-11448

LSB BANCSHARES, INC.

LSB BANCSHARES, INC.
ONE LSB PLAZA
LEXINGTON, NORTH CAROLINA 27292

(336) 248-6500

     Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days Yes x No  o

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

LSB Bancshares, Inc. had 8,579,468 shares of common stock outstanding as of November 3, 2004.

LSB BANCSHARES, INC.

FORM 10-Q

INDEX

PART I. FINANCIAL INFORMATION

LSB Bancshares, Inc.

Notes to consolidated financial statements are an integral part hereof.

LSB Bancshares, Inc.

Notes to consolidated financial statements are an integral part hereof.

LSB Bancshares, Inc.

Notes to consolidated financial statements are an integral part hereof.

LSB Bancshares, Inc.

Notes to consolidated financial statements are an integral part hereof.

LSB Bancshares, Inc.

Note 1. Basis of Presentation

		The accompanying interim unaudited consolidated financial statements have been prepared in accordance with generally accepted accounting principles in the United States for interim financial information and in accordance with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. They do not include all of the information and footnotes required by generally accepted accounting principles in the United States for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the nine-month period ended September 30, 2004 are not necessarily indicative of the results that may be expected for the year ending December 31, 2004.
		LSB Bancshares, Inc. (sometimes referred to herein as “Bancshares” or the “Corporation”) is a bank holding company headquartered in Lexington, North Carolina. Bancshares principal business is providing banking and other financial services through its banking subsidiary, Lexington State Bank (“LSB or the Bank”). LSB has two wholly owned subsidiaries, Peoples Finance Company of Lexington, Inc. and LSB Investment Services, Inc. LSB offers a complete array of services in commercial banking including accepting deposits, corporate cash management, discount brokerage, IRA plans, secured and unsecured loans and trust functions through twenty-five offices in seventeen communities located in Davidson, Forsyth, Stokes, Guilford and Randolph counties. LSB also operates a mortgage production office in Wake County. Peoples Finance offers secured and unsecured loans to individuals up to a maximum of $10,000 as well as dealer originated loans. LSB Investment Services offers products through UVEST Investment Services, an independent broker-dealer. Investments are neither deposits nor obligations of LSB, nor are they guaranteed or insured by any depository institution, the Federal Deposit Insurance Corporation, or any other government agency.
		For further information, refer to the Consolidated Financial Statements and footnotes thereto included in the Corporation’s Annual Report on Form 10-K for the fiscal year ended December 31, 2003 filed with the Securities and Exchange Commission (the “SEC”) on March 15, 2004 (SEC File No. 000-11448) (the “Form 10-K”).

Note 2. Investment Securities

The valuations of investment securities as of September 30, 2004 and December 31, 2003 were as follows (in thousands):

No investment securities were sold during the period ending September 30, 2004.

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Investment securities with amortized cost of $83,931,753 and $81,004,555, as of September 30, 2004 and December 31, 2003, respectively, were pledged to secure public deposits and for other purposes. The Bank also has irrevocable letters of credit totaling $40,000,000, with the Federal Home Loan Bank (“FHLB”) including $20,000,000 that was established during the third quarter of 2004 and will expire in six months. The letters of credit are used in lieu of securities to pledge against public deposits.

Note 3. Loans (Table in thousands)

A summary of consolidated loans follows:

		Bancshares’ policy for impaired loan accounting subjects all loans to impairment recognition except for large groups of smaller balance homogeneous loans such as credit card, residential mortgage and consumer loans. The Corporation generally considers loans to be impaired when future payments of principal and interest are in doubt. Included in impaired loans are loans that are consistently past due, loans 90 days or more past due and all nonaccrual loans. Interest income on impaired loans is recognized consistent with the Corporation’s income recognition policy of daily accrual of income until the loan is determined to be uncollectible and placed in a nonaccrual status. For all impaired loans other than nonaccrual loans, interest income totaling $57,685 for the third quarter was recorded on an accrual basis. Interest income on nonaccrual loans is recognized on a cash basis. No interest has been collected during the third quarter on nonaccrual loans since being placed in a nonaccrual status. Interest income on nonaccrual loans that would have been recorded in accordance with the original terms of the notes was $107,347.
		At September 30, 2004, the total investment in loans that are considered impaired was $6,008,000, including nonaccrual loans of $1,825,000. A related valuation allowance of $1,581,000 was determined for the total amount of impaired loans. The average recorded investment in impaired loans for the quarter ended September 30, 2004 was approximately $6,163,000.
		At September 30, 2004, loans totaling $ 18,290,285 were held for sale stated at the lower of cost or market on an individual loan basis.

Note 4. Reserve for Loan Losses (in thousands)

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

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Note 5. Other Accounting Changes

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

In December 2003, the FASB revised SFAS 132, “Employers’ Disclosures about Pensions and Other Postretirement Benefits”. SFAS 132, as revised, retains the disclosures previously required, and requires additional disclosures related to pension plans and postretirement benefits. SFAS 132 is effective for fiscal years ending after December 15, 2003. Bancshares adopted SFAS 132 with no resulting material effect on its financial position or operating results.

In July 2002, President Bush signed into law the Sarbanes-Oxley Act of 2002 (“SOX”). The purpose of SOX is to increase the reliability of financial statements issued by public companies. SOX does this by increasing the number of independent parties responsible for the issuance of the statements, by increasing the independence of those already involved in the process and by the imposition of sanctions for those in violation of accounting and reporting rules. Bancshares intends to fully comply with SOX and is currently determining the costs related to comply with SOX.

In November 2002, the FASB issued FASB Interpretation No. 45 (“FIN 45”), “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others.” FIN 45 requires the recognition of a liability at fair value upon issuance of certain guarantees, including standby letters of credit. FIN 45 is effective for guarantees issued after December 31, 2002. Bancshares determined, if adopted, FIN 45 would have an immaterial effect on its financial position and operating results.

In March 2004, the FASB ratified Emerging Issues Task Force 03-1 “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments”. EITF 03-1 requires recording the impairment charge for certain investments that are other than temporarily impaired, and certain additional

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disclosures. Bancshares has adopted EITF 03-1 with no resulting material effect on its financial position or operating results.

Note 6. Stock Compensation Plans

Bancshares had three stock-based compensation plans at September 30, 2004, accounted for under Accounting Principles Board Opinion Number 25, under which no compensation cost has been recognized. A new equity compensation plan was approved at the Annual Shareholders’ Meeting on April 21, 2004. This plan will replace all existing equity plans and any future equity compensation grants will be made under this new plan. Had compensation cost for these plans been determined consistent with Statement of Financial Accounting Standards Nos. 123 and 148, Bancshares’ net income and earnings per share would have been reduced to the following pro forma amounts:

Note 7. Pension and Postretirement Medical Benefit Expenses

The components of net periodic benefit cost for pension and retiree medical plans are as follows:

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

		The discussion presented herein is intended to provide an overview of the changes in financial condition and results of operation during the time periods required by Item 303 of Regulation S-K for Bancshares and its wholly owned subsidiary, LSB. The consolidated financial statements also include the accounts and results of operation of LSB’s wholly owned subsidiaries, Peoples Finance Company of Lexington, Inc. (“Peoples Finance”) and LSB Investment Services, Inc. (“LSB Investment Services”). This discussion and analysis is intended to complement the unaudited financial statements, footnotes and supplemental financial data in this Form 10-Q, and should be read in conjunction therewith.
		This report contains certain forward-looking statements related to anticipated future operating and financial performance, and other similar statements of expectations. These forward-looking statements are often identified by words such as “believes”, “anticipates”, “expects” or other similar words or phrases. These forward-looking statements are based on estimates, beliefs and assumptions made by management and are not guarantees of future performance. Actual results may differ from those expressed or implied as the result of various factors, including: (1) the strength of the United States economy generally and the strength of the local economies in which Bancshares conducts operations may be different than expected resulting in, among other things, a deterioration in credit quality or a reduced demand for credit, including the resultant effect on Bancshares’ loan portfolio and allowance for loan losses; (2) the effects of, and changes in, trade, monetary and fiscal policies and laws, including interest rate policies of the Board of Governors of the Federal Reserve System; (3) inflation, interest rate, market and monetary fluctuations; (4) adverse conditions in the stock market, the public debt market and other capital markets

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		(including changes in interest rate conditions) and the impact of such conditions on Bancshares’ capital markets and capital management activities, including, without limitation, Bancshares’ private equity investment activities and brokerage activities; (5) the timely development (or lack thereof) of competitive new products and services by Bancshares and the acceptance of these products and services by new and existing customers; (6) the willingness of customers to accept third party products marketed by Bancshares; (7) the willingness of customers to substitute competitors’ products and services for Bancshares’ products and services and vice versa; (8) the impact of changes in financial services’ laws and regulations (including laws concerning taxes, banking and securities); (9) technological changes; (10) changes in consumer spending and saving habits; (11) the effect of corporate restructurings, acquisitions and/or dispositions, and the failure to achieve the expected revenue growth and/or expense savings from such corporate restructurings, acquisitions and/or dispositions; (12) the growth and profitability of Bancshares’ noninterest or fee income being less than expected; (13) unanticipated regulatory or judicial proceedings; (14) the impact of changes in accounting policies by the SEC or other regulatory agencies; (15) adverse changes in financial performance and/or condition of Bancshares’ borrowers which could impact repayment of such borrowers’ outstanding loans; and (16) Bancshares’ success at managing the risks involved in the foregoing. Bancshares cautions that the foregoing list of important factors is not exclusive. Bancshares does not undertake to update any forward-looking statement, whether written or oral, that may be made from time to time by or on behalf of Bancshares.
		Introduction
		Bancshares is a bank holding company headquartered in Lexington, North Carolina. Its principal assets are all of the outstanding shares of common stock of its commercial bank subsidiary, LSB. Founded in 1949, LSB operates as a North Carolina chartered commercial bank serving customers through twenty-five offices in seventeen communities located in Davidson, Forsyth, Stokes, Guilford and Randolph counties in North Carolina. Bancshares has expanded its operations through the opening of a mortgage loan production office in the Raleigh-Durham area of North Carolina. In the third quarter, LSB completed the modernization and consolidation of its branch network in Lexington in order to better serve its customers. This was accomplished through the closing of one office and the consolidation of two other offices into existing branches. LSB also opened an express drive thru in the third quarter of 2004 as part of its branch modernization plan. Through LSB and LSB’s two non-bank subsidiaries, Bancshares provides a wide range of financial services to individuals and corporate customers.
		Bancshares’ results of operations are dependent primarily on the results of operations of LSB and thus are dependent to a significant extent on net interest income, which is the difference between the income earned on its loan and investment portfolios and its cost of funds, consisting of interest paid on deposits and borrowings. LSB’s non-interest income has become increasingly important to its performance through fees earned by its non-bank subsidiaries, Peoples Finance and LSB Investment Services. Results of operations are also affected by Bancshares’ provision for loan losses, mortgage loan sales activities, service charges and other fee income, and noninterest expense. Bancshares’ noninterest expense principally consists of compensation and employee benefits, office occupancy and equipment expense, data processing, professional fees, and advertising and business promotion expenses. Bancshares’ results of operations are also significantly affected by general economic and competitive conditions, particularly changes in interest rates, government policies and actions of regulatory authorities.

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		LSB (and Bancshares as its holding company) faces competition in both the attraction of deposit accounts and in the origination of mortgage, commercial, and consumer loans. Its most direct competition for deposits has historically derived from other commercial banks located in and around the counties in which it maintains banking offices. LSB also competes for deposits and investments in money market instruments and mutual funds with both regional and super-regional banks. LSB competes for loans principally through the interest rates and loan fees it charges and the efficiency and quality of services it provides borrowers. Its competition for loans also comes principally from other commercial banks, including offices of regional and super-regional banks, located in and around the counties in which it maintains banking offices. Competition for deposits and loans is likely to continue to increase as a result of legislative, regulatory and technological changes and the continuing trend of consolidation in the financial services industry. Technological advances, for example, have lowered barriers to market entry, allowed banks to expand their geographic reach by providing services over the Internet and made it possible for non-depository institutions to offer products and services that traditionally have been provided by banks. Recent legislation permits affiliation among banks, securities firms and insurance companies, and further legislation will likely continue to change the competitive environment in which Bancshares does business.
		The following discussion and analysis is presented on a consolidated basis and focuses on the major components of Bancshares’ operations and significant changes in its results of operations for the periods presented. For further information, refer to the Consolidated Financial Statements and footnotes thereto included in the Form 10-K.
		Critical Accounting Policies
		The accounting and reporting policies of the Bank and its subsidiaries comply with generally accepted accounting principles in the United States and conform to standards within the industry. The allowance for loan and lease losses policy is particularly critical, as it requires the most subjective and complex judgments from senior management. Management considers several factors in determining the allowance for loan and lease losses. These include economic conditions, advice of regulators, historical experience and factors affecting particular borrowers. Changes in the assumptions of these policies could result in a significant impact on the Bank’s financial statements. For further information, see the Asset Quality and Provision for Loan Losses section herein.
		Bancshares offers pension and postretirement benefit plans to employees. The calculation of obligations and related expenses under these plans requires the use of actuarial valuation methods and assumptions. Actuarial valuations and the determination of future market values of plan assets are subject to management judgment and may differ significantly if different assumptions are used. For further information, see Note 7. to the Consolidated Financial Statements, “Pension and Postretirement Medical Benefit Expenses” provided herein.

Three Months Ended September 30, 2004 Compared to Three Months Ended September 30, 2003

Net Interest Income

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

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		interest paid on interest-bearing deposits and borrowed funds.
		Net interest income for the third quarter of 2004 of $9.788 million was down $359,000 or 3.5% compared to $10.147 million for the third quarter of 2003. Declines in the net interest margin year-over-year along with relatively flat average asset growth during the period were major factors in lower net interest income. Loan demand increased modestly in the third quarter of 2004 with some growth anticipated for the fourth quarter of 2004 as well. Total interest income of $12.403 million for the third quarter of 2004 was down $385,000 or 3.0% compared to $12.788 million for the third quarter of 2003. Total interest expense of $2.615 million for the third quarter of 2004 was down $26,000 or 1.0% compared to $2.641 million for the comparable period in 2003. The net interest margin for the third quarter of 2004 was 4.76% compared to 4.95% for the third quarter of 2003. In July, the Federal Reserve increased interest rates by 25 basis points, which resulted in banks moving the prime interest rate to 4.25%. The Federal Reserve also increased interest rates twice in the third quarter of 2004, which caused banks to increase the prime interest rate to 4.75%. These changes in interest rates had little effect on the Bank’s net interest margin in the second quarter of 2004 but at least partially caused the decline in the net interest margin in the third quarter of 2004.

Noninterest Income and Expense

		Noninterest income for the third quarter of 2004 of $3.540 million declined $298,000 or 7.8% compared to $3.838 million for the third quarter of 2003. This drop in noninterest income is at least partially attributable to a continued decline in mortgage loan refinancing which began in the first quarter of 2004. Income from mortgage loan refinancing for the third quarter of 2004 of $133,000 was down $270,000 or 67.0% from $403,000 for the third quarter of 2003. Deposit account fee income for the third quarter of 2004 was up $51,000 or 2.8% compared to the third quarter of 2003. Other operating income of $1.532 million for the third quarter of 2004 was down $79,000 or 4.9% compared to $1.611 million for the third quarter of 2003. Within the other operating income category, fee income for the third quarter of 2004 from the bankcard division increased a modest $24,000 or 4.0% compared to the third quarter of 2003. The increase in fee income from the bankcard division was down from the increase in the previous quarter as the economy continued to be slow. Income from the trust department increased in the current quarter, but also at a slower pace than the previous quarter. For the third quarter of 2004, trust department income increased $19,000 or 13.6% compared to the third quarter of 2003. Commissions generated by LSB Investment Services for the third quarter of 2004 decreased $48,000 or 12.4% compared to the third quarter of 2003. LSB Investment Services generates commission income from the sale of noninsured investment funds.
		Noninterest expense for the third quarter of 2004 of $9.654 million increased $294,000 or 3.1% compared to $9.360 million for the third quarter of 2003. Personnel expense for the period ended September 30, 2004, comprised of salaries and fringe benefits decreased $350,000 or 6.5% compared to the third quarter of 2003. Normal increases in compensation for the third quarter of 2004 were overshadowed by reduced personnel expense. This reduction in personnel expense was largely attributable to a smaller incentive payout from mortgage production goals as the refinance market continued its decline. It can also be attributed to a small reduction in full time equivalent employees and fewer temporary staffing positions. This was the result of mortgage loan refinancing activity that began to slow in the first quarter and continued to slow through the second and third quarters. Occupancy expense in the third quarter of 2004 was virtually unchanged from the third quarter of 2003. Equipment depreciation and maintenance expense increased $66,000 or 12.0% during the same period. Other operating

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		expense increased $581,000 or 19.4% for the third quarter of 2004 compared to the third quarter of 2003. Within the other operating expense category, automated processing expenses increased $107,000 or 21.9% for the third quarter of 2004 compared to the corresponding quarter of 2003. Expenses for the bankcard division increased slightly the third quarter of 2004 compared to the third quarter of 2003. Legal and professional expense increased $210,000 or 54.7% for the third quarter of 2004 compared to the third quarter of 2003. The majority of this increase is attributable to regulatory compliance costs associated with the Sarbanes-Oxley Act of 2002. Marketing expense increased $9,000 or 6.0% in the third quarter of 2004 compared to the corresponding period of 2003. Expenses of LSB Investment Services decreased $25,000 or 68.5% for the third quarter of 2004 compared to the corresponding period in 2003. Expenses incurred by LSB Investment Services are in connection with the operations of its business of selling mutual funds, annuities and equities.
		During the third quarter of 2004, three Bank offices were consolidated into existing offices in the Lexington, North Carolina area. The consolidation of these offices resulted in the disposal of assets, which were recognized under FASB Statement 144, “Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of”. These disposed assets consisted mainly of signs, parking, paving and miscellaneous items. The net book value of these assets was permanently impaired and expensed at the cease-use date. The expense totaled approximately $63,000.
		In addition to the cease-use expense discussed in the immediately preceding paragraph, the three consolidated offices were leased properties. The monthly lease payments for these properties total $4,098. Two of the leases expire within a short time frame. These payments are deemed insignificant and will be expensed as they are made. The third office has an additional 59 months at a lease payment of $2,276 per month. An analysis of the area leasing market indicates that the fair value of subleasing approximates the current lease payments, which would result in a net accrual of zero. Accordingly, lease payments will be expensed when paid and sublease income will be recognized when received.

Nine Months Ended September 30, 2004 Compared to Nine Months Ended September 30, 2003

Net Interest Income

		Net interest income for the first nine months of 2004 of $28.869 million was down $1.218 million or 4.0% compared to $30.087 million for the first nine months of 2003. Lower net interest income was largely attributable to a decline in the net interest margin; reduced mortgage-financing activity and earning assets that were relatively unchanged from the previous year. Total interest income for the first nine months of 2004 of $36.361 million was down $2.385 million or 6.2% compared to $38.746 million for the nine months of 2003. Total interest expense of $7.492 million for the first nine months of 2004 was down $1.167 million or 13.5% compared to $8.659 million for the first nine months of 2003. Loan demand increased modestly in the third quarter of 2004 with some growth anticipated for the fourth quarter of 2004 as well. For the first nine months of 2004 loan growth increased $38.515 million or 5.8% compared to December 31, 2003 and $28.242 million or 4.2% compared to September 30, 2003.
		For the period ended September 30, 2004, total deposits increased $29.931 million or 4.3% from December 31, 2003 and $10.579 million or 1.5% from September 30, 2003. Demand deposits were up $9.667 million or 11.7% compared to December 31, 2003 and $2.952 million or 3.3% compared to September 30, 2003. Savings, NOW and money market deposits increased

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$15.174 or 3.7% compared to December 31, 2003 and $8.105 million or 1.9% compared to September 30, 2003. Certificate of deposit growth was mixed for the nine months of 2004. Certificates of deposit under $100,000 decreased $7.940 million or 6.3% compared to December 31, 2003 and $13.348 million or 10.1% compared to September 30, 2003. Certificates of deposit over $100,000 at September 30, 2004 were up $13.030 million or 15.8% compared to December 31, 2003 and $12.870 million or 15.6% compared to September 30, 2003.

Noninterest Income and Expense

		Noninterest income for the first nine months of 2004 of $10.785 million was down $117,000 or 1.1% compared to $10.902 million for the first nine months of 2003. The decline in noninterest income is directly attributable to the decline in mortgage loan refinancing income. For the first nine months of 2004, mortgage loan refinancing income of $390,000 was down $750,000 or 65.8% from $1.140 million for the first nine months of 2003. Deposit account fee income for the first nine months of 2004 of $5.381 million increased $234,000 or 4.5% compared to $5.147 million for the first nine months of 2003. Other operating income increased $399,000 or 8.6% for the first nine months of 2004 compared to the first nine months of 2003. Within the other operating income category, fee income from the bankcard division increased $132,000 or 7.6% for the first nine months of 2004 compared to the first nine months of 2003. Income from the trust department increased $87,000 or 22.7% for the first nine months of 2004 compared to the comparable period of 2003. Commissions generated by LSB Investment Services during the first nine months of 2004 decreased $90,000 or 8.0% compared to the corresponding period of 2003. LSB Investment Services generates commission income from the sale of noninsured investment funds.
		Noninterest expense for the first nine months of 2004 of $28.226 million increased $800,000 or 2.9% compared to $27.426 million for the first nine months of 2003. Personnel expense for the nine month period ended September 30, 2004, comprised of salaries and fringe benefits, decreased $556,000 or 3.5% compared to the corresponding period of 2003. Normal increases in compensation for the first nine months of 2004 were overshadowed by reduced personnel expense, primarily related to slower mortgage production. The reasons for this decline were much the same as those stated in the prior three-month discussion, lower mortgage incentive payouts and lower FTE’s. Occupancy expense increased $99,000 or 8.1% for the first nine months of 2004 compared to the first nine months of 2003, while equipment depreciation and maintenance expense increased $185,000 or 12.1% during the same period. Other operating expense increased $1.072 million or 11.9% for the first nine months of 2004 compared to the same period of 2003. Within the other operating expense category, automated processing expenses were up $315,000 or 21.2% from the corresponding period of 2003. Some of this increase is attributable to improved item processing systems, which are expected to increase efficiencies and processing times while improving customer service. Marketing expense increased $61,000 or 9.8% for the first nine months of 2004 over the same period in 2003. Market branding and product promotion expenses were heavier in the first two quarters of 2004 resulting in this increase for the nine-month period. Legal and professional expense increased $403,000 or 34.2% for the first nine months of 2004 compared to the first nine months of 2003. A major portion of this increase is attributable to regulatory compliance costs associated with the Sarbanes-Oxley Act of 2002.

Asset Quality and Provision for Loan Losses

At September 30, 2004 loan loss reserves were $8.006 million or 1.14% of loans outstanding compared to $7.846 million or 1.18% of loans outstanding at December 31, 2003 and $7.795 million or 1.16% at September 30, 2003. Non-performing assets (including loans over 90 days past due

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		and still accruing) totaled $5.718 million or 0.63% of total assets at September 30, 2004 compared to $5.815 million or 0.67% of total assets at December 31, 2003 and $6.232 million or 0.70% of total assets at September 30, 2003. Non-performing assets include nonaccrual loans, restructured loans, other real estate acquired through foreclosure and accruing loans ninety days or more past due. Nonaccrual loans at September 30, 2004 increased slightly to $1.825 million from $1.754 million at December 31, 2003 but were below the $2.171 million at September 30, 2003. As of September 30, 2004, LSB had restructured loans totaling $588,000 down from $1.135 million at December 31, 2003 and $1.136 million at September 30, 2003. Properties held in the other real estate category at September 30, 2004 totaled $1.577 million, which was down from $1.742 million at December 31, 2003 and up slightly from $1.550 million at September 30, 2003. Accruing loans past due 90 days or more of $1.728 million at September 30, 2004 were up from $1.184 million at December 31, 2003 and $1.375 million at September 30, 2003. The accrual of interest is generally discontinued on any loan that becomes 90 days past due as to principal or interest unless collection of both principal and interest can be assured by way of collateralization, guarantees or other security and the loan is considered to be in the process of collection.
		Responsibility for market risk management resides with the Bank’s Asset/Liability Management Committee (the “ALCO Committee”). The ALCO Committee monitors market conditions, interest rate trends and the economic environment in its decision-making process. Based upon its view of existing and expected market conditions, balance sheet strategies are adopted to optimize net interest income while minimizing the risks associated with unanticipated changes in interest rates.
		The provision for loan losses that was charged to operations the first nine months of 2004 was $2.396 million compared to $1.913 million for the first nine months of 2003. Net charge-offs for the nine-month period ended September 30, 2004 were $2.236 million or .44% of average loans outstanding on an annualized basis compared to $1.400 million or .28% for the nine-month period ended September 30, 2003. Management continues to monitor the asset quality of the loan portfolio. Loans charged-off are recorded based upon the financial condition of the borrower and the likelihood of repayment.
		Loans classified for regulatory purposes as loss, doubtful, substandard or special mention that have not been disclosed as nonperforming do not represent or result from trends or uncertainties which management reasonably expects will materially impact future operating results, liquidity, or capital resources, or represent material credits about which management is aware of any information which causes management to have serious doubts as to the ability of such borrowers to comply with the loan repayment terms.
		In the opinion of management, all loans where serious doubts exist as to the ability of borrowers to comply with the present repayment terms have been included in the schedule presented.

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ASSET QUALITY ANALYSIS

* Denotes Annualized

Income Taxes

Accrued income taxes applicable to income for the nine-month period ended September 30, 2004 were $2.866 million compared to $3.874 million for the nine-month period ended September 30, 2003. Pretax income for the first nine months of 2004 of $9.032 million was down $2.618 million compared to $11.650 million for the first nine months of 2003. The decrease in accrued taxes for the period ended September 30, 2004 is primarily due to the lower taxable income. During 2003, the Bank purchased an investment tax credit partnership interest for $540,000. The partnership is expected to yield $1.000 million in tax credits over the years 2003 to 2009. Actual credits applied to the nine month period ended September 30, 2004

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were $141,000. Bancshares accounts for tax credits using the flow-through method, thereby reducing income tax expense in the year in which the credits were received.

Capital Resources and Shareholders’ Equity

		Regulatory guidelines require minimum levels of capital based on a risk weighting of each asset category and off-balance sheet contingencies. Regulatory agencies divide capital into Tier 1 or core capital and total capital. Tier 1 capital, as defined by regulatory agencies, consists primarily of common shareholders’ equity less goodwill and certain other intangible assets. Total capital consists of Tier 1 capital plus the allowable portion of the reserve for loan losses and certain long-term debt. At September 30, 2004 based on these measures, Bancshares’ had a Tier 1 capital ratio of 11.92% compared to the regulatory minimum requirement of 4% and total capital ratio of 12.99% compared to a minimum 8% regulatory requirement.
		Additional regulatory capital measures include the Tier 1 leverage ratio. The Tier 1 leverage ratio is defined as Tier 1 capital divided by average total assets less goodwill and certain other intangibles and has a regulatory minimum of 3.0%, with most institutions required to maintain a ratio of at least 4.0% to 5.0%, depending primarily upon risk profiles. At September 30, 2004, Bancshares’ Tier 1 leverage ratio was 9.93%.
		The Board of Directors of Bancshares has authorized a repurchase program for shares of its common stock in the open market or privately negotiated transactions on a time-to-time and ongoing basis, depending upon market conditions and subject to compliance with all applicable securities laws and regulations. The repurchase plan is intended to help Bancshares achieve its goal of building shareholder value and maintaining appropriate capital levels.

The following table shows a breakdown of the shares that have been repurchased under the plan during the quarter.

ISSUER PURCHASES OF EQUITY SECURITIES

Footnotes:

* All of Bancshares’ repurchases listed in the table above were made pursuant to a publicly announced share repurchase program.

** The plan was originally announced in November 1998 with extensions approved in August 1999 and May 2004.

*** The original plan authorized 300,000 shares as have each of the extensions.

**** The plan will expire on May 31, 2006.

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		Market Risk Management
		Bancshares’ market risk arises primarily from the interest rate risk inherent in its lending and deposit-taking activities. The objectives of market risk management are to ensure long-range profitability performance and minimize risk, adhere to proper liquidity and maintain sound capital. To meet these goals, the ALCO Committee monitors the exposure to interest rate risk, balance sheet trends, pricing policies and liquidity position. The objectives are to achieve relatively stable net interest margins and assure liquidity through coordinating the volumes, maturities or repricing opportunities of earning assets, deposits and borrowed funds. This is accomplished through strategic pricing of asset and liability accounts. As a result of this management, appropriate maturities and/or repricing opportunities are developed to produce consistent earnings during changing interest rate environments.
		Based upon its view of existing and expected market conditions, the ALCO Committee adopts balance sheet strategies intended to optimize net interest income to the extent possible while minimizing the risk associated with unanticipated changes in interest rates. Core deposits have historically been the primary funding sources for asset growth. Correspondent relationships have been maintained with several large banks in order to have access to federal funds purchases when needed. The Bank also has available lines of credit maintained with the FHLB that can be used for funding and/or liquidity needs. The Bank has irrevocable letters of credit totaling $40,000,000 with the FHLB that is used in lieu of securities to pledge against public deposits. The Bank also has a retail CD brokerage agreement, which provides an additional source for liquidity or funding needs.
		To minimize risk of interest rate movements, the asset/liability management process seeks to match maturities and repricing opportunities of interest-sensitive assets and interest-sensitive liabilities. The Bank uses an asset/liability simulation model to produce a gap analysis. The simulation model computes projected runoff of deposits that do not have contractual maturity dates. On September 30,2004, the gap between interest-sensitive assets and interest-sensitive liabilities was a positive $261,467,000 or 1.93%. Under current economic conditions, management believes that is an acceptable ratio.
		Asset/liability management also addresses liquidity positioning. Liquidity management is required in order to fund current and future extensions of credit, meet deposit withdrawals, maintain reserve requirements and otherwise sustain operations. As such, it is related to interest rate sensitivity management, in that each is affected by maturing assets and liabilities. While interest sensitivity management is concerned with repricing intervals of assets and liabilities, liquidity management is concerned with the maturities of those respective balances. The Bank’s liquidity position is primarily accomplished through deposit growth, loan repayments and investment securities management. The Bank also has access to federal fund lines at correspondent banks and borrowings from the Federal Reserve discount window.

Item 3. Quantitative and Qualitative Disclosures about Market Risk

		Market risk reflects the risk of economic loss resulting from adverse changes in market price and interest rates. This risk of loss can be reflected in diminished current market values and/or reduced potential net interest income in future periods.
		Bancshares’ market risk arises primarily from the interest rate risk inherent in its lending and deposit-taking activities. The structure of

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

Item 4. Controls and Procedures

		As of the end of the period covered by this report, Bancshares has evaluated, under the supervision and with the participation of Bancshares’ management, including Bancshares’ Chief Executive Officer and Chief Financial Officer, the effectiveness of Bancshares’ disclosure controls and procedures (as defined in Rule 13a-15(e) promulgated under the Exchange Act. Based upon that evaluation, Bancshares’s Chief Executive Officer and Chief Financial Officer have concluded that Bancshares’s disclosure controls and procedures are effective to ensure that information required to be disclosed by Bancshares in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within time periods specified in the rules and forms of the SEC.
		During the quarterly period covered by this report, there has been no change in Bancshares’ internal control over financial reporting (as defined in Rule 13a-15(f) promulgated under the Exchange Act) that has materially affected, or is reasonably likely to materially affect, Bancshares’ internal control over financial reporting.

PART II. OTHER INFORMATION

Item 1. Legal Proceedings

          Not applicable.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

          Not applicable.

Item 3. Defaults Upon Senior Securities

          Not applicable.

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

          Not applicable.

Item 5. Other Information

          Not applicable.

Item 6. Exhibits

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SIGNATURES

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

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Exhibit Number

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